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

Peter Sklar of BMO Nesbitt Burns Inc. has weighed in on the Dollarama story, cutting his target price from $47 to $42 but saying investors should not be too concerned with several issues in a recent short-sellers report.

U.S. firm Spruce Capital Management introduced its Dollarama thesis this week, questioning the company’s ability to boost sales and maintain high margins, and pointing out issues it has with the company’s accounting and disclosure.

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Mr. Sklar says “it is possible Dollarama may be closer to store maturity in Canada than the company believes,” and the company’s key same-store sales growth metric could erode without more price hikes. These are his two main concerns.

However, he disputes one of Spruce Point’s key arguments – increasing prices hurt its “dollar store” image – by saying his research suggests Dollarama can move up to a $6 price point, from the current top of $4, without denting demand. He also does not see U.S. discounter Dollar Tree expanding in the near future.

Mr. Sklar also says it’s unlikely Dollarama has violated accounting standards and investors are familiar with the founding Rossy family’s transactions with the company. Dollarama has paid nearly $150 million in the last five and a half years to the Rossys for rent and land purchases.

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Encana Corp.'s (ECA-N, ECA-T) US$5.5-billion acquisition of Newfield Exploration Co. (NFX-N) induced a negative reaction from analysts on the Street on Friday, leading to a series of rating downgrades and the expectation that near-term share price performance will likely be constrained.

Shares of Encana dropped 12.2 per cent on Thursday as investors expressed concern about the deal, which involves establishing a significant footprint in the Oklahoma shale play known as the Stack/Scoop.

Under the agreement, Newfield shareholders will get 2.6719 Encana shares for each Newfield share. Encana will also assume US$2.2-billion of Newfield debt.

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“We expect the market to remain cautious on the prospects for the SCOOP/STACK play until the company establishes operating performance through the deployment of its cube development model,” said Desjardins Securities analyst Kristopher Zack, who moved Encana to “hold” from “buy.”

“Some questions will likely still linger surrounding the motivation to expand into another core area after focusing the existing asset base. We expect that the other Newfield assets (ie minor positions in the Williston, Uinta and Arkoma basins, and oil assets offshore China) could eventually be put on the block.”

Though he believes the deal could eventually pay "significant dividends" to Encana in the long run, Mr. Zack expects Encana shares to be constrained initially as the market "rebuilds confidence" in the company's strategic plan.

"We estimate modest dilution to production per share on a pro forma basis, offset by a slight increase in EBITDA per share, while debt metrics will remain broadly unchanged," he said. "The deal metrics of US$39,000 per barrel of oil equivalent per day (boe/d) and 5.5 times EBIDTA (trailing-12-month) are within range of where ECA was trading prior to yesterday’s selloff at US$36,000/boe/d and 6.0 times, respectively. The liquids weighting will increase to 52 per cent of total production, which should be accretive to cash flow, while the expanded presence south of the border reduces exposure to wide differentials for both natural gas and light/heavy oil in Canada, with the U.S. expected to account (by our estimates) for more than 80 per cent of pre-hedge operating margin."

Mr. Zack lowered his target for Encana shares to US$13 from US$17. The average on the Street is US$16.85, according to Thomson Reuters Eikon data.

Similarly, Raymond James' Chris Cox called Thursday’s share price drop an “overreaction," believing the deal could prove “attractive” in the longer term as the market digests the news.

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Though he said investors “will likely move Encana into somewhat of a ‘show me’ story,” he lowered the stock to “outperform” from “strong buy” with a US$17 target, down from US$18.

“We believe downside to the story is limited from here, given the inexpensive acquisition cost of NFX, coupled with the potential for another round of asset sales following the transaction,” he said. “We think this creates an attractive risk-reward set-up for investors willing to own the stock through this ‘show me’ period.”

CIBC World Markets analyst Jon Morrison downgraded Encana to “underperformer” from “neutral” and lowered his target to US$13 from US$15.

“Overall, the Newfield acquisition reiterates why we didn’t have an Outperformer on the stock,” he said. “Despite our positive stance on the company’s concentrated land position in a number of highquality/impact plays and the benefit of a solid hedge book/market access that protects the platform against pricing/differential risks through 2020, there have been numerous strategic shifts over the past decade that don’t make it a simple story to tell. The addition of Newfield only reemphasizes that narrative and reaffirms some of the questions we have raised around the long-term strategy. We also find the decision to announce an all-stock acquisition concurrent with an increased share buyback as perplexing to say the least. Taking this all into account with our view that we do not see the Newfield deal as being additive to the asset base, we are electing to downgrade the stock.”

