Friday’s analyst upgrades and downgrades

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

The "broad" pullback in Canadian oil and gas equities in 2017 has created an "attractive" entry point for investors to add exposure to the sector, according to analysts at Desjardins Securities.

In a research note previewing the sector for 2018 that was released Friday, analysts Justin Bouchard, Kristopher Zack and Chris MacCulloch said mid-cap names that lagged should be of particular interest as those stocks "should eventually gain traction with increased confidence in commodity prices."

The group also emphasized a bias toward oil- and liquids-focused producers, citing continued "challenges" for AECO natural gas prices for the coming year.

"On the oil side, we are seeing signs of strengthening oil market fundamentals on the heels of the OPEC supply cuts, which have helped clear the global inventory overhang," the firm said. "However, we also note the potential for increased differential volatility for Canadian crude relative to WTI as pipelines fill and rail becomes a greater factor in setting prices at the margin. Our favourite oil-weighted names include CNQ and SU among the large caps; in the mid-cap space, we believe that RRX, SPE, TOG and TVE provide the best light oil exposure. We continue to highlight ERF's growing light oil production while also noting the added benefit of significant diversification from the potential challenges of Canadian commodity benchmarks given that its production base is largely focused south of the border.

"We see evidence of structural tightening in the North American natural gas market, although Canadian producers' ability to benefit from this trend remains in question due to egress challenges which have added pressure to basis differentials relative to NYMEX. While there is still potential for improved support from colder winter temperatures, we generally remain cautious that persistently weak AECO gas prices could put a number of producers in a precarious position that could be difficult to navigate in 2018. In this context, we remain biased toward producers with diversified physical transportation commitments, higher liquids weightings and active hedge books. Specifically, this group includes AAV, ARX and NVA in the mid-cap space. We also note the significant condensate exposure and price diversification of VII; after a series of lacklustre releases in 2017, we expect that 2018 will be a critical year in determining whether the company can get back on track with market expectations."

The analysts made a trio of rating changes in the note. They were:

- Mr. Zak upgraded his rating for Encana Corp. (ECA-T, ECA-N) to "buy" from "hold" with a target of $16, rising from $13.50. The average target on the Street is currently $19.02, according to Bloomberg data.

"In the large-cap space, we are upgrading ECA to a Buy, highlighting a total potential return of 19 per cent from current levels (versus 6 per cent for the large-cap group) based on a 7.0 times DACF [debt-adjusted cash flow] multiple at our 2019 estimates and $55 (U.S.) per barrel WTI, which is still slightly conservative relative to the current strip," he said. "While the company has operationally exceeded expectations in 2017, we also believe the market will continue to have a positive bias toward its growing liquids production and U.S. property diversification which, when combined with its hedge book, limits AECO price exposure to just 4 per cent of revenue in 2018. We also expect the company to run a balanced cash flow budget in 2018; when combined with the margin improvement, the balance sheet should continue to improve as a result. We forecast a debt-cash flow of 2.1 times at year-end 2018, and this ratio should continue to move lower at $55 per barrel WTI in 2019."

- Mr. Zak lowered Bonavista Energy Corp. (BNP-T) to "hold" from "buy" and dropped his target to $2.75 from $4.25. The average is $2.83.

"While we continue to have a positive bias toward how the company has focused its asset base and reduced cost structures, and while we note that the stock is trading below what we believe to be its base fundamental value, we have a tough time envisioning a catalyst for outperformance given our more cautious outlook for AECO gas prices — particularly relative to larger-cap names with lower debt levels," he said.

- Mr. Bouchard downgraded Cenovus Energy Inc. (CVE-T, CVE-N) to "hold" from "buy" with a target of $14, down a loonie. The average is $14.65.

"Although we continue to believe that the company's oil sands assets are among the best in the business and that the stock offers significant torque to increasing commodity prices (at least relative to its peer group), we believe CVE is facing an uphill battle in 2018," he said. "In addition to the hedge book, stock ownership by ConocoPhillips, debt levels and the fact that the company is in transition from a strategic standpoint, our outlook for lower gas prices and wider heavy oil differentials certainly do not help the story in 2018. For the time being, we find it difficult to see a catalyst for outperformance — particularly relative to some of the other larger-cap names."

