Wednesday’s analyst upgrades and downgrades

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

Citing its "soft" first-quarter U.S. results, Credit Suisse analyst Nick Stogdill downgraded Sun Life Financial Inc. (SLF-T) to "neutral" from "outperform."

On Tuesday, Sun Life reported underlying earnings per share of 93 cents for the quarter, missing both Mr. Stodgill's estimate of $1 and the consensus projection of 99 cents. He said "unfavourable policyholder experience" in the U.S. dropped EPS by 9 cents, while currency was a 4-cent headwind.

"Earnings growth in Asia remains strong up 16 per cent year over year, MFS [Investment Management] improved to 7 per cent year over year (assisted by easy comps) with Canada  up 5 per cent," said Mr. Stodgill. "This was more than offset by a 31-per-cent decline in U.S. earnings due to negative policyholder experience across several businesses."

In response to the results, Mr. Stodgill lowered his 2017 and 2018 projections by 14 cents (or 3 per cent) to $3.96 and $4.30, respectively, due to "a more cautious outlook for MFS and a lower positive contribution from notable items."

He lowered his target to $52 from $56 based on his lower growth outlook. The analyst average is $53.15, according to Bloomberg data.

"SLF remains well positioned with 40 per cent of earnings coming from its capital-light Wealth operations, exposure to higher growth Asia, and a strong balance sheet," said Mr. Stodgill. "However, we believe our lower '17 EPS growth and return-to-target no longer warrants an Outperform rating. We view the deployment of excess capital as a key risk to our downgrade."

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With its Paw Patrol property "on a roll," Raymond James analyst Kenric Tyghe believes a premium valuation is warranted for Spin Master Corp. (TOY-T) given its industry-leading growth profile.

He initiated coverage of Toronto-based toymaker Spin Master, which he called "a leading children's entertainment (versus simply a toy) company," with an "outperform" rating.

"The particularly strong momentum within key properties, combined with a diversified platform that is well positioned for growth (and a balance sheet that supports further strategic acquisitions), and strong execution, support our Outperform rating," he said. "Spin Master's Paw Patrol franchise is gaining global market and mind share, with other key properties in Hatchimals, Air Hogs, and Rusty Rivets also exhibiting very strong momentum through our forecast window. We believe that Spin Master's 10-year sales CAGR [compound annual growth rate] of 14.0 per cent, which is a multiple of both the global toy industry's (and key peers') growth, highlights how effectively the team has managed to out play its peers, be it through being more innovative, better acquirers, or simply on trend. The bottom line is that they have (and continue) to get it more right (more often) than anyone else in the business, which in our opinion warrants a premium valuation (relative to the peer group). The Paw Patrol pups have legs, the Hatchimals are cracking the collectibles trend, and the option value on the Bakugan property (relaunch) is material."

Mr. Tyghe emphasized the momentum behind its Paw Patrol property, its leading brand, which he said generated between 25–30 per cent of product sales (or approximately $350-million) in the 2016 fiscal year.

"Spin Master launched Paw Patrol in 2013, and today it is broadcast in over 160 countries and territories, and airs over 60 times a week on Nickelodeon," he said. "Season 4 of Paw Patrol is currently on air (in North America) with Spin Master in production on Season 5 and Season 6. In Europe they are currently airing Season 2 and Season 3, and in China Season 1 launches later in 2017. Paw Patrol has received consistently high ratings, and was ranked the third highest rated pre-school TV program in 2016 and the number one show with kids 2–5 on all TV for 1Q17. Paw Patrol toys were launched in 2014, and received very positive customer response and generated robust sales. The successful creation of evergreen properties not only generates a stable stream of licensing revenues from broadcasters, but also creates very long toy life cycles (given the long lives of these shows, and the control they allow the owner to exert over the brand), at very attractive margins. Spin Master marries the toy and entertainment content when it produces a season of a new show, which creates an aspirational ('I want') element to the toys (with new toys, versions and characters, introduced in each new season).

Suggesting under the belief its ultra-successful Hatchimals line, a must-have toy for 2016, was "no one hatch wonder," Mr. Tyghe said the company is poised for growth despite the struggles of the retail market, particularly south of the border.

