Wednesday's analyst upgrades and downgrades

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

Cenovus Energy Inc. (CVE-T, CVE-N) finds itself in a "particularly precarious position," according to Desjardins Securities analyst Justin Bouchard.

Mr. Bouchard said a "depleted margin of safety" has increased the risk surrounding the Calgary-based integrated oil company, amplified by $43 (U.S.) per barrel WTI.

However, the analyst believes Tuesday's investor day in Toronto did provide "incremental clarity" on its strategy moving forward, including the announcement that Brian Ferguson is poised to retire as chief executive officer and director at the end of October.

"CVE refreshed its strategy, including an updated disposition target of $4–5-billion (which has been expanded to include Palliser and Weyburn) by year-end, the deferral of additional oil sands projects until it has sufficiently delevered, additions to its oil sands growth portfolio through land acquisitions and technology improvements," said Mr. Bouchard. "It also noted the potential for medium-term infrastructure constraints as it works to execute its Deep Basin growth plan."

However, Mr. Bouchard referred to numerous headwinds faced by Cenovus, which he said put it "between a rock and a hard place."

"The confluence of elevated net debt levels, low oil and gas prices, limited financial liquidity ($5.3-billion of debt maturing by year-end 2019), substantial increase in shares outstanding and impending divestment of CVE shares by ConocoPhillips (adding technical pressure on the stock price), loss of market confidence in the story and attempt to execute a substantial divestment strategy in a buyer's market (which increases the risk of fetching an underwhelming price for the assets) all contribute to the negative sentiment," he said. "In our view, the only way out of this tailspin begins with the successful execution of its divestment strategy, followed closely by a rebound in commodity prices (to $55 U.S. per barrel plus WTI), which would in turn solve the company's liquidity concerns. However, even then, we believe market confidence would only return following an extended period of successful execution of its Deep Basin strategy—which probably will not occur until after 2018 (at the earliest). Meanwhile, looking at the downside risks in the section that follows, we believe Cenovus is out of 'easy levers' to pull in the event that oil prices remain low for longer."

Accordingly, Mr. Bouchard dropped his target price for Cenovus shares to $14 from $20 with an unchanged "buy" rating. The analyst consensus price target is $16.94, according to Bloomberg data.

"From our perspective, the core of Cenovus — the FCCL and Narrows Lake assets — remains highly attractive owing to its best-in-class oil sands acreage, long-life and low-decline production base, and opportunities for further expansion at attractive capital efficiencies," he said. "From a fundamental perspective, the stock is trading well below its intrinsic value (in our view), but that's not the market focus right now. Instead, the market's attention is set squarely on the fact that the company has depleted its margin of safety and muddied the waters through its purchase of the Conoco Deep Basin assets. That, in turn, has greatly increased the number of headwinds and has dramatically amplified the risks surrounding the story — including elevated debt levels, reduced liquidity, its execution of a divestment strategy in a buyer's market, questions surrounding its ability to deliver on the Deep Basin assets, the significant increase in shares outstanding and the loss of market confidence — each of which is magnified given the current commodity environment ($45 U.S. per barrel WTI) and simply cannot be ignored. As a result, while we are maintaining our Buy rating, we are cutting our target price."

Elsewhere, while acknowledging risks remain for investors due to the recent share price decline, Peters & Co. analyst Tyler Reardon said the current valuation is "attractive enough now to warrant buying the stock."

He upgraded Cenovus to "sector outperform" from "sector perform."

"With the recent weak performance in Cenovus' stock price, it is becoming more evident that many of the challenges the company faces are reflected in the share price," the firm said. "We believe that the asset sales as outlined by the company will be completed with the anticipated proceeds sufficient to cover the bridge loan ($3.5-billion). Even with these dispositions, debt levels remain high as netbacks are very low at oil prices. The question of whether to buy the stock at this level really comes down to three things: (1) does it have sufficient longevity to allow an investor time for a commodity price recovery; (2) are the assets of high enough quality to matter in a $45 U.S. per barrel to $55/B pricing environment; and (3) is the potential upside in the share price attractive enough at this point to compensate for the downside risk. With asset sales to be completed in the coming months, this should allow the company time to withstand lower oil prices. Although the various metrics look challenged at strip prices and the equity is very sensitive to lower commodity prices, we believe that its assets are generally high quality and will compete with most other North American developments in this pricing range."

