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Wednesday's analyst upgrades and downgrades

A man walks past a Scotiabank branch on Bloor Street West in Toronto in this file photo.

Darren Calabrese/The Globe and Mail

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

Citing its valuation and business mix, Scotiabank Capital Markets analyst Sumit Malhotra upgraded his rating for Bank of Montreal (BMO-T).

On Tuesday prior to market open, the bank reported operating earnings per share of $2.08, topping Mr. Malhotra's projection of $1.87 and the consensus of $1.88. It was an increase of 19 per cent year over year.

"Though the bank did derive a sizable contribution from items that can be volatile (trading revenue, insurance earnings), in our view the bigger takeaway from the results in terms of staying power was the strength in the "3 C's" -- credit quality (PCL ratio down to 18.5 basis points), costs (all-bank operating leverage of a robust 5.1 per cent increase), and capital (which jumped a hefty 91 basis points to 11.06 per cent)," said Mr. Malhotra, moving his rating to "sector outperform" from "sector perform."

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In reaction to the results, Mr. Malhotra raised his 2017, 2018 and 2019 operating EPS projections to $8.30, $8.49 and $8.95, respectively, from $8.04, $8.38 and $8.98.

He bumped his target price to $113 from $108. The analyst average price target is $104.14, according to Bloomberg.

"Following the 1-per-cent increase in our estimate, BMO shares are trading at 11.9 times our 2018 estimate, on-par with the sector average, though we note that the stock is at a 2-per-cent P/E [price-to-earnings] discount on a capital-adjusted basis," he said. "In our view, the combination of (1) positive trends in credit quality and cost control; (2) favourable loan mix (more U.S., less Cdn. residential mortgages); and (3) rebound in capital are likely to drive the shares back to premium status, and as such we are upgrading our rating."

Elsewhere, BMO deserves "credit when credit is true," said Desjardins Securities analyst Doug Young.

"1Q FY17 was a good quarter for BMO," said Mr. Young. "We like its more commercial (versus personal) lending focus in Canada. Its U.S. P&C banking operations stand to benefit from potentially higher U.S. interest rates. However, we believe these items are well-understood and are fully reflected in its stock price."

He added: "All operating divisions contributed to the beat versus our estimate, with the largest delta from capital markets and wealth management, while the corporate loss was larger than expected," said Mr. Young. "Outsized gains at BMO insurance represented 6 cents of the outperformance, while the delta from capital markets contributed another 15 cents. In terms of positives: (1) the CET1 ratio of 11.1 per cent was materially higher vs what we anticipated, and benefited from actions management took to mitigate the Basel I floor impact; (2) traditional wealth management earnings increased 16 per cent year over year; (3) adjusted Canadian P&C banking earnings grew 9 per cent year over year; (4) capital markets had a strong quarter, partially attributed to its U.S. efforts; (5) the US P&C banking division benefited from NIM expansion, which is likely to continue through FY17; and (6) credit was a non-issue. Our only issue was trying to figure out the corporate segment."

Mr. Young did caution investors that the EPS result included "unusually strong" insurance earnings.

"BMO recorded a gain on the sale of its stake in Moneris US ($168-million) and loss on the sale of a portion of its U.S. indirect auto loan portfolio ($35-million), which nets out to a 20-cent gain and has been excluded from cash EPS. The former was in Canadian P&C banking, the latter in U.S. P&C banking. On a segmented basis vs our estimate and adjusting for the aforementioned items, the beat was driven by capital markets, wealth management/insurance, Canadian P&C banking and U.S. P&C banking, offset by a larger-than-anticipated corporate loss — so overall, a decent composition. There are two other items worth noting. Relative to our estimate, capital markets contributed 15 cents, and unusually strong insurance results due to favourable market conditions added 6 cents."

BMO reported a loss of $157-million for its corporate segment, exceeding Mr. Young's expectation of a $125-million loss as well as the consensus estimate of a $142-million loss.

"We find modelling this division challenging," the analyst said. "According to management, there were no unusual items. The benefits from credit marks on a previously acquired U.S. loan book have diminished materially year-over-year. Expenses are seasonally higher in 1Q due to compensation impacts from employees eligible to retire ($30-million). Otherwise, corporate expenses were generally high and could remain elevated."

