Friday's analyst upgrades and downgrades

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

After it reached agreements with the Alberta government on a pair of issues, Raymond James analyst David Quezada upgraded his rating for stock of Capital Power Corp. (CPX-T).

On Thursday, the Edmonton-based power producer announced deals relating to the 2030 coal phase-out and the settlement of a Power Purchase Arrangement (PPA) dispute.

"These two resolutions, plus [Wednesday's] announcement that Alberta will move to a capacity based power market, remove much of the risk associated with operating coal power assets in Alberta," said Mr. Quezada. "And, while we do not yet know if CPX will go ahead with its Genesee 4/5 gas project, we believe it paves the way for the company to turns its focus back to growth. This supports our upgrade to Outperform [from Market Perform]."

Under the coal phase-out deal, Capital will received annual cash payments from the province of $52.4-million for 14 years for a total of $734-million.

"We calculate that, prior to this announcement, the stock had been discounting roughly $500-million in compensation and thus expect the stock to trade higher on this news," said Mr. Quezada. "The release also notes the company regards this compensation as fair because it repays shareholders for stranded capital while also recognizing the potential for extending the lives of certain coal power plants (at Genesee site) by converting them to natural gas. While few details were provided on this front, we expect more information at the company's investor day on Dec. 15. The issue of compensation for stranded coal assets had represented a significant overhang for CPX and we believe this resolution represents a material positive."

Capital has agreed to pay $20-million, or $15-million after tax, to settle its portion of the dispute over the Sundance C Power Purchase Arrangement.

"The second resolution related to the legal dispute between CPX and the AB government on the return of unprofitable PPAs to the Balancing Pool," the analyst said. "Recall, the rationale for the return of these unprofitable agreements (in which the producers were obligated to purchase power at rates much higher than spot power prices) had been returned to the pool based on a change in law that rendered these agreements 'more unprofitable.' The power producers believed changes to carbon compliance rules had constituted a change in law and attempted to return them, prompting legal action by the government. We believe the $20-million CPX will pay to settle this dispute is minor in relation to the stranded asset compensation."

With the upgrade, Mr. Quezada also raised his target price for the stock to $24 from $20 "to reflect the removal of this uncertainty." The analyst average price target is $23.09, according to Bloomberg.

The stock was also upgraded by the following analysts:

- Scotia Capital's Robert Hope to "sector perform" from "sector underperform" with a target of $21, up from $18.50.

- Industrial Alliance's Jeremy Rosenfield to "buy" from "hold" with a $26 target, rising from $22.50.

BMO Nesbitt Burns analyst Ben Pham maintained his "market perform" rating and raised his target to $23.50 from $21.50. He said: "The Alberta government's decision to provide compensation to CPX for stranding capital invested in coal power plants is a positive development. Not only did the government make a rational decision, when combined with other actions this week (i.e., transition to a capacity market), we see this as improving investor confidence in the AB power market following a year of significant uncertainty and disruption. We understand that compensation was only provided for coal plants that were originally slated to operate beyond 2030 (Sheerness 1-2, Genesee 1-3, and K3)."

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"Christmas came early" for TransAlta Corp. (TA-T), said BMO Nesbitt Burns analyst Ben Pham, who believes Alberta's decision to provide compensation for stranding capital invested in coal power plans is a "positive development."

"Not only did the government make a rational decision, when combined with other actions this week (i.e., transition to a capacity market), we see this as improving investor confidence in the AB power market following a year of significant uncertainty and disruption," said Mr. Pham.

Mr. Pham noted the company's payments of $37.4-million through 2030, for a total of $524-million, fell below his expectation of $600-million. However, he said it was "likely above tempered expectations coming into this week."

"Further, these proceeds could be redeployed to new investments such as coal-to-gas conversions and renewable power," he said.

Mr. Pham maintained his "market perform" rating for the stock, but he raised his target to $7.50 from $6.50. The analyst average is $6.97.

"We believe the stock will trade closer to our NAV [net asset value] projection and expect a significant boost to near-term sentiment," he said. "This new TP implies 6.6 times EBITDA on our 2018 estimates."