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WestJet Airlines Ltd.(WJA-T) is "poised to regain lost altitude," according to Raymond James analyst Ben Cherniavsky, who upgraded his rating for its stock to "outperform" from "market perform."

"The company's share price is 10 per cent below our last rating downgrade to Market Perform almost three years ago (Apr. 20, 2015), marking an extended period of both market and sector underperformance," he said.

"Although we are mindful of the risks that remain, we believe there is now an opportunity for the stock to make up for some of this lost ground. Our upgrade does not represent a fundamental revision to our investment thesis, but rather a 'marking to market' of our call and a recalibration of expectations going forward. We believe that many of the concerns we have expressed over the past few years are now priced into the stock, which implies a value/contrarian case to be made for owning it. Despite the lingering questions regarding this company, it still boasts a long record of profitability, a strong balance sheet, and a considerable cost advantage against its biggest competitor."

Mr. Cherniavsky pointed to four main reasons for his neutral stance on the airline's stock over the past few years. They were:

- excess industry capacity growth that he believed "suppressed" both pricing power and revenue per available seat mile (RASM)

- "increased" complexity and "heightened" execution risk in the company's strategy

- "'change management' challenges that have effected labour dismay"

- The 'new entrant' risks associated with aspiring Canadian ultra-low cost carrier startups

"By and large, we feel that this script has now run its course since 2015, resulting in a generally negative consensus view on WestJet at present (hence the discounted multiple and share price underperformance)," he said. "Given these circumstances, the company simply needs to perform better than most investors now fear in order to be re-rated higher."

In the wake of better-than-anticipated fourth-quarter traffic results, Mr. Cherniavsky raised his 2017 and 2018 earnings per share expectations to $2.49 and $2.60, respectively, from $2.42 and $2.33.

"Our revisions also include higher fuel price assumptions for this year (70 cents per litre and WTI of $60 U.S.)," he said. "Although fare discounting remains evident in Canada's prevailing 'turf war,' WestJet's load factors are tracking very high, reflecting both strong demand for travel and the benefits of the airline's growing network. Delta customers, for example, now reportedly account for 10-15 per cent of all passengers on WestJet-operated code-share flights. This is poised to grow following the JV that both airlines announced last month."

With the rating change, he raised his target price for the stock to $31 from $28 in order to reflect the 2018 EPS bump. The analyst average price target is $28.38.

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Raymond James analyst Andrew Bradford lowered his fourth-quarter 2017 and first-quarter 2018 financial estimates for Calfrac Well Services Ltd. (CFW-T) and Trican Well Service Ltd. (TCW-T) based on reduced cash flow contributions from natural gas in Western Canada.

In a research note released Friday, Mr. Bradford said that reduction is "[taking] the wind out of fracker momentum."

"It's safe to say that a positive thesis on the pressure pumpers has been widely accepted as the consensus view, at least relative to most other oilfield service lines," he said. "Our own long-term forecasting is heavily influenced by the attractive economics within Canada's liquids-rich plays compounded by increasing fracturing intensity in those plays. However…our near-term thesis on the pumpers is complicated by what we expect will be a weaker EBITDA [earnings before interest, taxes, depreciation and amortization] profile over the next 2 or 3 quarters than implied by the current consensus range. We expect this nearer-term view is fairly widely appreciated as well, which limits downside risk, though the absence of tangible evidence over the next couple of quarters for the growth thesis can also cap stock performance regardless.

"On balance, we remain fundamentally positive on the group – fracturing intensity is still growing and, importantly, it's growing in the most fracturing-intensive and economically robust plays in Canada. The caveat we place on this thesis is that the next 2 to 3 quarters will likely be nothing to write home about. We advise buying on weakness and rate both Calfrac and Trican Outperform."

Citing its recent share price performance and resulting relative upside to his target price, Mr. Bradford downgraded Trican to "strong buy" from "outperform."

He noted the changes to his estimates affect Trican more than the Calfrac given 100 per cent of its operations are in Canada.

"Investors should note, however, that Trican has meaningful economic participation in the U.S. via its indirect ownership of the Keane Group – we estimate the value of this investment at 92 cents per share – 12 per cent of our target price," he said.