He raised his EPS projections for 2017 and 2018 to $7.95 and $8.35, respectively, from $7.80 and $8.20.

Mr. Young maintained a "hold" rating for the stock and increased his target to $104 from $99.

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The first-quarter earnings beat for Bank of Nova Scotia (BNS-T) "wasn't enough," according to Desjardins Securities analyst Doug Young.

On Tuesday, Scotiabank reported cash earnings per share of $1.58, topping both Mr. Young's projection ($1.54) and the consensus estimate ($1.57).

"However, we believe the market is expecting the banks to beat and the variance versus our and consensus EPS estimates was lower than what we have seen for its peers so far this quarter," he said.

Mr. Young added: "On a segmented basis vs our estimates: capital markets and international banking beat, and Canadian banking (excluding real estate gains) was essentially in line, offset by a loss in corporate. In terms of positives: international banking earnings increased 14 per cent year over year and should benefit as rate increases across LatAm roll through its loan books; the CET1 ratio of 11.3 per cent was above our 11.1 per cent estimate and provides lots of flexibility; BNS is making progress on expense-reduction initiatives; and the quarterly dividend was increased 2 cents, as we expected. That said, loan growth in LatAm was lacklustre (up 5 per cent year over year), primarily due to a slowdown in commercial; however, management believes activity will pick up through 2017. And the corporate noise is tough to decipher, in our view."

Based on the results, Mr. Young raised his 2017 and 2018 EPS estimates to $6.49 and $6.90, respectively, from $6.39 and $6.86.

He maintained a "buy" rating for the stock and increased his target price to $86 from $83. The analyst average target price is $83.83.

"There are two drivers of our positive bias," the analyst said. "First, the earnings outlook for its international division (specifically, the LatAm countries of Mexico, Colombia, Chile and Peru), which we believe will be driven by organic growth, expense reductions, integration of past acquisitions and margin improvements. Second, management has laid out clear expense-reduction targets which should flow through in 2017–19."

Elsewhere, BMO Nesbitt Burns analyst Sohrab Movahedi bumped his target to $83 from $80 with an "outperform" rating (unchanged).

Mr. Movahedi said: "Our 2017 EPS growth expectation of 7 per cent is unchanged, given the bank's good traction around business growth, cost containment, and credit risk management."

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Avigilon Corp.'s (AVO-T) "strong" growth in the fourth quarter "is very encouraging," according to BMO Nesbitt Burns analyst Thanos Moschopoulos.

In raising his target price for shares of the Vancouver-based provider of business intelligence and security solutions, Mr. Moschopoulos also applauded its management team's focus on profitability.

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On Tuesday, Avigilon reported quarterly revenue of $102.2-million, an increase of 25 per cent year over year and in line with the Street's expectations. Adjusted earnings before interest, taxes, depreciation and amortization of $20.8-million topped the consensus estimate of $16.8-million, while adjusted earnings per share of 26 cents beat the Street by 7cents.

"Relative to our model, the earnings beat was driven by lower sales/ marketing and G&A costs," said Mr. Moschopoulos. "The gross margin was in line, at 51 per cent. Earnings quality was better than last quarter, with a lower level of R&D capitalization and nonrecurring costs stripped out of adjusted EPS. Management noted that its bias is towards 'maximizing profitability with growth,' now that it's a larger and more mature company."

The company also introduced 2017 guidance, calling for revenue of $390-million to $425-million (an increase of 10 to 20 per cent year over year) and adjusted EBITDA margin of 13 to 17 per cent. The midpoint of that guidance implies revenue of $407.5-million and adjusted EBITDA of $61.5-million, in line with the consensus estimates of $409.8-million and $59.7-million, respectively.

With an "market perform" rating (unchanged), the analyst's target price for the stock rose to $17 from $12. The analyst average target price is $18.40, according to Bloomberg.

"We believe that Avigilon has a strong and competitively differentiated product offering, albeit in a market that seems to be experiencing slowing growth and increased pricing pressure," said Mr. Moschopoulos. "We're neutral on the stock as we'd like better comfort that Avigilon can get back towards achieving a healthy level of year-over-year EPS growth."