"While the total return profile for TA is now compelling and we expect a near-term boost in investor sentiment and improved valuation, Alberta power prices will likely remain weak over the next year and the potential benefits of coal-to-gas conversions will likely not occur until the next decade."

Elsewhere, the stock was raised to "outperform" from "sector perform" by National Bank analyst Patrick Kenny. He maintained a target of $7.50.

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Valener Inc. (VNR-T) delivered "solid" fourth-quarter results, said BMO Nesbitt Burns analyst Ben Pham, who said he's encouraged by the Quebec-based energy company's guidance for the 2017 fiscal year.

On Thursday, Valener reported adjusted earnings per share of a loss of 2 cents, up from a 10-cent loss a year ago and ahead of the consensus projection of an 11-cent loss and Mr. Pham's estimate of an 18-cent loss. He cited better-than-expected contributions from Gaz Métro's energy distribution business as the chief rationale for the beat.

"Consistent with our expectations and management's previous guidance, the Board announced an increase in the dividend to $1.12 from $1.08, effective January 2017," said Mr. Pham. "Management also reiterated further dividend growth of 4 per cent in 2018."

"Management is guiding for Quebec utility earnings of $136-million in FY17 versus $130-million in FY16, driven largely by an increase in non-rate base investment and, to a lesser extent, rate base growth (estimated to be up $88-million). While the allowed ROE [return on equity] for Gaz Métro-QDA remains at 8.9 per cent, the 2017 regulated ROEs in Vermont are expected to be 9.02 per cent at Green Mountain Power (vs. 9.44 per cent) and 9.7 per cent at Vermont Gas Systems (versus 10.09 per cent). Management also expects total capex of $430-million for Gaz Métro, with 90 per cent allocated towards the Energy Distribution segment (QDA, GMP & VGS)."

Based on the results and guidance, Mr. Pham raised his 2017 and 2018 earnings per share projections to $1.27 and $1.24, respectively, from $1.18 for both years.

He kept his "market perform" rating for the stock and raised his target to $22 from $21. The analyst consensus is $23.08, according to Thomson Reuters.

"While the 5.2-per-cent yield and high earnings quality profile is attractive, we are maintaining our Market Perform rating due to relative total return," he said.

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Citing the potential of both its Kamoa copper project in the Democratic Republic of the Congo and Kakula deposit, the southern part of Kamoa, Canaccord Genuity equity analyst Tony Lesiak initiated coverage of Ivanhoe Mines Ltd. (IVN-T) with a "speculative buy" rating.

"The rumble in the jungle is the sound of seven drills turning on what could be the world's most prolific copper discovery in decades," he said. "Despite the remaining exploration potential, Kamoa/Kakula already ranks as the world's fifth largest and highest grade copper deposit. Another rumble is coming from Kinsasha (DRC) where President Kabila is not expected to relinquish control when his second mandate expires (Dec. 19). After battling depressed metal prices, funding issues, a share overhang, and Rio Tinto (previous Ivanhoe), Executive Chairman, Founder and Chief owner (21.5 per cent) Robert Friedland is back in the spotlight with a new discovery, two other strategic assets, and a Chinese partner and potential financial backstop, the Zijin Mining Group (9.9-per-cent equity stake in IVN). While it may take an extra round for the valuation knock-out blow, a strong balance sheet ($400-million in cash and pending asset sale proceeds) should keep Ivanhoe in the ring. Ultimately, the world's senior mining companies are seeing declining reserves, head grade and asset quality. Ivanhoe may ultimately represent a solution or competition."

Saying Ivanhoe possesses three tier-one assets, Mr. Lesiak said: "Ivanhoe controls three of the world's highest grade and most strategic mining assets with most miners typically fortunate to control just one: Kamoa/ Kakula (40-per-cent stake, DRC, copper, start late 2020), Platreef (64-per-cent stake, South Africa, PGM's and nickel, start late 2020), and Kipushi (68-per-cent stake, DRC, zinc/copper, start 2019). While the location (72-per-cent DRC, 28-per-cent South Africa) of Ivanhoe's assets may give pause to North American investors, the DRC Copperbelt is becoming a preferred investment destination for others."