AltaCorp Capital’s Nicholas Lupick downgraded the stock to "sector perform" from "outperform" with a target of $13.50, falling from $17.50.

Mr. Lupick said: “Overall we are negative on the announcement to acquire NFX as we believe that it resets the company’s portfolio back to the more scattered state it was in three years ago. Additionally, we are disappointed in the lack of clarity provided by management, leaving investors without a clear understanding of the development strategy, capital requirements and future core focus of the company. Given the magnitude of unknowns we believe that the stock will carry elevated risk for investors until clarity is provided in Q1/19 at the closing of the transaction.”

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Meanwhile, the deal also prompted downgrades to Newfield stock.

RBC Dominion Securities Brad Heffern moved the Houston-based company to “sector perform” from “outperform” with a US$34 target, down from US$38. The average is US$38.78.

“NFX’s sale to ECA appears to us to be a tacit admission that there is no obvious path to unlocking the undeveloped upside in the Anadarko Basin other than a sale,” he said. “While we think the deal undervalues NFX’s assets, shareholders will be able to participate in the upside through ECA, and hopefully Canadian investors will appreciate the STACK more than U.S. investors have.”

Citi analyst Robert Morris downgraded it to “neutral” from “buy” with a US$24 target, down from US$36.

Mr. Morris said: "We view the decision by NFX to sell to a larger, more diversified E&P at this stage as the right decision. And while we also believe that the value of NFX’s assets are still underappreciated by the market, we feel that the best deal for NFX at this juncture has been struck and a higher bid is very unlikely to emerge."

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Raymond James' Chris Cox added Canadian Natural Resources Ltd. (CNQ-T) to the firm’s “Canadian Analyst Current Favourites” list, replacing Encana.

“We see an attractive risk-reward set-up for CNQ,” he said. “Downside is supported by robust FCF at strip pricing and the company’s ability to fund sustaining capital and the dividend down to $40-$45/bbl WTI. Following the company’s more defined FCF allocation policy, we see an outlook for robust share buybacks. Finally, we expect a meaningful improvement in Canadian oil differentials over the coming months, which should disproportionately benefit shares of CNQ, especially in the context of the stock’s inexpensive valuation and with higher cash flow from improving diffs translating directly toward more robust FCF.”

Mr. Cox has an “outperform” rating and $65 target for Canadian Natural Resources shares.

After his downgrade of Encana, he has an “outperform” rating for its stock and US$17 target.

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Challenges to the global dairy market are likely to persist longer than originally expected, according to CIBC World Markets analyst Mark Petrie.

“Furthermore, competitive pressures in the U.S. and Canada are taking a greater toll than we had forecast and again, a recovery is not imminent,” said Mr. Petrie.

That led him to lower his rating for Saputo Inc. (SAP-T) to “neutral” from “outperformer” following Thursday’s release of lower-than-anticipated quarterly results.

“SAP again reported weaker-than-expected U.S. profitability, and again we have cut our forecast," the analyst said. "The market remains challenged by oversupply, and this dynamic is not easing, while other cost (freight, ERP) and regulatory (California FMMO change) issues only add to the pressures. Similar dynamics exist in Canada, and while the USMCA preserves supply management, the precise impact of other concessions is unclear, and we have also reduced forecasts in that region. International is a bright spot, boosted by favourable FX dynamics in Argentina and improvements in Australia, but this is not enough to offset the pressures in SAP’s two largest markets.

"M&A remains a key part of the Saputo strategy and the company has been prolific in the last year. We expect ongoing activity, and management highlighted that several of the deals it is looking at today are material. In general, we are bullish on M&A for SAP, and build in a premium to our valuation as a result. However, while challenging macro dairy condition could lead to opportunistic deals, it also limits the near-term upside from a transaction. "

After lowering his earnings expectations to factor in lower margin expectations for both Canada and the United States, Mr. Petrie dropped his target price for Saputo shares to $42 from $47. The average is $43.67.