"While retailer concentration in the U.S. toy business is worth noting, the Amazon effect is hard to ignore, with a recent report by One Click Retail, pegging Amazon's share of the market at an eye popping 20 per cent in 2016. Amazon's estimated 20-per-cent share reflected toy sales growth of 24 per cent to approximately $4.0-billion (versus growth of 4.7 per cent to $26-billion for the total U.S. toy market). In 2016, Wal-Mart, Target and Toys "R" Us accounted for 51.9 per cent of Spin Master's Gross Product Sales (down from 57.4 per cent in 2015, and 62.8 per cent in 2014), while online sales represented 22 per cent. The top performing category by sales on Amazon is consistently Building Blocks (with nearly double the sales of the next closest category) which reported 19-per-cent growth in 2016, followed by Board Games with growth of 39 per cent. Rounding out the top 3 categories on Amazon are Boys' Role Play and Action Figures according to One Click Retail data. Spin Master is well positioned given its portfolio mix (board games) and brand awareness (Paw Patrol, Hatchimals, etc.)."

Mr. Tyghe set a price target of $48 for the stock. The analyst consensus price target is $43.55, according to Thomson Reuters data.

"We apply a target EV/EBITDA [enterprise value to earnings before interest, taxes, depreciation and amortization] multiple of 13.0 times to our 2018 estimated adjusted EBITDA of $262.4-million, which is at a premium relative to the U.S. peer group average of 10.4 times," he said. "We believe Spin Master warrants a premium valuation relative to its US toy producer peer group given its higher sales and EBITDA growth trajectory. In addition, Spin Master's material EBITDA margin expansion opportunity (due to operating leverage as the company grows its topline), is supportive of a higher EBITDA growth rate (further underpinning the case for a premium valuation)."

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Though first-quarter results met his expectations, Desjardins Securities analyst Michael Markidis downgraded Artis Real Estate Investment Trust (AX.UN-T) based on recent unit price appreciation.

"The change takes into account year-to-date outperformance versus peers (10-per-cent total return versus 5 per cent for the S&P/TSX Capped REIT Index), as well as the REIT's comparatively flat organic growth profile and elevated capital requirements," said Mr. Markidis, moving his rating to "hold" from "buy."

Expecting the Winnipeg-based REIT's pace of acquisitions is poised to pick up, Mr. Markidis also emphasized its disposition program, which has largely been centered on Alberta in recent months, will have a greater U.S. component in 2017.

"Over the past year, AX has embarked on a disciplined disposition program primarily focused on reducing its exposure to Alberta, which accounted for 28 per cent of NOI [net operating income] in 1Q17 (versus 33 per cent in 1Q16)," he said. "This theme will likely remain predominant for the foreseeable future, as AX works toward reducing its Alberta exposure to 20 per cent. Within the 1Q17 disclosure, management has also revealed plans to sell (1) all seven of its retail properties located in Minnesota, (2) seven (of 31) industrial properties located in Minnesota, and (3) the Humana Building (a single-tenant office property located in Phoenix, Arizona). If successful, we anticipate these sales should generate gross proceeds of $150–170-million.

"AX does not own any other retail properties in the U.S.. Limited scale, as well as a seemingly bearish view on the retail environment in the U.S., generally appears to be influencing management's asset management strategy. On the flipside, management is committed to growing its presence in the U.S. industrial market. The seven assets that have been identified are lower-quality properties. Management believes that it can recycle the capital from this disposition into newer generation assets (via acquisition and development) with better return profiles."

He maintained a target of $13.75 per unit. Consensus is $13.44.

"AX investors have benefited from a strong start to 2017 (total return of 10 per cent year to date versus 5 per cent for the S&P/TSX Capped REIT Index)," the analyst said. "Admittedly, the stock still screens attractively from a comparative valuation perspective (15.5 times EBITDA, 9–9.5 times funds from operations). However, the organic growth profile has flatlined and capex is somewhat elevated. From our lens, it is becoming more difficult to envision a catalyst that could drive additional outperformance vs peers over the next 12 months. Accordingly, we are adjusting our rating."

Elsewhere, BMO Nesbitt Burns analyst Heather Kirk bumped her target to $13.75 from $13 with a "market perform" rating (unchanged).

