Friday's analyst upgrades and downgrades

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

Fundamental trend shifts and rising competitive pressures are hurting Lululemon Athletica Inc.'s (LULU-Q) position in the market, according to Canaccord Genuity analyst Camilo Lyon.

He lowered his 2017 financial estimates for the Vancouver-based designer, distributor and retailer of athletic apparel in response to a recent survey of shoppers "with the aim of assessing consumers' future intent to purchase LULU yoga pants relative to previous purchases." The results caused him to question both the company's direction and future.

"Fashion trend shifts are like ocean waves: they both take time to form and are often difficult to spot until they are large and upon us," said Mr. Lyon. "We believe this analogy describes the unfolding trend shift from athletic apparel to denim. In the third installment of our LULU survey, we saw a decline in LULU customers' purchase intent of yoga leggings. In fact, wave #3 of our survey showed the most significant deterioration of metrics to date, thus further supporting our SELL thesis and the risks that LULU faces from shifting fashion trends and increasing competition. The combination of declining purchase intent, increasing signals of denim gaining traction, peaking margins, and a more focused Athleta creates a risk/reward that skews heavily downward, in our opinion.

"We are also witnessing some shifts in brand preferences away from Nike and Under Armour, and in favor of Athleta. Athleta's rise could add to LULU's competitive concerns particularly as Gap Inc. re-focuses its growth efforts on the concept. Separately, increased frequency of warehouse sales seem to be mitigating market share losses but pose concerns to the brand's long-term health."

Mr. Lyon pointed to four key takeaways from the survey, which he said reinforced his "sell" rating for the company: "(1) Respondents intend to buy 21 per cent fewer LULU pants over the next 12 months (2.08 pairs) than they bought in the last 12 months (2.62 pairs), 400 basis points worse than our last survey in May; (2) intent to purchase more pairs of jeans over the next 12 months increased by 150 bps, while the intent to buy fewer pairs of jeans over the same time period declined by 500 bps; (3) intent to buy more denim than yoga pants was stable at 28 per cent while intent to buy more yoga pants than denim decreased by 600 bps; and (4) 68 per cent of respondents said they wear athletic/yoga pants for activities other than yoga or working out more often now than they did a year ago, making them more susceptible to fashion trend shifts."

The analyst emphasized that takeover speculation "continues to swirl" around the company, yet its current valuation remains an obstacle to a deal.

"Takeout chatter continues to envelope LULU, with the latest speculation suggesting Adidas as a potential suitor," he said. "In discussions with our industry contacts, we believe the most significant hurdle to a takeout of LULU is its premium valuation (12 times next 12 month enterprise value/EBITDA) and a lack of self-help opportunities to improve margins. Since LULU has essentially realized the maximum gross margin benefit from its operational improvements, there is little room for further margin gains. Therefore, the remaining driver of future cash flow is store and comp growth, and more specifically international expansion, an expensive and margin dilutive endeavor. As for private equity, we continue to think it is highly unlikely for PE to bid for LULU at a significant premium to current valuation as the IRR would not be attractive enough. We have previously published that based on our LBO model, we believe PE would get interested at $41, an assertion that has not changed."

In reaction to the survey results, Mr. Lyon lowered his 2017 sales projection to $2.552-billion (U.S.) from $2.596-billion, resulting in a 3-cent drop in his earnings per share projection to $2.33. He raised his 2018 sales estimate to $2.788-billion from $2.721-billion, which pushed his EPS expectation to $2.35 from $2.30.

With a "sell" rating, he maintained a $43 target for the stock. The analyst consensus price target is $64.10, according to Thomson Reuters data.

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Citing more conviction in its growth strategy, Credit Suisse analyst Nick Stogdill upgraded ECN Capital Corp. (ECN-T) to "buy" from "neutral."