Mr. Reardon lowered his target to $13 from $14.

Canaccord Genuity analyst Dennis Fong upgraded the company to "buy" from "hold" with a $15 target (unchanged).

On the flip side, Macquarie analyst Brian Bagnell downgraded Cenovus to "underperform" from "neutral" with a $8 target (from $15).

TD Securities analyst Menno Hulshof said Cenovus' road is "now defined, but appears long and winding."

He lowered his target to $15.50 from $18.50 with a "buy" rating (unchanged).

"Although the role of the Deep Basin in its five-year strategic plan was well-articulated, its extended balance sheet remains front-and-center," the analyst said. "To this end, CVE has increased its year-end divestiture target to $4-billion-$5-billion from $3.6-billion. Assets added to the list (i.e., in addition to Pelican Lake and Suffield) include Weyburn and Palliser Block. It also flagged the potential for the sale of Deep Basin GORRs, oil sands GORRs, undeveloped oil sands leases, and infrastructure. However, with WTI oil prices continuing to slide (now $44 U.S. per barrel), it is unlikely that the market will give CVE the benefit of the doubt until it can get some of these transactions across the line. Selling Pelican Lake and Suffield in Q3 (per guidance) at reasonable metrics would be a step in the right direction, in our view."

CIBC World Markets analyst Arthur Grayger dropped his target to $13 from $18 with a "neutral" rating.

"Cenovus' 2017 Investor Day covered a range of topics: including an update on expected disposition proceeds, capital allocation expectations once the balance sheet is in better shape, various sustainable improvements to the cost structure of the oil sands business and growth plans, commentary on the latest technological innovations, and a deep dive on the Deep Basin assets," he said. "Unfortunately, the market remains acutely focused on the near-term priorities for the company such as debt repayment and now management uncertainty, which overshadowed the key takeaways from the Investor Day presentation."

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Industrial Alliance Securities analyst Dylan Steuart upgraded his rating for Home Capital Group Inc. (HCG-T) in reaction to its agreement to sell a portfolio of commercial mortgage assets valued at approximately $1.2-billion to KingSett Capital.

"The agreement is positive for two reasons," he said. "First, the $1.16-billion of expected proceeds will enable HCG to pay down a significant portion of the $1.65-billion of outstanding balance on the 10-per-cent[Healthcare of Ontario Pension Plan] credit line. Second, the proceeds are estimated at 97 per cent of the total principal value ($1.2-billion). The estimated impact on earnings of $15-million from the divestiture is fairly modest given the very recent distressed situation at the firm."

Mr. Steuart said the troubled company's liquidity situation is "stabilizing," adding: "While earnings power remains negatively impacted by recent events, the funding situation has improved. Current liquidity of $1.14-billion has stabilized over the past month, with indications that asset run-off has been in line with the deposit outflow."

"The biggest outstanding question is, what is the earnings power of the operations on an ongoing basis? At this stage, there are likely too many unknowns to get a solid handle on that question, but two things we know for sure: 1) the asset base is shrinking, and 2) margins are likely narrowing. Net interest margin as of Q1/17 was 2.44 per cent, up 6 basis points year over year, but marked a period of time not impacted by recent turmoil. This asset sale of high yield commercial mortgages (yielding 5.76 per cent as of Q1/17) will put downward pressure on margins. We estimate a 10 basis points negative impact to asset yields from this transaction in a vacuum. Recent increases in GIC rates (Oaken rates are up ~75 bps since the crisis began) are expected to be somewhat offset by increases in non-prime mortgage rates, but we still expect some compression in net interest margins. Combine narrowing margins with a shrinking loan book, and it is clear that the earnings power of the franchise has been negatively impacted over the medium term. We calculated core EPS of $1.03 in Q1/17 ($4.11 on an annualized basis). Stressing run-rate earnings assuming a shrinking balance sheet and narrowing margin indicate that the earnings impact of recent events is meaningful."

Mr. Steuart said HCG's outlook has "brightened considerably" since his the latest update to his financial model for the company following the release of its first-quarter results on May 11.

"We assume a much slower reduction of the uninsured loan portfolio and more favourable terms on the line of credit starting in Q3/17," he said.

He raised his full-year operating earnings per share projection to 75 cents from 42 cents, while his 2018 expectation is now 67 cents, rising from a 95-cent loss. He now projects HCG will have a tangible book value per share at $24.08 at the end of 2018.