“We have been placing a premium multiple on Saputo based on its excellent longterm track record of capital allocation and operational excellence," he said. "While we still believe a premium is justified, a lower-for-longer outlook on operating margins compels us to reduce our valuation. Historical averages for Saputo have placed the next-12-months multiple generally in the range of 19-21 times. A move to the bottom end would be overly punitive given today’s below-average earnings in core markets, but our previous multiple of 24 times was overly generous.”

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Seeing “early signs of success” in adjusting its retail strategy, Desjardins Securities analyst Keith Howlett raised his rating for Gildan Activewear Inc. (GIL-T, GIL-N) following Thursday’s release of its third-quarter ratings, believing “the period of maximum risk has been traversed.”

“Gildan is achieving encouraging early results in shifting its retail channel strategy to meet evolving strategies of mass merchants,” he said. “Gildan brand men’s underwear, sold at a major U.S. mass merchant, will be replaced on shelf by the end of 2Q19 with private label men’s underwear manufactured by Gildan. The space allocation will increase by 50 per cent. Three other private-label programs at major U.S. retailers will ship in 4Q18. Gildan is getting ahead of a trend which would otherwise have damaged its business.”

Before market open, the Montreal-based clothing manufacturer reported operating earnings per share for the quarter of 57 US cents, meeting the expectation of the Street and exceeding Mr. Howlett’s projection by 3 US cents.

“Management has completed the bulk of the major task of combining its printwear and retail channel businesses, reducing the SGA expense rate in 3Q by 150 basis points year over year,” the analyst said. "Recognizing the pending shift of major U.S. retailers toward a mix of dominant brands and private-label apparel products, Gildan has adapted quickly. It has secured four significant private-label contracts. Management is focusing on categories and products which play to its competitive strengths, being activewear and men’s underwear produced in proximate manufacturing plants producing high-quality products at a cost advantage. Proven capability combined with ethical sourcing and socially responsible business practices are resulting in directly negotiated contracts.

“Note, however, that the success of private-label apparel products with consumers has still to be proven. In our view, it will be a new era of higher-quality, well-packaged private-label products, better promoted and displayed. This is reflected by Canadian Tire spending $1-billion to acquire Helly Hansen to add to its stable of private labels.”

Mr. Howlett maintained a $44 target for Gildan shares, which falls below the average of $46.41.

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Source Energy Services Ltd.'s (SHLE-T) third quarter “clearly wasn’t positive,” said CIBC World Markets' Jon Morrison, who downgraded its stock to “underperformer” from “neutral.”

“Unfortunately the conference call didn’t instill a whole lot of confidence that things are on the verge of inflecting in the near term,” said Mr. Morrison. "Despite the fact that we took the opportunity to materially dial back our pricing and margin assumptions for the Canadian sand market coming into the quarter, the negative headwinds are stronger than we expected and we continue to believe that domestic brown sand adoption within the Permian, Eagle Ford and Haynesville is causing a major “Southern Redirection” challenge, which is resulting in material price dislocation across the North American market. This is driving Wisconsin mine gate pricing to be very sloppy and a number of more course mesh sizes of Northern White sand (i.e., 20/40, 30/50) to clear into Canada at what looks like break-even prices. Given the more fixed cost nature of the frac sand business, this creates material challenges for margins and profitability in this operating environment. "

His target dropped to $2.25 from $4.50. The average is $4.86.

"While we fully recognize that the shares look ‘cheap’ on a number of metrics, realized results have underperformed expectations over the past year and as we highlighted in our Oct. 15 note titled “Lack Of Takeaway Capacity Will Leave Structural Heartburn In The WCSB”, we do not believe Canada can be a growth market until long-term egress issues are resolved and, in our view, this will be at least 12-18 months down the road. "

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Believing “all signs point to [a] strong spring” of 2019, Citi analyst P.J. Juvekar upgraded CF Industries Holdings Inc. (CF-N) to “buy” from “neutral,” expecting a 3-4-per-cent year-over-year increase in nitrogen demand.