Mr. Bradford added: "The pumpers are 'booked until breakup.' Even so, without much in the way of cash flow contribution from natural gas, producers' aggregate ability to fund liquids-oriented capital programs is dampened to a degree. As such, it's reasonable to expect that any adverse weather events will have amplified impacts on field activity. For this reason, we are forecasting Canadian EBITDA in 1Q18 higher sequentially, but still be below 3Q17 levels.

"Pricing remained roughly flat through 4Q and we expect it will remain flat until summer 2018. Pricing will not increase without at least some tension in the supply-demand dynamic. We think pricing for 1Q18 had been largely set in the late fall and there are almost never meaningful pricing moves in the breakup quarter – at least not pricing moves that stick. So this means today's prices are likely to persist until summer."

Mr. Bradford raised his target price for Trican to $8 from $6. The average on the Street is $6.61.

With an "outperform" rating, his Calfrac target rose to $8.50 from $6, compared to a $7.20 average.

"Our price targets are set based on historical multiple ranges (7.5 times EBITDA for TCW and 7.0 times for CFW)," he said. "In truth, CFW's historic range is about half-a-turn lower than this, though we envision no economic justification for a disparity with Trican further into our forecasting horizon. We apply these multiples on an equal-weighted basis to our 2018 and discounted 2019 estimates."

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Desjardins Securities analyst Maher Yaghi said underlying trends and a "resilient" wireless market should continue to help the Canadian telecom and media sector in 2018.

"However, investors should tread carefully if interest rates continue their unrelenting ascent," said Mr. Yaghi in a research note previewing 2018.

He added: "For 2018, we forecast that industry revenues will grow by 3.3 per cent and EBITDA will grow by 4.3 per cent while the same metrics are expected to grow by 2.9 per cent and 3.9 per cent, respectively, in 2019. The expected slight decline in growth in 2019 is mainly due to slower growth in wireless as competition from Shaw picks up. Overall, we believe these levels of industry growth are indicative of our positive outlook for the sector from a fundamental perspective. While regulatory risks exist, we are not expecting major changes or new policies that might change the competitive dynamics in the industry to be initiated in the short to medium term. More importantly, and as we have highlighted in the past, the sector's stock performance is highly correlated with long-term interest rates. We have seen over the last few months a material and persistent upward move in interest rates. Until now, this move has not been fully reflected in stock prices. However, if this were to continue, it could put additional pressure on the sector even if fundamentals continue to be strong."

Citing changes to his long-term interest rates assumptions, Mr. Yaghi downgraded his rating for BCE Inc. (BCE-T, BCE-N) to "hold" from "buy" with a target of $62, falling from $66. The average target is currently $61.73.

"Based on our views on current valuations and company outlooks, our top three picks are Telus (attractive above-average organic growth coupled with a stable to declining capex cycle), Rogers (attractive valuation and solid organic growth) and Quebecor (strong potential capital gains, downside support due to valuation)," he said.

He has a "buy" rating and $52 target, up a loonie, for Telus (T-T). The average is $50.90.

His rating for Rogers (RCI.B-T) is also "buy" with a $71 target, down $1. The average is $70.11.

He raised his target for Quebecor (QBR.B-T) to $29 from $27 with a "buy" rating. The average is $27.42.

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Industrial Alliance Securities analyst Neil Linsdell initiated coverage of EnWave Corp. (ENW-X), a Vancouver-based technology company, with a "buy" rating and target of $1.50.  

"We have seen a significant ramp-up in partnerships and unit deliveries over the last few years as Moon Cheese and other partnerships have proven the value of EnWave's technology," he said. "The company is now working to increase its capacity to manage and deliver against this increased level of interest. We also expect the steady royalty stream from the installed units to increase substantially over the next few years and for the installed capacity and utilization rates to increase."

The lone other analyst currently covering the stock, according to Bloomberg, is Cormark analyst Kyle McPhee. He has a "speculative buy" rating and $1.60 target for the stock.

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Analyst Michael Markidis of Desjardins Securities is expected another good year in the Canadian real estate sector.

"The Canadian REIT sector performed admirably in what could arguably be characterized as the first full year of monetary policy normalization in North America," said Mr. Markidis in his 2018 outlook, released Friday. "Provided that economic performance (employment growth, retail sales, etc) does not deteriorate meaningfully, we believe investors will be similarly rewarded in 2018. We are most bullish toward the prospects for multifamily and advocate an overweight position to this sub-sector."