Though he said the company currently features a "compelling" valuation, Mr. Lesiak said Ivanhoe is not a near-term free cash flow story. He added funding and further feasibility work is required.

"Overall, the key takeaway is that Ivanhoe controls what we view as three of the most strategic mining development assets globally and that these assets should be prized by the larger diversified and base metal miners, particularly given declining reserves and production and grade profile," he said.

"Strategic assets typically trade at a premium, not a discount. Ivanhoe has publicly announced (Aug. 2016) unsolicited interest in both the company and its projects. The recent announced acquisition of Tenke Fungurume in the DRC (FCX selling stake to China Moly) signals that Chinese investment interest in the DRC remains strong. We calculate that the terms of the Tenke transaction imply a 10% discount rate for valuation purposes which is below the 12-per-cent DCF rate we have used to value Ivanhoe's DRC assets and well below western estimates. As mentioned previously, utilizing a 10% DCF rate for Ivanhoe's DRC assets would increase our NAV by 19 per cent. Utilizing an 8-per-cent discount rate for all three assets would improve our NAV by 63 per cent."

Mr. Lesiak set a price target of $3.50 per share. The average is $2.90.

 "Selecting a specific target price on a 12-month basis for Ivanhoe Mines is problematic in the context of the current volatile commodity (copper, zinc and platinum group metal [PGM]) and currency (ZAR) market, the multitude of additional funding/partnership options, changing political risk profiles (various discounting rates), and given the rapidly changing status and strategic nature of the existing assets. In the longer term, however, we are confident the shares may be valued significantly greater than they are today," he said. "The three core assets in the company which include a 39.5-per-cent stake in Kamoa (copper), 64-per-cent stake in Platreef (PGM and nickel) and 68-per-cent stake in Kipushi (zinc and copper) are viewed as world class. In our opinion, all three assets will be developed which could result in a material rerating of Ivanhoe's shares."

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Credit Suisse analyst Ralph Profiti raised his target price for stock of Teck Resources Ltd. (TCK.B-T, TCK-N) in reaction to its fourth-quarter 2016 coal price update.

On Wednesday, Teck increased its realized price expectations to $200-$205 (U.S.) per tonne from $185.

"Teck's equity-implied coal price has benefited from debt reduction, cost savings, weaker Canadian dollar and stronger copper and zinc prices," said Mr. Profiti. "We estimate Teck is trading at an equity-implied coking coal benchmark price of $140/t (at $2.45/lb copper, $1.10/lb zinc and $0.75). Since the most recent trough in spot coking coal prices in June 2016 ($87/t), the impact of a weaker Canadian Dollar (down 3.0 per cent), debt restructuring, cost savings and stronger base metals prices yields an equity-implied coal price of 26 per cent to $140/t."

In reaction to the change, Mr. Profiti increased his fourth-quarter 2016 EBITDA and EPS projections to $1.824-billion and $1.54, respectively, from $1.353-billion and $1.00. His full-year 2017 EPS estimate rose to $2.52 from $1.90.

"We see compelling valuation support for Teck in a tight coking coal market in 2017, constrained supply-side response, reflation of the steelmaking cost curve, equity scarcity among global coking coal plays, stronger than expected base metals prices, and weaker Canadian Dollar," said Mr. Profiti.

He maintained an "outperform" rating for the stock and raised his target to $35 from $33. The average is $33.63.

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In other analyst actions:

RBC Dominion Securities analyst Ioannis Masvoulas upgraded ArcelorMittal SA (MT-N) to "outperform" from "sector perform." He said: "ArcelorMittal offers good exposure to US fiscal stimulus and trade protectionism and is trading at discounted multiples. The company should be well positioned to address macro headwinds over the medium term given its structural cost reduction, improved cash conversion, and recent equity raising."

Canadian Equipment Rentals Corp. (CFL-X) was cut to "sector perform" from "speculative buy" by Alta Corp analyst Aaron MacNeil. He lowered his target to 35 cents from 50 cents. The average is 57 cents.