Friday’s analyst upgrades and downgrades

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

RBC Dominion Securities analyst Stephen Walker raised his rating for Centerra Gold Inc. (CG-T) in reaction to its settlement of outstanding disputes with Kyrgyzstan over its vital Kumtor gold mine.

On Monday, the Toronto-based company announced it has reached a "comprehensive" agreement with the Asian nation, settling issues regarding the Kumtor mine, which is the biggest for both the company and country.

Under the deal, all Kyrgyz arbitral and environmental claims disputes, proceedings and court orders against Kumtor are to be dropped. Centerra is also poised to transfer funds from the country that had been frozen.

Mr. Walker now believes concerns over Centerra's liquidity have been alleviated, calling it "manageable" at current gold price levels.

He said: "The company outlined key terms of the proposed settlement, which include: (1) an affirmation of the existing 2009 agreement governing the Kumtor project and settlement of all outstanding disputes; (2) a one-time lump sum payment of $57-million ($50-million towards a Nature Development Fund and $7-million for a Cancer Care Support Fund) plus a $3-million payment to the Cancer Support Fund within 12 months of closing; (3) annual payments of $2.7-millionm to a new Nature Development Fund; and (4) accelerated payments to the Kumtor Reclamation Trust Fund of $6M/year until the total contribution reaches the estimated reclamation cost of $69-million based on an independent assessment. We estimate the incremental liability of the settlement to have an NPV of $85-million at 5 per cent."

Moving his rating for the stock to "sector perform" from "underperform," Mr. Walker raised his target price to $10 from $8. The analyst consensus price target is $9.07, according to Thomson Reuters data

"With the overhang of the frozen Kumtor cash lifted, we lowered our discount rate for Kumtor from 12 per cent to 10 per cent, more in line with discount rates used for other assets with similar geopolitical risk profiles. Our NAV [net asset value] increases from $8.43 to $8.98 (including Q2/17 updates and the impact of a stronger Canadian dollar in our USD to CAD valuation conversion). We raised our P/NAV target multiple from 0.9 times to 1.0 times based on our multi-factor valuation model and raised our enterprise value/adjusted cash flow multiple from 10.0 times to 11.5 times, in line with the average used for global intermediate gold producers under RBC coverage. Our price target increases … and our Sector Perform recommendation is supported by the implied return of 10 per cent, in line with the average implied return of 10 per cent for Sector Perform-rated peers."

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Empire Company Ltd. (EMP.A-T) has made "impressive" progress in its efforts to stabilize after a "forgettable" 2016, said CIBC World Markets analyst Mark Petrie.

Reacting to "excellent" first-quarter financial results, Mr. Petrie upgraded Empire, the parent company of Sobeys Inc., to "outperformer" from "neutral."

"Any concerns we have had around Empire's target of $500-million in cost savings by fiscal 2020 have not been around the opportunity, rationale or even execution of its plans to consolidate and simplify the organizational structure," said Mr. Petrie. "Rather, we have hesitated with regard to how much of these savings would fall to the bottom line vs. be re-invested back into the business to help rebuild the top line. We continue to believe the company will need to invest in marketing, promotions and in-store experience in order to maintain competitiveness (particularly without a meaningful discount presence in any market besides Ontario), or certainly to re-build the top line. However, we interpret Q1's internally engineered inflation, GM% expansion and well-controlled SG&A line as evidence of the underlying power of the company's brands and locations, and the substantial low-hanging fruit Empire has available to be harvested, completely separate from the $500-million.

"It is impossible to put a specific figure on the final net savings given the uncertainty of how smoothly this massive change will unfold, or how the competitive environment will evolve. But where we might have pegged 60-70 per cent as the estimate of savings flow through, we see it as more likely at least 80 per cent now."

Mr. Petrie said it is "highly likely" that Empire will test its FreshCo discount chain in Western Canada in the next 6-12 months. He expects a slow, cautious roll-out with a small number of locations, with an aim to minimize capital and opex investments.