Elsewhere, Raymond James analyst Steven Li upgraded the stock to "outperform" from "market perform" and increased his target to $20 from $12.

"This is the second quarter in a row that AVO has outperformed relative to expectations," said Mr. Li. "With its IP licensing program starting to make a material contribution (and driving upside), a steady cadence of new products with solid margins (improving mix) and stronger CF conversion, we are upgrading AVO."
 
The stock was also upgraded by GMP analyst Justin Keywood, who raised his rating to "buy" from "hold" and bumped his target to $19 from $10.50.

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CCL Industries Inc. (CCL.B-T) has become a "free cash flow machine in an industry with GDP-type revenue growth," according to CIBC World Markets analyst Scott Fromson.

He initiated coverage of the stock with an "outperformer" rating.

"We think CCL's leadership position, including large product and geographical footprint, gives it a key competitive advantage in serving its multinational customers in food, beverage, packaged goods, auto, industrial and health care," said Mr. Fromson. "CCL is able to provide local-market service across a broad product range in major markets all over the world.

"Internal growth is strong, and further acquisitions, such as the recently announced Innovia deal, comprise a key catalyst. CCL has a proven strategy to convert acquired revenues into free cash flow. CCL buys good companies that complement or expand the product line, geography and/or customer base. Accretion is key: CCL doesn't buy 'basket cases' or low-margin, commodity businesses, doesn't play in auctions and doesn't overpay."

Mr. Fromson said acquisitions have become "crucial" to the Toronto-based company's growth, and have supported its premium valuation. However, he said CCL shouldn't be considered "just another roll-up vehicle."

"CCL's position is not unusual, operating in an industry with moderate growth prospects against the backdrop of a muted global economy," he said. "Fortunately, CCL has a strong, proven ability to convert growth revenues into free cash flow – and given its organic growth prospects, CCL needs to put this excess capital to work. A significantly higher dividend and/or share buybacks are possible uses, but haven't been prominent in CCL's capital allocation strategy, and we don't view them as high-probability future uses. CCL did announce a 15-per-cent dividend increase in conjunction with strong Q4/16 results; we see this as largely keeping within a payout range. CCL's track record suggests it has better ways to deploy capital. This leaves internal investment and acquisitions. CCL has invested in new capacity and will probably continue to do so. Given CCL's large size, however, such investments are unlikely to significantly move the needle.

"We believe CCL will continue to seek acquisition opportunities among the fragmented industry, filling out the product and geographic portfolio. This issue is sufficiently important to address in the early part of this report. Market history has shown on countless occasions that Growth by Acquisition can be a tricky approach. Do it right and the market giddily takes the stock higher. But if the strategy turns sour, the market is merciless."

Mr. Fromson set a target price of $320 for the stock. The analyst consensus price target is $242.20, according to Thomson Reuters.

"We believe CCL deserves its premium valuation: the company has a leading market position, prudent acquisition growth strategy and proven ability to convert revenue growth into free cash flow," the analyst said. "Our $320 price target is derived by applying a 12.5 times enterprise value-to-EBITDA multiple to our 12-month forward estimate."

Mr. Fromson also initiated coverage of Winpack Ltd. (WPK-T) with a "neutral" rating, calling it a "story about barriers to entry.

"Superior technology is Winpak's competitive barrier: it has developed techniques to produce sophisticated multi-layer plastic films, which it converts into physical-barrier packaging products for perishable goods," he said. "While Winpak's technology lowers its own production costs, it also allows the company to play in higher-margin spaces. Here the economic argument is clear: the higher cost of superior packaging offsets the opportunity cost of spoilage."

"From a shareholder perspective, Winpak's advantage lies in a strong record of converting revenues into free cash flow. Winpak is debt free and is continuing to build a large excess cash position. We think this will lead to catalysts. Potential uses of cash include special dividends, acquisitions and/or internal capacity additions. Winpak has done all three in the past. There is significant deal competition in the highly fragmented packaging industry, so Winpak will have to be choosy on both price and quality. The alternative route is adding internal capacity, something with which Winpak has significant experience. Any of these possibilities would, in our view, support the current stock valuation."

