Wednesday’s analyst upgrades and downgrades

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

Earnings beats and bullish guidance are on tap for Canadian building materials stocks during the third-quarter earnings season, according to Raymond James analyst Daryl Swetlishoff.

"Surging building materials stocks have been the place to be in 2017 with an average 33-per-cent return year-to-date (versus the TSX at 3 per cent)," said Mr. Swetlishoff in a research note released Wednesday.

"Given this run, investors may be tempted to take profits. While hard to argue with crystallizing gains, our estimates suggest potential for 3Q17 earnings beats with bullish forward guidance. Further, we expect building materials share prices to move materially higher over our 6-12 month investment horizon with growing demand balancing capacity expansions. We also expect strong [free cash flow] to be a positive valuation factor in coming quarters with eroding enterprise values and high potential for share buybacks and dividend hikes. Lastly, we note that our estimates assume the full preliminary 27 per cent duty is in place for all of 2018. While we have no special insight on final duty rates nor negotiated settlement potential we highlight that Canadian lumber stocks have high leverage to lower or eliminated duties and would rally hard on this outcome. As such, we advocate investors maintain core building materials positions and opportunistically add in the event of volatility. Pulp & Paper stocks have also performed well on the back of unexpected commodity strength and we are increasing targets for P&P leveraged names."

Though Mr. Swetlishoff expects quarterly results to fall sequentially from the record levels recorded in the second quarter, he expects Canfor Corp. (CFP-T), Interfor Corp. (IFP-T), Mercer International Inc. (MERC-Q), Norbord Inc. (OSB-T, OSB-N) and West Fraser Timber Co. Ltd. (WFT-T) to exceed the Street's projections. He estimates Acadian Timber Corp. (ADN-T), Conifex Timber Inc. (CFF-T) and Domtar Corp. (UFS-N, UFS-T) will fall in line with projections. Conversely, he thinks Canfor Pulp Products Inc. (CFX-T) and Western Forest Products Inc. (WEF-T) will record misses.

"We caution that consensus estimates do appear somewhat stale with the potential for upward earnings revisions ahead of reporting," he said. "That said; we expect management commentary on current strong profitability to be a bullish forward looking indicator."

Mr. Swetlishoff downgraded a trio of stocks due to share price appreciation. They are:

- Acadian Timber Corp. (ADN-T) to "outperform" from "strong buy" with a target price of $23 (unchanged). The analyst consensus target is $19.50.

- Canfor Corp. (CFP-T) to "outperform" from "strong buy" with a target price of $28, rising from $25. Consensus is $23.38.

- Western Forest Products Inc. (WEF-T) to "outperform" from "strong buy" with a $3.25 target, up from $3.10. Consensus is $2.94.

In justifying the moves, he explained: "Returning an average 33 per cent (compared to the 3-per-cent TSX return) forest products stocks have been on fire in 2017. Canfor has been the top share price performer with a 59-per-cent year-to-date return. While we remain constructive on CFP's outlook, with 15-per-cent upside to our revised target an Outperform rating is more appropriate than Strong Buy. Similar, with a 43-per-cent year-to-date return and 23-per-cent upside Western Forest also moves down one notch to Outperform. With 21-per-cent indicated potential upside from our target we are also reducing Acadian Timber to Outperform (from Strong Buy). We highlight Interfor and Norbord as our only remaining Strong Buy rated stocks."

He made the following target price changes:

- Interfor Corp. (IFP-T, "strong buy") to $28 from $27. Consensus: $23.92.

- Norbord Inc. (OSB-T, OSB-N , "strong buy") to $65 from $55. Consensus: $50.19.

- West Fraser Timber Co. Ltd. (WFT-T, "outperform") to $82 from $76. Consensus: $71.

- Canfor Pulp Products Inc. (CFX-T, "outperform") to $17 from $14.50. Consensus: $13.35.

- Fortress Paper Ltd. (FTP-T, "outperform) to $6 from $8. Consensus: $8.