Bumping his rating to "speculative buy" from "hold," Mr. Steuart increased his target price for HCG shares to $19 from $10.50. Consensus is 14.07.

Meanwhile, Raymond James analyst Brenna Phelan also hiked her target price for its shares.

"Recently, Home Capital has faced a number of negative events, culminating in a crisis of confidence whereby it lost $2.5-billion of deposit funding and saw its share price decline to close at a low of $5.85 per share," she said. "We view recent developments, specifically settlement with the OSC for $30-million, mostly stabilizing (although still costly) deposit funding, a reconstituted Board of Directors, and a stated intent to focus on its core business as increasingly both encouraging and reflective of a more certain operating future for its non-prime mortgage lending business. Our estimates, which had previously assumed non-core asset dispositions at a discount of 5 per cent in 2Q, are revised to reflect the more favorable terms of this $1.2-billion portfolio sale. Overall, the price (see below) and the liquidity this sale provides, coupled with more stable funding, still-strong demand for non-prime loans and the removal of overhang from the OSC suits serve to brighten our outlook meaningfully."

With the transaction, Ms. Phelan's adjusted earnings per share projection for fiscal 2017 jumped to 43 cents from a loss of $1.18. Her 2018 estimate is now $2, up from 43 cents.

With an unchanged "market perform" rating, her target jumped to $17.50 from $10.

"While we continue to believe a discount to book value is appropriate as current funding costs remain too costly to allow for profitable portfolio growth, we are increasing our multiple to reflect solid recent progress and much greater visibility," she said. "We note that $17.50 equates to 9.0 times our 2018 EPS estimate, to which there may be upside if funding costs improve."

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Industrial Alliance Securities analyst Elias Foscolos called Enerflex Ltd.'s (EFX-T) $140-million deal for Mesa Compression LLC a "beachhead" acquisition.

Under the deal, announced Monday night, the analyst expects EFX's total compression fleet to almost 600,000 horsepower, while expanding its geographic footprint south of the border. He projects the deal to be immediately accretive to earnings.

"We believe that EFX has been looking to grow both its compression rental and After Market Service ) business in the U.S. for many years," said Mr. Foscolos. "The U.S. is the world's largest gas producer, and to us it makes sense that EFX has made this acquisition to establish a 'beachhead' position in the United States.

"One key challenge that EFX has faced in growing its U.S. rental business has been that beyond E&P companies owning compression assets, the U.S. market has a substantial amount of Master Limited Partnerships that dominate the compression rental space. These MLPs are similar to the old Corporate Income Trusts in Canada, in that they eliminated a layer of taxation. We speculate that EFX's ability to quickly close the transaction with cash and credit facilities will be a strong selling feature for vendors. We view the Mesa acquisition as a 'mini-AXIP' transaction. In mid-2014, EFX made a transformative acquisition by acquiring the international compression assets of AXIP International for $430-million U.S., which included 285,000 HP of compression (448 units) in addition to some gas processing facilities. Over time, the Company was able to organically grow its compression fleet using the AXIP acquisition as a toe-hold and improve its AMS revenue. As in the AXIP acquisition, we believe value will ultimately come from cross-selling opportunities."

Keeping his "strong buy" rating for the stock, Mr. Foscolos bumped his target to $23.50 from $23. Consensus is $24.39.

"While we believe the acquisition will be accretive to EBITDA over time, the impact at this point is not material enough in nature to move the needle on a multiple basis as we are basing our multiple based target valuation on the 12-month period ending June 30, 2018, and we believe cross-selling opportunities in the short term may be limited," he said. "We do see a longer-term benefit and as a result our DCF [discounted cash flow valuation has increased to $20.25 (previously $19.75)."

Raymond James analyst Andrew Bradford bumped his target for Enerflex shares to $22 from $21.50.

Mr. Bradford said: "We believe that Enerflex's acquisition of Mesa Compression LLC represents attractive value for investors, especially given the stability of its cash flow. Mesa's market focus is different than EFX's traditional mid-stream orientation, which makes it difficult for us to comment on the acquisition's strategic value with any confidence. That said, our expectation is that EFX will have little trouble growing Mesa's core business, and perhaps will broaden the service offering to larger-scale mid-stream contract compression services as well. We continue to rate Enerflex Outperform."

