Wednesday's analyst upgrades and downgrades

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Inside the Market's roundup of some of today's key analyst actions

Heroux-Devtek Inc.'s (HRX-T) "disappointing" fiscal 2018 guidance makes "the story less compelling," according to Desjardins Securities analyst Benoit Poirier.

Despite reporting third-quarter 2017 financial results that met expectations, Mr. Poirier downgraded his rating for the Longueuil, Que.-based aerospace company to "hold" from "buy."

On Tuesday, Heroux-Devtek reported adjusted earnings per share of 17 cents, a penny better than the projections of both Mr. Poirier and the Street. Sales of $98-million were an increase of 2 per cent year over year and slightly below the analyst's expectation ($103-million), though ahead of the consensus ($97-million).

"The company also slightly reduced its FY17 sales guidance, but the main surprise was management's guidance of a 'low-single-digit' decline in FY18 sales versus a year ago amid recent production rate adjustments on certain programs, including the B-777," said Mr. Poirier. "HRX also highlighted weakness in the business jet and civil helicopter markets to explain this year-over-year decline. The company expects sales to gradually ramp up after that to $480–520-million in fiscal 2021, about two years later than expected."

Mr. Poirier said the company's long-term fundamentals "remain solid," but his short-term enthusiasm has "faded." However, he feels the stock still has "key pieces in place" to reach $20. It closed at $13.69 on Tuesday.

"HRX now expects to reach revenues of $480–520-million by fiscal 2021 instead of $500-million in fiscal 2019," he said. "Assuming the low end of the range and a 17-per-cent EBITDA margin, we would derive a target of $20–22/share (based on a 10–11 times enterprise value/EBITDA multiple) by the end of 2020, which would provide significant return potential vs the current share price. Meanwhile, we expect the company to generate significant FCF in the coming years, well enough to pay down debt and build a war chest for acquisitions."

"We are lowering our estimates on HRX for fiscal 2018 and fiscal 2019 … We now expect the company to deliver 36 shipsets to Boeing on the B-777 program in FY18 (down from 40 units previously). We are reducing our FY18 revenue forecast considerably to reflect the wind-down of the former contract with Goodrich to supply parts to the B-777 program amid significant production rate cuts (60 units/year starting in August 2017 versus 100 units in CY16). This lowers our revenue forecast by $65-million, which also reflects a softer market for bizjets and civil helicopters (9 per cent of total revenues). For fiscal 2019, we expect HRX to deliver 52 shipsets to Boeing for the B-777 (including 10 shipsets for the B-777X), and we maintain a production rate of 60 units thereafter (we assume a production rate of five aircraft/month for the B-777X)."

Mr. Poirier's adjusted EPS projections for 2018 and 2019 fell to 67 cents and 81 cents, respectively, from 92 cents and 99 cents.

His target price for the stock fell to $16 from $18. The analyst consensus price target is $16.50, according to Thomson Reuters.

"We expect the shares to trade sideways in the coming months, pending additional visibility on revenue growth and a margin recovery expected in fiscal 2019, as well as the strength of the commercial aerospace industry," he said. "We believe the shares are fairly valued at current levels given the limited upside (17 per cent) to our target price, especially for a small-cap name."

Elsewhere, Raymond James analyst Ben Cherniavsky lowered his target to $14.50 from $15 with a "market perform" rating (unchanged).

"Recall, we recently downgraded Heroux following news that a recent cut to Boeing's 777 production rate will make it difficult for Heroux to achieve its previous long-term (F2019) sales objective of $500-million," said Mr. Cherniavsky. "While we still like the longer-term prospects for the company given its broader exposure to the commercial segment, ramping volumes from contracts that are scheduled to accelerate, tailwinds from a weak Canadian dollar, and the potential for a turnaround in defence spending, our main concern rests with valuation. We value Heroux using a 'full cycle' scenario through 2021 to account for its updated guidance and have determined the risk-reward is not sufficient to justify a positive stance at this time."