"With generally higher commodity price forecasts offsetting a stronger CAD assumption (80 cents U.S. versus 76 cents previously) target prices are up across the board," the analyst said. "Canfor has been the top share price performer with a group leading 59-per-cent year-to-date return with Western Forest up 43 per cent year-to-date. Assuming no relief from 27-per-cent U.S. lumber duties yields 15-20-per-cent upside to our revised targets making Outperform ratings more appropriate than Strong Buy. With similar upside potential we are also taking Acadian Timber down a notch to Outperform (from Strong Buy). We have increased targets on our remaining Strong Buy rated stocks Interfor and Norbord and highlight the implied 30-40-per-cent upside."

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Calling Canadian Pacific Railway Ltd.'s (CP-T, CP-N) third-quarter financial results "stellar," Desjardins Securities analyst Benoit Poirier said it is "time to jump on the train if not on board yet."

On Tuesday after market close, the railway company reported adjusted fully diluted earnings per share of $2.90, exceeding both Mr. Poirier's projection ($2.83) and the consensus ($2.87). The beat came with an "strong" operating ratio of 56.7 per cent, beating the analyst's expectation (56.8 per cent) and representing a 1.0-per-cent improvement year over year.

Mr. Poirier called the company's fourth-quarter outlook "strong" with "solid" fundamentals pointing to a "bright" 2018.

"Management expects RTM growth in 4Q similar to the 3.7-per-cent year over year achieved in 3Q17," he said. "As a result, we are increasing our RTM [revenue ton mile] growth forecast to 3.9 per cent from 3.0 per cent. Management also increased its 2017 guidance and now expects double-digit EPS growth (from high single digits) despite the postponed land sales in 2018 ($45–50-million remaining) and the impact of a stronger Canadian dollar. Furthermore, we are encouraged by management's comments about 2018, which should benefit from (1) solid pricing momentum, (2) future realization of land sales, (3) a positive pension income contribution, (4) upcoming growth opportunities, and (5) continuous improvement in OR."

With an unchanged "buy" rating, Mr. Poirier raised his target for the stock to $254 from $230.  Consensus is $231.91.

"We maintain our positive stance on the stock based on a strong outlook and potential upside to our target price (22-per-cent potential return)," he said. "We continue to find the name attractive and have increased confidence that CP has the key ingredients to close the valuation gap vs peers (CP is the most attractive among Class 1s on a P/E basis). We see further growth opportunities as well as cost-reduction initiatives that should translate into further OR improvement and provide the stock with additional momentum."

Elsewhere, BMO Nesbitt Burns analyst Fadi Chamoun raised his target to $238 from $225 with an "outperform" rating.

"We suspect that the positive trends in revenues could persist into 2018 given the favorable demand backdrop, CP Rail's competitive cost structure, increased emphasis on service and marketing under the new leadership team, and tighter capacity across transportation modes including at the company's main Canadian rail competitor," said Mr. Chamoun.

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CannTrust Holdings Inc. (TRST-CN) has exhibited industry-leading growth over the past few quarters , said Canaccord Genuity analyst Neil Maruoka, calling it "a leader in the 'medical-ization' of cannabis."

"The company's registered patient base grew 117 per cent from 15,000 in May of this year to 32,500 patients in October," he said. "We believe that cannabis sales into the medical market represent 'sticky' revenue, as patients tend to re-order from a producer so long as quality remains high and inventory is available. CannTrust reported preliminary revenue of $6.1-million in Q3, a 680-per-cent increase compared to the same period last year. We believe this strong growth in all aspects of its business justifies a premium valuation for CannTrust relative to peers.

Mr. Maruoka initiated coverage of the Vaughan, Ont.-based company with a "speculative buy" rating.

"Given the risks associated with capacity expansion, achieving low production costs, wholesaler pricing, Health Canada licensing, and regulatory risks related to the, as yet, illegal recreational market, we believe it is prudent to classify 'Buy' ratings for cannabis companies as 'Speculative,'" he said. "Further, we expect that CannTrust will have a $18-million funding gap as it completes the Phase II expansion of its new greenhouse facility. While we believe the company has access to capital, we believe this financing risk underscores our 'Speculative' rating for the stock."