"[Thursday], ECN hosted a presentation for sell-side analysts to profile Service Finance Company (SFC), an originator of U.S. home renovation financing loans sourced through exclusive national vendor programs," he said. "Following the presentations, we have a greater appreciation of the business and increased confidence in its growth prospects.

Mr. Stogdill emphasized three key takeaways from the meetings: "(1) The company is led by a strong management team that has a good grasp on all aspects of its business: the growth opportunities, the competitive landscape, its key success factors as well as threats to its operating model; (2) Current growth projections (originations expected to increase by ~80% between 2017-2019) do not incorporate a number of potential new manufacturer relationships and channel opportunities that were outlined; (3) The model is scalable and SFC has initiatives underway (i.e. moving to paperless) that will not require headcount to increase in-line with originations/managed portfolio growth."

Based on "increased conviction" on its targets, the analyst raised his 2018 and 2019 earnings per share projections to 29 cents and 35 cents, respectively, from 27 cents and 32 cents.

Mr. Stogdill increased his target for ECN stock to $4.75 from $4.50. The analyst average is $4.87, according to Bloomberg data.

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"Potential near-term negatives offset an otherwise strong, long-term setup" for TransCanada Corp. (TRP-N, TRP-T), said Morgan Stanley analyst Tom Abrams.

On the heels of a period of "strong" midstream performance, he initiated coverage of the stock with an "equal-weight" rating, believing fundamental strength is offset by a fair valuation and project uncertainties.

"A highly concentrated longer-term backlog faces significant hurdles to being realized, and the firm will see more limited growth in the U.S. natural gas business after 2020," said Mr. Abrams. "We give TRP little credit for projects in its long term backlog and thus see 2020+ growth at the low-single-digit level. However, headline risk if projects are canceled or run into permitting issues would still be expected to impact near-term trading sentiment."

"We could become more interested in the stock once past potential project headlines, as we move closer to material balance sheet strengthening, or when more compelled around commodity exposure. TRP as a representative Canadian firm may have more energy (or currency) beta in performance than its actual low EBITDA exposure would suggest."

Mr. Abrams set a price target of $53 (U.S.). The analyst average target is $57.41, according to Bloomberg.

"TransCanada versus Enbridge is an important decision for many managers investing in Canada. Often the comparison seems like an even horse race, with one pulling ahead and then the other," he said. "Currently, we are equal-weight both names relative to the totality of our coverage, but we would prefer TransCanada to Enbridge on fundamentals and near-term project risk; valuations favor TRP, but only slightly. As mentioned, we are Equal-weight both given the sharp relative outperformance of TRP in recent months."

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Endeavour Mining Corp. (EDV-T) is "primed to deliver" through its new projects and optimized mines, said Raymond James analyst Chris Thompson.

On Wednesday, the London-based company reported results of an optimization study and construction approval for its Ity CIL project in Ivory Coast. The analyst said the 80-per-cent owned project showed "significant" improvement over its 2016 feasibility study in grade, tonnage, strip ratio and recovery.

"The increase in throughput has resulted in higher initial and upfront Capex, though the increases in cash flow from the expanded operating scenario more than offset the increased costs," he said.

"EDV recently expanded its revolving credit facility by $150-million (now $500-million), while improving the facility's terms. The RCF now matures in Sept 2021, with a bullet structure instead of the phased repayments required under the previous RCF. Interest has decreased to a sliding scale between LIBOR plus 2.95 per cent to 3.95 per cent based on leverage ratio (down from LIBOR plus 3.75% to 5.75% prev.) and standby fees have decreased to 1.03 per cent (down from 1.31 per cent to 2.01 per cent previously). The lower maintenance fees are expected to save EDV $5-million per year. We see the Ity CIL project as fully-funded from available liquidity sources."

Mr. Thompson also said the company's growth pipeline has been "refilled" following the completion of its all-stock purchase of Avnel Gold Mining Ltd.

"The Avnel purchase brings an 80-per-cent stake in the Kalana project in Mali, which EDV plans to optimize and explore, with the aim of constructing Kalana once construction of the Ity CIL project is completed, which would help maintain EDV's production profile near 2020 levels," he said.