“Earlier this year we tactically moved to the sidelines on CF, but at that time our longer-term fundamental view of favorable supply/demand fundamentals into 2019-2020 remained intact,” he said. “With the more than 10-per-cent pull back in the shares over the past few weeks we think CF is now again attractive reflecting: 1) Supportive cost curve fundamentals, with higher cost natural gas and LNG widening the cost spread between Europe & Asia and low-cost producer CF (benefits from cheap U.S. gas); 2) Favorable medium-term supply demand fundamentals as the pace of supply growth is anticipated to be low over the next few years; and 3) Tactically, a strong set-up into U.S. spring with the anticipated shift of 3-5 million acres into corn, the biggest user of nitrogen fertilizers. We believe that over time CF’s multiple will gradually compress as the urea market approaches mid-cycle in 2020/21, but the benefit from higher urea prices and profitability (each $25/ton each equates to $350-million of annualized EBITDA for CF) will allow the shares to outperform.”

After increasing his earnings expectations through 2020 based on higher prices, Mr. Juvekar raised his target for CF Industries shares to US$60 to US$56. The average on the Street is US$56.06.

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Citi analyst Keith Horowitz adjusted his financial estimates for U.S. banks in a research note released Friday in order to account for a higher cost of equity "given where we are in the economic cycle."

With the changes, Mr. Horowitz made a trio of rating revisions:

He upgraded Wells Fargo & Co. (WFC-N) to “buy” from “neutral” with a target of US$60, down from US$62 and below the average of US$61.93.

“Given our view of a reasonable valuation combined and a clear path to improving returns, we are upgrading WFC ... which we expect to begin growing revenues in 2Q19 while generating positive operating leverage,” the analyst said.

He also raised Comerica Inc. (CMA-N) to “neutral” from “sell” with a US$86 target, down from US$88. The average is US$99.68.

“We are upgrading CMA as the valuation looks more reasonable,” said Mr. Horowitz. “Our revised price target of $86 reflects 19-per-cent normalized ROTCE [return on tangible equity] and an implied cost of equity of 10.65 per cent.”

Mr. Horowitz lowered his rating for U.S. Bancorp (USB-N) to “neutral” from “buy” with an unchanged target of US$58, which falls 8 US cents below the average.

“While we still like USB’s organic growth story and that fact that it’s a good defensive play, we are downgrading to Neutral as we think the valuation looks fair at these levels,” he said. “We believe this has mostly played out here, and view WFC as a better defensive play for new money.”

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The outlook for Transat A.T. Inc. (TRZ-T) “remains challenging,” said CIBC World Markets analyst Kevin Chiang, who expects continued headwinds in its leisure travel operations based on the third-quarter results of North American airlines.

“While we recognize that each airline has its own revenue management programs in place and mix issues, a key observation we would make is that airlines with more established premium/business cabin products have posted better RASM [revenue per available seat mile] performance and a positive spread between RASM and adjusted CASM [cost per available seat mile] in Q3,” the analyst said. "Business cabin yields have been a key driver in helping airlines raise fares to offset rising fuel costs. TRZ, which is over indexed to leisure travelers, is dealing with a much more price-sensitive customer. TRZ acknowledged on its FQ3 call that it has been unable to raise fares as other airlines have done given its lack of a premium product line.

"We expect TRZ to continue to face challenges during the upcoming winter season. First, all the major carriers pointed to a soft pricing environment in Mexico, a key sun destination market for TRZ. Second, we foresee TRZ facing more competition, whether from the fare unbundling initiatives from the Canadian scheduled carriers to offer cheaper base fares or from increasing capacity, especially as WJA looks at seasonal redeployment of its widebody fleet in the winter. We suspect this capacity will find its way into the sun destination markets."

Moving the stock to “underperformer” from “neutral,” Mr. Chiang lowered his target by a loonie to $7, which sits beneath the average of $9.63.

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In other analyst actions:

TD Securities analyst John Mould raised TransAlta Renewables Inc. (RNW-T) to “buy” from “hold," while Canaccord Genuity’s David Galison upgraded the stock to “buy” from “hold.”

TD’s Sean Steuart raised Norbord Inc. (OSB-N, OSB-T) to “buy” from “hold” with a $33 target, up from $31. The average is $45.13 (Canadian).

National Bank Financial analyst Vishal Shreedhar cut Sleep Country Canada Holdings Inc. (ZZZ-T) to “sector perform” from “outperform” with a $27 target, falling from $34. The average is $37.22.

Canaccord Genuity analyst Mark Rothschild cut Artis Real Estate Investment Trust (AX.UN-T) to “hold” from “buy” and lowered his target to $11.50 from $13. The average is $13.36.

With a file from David Milstead

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