"The vast majority of Safeway's near 200 stores are much too large to be converted to discount, with locations that are better-suited to a full-price offer anyway," he said. "However, approximately 15 per cent are around 30,000 square feet, which means that a conversion to discount would not require cutting off any part of the store. We suspect the company would proceed cautiously, likely starting with five to ten locations, but could see substantially more potential for the concept as it is proven out and awareness builds with consumers. Legacy labour contracts will be something that need to be addressed in time, but we see this as a negotiable constraint.

"When FreshCo was launched in Ontario back in 2010 we estimate that the company spent about $1-million per location in order to complete the conversion from Price Chopper. Costs have risen since then, and the Safeway stores that would be replaced are in similarly rough shape as the Price Chopper stores were in Ontario, so ball-parking $1.5-million per location is probably reasonable. With only a handful of conversions, this type of spend could easily be accommodated without substantially pushing capital budgets, though we have upped our F2019 capex forecast modestly. Overall, we estimate that less than 40 per cent of the Western Canada market moves through 'discount,' which puts it roughly in line with Quebec but substantially below Ontario where we peg it at 55 per cent-plus Customer tastes have certainly evolved toward discount in recent years, and this would need to continue in order to support additional square footage growth. But based on our belief that the market will continue to evolve this way, and the store counts in the market today, we believe there is an attractive opportunity for a focused discount grocery offer."

Based on the quarterly results, Mr. Petrie raised his fiscal 2018 and 2019 earnings per share estimates to $1.05 and $1.71, respectively, from 85 cents and $1.41.

His target price for Empire shares moved to $27 from $20. The analyst consensus price target is $23.61.

"We also recognize that the competitive environment is challenging, and the evolution to online brings additional uncertainty," the analyst said. "However, the Q1 results underscore the underlying power in these assets, before any substantial market share is recovered. In our view, the shares can be bought today even absent a view that Empire will return its market share to former heights."

Elsewhere, Raymond James analyst Kenric Tyghe said Empire is "picking up momentum on a long (windy) runway."

"Empire's same-store sales performance (SSS growth of 0.5 per cent) reflected ticket and traffic growth (on positive internal food inflation) versus negative Food CPI in the quarter, for modest market share gains," the analyst said. "The key point here is not that the share gains were modest, but rather that there were gains, which were achieved in a highly disciplined fashion (as highlighted by the better than expected gross margin performance). While we believe that there necessarily remains room to improve gross margins and significantly reduce SG&A, we are also mindful of the risks of increased competitive intensity (as the battle around Organics heats up) and the wage inflation headwinds facing the industry through 2020.

"As such, while the performance (and beat) in the quarter were impressive, and we have confidence in Project Sunrise's ability to deliver the expected benefits, we are loathe (this early) to get ahead of it given the length of the runway (and the number of potential bumps)."

With a "market perform" rating (unchanged), Mr. Tyghe increased his target price for the stock to $24 from $22. "Our new $24.00 target price is based on our SOTP [sum-of-the-parts] calculation, which applies a 14.0 times multiple to our revised F2019 EPS for a NAV of $23.76," he said. "We believe that our target multiple represents an appropriate discount versus its Canadian peer group given the new strategic priorities (and urgency), while still allowing for the reality that the road back will be neither quick nor easy."

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CIBC World Markets analyst Oscar Cabrera believes "the cycle has turned" for base metals.

"Base metal prices and equities hit five-year lows in Q1/16 on concerns over China and extended balance sheets," he said. "However, we forecast base metal producers to benefit from improved metal price fundamentals on the back of a period of sustained global growth, marked by a reversal of easing monetary policies around the world."

"We expect base metal equities' price/earnings and enterprise value/EBITDA to peak in 2017, with improving metrics in 2018 and 2019 due to increasing base metal prices, declining net debt levels and improving operating performance for most of our covered companies. While lower metal prices pose the highest risk to our recommendations, we forecast an upturn in the base metal cycle. As such, we view financing and development project risks as the main hurdles to reaching our price targets."