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Granite Real Estate Investment Trust (GRT.UN-T) has certain advantages over its Canadian REIT peers, however it is currently fairly valued, said BMO Nesbitt Burns analyst Troy MacLean.

He initiated coverage of Granite with a "market perform" rating.

"With a 5.9-per-cent yield, and the potential for modest valuation expansion from its current [approximately] 6 –per-cent discount to our NAV [net asset value] estimate, we think Granite can deliver a 10-15-per-cent 12-month total return, which is in line with the average for our Canadian REIT coverage universe," said Mr. MacLean. "Our estimates imply 2-per-cent FFO [funds from operations] growth in 2017, with room for upside depending on the REIT's level of investment activity."

Mr. MacLean pointed to a pair of potential catalysts for the REIT, given its leasing program for its special purpose property portfolio is complete and its debt is termed out until 2021.

He pointed to:

- The possibility of acquisition by another entity, noting: "During its strategic review (June 2015 to March 2016), the REIT was in exclusive negotiations with a private equity fund for the purchase of the REIT; however, a transaction was not able to be completed due to volatility in the capital markets. While Granite's unit price is up 14 per cent since the end of the strategic review, which could deter interested buyers, we do not exclude the potential for another transaction given the REIT's cash-flow quality and reasonable valuation."

- A rise in acquisition and development activity. He said: "The REIT's under-levered balance sheet could provide meaningful FFO/AFFO growth (above our current estimates); however, Granite's target market (logistics properties in the U.S. and Europe) is currently very competitive due to strong investor interest."

"Given its strong balance sheet and liquidity (21-per-cent debt/assets at Q3 versus a target of 40 per cent and the sector average of 45 [per cent), as well as the quality of the cash flow from its main tenant, Magna (A rated by Moody's), we think there is room for valuation expansion, but this will be dependent on further capital deployment," the analyst said. "The REIT's investments over the last four years were principally for newer logistics properties that are becoming increasingly attractive to investors. Due to its liquidity and low leverage, Granite would be well positioned if REITs were to sell off, by providing a less competitive acquisition market. Granite's busiest period of investment activity was 2013 and 2014, after the Taper Tantrum reduced REIT prices globally.

"Given its sizable weighting to Magna (78 per cent of annual lease payments, A- credit rating), its relatively modest lease schedule (7.2 year remaining lease term), and its very strong financial position ($175-million of cash and $250-million available from its credit facility at Q3, industry low leverage with no debt maturities until 2021), we think the REIT has below-average operating risk."

Mr. MacLean set a target price of $47.50 per unit. Consensus is $46.43.

"Granite has two principal advantages compared to its peer group: 1) an international platform that can invest in Canada, the U.S., and Europe, and 2) an under-levered balance sheet (21 per cent debt/property fair value) that can fund sizable acquisition growth (more than $1-billion of financing capacity lifting leverage to 40 per cent) without tapping the equity market," he said. "By having a global platform, the REIT can invest in a wide variety of markets and not be hindered from finding attractive investments by a tight domestic market where opportunities are well bid (the current GTA market, for example). We expect the REIT will deliver consistent FFO growth due to its lease structure, which includes regular inflation adjustments, and potential growth from increasing its leverage through acquisition and development activity. We think the REIT is well positioned to deliver FFO growth even if interest rates continue to rise as it has termed out its debt with no debt maturities until 2021."

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Cott Corp.'s (COT-N, BCB-T) fundamentals "remain strong," said Canaccord Genuity analyst Derek Dley ahead of the release of its fourth-quarter financial results, scheduled for Feb. 23.

Mr. Dley is projecting quarterly revenue for the Mississauga-based company of $908-million (U.S.), an increase of 30 per cent year over year, due largely from contributions from Eden Springs, a direct-to-consumer water and coffee, and S&D Coffee. Both were acquired in August of 2016.

He's forecasting earnings before interest, taxes, depreciation and amortization (EBITDA) of $89-million, topping $81-million in the previous year. He expects the two acquisitions to contribute $20-million to EBITDA during the quarter "on top of organic growth, offsetting customer addition and foreign exchange headwinds."