"The S&P/TSX Capped REIT Index generated a total return of 6 per cent in 4Q17, bringing the 2017 performance to 10 per cent. Our base-case outlook for 2018, which calls for a sector total return of 7–12 per cent, is predicated on an upward shift in the long end of the curve, offset by continued yield spread compression. An economic recession in North America and/or NAFTA withdrawal are the primary potential risks to our outlook."

Mr. Markidis upgraded Canadian Apartment Properties REIT (CAR.UN-T) to "buy" to "hold," citing its recent weakness (down by 5 per cent since mid-December) and  an upward revision to his net asset value estimate.

His target rose to $40 from $36. The average is $38.38.

He downgraded his recommendation for Pure Industrial Real Estate Trust (AAR.UN-T) to "hold" from "buy."

On Tuesday, the Vancouver-based REIT announced it has entered into a deal to be acquired by New York-based Blackstone Property Partners  in an all-cash transaction valued at $3.8-billion including debt.

"The stock is essentially trading at Blackstone's offer price," said Mr. Markidis. "We do not expect a superior offer to emerge. While the stock offers protection to a potential downdraft in equities, we see no reason to add to positions at existing levels."

His target rose to $8.10 from $7.25 to reflect the purchase price. The average is $7.96.

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RBC Dominion Securities analyst Paul Quinn downgraded Domtar Corp. (UFS-N, UFS-T) to "sector perform" from "outperform"

"2018 should be a good year for Domtar as the company is experiencing tailwinds from stronger pulp prices and and a tighter UFS [united fibre system] market," he said. "However with the stock now in line with our target price and up 40 per cent in the last 6 months (versus a 13-per-cent return for the S&P500), the shares look to have priced much of this in already."

He maintained his $50 (U.S.) target, which is $4 more than the average.

Mr. Quinn also upgraded a pair of stocks, raising Canfor Corp. (CFP-T) to "sector perform" from "underperform." His target increased to $26 from $20. The consensus on the Street is $27.71.

He also moved West Fraser Timber Co.  (WFT-T) to "sector perform" from "underperform" with a target of $80, jumping from $60. The average is $81.67.

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BMO Nesbitt Burns analyst Randy Ollenberger upgraded Peyto Exploration & Development Corp. (PEY-T) to "outperform" from "market perform" with a target of $16, falling from $23. The average is $18.48.

Mr. Ollenberger said: "Peyto announced that it is cutting 2018 capital spending to $200-$250 million and its dividend by 45 per cent due to persistently weak natural gas prices. This is the right decision, in our opinion. The company also announced that it has achieved its 2017 production target of 115,000 barrels of oil equivalent per day. We believe the shares will react positively to a more sustainable capital program and dividend payout. In our opinion, the company's stock has bottomed, and we are upgrading our rating."

Conversely, Scotia Capital analyst Patrick Bryden downgraded this rating for Peyto to "sector perform" from "sector outperform" and dropped his target to $17.50 from $22.50.

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In other analyst actions:

Expressing concern about the uncertainty related to its news feed changes, Stifel analyst Scott Devitt downgraded Facebook Inc. (FB-Q) to "hold" from "buy" with an unchanged target of $195 (U.S.). The average target on the Street is $213.66.

TD Securities analyst Vince Valentini upgraded Shaw Communications Inc. (SJR.B-T) to "action list buy" from "buy" with a $34 target for its stock (unchanged). The average target on the Street is $29.39.

Tudor Pickering & Co initiated coverage of TransCanada Corp. (TRP-T, TRP-N) with a "hold" rating and $69 target. The average is $72.35.

Haywood Securities Inc. analyst Pierre Vaillancourt downgraded Lundin Mining Corp. (LUN-T) to "hold" from "buy." Mr. Vaillancourt raised his target price to $9.50 from $9, versus the consensus average of $9.11.

Wells Fargo Securities analyst Richard M Kwas upgraded Magna International Inc. (MG-T, MGA-N) to "outperform" from "market perform."

SunTrust Robinson Humphrey analyst Youssef Squali upgraded eBay Inc. (EBAY-Q) to "buy" from "hold" and increased his target to $46 (U.S.) from $38. The average is $40.93.

Evercore ISI analyst Robert E Ottenstein upgraded Coca-Cola Co. (KO-N) to "outperform" from "in-line" with a $55 (U.S.) target. The average is $48.90.