CIBC World Markets' Jon Morrison raised his target by 50 cents to $25 with an "outperformer" rating.

Mr. Morrison said: "We view the Mesa acquisition as a solid transaction that is on point with Enerflex's long-term corporate strategy and is being completed at what we consider as an attractive and logical purchase price. In addition, the assets are adjacent to three of the most active unconventional plays in the Lower 48, which positions the company to be able to: 1) realize a long tail of operating and financial contribution from the acquired fleet, which matches the long-life nature of the assets; and, 2) further expand Enerflex's presence in the U.S. contract compression business, which has been a long-term goal for the company."

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Kinder Morgan Canada Ltd. (KML -T) possesses an "unprecedented transformational secured growth outlook" due to the Trans Mountain Expansion Pipeline, according to TD Securities analyst Linda Ezergailis.

She initiated coverage of the energy infrastructure company with an "action list buy" rating.

"We like KML based on our view of its: 1) substantial asymmetric upside, 2) unprecedented secured growth profile, 3) unique asset positioning, 4) base business midstream pure play, 5) stable low-risk cash flows, 6) scale and experience, 7) aligned sponsor, and 8) no plans to raise common equity," said Ms. Ezergailis. "We see significant benefit in taking a position in advance of TMEP construction commencing (target date is September 2017). We believe KML shares will re-rate upwards, once investor confidence in the timing of bringing TMEP into service is bolstered by a clear line of sight to the conclusion of provincial political uncertainty and litigation associated with social license issues."

Ms. Ezergailis set a price target of $26 for the stock. Consensus is $22.67.

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Citing its current valuation and a lack of a "meaningful" catalyst, Citi analyst Kate McShane downgraded Target Corp. (TGT-N) to "neutral" from "buy."

"TGT was already under pressure given the soft [bricks and mortar] traffic trends, volatile guidance, and intensifying competition," she said. "Plus, Signature, TGT's key differentiator, has been decelerating (we estimated flat in Q1 versus low-single digit growth in previous quarters). With [Wal Mart Stores Inc., WMT] enhancing its e-comm portfolio with Jet.com and Bonobos over the past year through acquisitions that target millennials and AMZN's sizable entry into fresh/organic food with Whole Foods Market acquisition, TGT's two main competitors have very quickly changed the game. This makes TGT's revenue growth prospects through organic or acqusition growth tougher to achieve, absent any kind of game changing move."

Ms. McShane also believes Target's "big" catalysts have already been realized, adding: "CEO Brian Cornell (who started Aug 2014) has already improved the profile of the business significantly over the past couple years through: 1) Closing the underperforming Canadian TGT segment (Jan. 2015), 2) Selling the underperforming pharmacy business to CVS (June 2015), 3) Cutting costs by $2.0-billion, and 4) Improving capital allocation with greater-than $7.0-billion in share buybacks and the annual dividend per share payout grew greater-than 24 per cent."

The analyst lowered her target price for Target shares to $56 (U.S.) from $63 "on flattish growth ahead combined with higher assumptions for capex." Consensus is currently $59.59.

"Though TGT's 3-year multiple average is slightly above 14 times, we think the implied 14-times multiple is still fairly pricey given the declining comp trends driven in part by decelerating Signature comps," she said. "Plus, TGT's prospects of reaccelerating comps are more uncertain compared with prior years as their closest competitors are aggressively increasing omnichannel capabilities through acquisitions (AMZN/WFM, WMT/Jet.com).

"TGT has a challenging road ahead with likely need for greater investment spend which could put more down pressure on the stock. We could see potential upside if TGT benefits in the short term from dept. store (and others) door closures and better inventory management, but we think upside is limited given long term secular concerns."

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Canaccord Genuity analyst Richard Davis believes Adobe Systems Inc. (ADBE-Q) is "doing just what exceptional companies do – execute consistently and well."

On Tuesday, the San Jose-based software company second-quarter 2017 financial results that Mr. Davis deemed "solid across the board." It reported total revenue for the period of $1.772-billion (U.S.), ahead of the analyst's expectation by $42-million and a 27-per-cent increase year over year. It achieved operating margins, earnings per share and operating cash flow of 37.2 per cent, $1.02, and $645-million, ahead of the analyst's estimates by 190 basis points, 8 cents, and $280-million.