In a research report on the sector, Mr. Cabrera initiated coverage of seven companies.

Citing its "best-in-class strategy" among North American miners, he called Lundin Mining Corp. (LUN-T) his top pick, giving it an "outperformer" rating and target of $12 per share. Consensus is $9.41

"LUN's disciplined growth, based on developing high value-add projects, is best in class among North American metals and mining companies under coverage," he said. "In addition, LUN has a high leverage to our preferred base metals, zinc and copper. We expect the company's EBITDA to increase 122 per cent to $1.3-billion by 2020 driven by a 60-per-cent increase in zinc production from the Neves Corvo (NC) mine expansion and higher zinc and copper prices. LUN's strong balance sheet should also allow the company to seek accretive external growth opportunities (e.g., Candelaria, Eagle)."

Mr. Cabrera also gave "outperformer" ratings to the following stocks:

Capstone Mining Corp. (CS-T) with a target of $2. Consensus is $1.61.

"CS' high-cost operations are among the most leveraged to the copper price in our coverage universe," he said. "We expect the copper price to increase steadily to an incentive price of $3.70 per pound in 2023. Despite relatively flat copper production, we expect CS' EBITDA to increase 61 per cent to $249-million by 2020. Thus, we regard continued operating improvements and mine life expansion at Pinto Valley as the main catalysts for the company."

Freeport-McMoRan Inc. (FCX-N) with a target of $18 (U.S.). Consensus is $15.35.

"The largest publicly traded copper producer in the world is refocusing its value-creation strategy to its copper assets, after a failed attempt to diversify into oil & gas left it with high debt levels," the analyst said. "A positive resolution of the dispute between FCX and the Government of Indonesia (GoI) over Grasberg long-term rights could be the largest near-term catalyst for FCX shares, potentially adding 9 per cent to our NAV with a lower discount rate on the project (14 per cent to 10 per cent)."

Turquoise Hill Resources Ltd. (TRQ-T) with a target of $5. Consensus is $5.33.

"TRQ's 66-per-cent-owned Oyu Tolgoi (OT) coppergold deposit, in partnership with the Government of Mongolia (34 per cent), is expected to be the third-largest copper-producing mine next decade, with the fourth-largest reserves, offering great leverage to copper, one of our preferred base metals," said Mr. Cabrera. "This world-class deposit started production in Q3/13 with an open pit, but copper production is expected to increase from 172Kt in 2017 to over 600Kt in 2025 with the OT underground. TRQ has received technical and financing support from its 50.8-per-cent equity owner Rio Tinto, lowering the challenges posed by OT underground development, in our view."

Mr. Cabrera gave the following stocks "neutral" ratings:

First Quantum Minerals Ltd. (FM-T) with a target of $15.50. Consensus is $16.92.

"We expect FM's EBITDA to nearly triple to $3.2-billion by 2020 driven by higher copper prices, lower costs and a 64-per-cent increase in copper production," he said. "However, we believe this potential upside is well balanced with development and refinancing risks from its next leg of growth, the Cobre Panama project."

Ivanhoe Mines Ltd. (IVN-T) with a target price of $5 per share. Consensus is $5.85.

"IVN is the majority owner of three world-class copper, platinum group elements (PGE) and zinc deposits located in Africa: Kamoa-Kakula (moving to 41.2-per-cent ownership), Platreef (64 per cent) and Kipushi (68 per cent)," he said. "While the company's projects have significant potential due to their mineral resource size, scalability and high grade, we see substantial development, financing and sovereign risks (DRC and South Africa)."

Mr. Cabrera gave Imperial Metals Corp. (III-T) an "underperformer" rating with a target of $3.50. Consensus is $4.26.