"We are forecasting $3-million in incremental customer sign-up expenses during the quarter," he said. "Furthermore, as Cott has experienced robust customer additions during the first nine months of the year, this has led to inefficiencies as the company looks to right-size its services levels, and we expect this will reduce EBITDA by approximately $3-million at DS Services. In 2017, we expect S&D to outperform, given the division's substantial opportunity to secure larger contracts with new customers."

Mr. Dley said foreign exchange "remains a hot topic" for Cott, given the volatility stemming from the uncertainty surrounding Brexit and the devaluation of the pound versus the greenback. He expects the company to continue to face near-term issues due to forex, forecasting a $6-million headwind in the fourth quarter alone.

Going forward, Mr. Dley said he expects Eden Springs and S&D Coffee to add $110-million to EBITDA in 2017, pointing to "potential upside from synergies over the course of the year, and new contract wins."

"This will more than offset the potential foreign exchange headwinds and near-term inefficiency costs," the analyst said. "In our view, this will lead to EBITDA growth of 26 per cent to $475-million, year-over-year free cash flow growth of 16 per cent to $160-million.

"We are introducing our 2018 estimates of EBITDA of $499-million and free cash flow of $190-million, which represent year-over-year growth of 5 per cent and 19 per cent, respectively."

With a "buy" rating (unchanged) for the stock, Mr. Dley lowered his target to $21 (U.S.) from $24. Consensus is $16.14.

"Our revised target represents a 10.1 times enterprise value (EV) to EBITDA multiple (from 11.1 times previously) on our 2017 EBITDA estimate of $475-million (from $485-million previously)," he said. "We note that both Cott's target multiple and Cott's current valuation multiple of 7.3 times our 2017 EBITDA estimate represent a discount to the company's beverage industry peers, which currently trade at 11.5 times (excluding Monster). Given the company's 11-per-cent free cash flow yield, and continued shift into higher margin, growth categories, we believe the shares represent an attractive buying opportunity at current levels."

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Gilead Sciences Inc.'s (GILD-Q) new guidance could create a new floor, said Citi analyst Robyn Karnauskas.

In reaction to the California-based biopharmaceutical company's announcement on Tuesday, which came with its fourth-quarter 2016 results, Ms. Karnauskas downgraded her rating for the stock to "neutral" from "buy."

Gilead's 2017 guidance for its chronic hepatitis C (HCV) products of $7.5-billion (U.S.) to $9-billion was "considerably" below the estimates of both Ms. Karnauskas ($10-billion) and the consensus ($12-billion).

Based on that announcement, she lowered her HCV projections for 2017, 2018 and 2019 to $8.9-billion, $6.9-billion and $5.2-billion, respectively, from $10-billion, $8.5-billion and $7.2-billion.

"We are lowering our volume assumptions in-line with company guidance," she said. "Keeping our pricing (6-per-cent worsening of gross to net) and market share assumptions (80 per cent for GILD), we see 2017 HCV sales at $7.6-$8.9-billion versus company guidance of $7.5-$9-billion."

Ms. Karnauskas did say Gilead's HIV business "continues to shine" with her expectations.

"In 2016, Non-HCV business has become 50 per cent of total revenues and we expect Non-HCV business to contribute 65 per cent to GILD franchise in 2017," the analyst said. "Genvoya has captured 30 per cent of the new patient market and its launch has been the best HIV drug launch so far. Genvoya is now top prescribed HIV medicine in the US (in both new and existing patients). TAF based regimens are now contributing to 26 per cent of HIV sales which is crucial for the longevity of the franchise. We model the new products to contribute 66 per cent to GILD's HIV before 2021 patent cliff. We expect Bic-TAF to be another significant driver for this franchise starting 2018."

She lowered her target price for the stock to $76 (U.S.) from $87. Consensus is $95.10.