"We believe Adobe, through skillful acquisitions and on point development, has perhaps the widest competitive moat of any software firm we know," said Mr. Davis. "We are not saying Adobe has no competition, but the competitive set is simply not as intensely or directly overlapping as what other software firms face. When you combine a very compelling business with an investor expectations setting machine that literally is second to none, you get exactly what we have seen from ADBE shares: pretty consistent, better-than-market appreciation. Therefore, guess what, Adobe did it again with another strong quarter, even adjusting for a bit of sandbagging guidance we got off of the last print; even so, the algorithms will rejoice and the longs might react favorably, both of which should propel ADBE shares higher. We call Adobe one of our secular BUY 'compounding' stocks, which means that investors should rationally expect ADBE shares to roughly double within a five-year window."

With the results, Adobe also released third-quarter revenue guidance of $1.815-billion, beating Mr. Davis's expectation by $22.5-million. Non-GAAP EPS is projected to be $1, which is four cents ahead of the analyst's projection.

In reaction to the results and guidance, Mr. Davis increased his target for Adobe shares to $165 (U.S.) from $145. Consensus is $146.54.

He maintained a "buy" rating for the stock.

Elsewhere, RBC Dominion Securities analyst Ross MacMillan also raised his financial projections for the company, but he did not touch his $157 target or "outperform" rating.

"ADBE continues to deliver on the promise of better operating leverage and a longer tail to the model transition, but still has pricing and capital allocation muscles to flex," said Mr. MacMillan. "We continue to see a strong earnings/ cash flow compounding story."

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Exchange Income Corp. (EIF-T) is "designed to deliver safe dividend growth," said Cormark Securities analyst David Tyerman.

He initiated coverage of the Winnipeg-based company, which is focused on opportunities in aerospace and aviation services and equipment, and manufacturing, with a "buy" rating.

"EIC has increased its dividend 12 times since its first dividend in June 2004, raising the dividend at a 5.8-per-cent annual rate (106 per cent total) to the current 17.5 cents per month rate (7.2-per-cent annual yield) and without a single decrease," said Mr. Tyerman. "EIC has achieved this by building a diversified business portfolio focused on aviation, aerospace and manufacturing assets. Growth is driven through acquisition and organic sources. The Company focuses on businesses with low volatility and low cross-correlation. EIC also seeks to protect and grow the dividend by maintaining prudent financial leverage and payout ratios."

Mr. Tyerman believes additional growth is "baked in," expecting to see returns on recent "large organic invested capital deployment."

The analyst set a price target of $40 for the stock. Consensus is $44.70.

"We recommend investors buyEIC shares to benefit from EIC's attractive dividend yield and EPS and dividend growth potential," he said. "EIC's $2.10 annualized dividend (paid monthly) yields 7.2 per cent at the Company's current share price. We estimate EIC will increase its dividend by an average of 6.4 per cent per year and its EPS by 7.1 per cent per year from 2016 to 2019. We also think the stock is undervalued. We believe the combination of good EPS growth, a moderate valuation multiple bump and solid and growing dividends should generate an attractive 44.6-per-cent investment return over the next year. We expect continued good investment upside beyond the next year from the same factors."

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In other analyst actions:

- BMO Nesbitt Burns analyst Gerrick Johnson initiated coverage of Camping World Holdings Inc. (CWH-N) with an "outperform" rating and $36 (U.S.) target. Consensus is $36.14.

"CWH is the largest retailer of recreational vehicles (RV) in the United States," he said. "We believe CWH stands to grow earnings and EBITDA at a better rate than the market currently anticipates owing to strong growth in the RV industry, opportunities to take share through scale and differentiated product offerings,and a roll-up strategy of acquiring independent dealers."

- BMO Nesbitt Burns analyst R. Scott Graham initiated coverage of Xylem Inc. (XYL-N) with an "outperform" rating and $60 (U.S.) target. Consensus is $56.

"We believe XYL is about to improve its long-term earnings growth, which has averaged only 1 per cent per year since its 2011 spin from ITT [Corp.]," said Mr. Graham. "Legacy sales should increasingly benefit from better verticals, secular trends, its 35-40-per-cent replacement/recurring business, emerging market growth and new go-to-market plans. We expect cost-down programs to drive margin expansion. Newly acquired Sensus has similar growth dynamics, and should be accretive to sales and earnings growth. We see mid-teens earnings growth in '17-18 with potential upside. We expect XYL to outperform from this growth and modest relative multiple expansion."