The analyst believes the company's oil sales, which outpace the industry average, are likely to protect margins going forward.

"In its most recent quarter, CannTrust reported revenue from oils and extracts totaling $2.3-million, representing 50 per cent of sales (in dollars) and 52 per cent of sales by volume," he said. "This far outpaces the most recent (Q1) industry data from Health Canada that suggests oils and extracts represented an estimated 15 per cent of total sales by volume. We believe that CannTrust's high quality, customer service, and standardization of dosing are appealing to both doctors and patients, and are the primary drivers of oil sales growth. As the Canadian cannabis industry shifts to a wholesaler model, we believe that LPs will experience pricing pressure and margin compression. We believe that producers must combat this through strategic differentiation and a shift to value-add products (such as oils) to remain competitive. Oils can sell for 2-3 times the price of dried cannabis per gram processed. As such, we expect that CannTrust will remain ahead of the pack, with a shorter path to sustainable profitability through its successful oil strategy.

"CannTrust is primarily focused on the medical cannabis market in Canada. Through its partnership with private multinational generics company Apotex, we expect CannTrust will develop formulations of cannabinoid extracts that could solve many of the issues surrounding the delivery of these drugs. If successful, we project that CannTrust will achieve much higher pricing for novel pharmaceutical versions of cannabis, further driving EBITDA margin expansion. The company's existing cannabis oil and extracts have been developed along these lines, providing patients and doctors with standardized products. The cannabinoid content in CannTrust's oils is diluted to 12.5 mg or 25 mg increments, which is a familiar dosage form for prescribing physicians. We believe this pharmaceutical approach to development has been a key driver of the rapid market uptake for CannTrust's product."

Mr. Maruoka set a price target of $7.25 for CannTrust shares. Consensus is currently $7.82.

"With industry-leading growth in its registered patient base and higher-priced oil sales, we believe CannTrust is poised for strong future growth. Starting in FY2018, we forecast a four-year revenue CAGR [compound annual growth rate] of 52 per cent (to $266-million in fiscal 2022) and a four-year adjusted EBITDA CAGR of 108 per cent (to $120-million in FY2022). We project that CannTrust will generate positive adjusted EBITDA next year."

"CannTrust currently trades at 12.4 times 2017 estimated funded capacity, above the peer group average of 7.7x, but in line with the larger players including Canopy Growth (WEED-T, "sell" rating and $11 target) at 12.7 times, and Aphria (APH-T). Given its stronger growth profile, we believe CannTrust should trade at a premium to peers. If we assume that 100 per cent of CannTrust's capacity is funded (ignoring the $15- $20 million funding gap), CannTrust would trade at 9.5 times funded capacity."

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CIBC World Markets analyst Jamie Kubik upgraded Kelt Exploration Ltd. (KEL-T) to "outperformer" from "neutral" upon assuming coverage of Calgary-based company's stock.

"Kelt's liquids-rich Montney focus provides considerable optionality to commodity pricing," said Mr. Kubik. "The challenge for most investors has never been the company's Montney exposure, but mostly the valuation of the stock, which continues to carry a significant premium to the peer group. We see much of this premium rightfully tied to the track record of superior return generation from this group, in addition to the alignment of management and insiders (19 per cent on a fully diluted basis), and material NAV exposure to liquids-rich and oil-charged Montney acreage (675 net sections). What we like at this stage is we see the company's transition towards development style drilling as a critical step towards improving forward capital efficiencies (we estimate at $15,000 per barrel of oil equivalent for 2017/18, a 35-per-cent improvement over $24,000 per Boe/d for 2015/16), which could begin to propel production growth ahead of estimates. Kelt's recent pad drilling success at Pouce Coupe offers insight into what its land base could be capable of. With a second five-well pad at Pouce Coupe and a five-well pad at Inga expected in the next six months, we see significant near-term catalysts that could continue to push the stock higher."

Mr. Kubik said "strong" growth visibility and a premium valuation are "here to stay," raising the firm's target for the stock to $9 from $7. Consensus is currently $8.40.