"The stock is holding up at $69- $70 per share post close [on Tuesday]," she said. "This does not leave enough upside to justify recommending investors to accumulate at these levels. We, at $8.9-billion estimates for HCV are getting $76 per share NPV [net present value]. We see FV [fair value] at $68 per share at low end of HCV guidance. However we think low end of the guidance range is conservative."

"We await clarity on where consensus settles and believe the new guidance could ULTIMATELY help set a floor for shares. This is now dependent on volume trends and in particular IMS [Health] trends will become very important in figuring out guidance. IMS at this point is suggesting $9-billion."

Elsewhere, RBC Dominion Securities analyst Michael Yee lowered his target to $75 from $90 with an "outperform" rating.

Mr. Yee said: "We see $65-70 as reasonable DCF [discounted cash flow] floors and stock will probably test these levels where value investors may find it attractive with a 3-per-cent-plus yield. However, GILD will have to work to get investors more comfortable and they need to do more M&A deals. At current low multiple and near DCF floor levels, risk/reward is to upside over long-term but it will take time for GILD management to turn it around."

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CIBC World Markets analyst Paul Holden expects cost reductions for TMX Group Ltd. (X-T) to lead to another quarter of earnings per share growth.

In a preview of the company's fourth-quarter financial results, scheduled to be released on Feb. 13, Mr. Holden said he also expects impact to be felt from higher trading volumes across the equity, derivatives and energy markets.

Mr. Holden is projecting a 2-per-cent rise in revenue year over year (a 5-per-cent rise excluding the de-consolidation of the BOX Options Exchange) and a 13-per-cent drop in operating expenses. His operating EPS estimate is $1.15, up from 87 cents a year ago and $1.08 in the third quarter.

"Capital formation should get a lift from the year-over-year increase in total market capitalization and the number of financings (up 8 per cent)," the analyst said. "Equity trading volumes increased on the TSX by 8 per cent year over year and on the Venture by 69 per cent.

"It was a very good quarter for MX trading volumes (up 23 per cent year over year) and energy trading volumes (up 15 per cent year over year). The company reduced headcount in Q3 and that should flow into lower compensation costs in Q4. We assume comp costs are down $2-million quarter over quarter."

Mr. Holden maintained a "neutral" rating for the stock and raised his target to $74 from $68 to reflect higher trading multiples. Consensus is $73.40.

"The company has entered into full execution mode with respect to its strategic transformation. Announced cost savings are material and more are likely coming, representing upside to earnings estimates," he said. "The company has reached an agreement to sell Razor Risk and we will look for further dispositions in 2017 as the company becomes more focused. Growth initiatives are expected to start making a noticeable impact starting 2017, which would support the drive towards sustained profitable growth."

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In other analyst actions:

Yamana Gold Inc. (YRI-T, AUY-N) was downgraded to "hold" from "buy" at GMP by analyst Steven Butler. His target fell to $5.50 from $7.75. The analyst average price target is $5.62, according to Bloomberg.

Concordia International Corp. (CXRX-Q, CXR-T) was downgraded to "reduce" from "hold" by TD Securities analyst Lennox Gibbs with a target of $1 (U.S.), down from $2.50. The average is $1.02.

BTIG LLC analyst Richard Greenfield upgraded Twitter Inc. (TWTR-N) to "buy" from "neutral" with a target of $25 (U.S.). The average is $16.77.

Mondelez International Inc. (MDLZ-Q) was downgraded to "neutral" from "positive" at Susquehanna by analyst Pablo Zuanic. His target fell to $46 (U.S.) from $53 per share. The average is $49.54.

FMC Corp. (FMC-N) was raised to "buy" from "neutral" at Longbow Research by analyst Dmitry Silversteyn with a target of $70 (U.S.). The average is $61.87.

Thor Industries Inc. (THO-N) was raised to "outperform" from "neutral" at Baird by analyst Craig Kennison. He raised his target to $120 (U.S.) from $105. The average is $112.50.

Mosaic Co. (MOS-N) was cut to "outperform" from "buy" at CLSA with a target of $35 (U.S.), up from $33. The average is $26.43.

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