Monday’s analyst upgrades and downgrades

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

The recent underperformance of the shares of Imperial Oil Ltd. (IMO-T) holds opportunity for investors, said AltaCorp. Capital analyst Nick Lupick.

He upgraded his rating to "sector outperform" from "sector perform."

"IMO's stock has underperformed markedly versus the Canadian large cap peer group since the end of March on the back of little operational news," said Mr. Lupick. "Overall we believe that the operational missteps seen at Kearl (the largest driver of sentiment) are behind the company with expectations within the company anticipating the asset to produce at an average rate of 156,000 barrels per day (ie. sustained nameplate capacity)."

He added: "The stock has underperformed markedly versus the Canadian large cap peer group since the start of the year with the company's equity only slightly off the lows set in February when heavy oil reached $19.5/bbl. Since this time WCS [Western Canadian Select] has rebounded to $38.5/bbl (an improvement of 98 per cent) and justifies a greater improvement in IMO share price given the company's net exposure to heavy oil (discussed further below). While we do not believe that Imperial should receive the same share price improvement to the rising commodity prices as other non-Integrated, more levered, entities (such as CNQ and ECA), given the company's FCF [free cash flow] generation, IMO's best-in-class balance sheet, and improving operational performance leaves us puzzled by the stock's underperformance year to date – which currently sits at negative 32 per cent versus the other Canadian large caps."

Mr. Lupick said Imperial is now in a position to focus on operational efficiencies and lowering unit costs given a lack of major projects on the go. He said: "With capital spending expected to only be at sustaining capital levels (approximately $2.0-$2.5-billion/year) for the near term, IMO has the ability to harness its FCF [free cash flow] and further improve its already best-in-class liquidity position."

Calling Canadian refining margins "robust" after industry worries to start the year, Mr. Lupick said the company is a "defensive" name if the market turns negative.

"Given the ongoing strength in downstream margins, Imperial will continue to be insulated by its Canadian downstream portfolio," he said. "As a result, we believe that, in the event that market participants decide that they no longer believe in the most recent run in commodity prices and equities retrace their gains, we believe that IMO will once again be a 'safe haven' for investors as it was throughout 2015 and outperform those which will see meaningful reversions."

He maintained a target price of $50. Consensus is $44.19, according to Thomson Reuters.

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Though shares of Resolute Forest Products Inc. (RFP-N, RFP-T) have risen almost 40 per cent since the beginning of February, compared to a 9-per-cent rise by the broader TSX, RBC Dominion Securities analyst Paul Quinn sees "limited upside in sight."

Accordingly, Mr. Quinn downgraded his rating for the Montreal-based company's stock to "sector perform" from "outperform."

"With the current share price close to our target, we are on the sidelines on the story," he said.

The analyst raised his 2016 EBITDA (earnings before interest, taxes, depreciation and amortization) projection to $307-million (U.S.) from $289-million to account for a rise in the price of newsprint, however he is forecasting lower pulp and tissue sales for both 2016 and 2017.

"In diversifying away from declining industries, Resolute is entering a crowded space," said Mr. Quinn. "We like Resolute's strategy of integrating its existing pulp capacity with the operations of newly acquired Atlas Paper, but the imbalance between supply and demand remains a headwind at a time when Resolute's leverage levels require very favourable conditions in our view."

He maintained a price target of $7. The analyst consensus price target is $5.95, according to Thomson Reuters.

"While management views specialty papers as undervalued, they recognize near-term headwinds driven by cheaper imports, grade interchangeability, and seasonal headwinds," said Mr. Quinn, who called the management's current outlook "muted." "For pulp, RFP continues to believe that long-term market fundamentals are strong, but remains cautious in the short-term. The company is confident that its asset base will help weather the dip in the cycle in lumber, and remains optimistic on the recovery of the U.S. housing market and tightening of NA [North American] lumber supply."

Elsewhere, CIBC World Markets analyst Hamir Patel downgraded the stock to "sector undeperformer" from "sector performer" with a target of $5 (down from $6).

"While our rating change is largely for valuation reasons, we also see increasing downside risk for the story from potential U.S. anti-dumping (AD) and countervailing duties (CVD) next year if Canada and the United States are not able to reach a new Softwood Lumber Agreement (SLA)," said Mr. Patel.

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Semafo Inc. (SMF-T) currently presents investors a "compelling" valuation, said Raymond James analyst Chris Thompson.

He upgraded it to "outperform" from "market perform" after adjusting financial estimates to his modelled operating plan for its Mana mine in Burkina Faso, incorporating a recent $115-million bought deal equity financing and other valuation tweaks.

Mr. Thompson called Semafo a "low-cost West African producer" with the potential for low all-in sustaining costs (AISC) of $890 (U.S.) per ounce for 2016 through 2018 and less-than $750 from 2019 on. He said those costs would rank "the company as a lowest quartile cost producer with exceptional [free cash flow or FCF] potential."

He added the company is "more than" fully funded to grow by 500,000 ounces annually by 2019.