"Our price target of $9.00 per share is based on a 2018 estimate enterprise value/debt-adjusted cash flow multiple of 12.8 times on strip pricing (junior/intermediate gas peers at 8.9 times)," he said. "The stock has maintained a healthy premium to the peer group since inception (up 4.5 times to the peer group average of 6.1 times), and with Kelt beginning to hit its stride operationally in key areas such as Inga and Pouce Coupe, along with the track record of strong returns from this team, we see this stock maintaining a premium valuation over the next 12 to 18 months."

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Desjardins Securities analyst Frederic Tremblay initiated coverage of five TSX stocks late Tuesday.

Calling it a "one-stop shop for facility services," he gave GDI Integrated Facility Services Inc. (GDI-T) a "buy" rating and $19 target. Consensus is currently $19.50.

"We view the company's scale and full range of facility services in Canada as key positive attributes that should strengthen its already solid relationships with commercial property owners," he said. "Meanwhile, we believe the U.S. operations can continue to deliver above-average growth and margins, and provide a solid base from which to expand."

He added: "We believe GDI offers good value at current levels, considering its solid operational outlook and potential M&A catalysts."

Mr. Tremblay also gave a "buy" rating to Lassonde Industries Inc. (LAS.A-T), calling it a "fruitful investment."

"We believe Lassonde is adequately positioning itself in an evolving beverage industry by focusing on product innovation in branded products and customer development in private label," he said. "A solid balance sheet and $100-million free cash flow run rate are supportive of potential growth initiatives, both internal and acquisitive."

He gave the Rougemont, Que.-based drink company a target price of $275. Consensus is $250.

"In light of its earnings expansion, Lassonde's dividend has also been on an upward trajectory," he said. "Management is targeting an annualized dividend of 25 per cent of the prior year's net earnings. The latest increase, announced earlier this year, took the quarterly dividend per share to 61 cents (up 19.6 per cent) from 51 cents, which implies a yield of 1.0 per cent at the current share price. The dividend has essentially doubled since 2012 (was 31 cents per share). Based on our 2017 forecast, and assuming that the target of 25 per cent of prior-year net earnings remains intact, we believe a 10-per-cent dividend increase to 67 cents per share in 2Q18 is possible. In our 2018 free cash flow forecast, the annualized cash outflow of $18.6-million for the dividend would imply an 18-per-cent payout.

"We believe Lassonde's track record of profitable growth and regular dividend increases has been a key contributor to its significant share price appreciation, both on an absolute and on a relative basis."

Mr. Tremblay initiated coverage of Rogers Sugar Inc. (RSI-T) with a "buy" rating and $7 target. Consensus is $7.06.

"We are pleased to see the company, which was already the largest player in the duopoly-like Canadian refined sugar market, add a significant growth platform by entering the maple syrup bottling and distribution market via its recent acquisition of global market leader LBMT," he said. "A sustainable 5.8-per-cent dividend yield makes RSI an even sweeter investment opportunity, in our view."

Believing there's "more chapters left in this growth story," Mr. Tremblay pegged Brampton, Ont.-based Savaria Corp. (SIS-T) with a "buy" rating and $16.50 target, versus the consensus of $17.04.

"We believe the company's strong organic growth profile is intact and forecast meaningful contributions from recent acquisitions," said Mr. Tremblay. We believe a solid financial position and FCF profile advantageously position the company as it remains focused on profitable growth. Our preliminary analysis points to a $25–30 share price if management reaches its revenue objective of C$500m by the end of 2021."

Finally, Mr. Tremblay set a "buy" rating and target price of $4 for shares of TSO3 Inc. (TOS-T). The consensus target for the Quebec-based company, which develops sterilization systems designed to eliminate microbial contaminants from medical devices, is $3.84.

"With its best-in-class technology and extended claims, TSO3 appears poised to gain market share in the existing low-temperature sterilization market, in addition to potentially displacing high-level disinfection in the GI market," the analyst said. "With strong execution, we believe the company can unlock significant value for shareholders."