"The lack of expected operating performance at III's main asset, the Red Chris copper-gold mine, led to non-compliance of debt covenants under the company's bank senior credit facility in Q2/17," he said. "As a result, III is revising its mine plans and looking to secure additional financing or request an extension of debt maturities. Given operating and capital structure uncertainty, we view risks as skewed to the downside, despite the company's high leverage to one of our preferred commodities, copper."

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Reaffirming his positive thesis on Nutrien, the company set to stem from the friendly merger of Potash Corp. of Saskatchewan Inc. (POT-N, POT-T) and Agrium Inc. (AGU-N, AGU-T), RBC Dominion Securities analyst Andrew Wong raised his target price for shares of both companies.

"We believe the combined company provides clear synergy opportunities and view the $500-million target as very reasonable when compared to precedent transactions," said Mr. Wong. "We also note that recent clarity on the potential remedies required by regulators (smaller assets in nitric acid and superphosphoric acid) alleviates any concern of a larger divestment that could impact the original synergy plans."

Adding re-allocating of capital in equity investments "could create significant value," the analyst said: "We think there is a significant opportunity to create value by re-allocating capital currently tied-up in Potash Corp's equity investments worth$5.7-billion, and the 'forced sale' of these investments required by regulators in India and China may help expedite this process. We roughly estimate that ~$1B capital re-allocated to Retail acquisitions could generate $400-600-million of additional value, while there is attractive optionality in share repurchases, M&A opportunities (upstream Retail or undervalued assets), and greenfield Retail investment."

Mr. Wong maintained his "outperform" rating for both stocks.

His target price for Potash shares rose to $20 (U.S.) from $19. Consensus is $20.56.

"PotashCorp has invested heavily to grow its potash capacity and is well positioned to meet rising potash demand as these projects come online through 2017," the analyst said. "We expect to see improving free cash flow as the potash market gradually recovers and capex investments are essentially completed."

His target for Agrium grew to $115 (U.S.) from $110. Consensus is $106.81.

"Agrium has built the most diverse, vertically integrated agricultural input business," said Mr. Wong. "We believe the company has a clear path to earnings growth from both its Retail and Wholesale businesses that should translate to robust cash flows with lower volatility."

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Founders Advantage Capital Corp. (FCF-X) is finding a path to scalability with its recent partnership with Sagard Holdings, according to Industrial Alliance analyst Dylan Steuart.

On June 14, Founders closed a $100-million credit facility with Sagard, an investment subsidiary of Power Corporation of Canada (POW-T).

Mr. Steuart: "The benefits of the new credit facility are threefold: 1) the new credit facility removes some of the more stringent covenants of the replaced credit line; 2) the initial draw of $56-million provides the Company $30-million of 'dry powder' for future acquisitions with the option for further draws on the facility as opportunities arise; and 3) the partnership provides credibility to the FCF thesis and the potential to leverage Sagard's additional capital and expertise in future acquisitions."

Believing its current valuation provides an "attractive" entry point for investors, Mr. Steuart initiated coverage of Calgary-based Founders with a "speculative buy" rating.

"FCF's unique offering to potential private equity investment targets represents a competitive differentiator and will allow management to leverage recent funding developments and continue to build out its portfolio," he said. "While there are evident risks to the growth story of FCF's largest investment (Dominion Lending Centres (DLC)) and its exposure to the domestic housing market, current valuation at base levels remains attractive in our view, particularly assuming that diversification of the portfolio is secured in the near term."

He set a target price of $3.75 for shares of Founders. Consensus is currently $3.81.

"FCF is currently trading at 6.0 times on a forward enterprise value /EBITDA basis, a discount to peers, but at a valuation that we feel does not reflect the scalability of the platform," said Mr. Steuart. "Historically, peers have traded at an 11.0-times average EV/EBITDA on a trailing basis."

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RBC Dominion Securities analyst Steven Cahall is "conflicted" about the future prospects of Sirius XM Holdings Inc. (SIRI-Q), calling the next 12 months "decisive."