Ms. Kirk said: "AX continues to execute on its strategy of capital recycling, lower leverage, reducing Alberta exposure and pursuing value-add developments. Capital recycling remains active and focused on portfolio high-grading and lowering leverage with the REIT now at its 50-per-cent target. Calgary office (13 per cent of NOI) showed signs of continued stabilization. We are increasing our target price to $13.75 to reflect an increase in NAV."

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Industrial Alliance Securities analyst George Topping initiated coverage of a trio of Canadian "premier" mid-tier mining producers.

He gave both Hudbay Minerals Inc. (HBM-T) and Lundin Mining Corp. (LUN-T) "buy" ratings, while First Quantum Minerals Ltd. (FM-T) received a "hold" rating.

"We view First Quantum as carrying the highest risk, technically, given the 2018 start-up of the massive Cobre Panama (though First Quantum has a strong technical background) as well as high country risk owing to the unreliable Zambian government," said Mr. Topping. "Hudbay may have future issues in Peru, where local communities across the country have been targeting mines for additional local funding. However, as an existing operation, Constancia is less likely to be materially impacted. The other key operation, Lalor, is in a safe and stable Canadian jurisdiction, and its development project is similarly safe in Arizona.

"Lundin has a strong balance sheet and perhaps the greatest risk is a dilutive acquisition, which we consider unlikely. We expect higher nickel prices to skate Eagle onside while Candeleria continues to be the primary source of revenue through its large-scale copper production in mining-friendly Chile."

Mr. Topping called Hudbay a "quality producer with a proven track record of exploration, development, and operations." He believes it has begun to rebound from attempts to repair its balance sheet, noting management has been focused on improving efficiency and cutting costs to generate free cash flow, projecting FCF of $231-million in 2017. He says strong FCF has allowed it to cut debt as it moves toward future expansion of its Rosemont project in Arizona.

"The older Manitoba mines (Reed, 777 and associated smelter) will close over the next five years, barring an acquisition or new discovery," he said. "The Company will then be focused on the two larger mines (Constancia and an expanded Lalor) and one large project (Rosemont). These will be easier to manage and be more attractive to the market and industry peers alike."

He added: "As Manitoba's 777 Mine winds down over the next five years, its free cash flow component should increase as development and capex is curtailed prior to being offset by an expanded Lalor and Rosemont. The recent tough times caused by Constancia's build and commissioning at a time of falling copper prices, have necessitated a leaner more focused company that should work well in today's improved metal markets."

Mr. Topping set a price target of $13 for Hudbay stock. Consensus is $11.60.

Having sold its stake in Tenke Fungurume Mining SA, the risk profile for Lundin has improved, according to Mr. Topping.

Though he expects the company to seek out projects in replace Tenke, he thinks a dilutive or high-risk acquisition is unlikely.

"Lundin Mining's history has been one of opportunistic acquisitions of out-of-favour assets," he said. "Therefore, we do not expect a near-term public company acquisition of size. More likely is an advanced exploration or operating asset purchase that requires technical expertise and capital, either of which would add at least 50 per centto current production. Lundin has indicated a preference for copper or copper/gold projects low in the cost curve. While mining friendly jurisdictions like Peru, Chile, or Eastern Europe are obviously preferred, Lundin is not afraid of country risk."

Mr. Topping set a target of $11.20 for Lundin stock. Consensus is $9.73.

In justifying his "hold" rating for First Quantum, Mr. Topping noted the start-up risks involved with its Cobre Panama open-pit copper development project.

"With commercial production slated to begin in 2018, Cobre Panama will be one of the largest copper producers in the world, with almost 27-billion pounds in P&P [proven and probable] reserves," he said. "With a 40-year mine life, average annual copper production of 935 million pounds Cu p.a. and AISC [all-in sustaining costs] of $1.39 per pound, we calculate an NPV5% of $6.5-billion (NPV7% of $4.2-billion) as a standalone mine. However, the mine is a challenging build-out even for experienced mine builders such as First Quantum."

He set a $17 target for shares of First Quantum. Consensus is $18.54.

"Beyond the hedges, FM has the best sensitivity to the copper price in the largest most liquid vehicle," said Mr. Topping. "However, this could be 2 years or more away and comes with higher technical (Cobre) and country risks (Zambia). Most mine commissioning encounters teething problems for the first 12-18 months, therefore, we elect to remain on the sidelines until the Cobre Panama project is through start-up."