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Shares of Delphi Energy Corp. (DEE-T) are currently undervalued, said BMO Nesbitt Burns analyst Joe Levesque.

Believing the market is "underappreciating an improved balance sheet and Delphi's firm service with Alliance Pipeline which gives access to better pricing and avoids looming constraints on the NGTL system," Mr. Levesque initiated coverage of Calgary-based company with an "outperform rating.

"Delphi is an emerging Montney-focused E&P listed on the TSX," he said. "The company's operations are focused at Bigstone, where it has been accumulating land since 2010. Leadership at the company has remained intact with the exception of a recent change of CFO in April 2017. Operating results have been strong, in our view, and position the company to grow production at a 30-per-cent CAGR [compound annual growth rate] over the next three years into 2020. The company has a growth focus, intending to develop its large land inventory while maintaining a stable balance sheet. Delphi also strives to preserve liquidity in the event that additional consolidation opportunities become available.

"Delphi offers investors exposure to an E&P well positioned to grow while gradually deleveraging its balance sheet with self-generated cash flow. The company's trading multiples are currently depressed and as operational execution improves we could see the multiples move closer to peer/industry averages. We expect the company will reach cash flow neutrality starting in 2019."

Mr. Levesque set a price target of $1.75 for the stock. Consensus is $1.88.

"On BMO's price deck, Delphi trades at 2018 estimated enterprise value-to-EBITDA of 5.0 times versus the peer group at 6.8 times," he said. "We believe the company is misunderstood in the market due to its debt load and limited growth to date; however, the company has shown initiative in addressing both these issues leaving them well-positioned to outperform. We forecast debt to cash flow at 2.8 times in 2017, falling to 1.7 times by 2019. Our target price is in line with our estimate of the company's 3P NAV of $1.78 per share."

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Pointing to three potential catalysts for its outperformance, RBC Dominion Securities analyst Ross MacMillan raised his rating for Ellie Mae Inc. (ELLI-N) to "outperform" from "sector perform."

"First, we think 2H17 numbers are low enough with volumes slightly better and stabilization in application to close timing. Second, we expect revenue growth to accelerate in CY18 with less bad volumes, the impact from price increases and ongoing seat activations. Third, we think the next-gen platform could drive higher revenue per loan, larger bank wins and more operating leverage in CY19 and beyond."

Believing the risk-reward proposition for investors is currently attractive, Mr. MacMillan bumped his target for the stock to $105 (U.S.) from $90. Consensus is $98.36.

"While there could be some transitory risk from hurricanes in 3Q17, aggregate volumes looks better (up 1 per cent quarter over quarter versus down 5 per cent quarter over quarter at time of guide), reports from major mortgage banks suggest 5-per-cent quarter-over-quarter volume growth and the time to close loans has stabilized relative to deterioration in 1H17," the analyst said. "We also think downside risk is quantifiable with 7.5 times annualized recurring revenue and 20 times annualized EBITDA pointing to $75-80."

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"Taking time for reflection," BMO Nesbitt Burns analyst Brendan Warn downgraded Chevron Corp. (CVX-N) to "market perform" from "outperform."

"Chevron's 2018 and 2019 PE multiples are trading at greater-than 30-per-cent premium to the Majors' average," he said. "Despite Chevron's promising growth prospects in the Permian and ramp up of Australian LNG volumes supporting the dividend and potential share-buybacks, we cannot justify a widening valuation premium."

Mr. Warn kept a target of $120 per share. Consensus is $122.63.

Elsewhere, Société Générale analyst John Herrlin downgraded the stock to "hold" from "buy" and raised his target to $130 (U.S.) from $120.

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In other analyst actions:

BofAML upgraded Magna International Inc. (MGA-N, MG-T) to "buy" from "underperform" with a target price of $63 (U.S.), rising from $37. The analyst average price target is $55.69, according to Bloomberg data.

BofAML downgraded Chipotle Mexican Grill Inc. (CMG-N) to "underperform" from "neutral" with a target of $285 (U.S.), down from $390. The analyst average is $365.27.

MORE TO COME