"We think it's well positioned to boost sub additions with used cars, offering potential upside to estimates," he said. "However, in Media the secular can quickly outweigh the stock-specific, and we worry that digital competition will overtake the narrative. We think investors need a more compelling entry point or better visibility."

Mr. Cahall initiated coverage of the New York-based company with a "sector perform" rating.

"Our Sector Perform rating leaves us aggressively sitting the fence as we see how the competitive landscape plays out," he said. "If SIRI can deliver upside to self-pay net adds driven by more visible penetration of the used car market, then earnings can move the stock toward our upside case. If digital competitors up the ante with better pricing, content, or functionality, then disintermediation fears should derate SIRI toward our downside case. It's a lot of unknowns to get past, hence we're on the sidelines initially, with an aim to get more bullish or more bearish as this competitive landscape evolves. The recent investment in [Pandora Media Inc., P-N), and [its 360L platform], add some defensiveness, but Silicon Valley's pockets are deep."

"While we think SIRI will 'block and tackle' its way to better-than-expected adjusted EBITDA (we're 3 per cent above consensus for 2017), net adds are likely to be more volatile as subs increasingly come from used vs. new car transactions. Our forecasts predict that used trial starts will climb from 35–40 per cent in 2014–16 to 50 per cent in 2018 and greater-than 50 per cent by 2020. We think SIRI is easy to own when SAAR is increasing, so better line-of-sight into growth from used adds would make us more bullish."

Mr. Cahall set a price target of $6 (U.S.) for Sirius shares. The analyst consensus is $5.67.

"SIRI is up 44 per cent over the last two years, outperforming the S&P 500 by 1,710 basis points," he said. "While it's arguably still a beat-and-raise story with excellent management, connected competition is on the rise while paying sub net adds are decelerating and tax assets are expiring. We therefore think that earnings, rather than the multiple, will be the primary driver of future stock appreciation, likely limiting compelling upside."

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Canaccord Genuity analyst Ken Herbert raised his target price for shares of Boeing Co. (BA-N) ahead of its annual investor day, scheduled for Sept. 18-19 at its facility in South Carolina.

At a Morgan Stanley conference on Wednesday, chief executive officer Dennis Muilenburg announced the aerospace giant plans to raise production of its 787 Dreamliner to 14 a month (from 12) in 2019. He expressed confidence that production rates for its older 777 have stopped falling and signals its faith in rebounding wide-body demand.

Mr. Herbert expects the company to further elaborate on the cost and execution progress of the 787 during the event. He also predicted Boeing will be "incrementally more confident on its ability to recover the deferred costs now across the 1,400-unit 787 accounting block."

"We also expect substantial discussion on the state of the commercial market, Boeing's services business, and the outlook for FCF upside and margin expansion," the analyst said.

"We expect substantial focus on the BGS (services) business, and specifically the M&A growth opportunity and strategy. Assuming a 6-7-per-cent organic growth outlook for this $14-billion business, this implies $27-billion in acquired revenues to hit the $50-billion in 2025 target. And while we do not expect investors to hold it against Boeing if it does not hit this target, we do expect substantial activity by Boeing in the near future which will better demonstrate the strategy, margin upside, and potential FCF contribution from the BGS business. We understand Kent Fisher (who ran supplier relations for BCA) is assembling a very large team now in Chicago to drive services M&A activity. As part of its cost and services push, BA is also looking to further vertically integrate. We expect Boeing will provide incremental details on these efforts as they support the services strategy, as well as contribute to the margin expansion story."

Mr. Herbert maintained a "hold" rating for the stock, noting "growing capacity risks, challenges with the mid-teens margin targets, and uncertainty around the growth of the BGS business."

He hiked his target to $235 (U.S.) from $215. Consensus is $253.20.