Mr. Fromson said a target price of $54 for Winnipeg-based Winpak. Consensus is $43.17.

"Winpak's ownership structure will play a significant role in determining how it disburses cash," he said. The company is controlled by, and essentially functions as the North American arm of, privately owned Finnish conglomerate Wihuri. This leads to one other barrier: Winpak's minority float and limited trading liquidity create a limitation on wider institutional ownership. We consider Winpak as suitable for patient, long-term investors."

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Founders Advantage Capital Corp. (FCF-X) is a "off to a running start in year one," said Raymond James analyst Michael Overvelde.

He initiated coverage of the Calgary-based company with an "outperform" rating.

"Founders Advantage Capital (FA Capital) is a recently-established investment company with a differentiated approach to investing designed to appeal to founding shareholders of successful growth companies that are seeking to partially monetize their holdings while retaining operating control of the businesses that they founded. It aims to take majority positions in companies with EBITDA run rates of between $5-$40 million, generally seeking exposure to companies that feature limited cyclicality, high free cash flow generation, an established growth trajectory and ongoing participation of founding management in managing the continued growth of their companies. We estimate that initial distributions from its three announced acquisitions will represent a weighted-average after-tax yield on investment of 9.6 per cent."

Mr. Overvelde called FA Capital a "middle-market investment company with a difference," noting: "The differentiating aspect of its investment structure is that it is designed to allow founding owners of investee companies to retain minority stakes while participating disproportionately in future cash flow growth that they help to generate. This is accomplished by entitling founders to a majority of any distributable cash flow generated in excess of a specified threshold that approximates run rate cash flow at the time of FA Capital's initial investment. We believe there is a favourable selection bias inherent in FA Capital's investment model as it is designed to appeal to business owners that have visibility on continued growth and the desire to see it materialize."

"The competition for investment in the type of high-quality private companies sought by FA Capital can be intense, and the differentiating aspects of its offering (i.e., vs. private equity, royalty and other types of capital providers) enable it to compete on terms other than price in circumstances where price maximization is not a vendor's only criteria. Within its target market of growth-oriented entrepreneurs that wish to remain engaged in the management of their companies, we believe that the unique attributes of FA Capital's investment structure should generally enable it to make investments at lower entry valuations than might be achievable for those businesses if sold in their entirety. In this respect, we believe that FA Capital is able to create value through the investment process considering the potential to achieve price optimization upon eventual monetization of its investments."

He set a price target of $4.50. Consensus is $4.88.

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In other analyst actions:

MAG Silver Corp. (MAG-T) was raised to "speculative buy" from "hold" at TD Securities by analyst Daniel Earle. He raised his target to $26 from $21. The average is $24.74.

Mullen Group Ltd. (MTL-T) was rated a new "buy" by Cormark Securities analyst David Tyerman, who set a target price of $19. The analyst average target is $20.19.

Rye Patch Gold Corp. (RPM-X) was rated new "speculative buy" at Canaccord Genuity by analyst Rahul Paul with a target of 50 cents. The average is 57 cents. share.

Allstate Corp. (ALL-N) was downgraded to "market perform" from "outperform" by Keefe Bruyette analyst Meyer Shields with a target of $81 (unchanged). The average is $83.63.

Intel Corp. (INTC-Q) was downgraded to "underperform" from "market Perform" at Bernstein by analyst Stacy Rasgon with a target of $30 (U.S.), down from $36. The average is $41.06.

Palo Alto Networks Inc. (PANW-N) was downgraded to "hold" from "buy" at Wunderlich by analyst William Choi with a target of $150 (U.S.). The average is $150.31.

The stock was also downgraded to "neutral" from "outperform" at Baird by analyst Jayson Noland. He lowered his target to $130 from $175.

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Globe Investor Content Editor

David Leeder is a content editor in the Report on Business. He was previously Deputy Sports Editor and Weekend Digital Editor at The Globe.  He holds an undergraduate degree from McMaster University and a graduate degree from Ryerson University. More

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