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A competitive environment is likely to persist for Alaris Royalty Corp. (AD-T) beyond its management's control, said Desjardins Securities analyst Gary Ho.

Expecting the Calgary-based company to find it tougher to deploy capital, he downgraded the stock to "hold" from "buy."

"A few reasons for our downgrade," he said. "First, the current overheated/competitive environment is likely to persist. PE firms have plenty of dry powder—boosting M&A valuations, high-yield/mezzanine debt remains competitive and we have recently seen an easing in business lending conditions—potentially competing against Alaris' structure. Second, redemption levels are elevated. Future repurchases may push payout ratios higher (2017 guidance implies 97-per-cent payout) and we have limited visibility. Lastly, we estimate an incremental cash tax payment of $4–5-million annually beginning in 2018, which will likely put a strain on cash flow. To be clear, we believe management is being prudent in pursuing new deals, we see solid progress in rectifying underperforming partners and we view dividends as safe near-term."

On Monday, Alaris reported first-quarter results that fell below Mr. Ho's expectations.

Normalized earnings before interest, taxes, depreciation and amortization came in at $18.1-million, below his projection of $18.7-million and the consensus of $19.3-million. In explaining the miss, he cited Group SM's revenue accounting and lower-than-expected capital deployment.

"Management noted that competition in the private financing space will likely continue for the foreseeable future, leading Alaris to focus more on smaller deals," said Mr. Ho. "We have seen industry data suggesting record dry powder waiting to be deployed by private equity firms, driving higher valuations. Alaris has shifted its focus to smaller companies with EBITDA greater than $2-million but an investment size of $20-million. There could be a few transactions in the pipeline, but overall we are modelling $60-million in deployment for 2017, below the five-year run rate of $130-million."

He lowered his target for the stock to $23 from $26. Consensus is $23.66.

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Credit Suisse analyst Anita Soni upgraded IAMGOLD Corp. (IAG-N, IMG-T) to "neutral" from "underperform" based on improved execution.

On Tuesday, the Toronto-based company reported adjusted earnings per share of 1 cent (U.S.), above Ms. Soni's projection of nil and the consensus of a 2-cent loss. Cash flow per share of 15 cents was 2 cents above her expectation.

With the results, she moved her rating to "neutral" from "underperform."

"We upgrade to Neutral following another solid quarter as IAG has made strides to address the concerns which had driven our Underperform view: shorter mine life, higher costs and limited FCF [free cash flow] generation," she said. "Exploration success at Saramacca is likely to extend Rosebel's mine life and could improve FCF, costs have been improved in at each of its assets and Q1 represents the third quarter in a row of positive FCF. Delivery on the Westwood ramp-up and Sadiola sulphides project, both of which we view as higher execution risk, could make us more constructive. IAG trades at 0.76 times P/NAV [price to net asset value] versus peers at 0.83 times. Commodity prices are the key risk to our view."

Her target rose to $5 (U.S.) from $4.50. Consensus is $5.02.

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In other analyst actions:

TD Securities analyst Graham Ryding downgraded Power Financial Corp. (PWF-T) to "hold" from "buy" with a target of $37, down from $41. The average is $36.86.

Mr. Ryding also lowered his recommendation for Power Corp. of Canada (POW-T) to "hold" from "buy" with a $33 target, down from $37. The average is $33.57.

TD Securities analyst Damir Gunja downgraded CCL Industries Inc. (CCL.B-T) to "hold" from "buy" with a target of $330. The average is $334.29.

Cormark Securities Inc. analyst David McFadgen upgraded TVA Group Inc. (TVA.B-T) to "speculative buy" from "market perform." He raised his target to $4.90 from $4.50, while the average is $4.72.

Mr. McFadgen downgraded Great Canadian Gaming Corp. (GC-T) to "market perform" from "buy" and lowered his target to $28 from $30. The average is $28.33.

Journey Energy Inc. (JOY-T) was cut to "hold" from "buy" with a target of $3.75 (down from $4.50) by GMP analyst Robert Fitzmartyn. The average is $3.80.