"There is a sense right now that Boeing can do no wrong," he said. "The stock (up 55 per cent year to date) has significantly outperformed its large cap peers. The company has been able to outperform recently on its FCF guidance, execution on the 737 MAX 10 launch was as good as can be expected, order activity broadly has seen some wide-body strength, macro trends are positive for both the commercial and defense business, and since the hiring of new BCA CEO McAllister, the commercial business seems to be outperforming across the board."

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In a research note released Thursday, RBC Dominion Securities analysts Brian Abrahams, Kennen MacKay and Matt Eckler initiated coverage of 35 U.S. biotech companies.

On the sector, as a whole, they said: "We believe sentiment has reached somewhat of a turning point, in light of a string of positive data catalysts and cooling off of political rhetoric around drug pricing. Despite recent appreciation, we see potential for sustained near-term momentum, with multiples still looking reasonable vs. the broader markets, increasing innovation and a favorable regulatory environment likely to continue to drive prolific drug development, and our analysis suggesting plenty of room for additional money flow into the space. Longer-term, maturing franchises, increasing competition, and pricing pressure may put some cap on future revenue growth and earnings power, as well as appreciation potential. With mid-cap biotechs having run up most of late due to M&A activity, we favor large-cap biotechs, as well as select small-cap names with promising assets."

Among large cap companies, the firm gave Celgene Corp. (CELG-Q) their "top pick" rating with a target of $176 (U.S.). Consensus is $151.83.

Mr. Abraham said they selected Celgene "for its unique, attractive combination of best-in-class medium-term growth prospects, broad early- and late-stage pipeline, favorable reward/risk into upcoming catalysts from the I&I franchise, and a business model that should enable strong sustained operating margins."

RBC called Alexion Pharmaceuticals Inc. (ALXN-Q) another favourite, with Mr. MacKay giving it an "outperform" rating and $161 (U.S.) target (versus consensus of $163.32), citing "upcoming Soliris expansion in MG [myasthenia gravis] and strong management leadership."

They also called Gilead Sciences Inc. (GILD-Q) and Vertex Pharmaceuticals Inc. (VRTX-Q) favourites.

Mr. Abrahams gave both stocks "outperform" ratings.

Gilead has a $94 (U.S.) target, compared to the consensus of$81.88

"With increased visibility towards HCV [hepatitis C virus] sustainability, HCV resiliency illustrating long-term cash flow potential, the pipeline maturing, and M&A execution improving sentiment, we expect shares to appreciate to levels more commensurate with peers and DCF fair value," the analyst said.

He gave Vertex a target of $175 (U.S.). Consensus is $178.35.

"We are bullish on the prospects of VRTX's CF [cystic fibrosis] triple-combo, their long-term competitive positioning, and the high-growth/margin potential of the core CF business – all of which we think reflect strong fundamentals and potential for additional share appreciation," said Mr. Abrahams.

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In other analyst actions:

Citing a noticeable lack of revenue per available seat mile (RASM) optimism, JPMorgan downgraded American Airlines Group Inc. (AAL-Q), Spirit Airlines Inc. (SAVE-Q)  and United Continental Holdings Inc. (UAL-N) to "neutral" from "overweight." The firm, led by analyst Jamie Baker, raised Southwest Airlines Co. (LUV-N) to "overweight" from "neutral" based on valuation and a more attractive risk-reward proposition for investors.

Credit Suisse analyst Tim Ramskill downgraded Carnival Corp. (CCL-N) to "neutral" from "outperform" based on an "uncertain" outlook. He lowered his target to $70 (U.S.) from $78.

"Industry supply growth is significant (2017-2022 estimated CAGR 6.1 per cent) and when coupled with increasing demand threats for 2018 in the top 3 cruise markets (Caribbean, Mediterranean and China) we assume more cautious 2018 yield growth (1.5 per cent from 3.0 per cent)," said Mr. Ramskill. "2018 estimated EPS and our DCF based target price fall 10 per cent."