Maintaining an "outperform" rating for the stock, Mr. Thompson hiked his target price for the stock to $34 from $30.50. Consensus is $30.97.

"We see both the Ity CIL construction decision and Avnel acquisition as positive developments, in-line with EDV's plan to transition all of its operations into the "magic box" of less-than$850 per ounce AISC [all-in sustaining cost] and 10-plus year mine life within the next two years," he said.

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Cowen analyst Novid Rassouli said steel prices have downside risk for the remainder of the year, citing a bearish outlook for Chinese finished steel and global raw material prices.

Accordingly, he downgraded United States Steel Corp. (X-N) to "underperform" from "market perform" with a $20 (U.S.) target, falling from $24. The consensus average is $29.73.

Mr. Rassouli also dropped ArcelorMittal SA (MT-N) to "market perform" from "outperform" with a $27 (U.S.) target, down from $32. The average is $30.03.

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Despite its shares jumping almost up 38 per cent year-to-date, compared to a 14-per-cent rise in the S&P 500, RBC Dominion Securities analyst Daniel Perlin believes MasterCard Inc. (MA-N) continues to gain momentum amid expansion of its total addressable market.

"We wanted to revisit/update our long thesis on the shares of MA, which is based on (1) cycling out of a period of trough earnings; (2) favorable 'rate of change' in revenue growth vs. 'core' op-ex growth; (3) acquisitions & innovation expanding the TAM; and (4) a business model that offers potential upside in an inflationary environment," he said.

Mr. Perlin said the credit card company is now emerging a trough earnings backdrop, noting: "We believe MA has been operating in an environment that has muted its ability to drive earning power including (1) lower gas prices, (2) FX headwinds, (3) emerging markets macro-issuers, (4) European uncertainty / regulation, (5) lower cross-border volumes, and (6) a heavy investment cycle. We believe many of these headwinds are either abating or turning into tailwinds."

"As MA moves through an investment cycle, related to building out its 'services' offerings and begins to absorb the integration of Vocalink, we believe it's important to focus on the rate of growth in its 'core' op-ex expense relative to the acceleration in revenue growth. In Q2/17, excluding acquisitions & FX impacts, net revenue growth increased 12 per cent year over year versus 'core' op-ex growth of 7 per cent year over year."

Keeping his "top pick" rating, he raised his target for the stock to $156 (U.S.) from $140. Consensus is $145.12.

"Although MA has meaningfully outperformed the market YTD, the stock still trades at a discount to its fundamental peers, which we believe suggest there is more room to run," he said. "In addition, based on the upside opportunities from gaining access to new payment flows via ACH/fast ACH, push payments, and IoT, we believe numbers could prove conservative in the out years, thus supporting higher near-term multiples. We believe that any conversation around valuing Mastercard must take into account their enviable fundamental characteristics and would argue that the shares should trade in line with its fundamental peer group."

"The shares are currently trading at 27 times calendar 2018 EPS (RBC estimate), which is a premium its long-term average of 22 times; however, they currently trade at 150 per cent on a relative basis to the S&P 500, which is only slightly above the historical average. We would also note that early in the year the stock was underperforming the XLF as investors were using MA as a source of funds, whereas more recently MA is outperforming."

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In other analyst actions:

UBS analyst Robin Farley upgraded BRP Inc. (DOO-T) to "buy" from "neutral" with a target of $47, rising from $40. The average is $45.42.

Wells Fargo Securities analyst William Warmington upgraded Equifax Inc. (EFX-N) to "outperform" from "market perform" with a target of $127 (U.S.), down from $135. The average is $123.33.

Barclays analyst Brandon Oglenski upgraded American Airlines Group Inc. (AAL-Q) to "overweight" from "equalweight" with a target of $65 (U.S.), rising from $55. The average is $56.19.