"With the addition of $115-million to SMF's coffers we estimate a second-quarter 2016 cash balance of $250-million (net debt: negative $190-million)," the analyst said. "SMF's exceptionally strong balance sheet and near-term FCF generating capability more than funds Natougou's Capex requirements ($230-million). Throughout construction, we see net debt remaining negative (less-than $150-million) at $1,275/oz."

Mr. Thompson raised his target price for the stock to $6 from $5.50. Consensus is $5.62.

"SMF has lagged its peers since early March (rising 2 per cent versus GDXJ [Market Vectors Junior Gold Miners ETF] up 28 per cent)," he said. "Recall, the company delivered in-line 4Q15 financial results and generated significant FCF ($16-million) in 4Q15 which we expect will continue in 2016. This, a compelling valuation (price/NAV less than 1x) and fully funded growth (watch for development news flow from Natougou) will catalyze a re-rating this year, in our view, reflective of our outperform rating."

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Crescent Point Energy Corp. (CPG-T) is a "solid beta call" given improving oil prices following its recent dividend cut, said CIBC World Markets analyst Arthur Grayfer.

He initiated coverage of the stock with a "sector performer" rating.

"The company has a dominant interest in key, large oil plays in the WCSB [Western Canadian Sedimentary Basin], which offer strong economics relative to its oil-weighted peers, a top-tier cash flow netback, and a shallowing decline profile (we estimate 29 per cent in 2016) that should improve sustainability," said Mr. Grayfer. "We forecast a minimum oil price of $42 (U.S.) per barrel in 2017 for the company to keep production flat at 165,000 Bbl/day and cover the dividend. Looking beyond this year, as Crescent Points pays down debt to levels it deems acceptable, we anticipate a higher focus on growth that will uniquely position the company in the Canadian large caps as a high-netback, non-oil sands, growth-focused producer with a high oil weighting."

In justifying his rating, Mr. Grayfer said he feels it will take some time for the company to regain the premium valuation it once held.

"Over time, the market became fatigued with Crescent Point's acquisitive strategy, stemming in part from the associated equity for the deals that became increasingly large, particularly in the context of a meaningful DRIP [dividend reinvestment plan], which supported a payout over 100 per cent," the analyst said. "Notwithstanding the stream of equity, we note that debt-adjusted per share growth has been above-average for the last five years. On the whole, Crescent Point's acquisitions were appropriate for creating longer term value, but as we estimate an inventory life of only 10 years based on drilling activity in a more normalized price environment, there is a requirement for further acquisitions. If Crescent Point focuses on organic growth and very selective acquisitions, we believe the management team can recapture its premium valuation; we just think this will take some time."

He set a price target of $26. Consensus is $22.34.

Mr. Grayfer also initiated coverage of MEG Energy Corp. (MEG-T) with a "sector performer" rating. He set a target of $9.50, compared to a $8.23 consensus.

"MEG has historically enjoyed a premium valuation given its strong asset base, aggressive growth profile, large resource potential, track record of beating guidance, and relatively low-cost structure," he said. "While the company still maintains a premium multiple today, the share price has declined with a precipitous fall in oil prices, but also because of company-specific factors such as increasing debt levels relative to cash flow. While we believe the company has a high-quality asset base that offers long-term growth potential and significant torque to oil prices (this is our preferred name for torque to oil), we have rated the stock sector performer given the higher oil price required, relative to its peers, to resume growth and pay down debt."

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The key drivers for stock of McDonald's Corp. (MCD-N) are "pointing in the right direction," said RBC Dominion Securities analyst David Palmer.

"The key drivers of McDonald's stock are ROIC [return on invested capital] and EPS [earnings per share] growth/revisions," said Mr. Palmer. "These financial outcomes are downstream to other factors such as global same store sales (SSS) growth, currency fluctuations, and restructuring of the business model (e.g., developmental licensing, refranchising, overhead reduction). These factors are generally pointing in the right direction for McDonald's as the company pursues a multi-faceted strategy to revive sales — particularly in the U.S.— while boosting shareholder value through a combination of refranchising, increased cash return to shareholders, and overhead reductions."

Following the release of its first-quarter earnings, Mr. Palmer raised his 2016 and 2017 EPS forecasts to account for higher sales, "sustained" profit margin leverage and a lower drag from currency. His 2016 estimate moved to $5.53 (U.S.) from $5.44, representing a 11-per-cent increase year over year and 10 cents higher than the consensus projection. For 2017, he expects EPS of $6.16 from $6.08, also an 11-per-cent rise from the previous year and 7 cents higher than the consensus.

Mr. Palmer also raised his ROIC projection to increase by 3.5 per cent over the next three years. He attributed the gain to same-store sales leverage, refranchising/licensing, cash return to shareholders, and benign costs.

Maintaining his "outperform" rating for the stock, Mr. Palmer raised his price target to $140 from $135. The analyst average is $132.24, according to Bloomberg.

"After a 19-per-cent move since the Oct. 1, the valuation has expanded meaningfully— from 19 times 2016 estimates to 23 times 2016 while the market view of 2017 estimated EPS will have increased about 10 per cent after Friday's earnings," he said. "McDonald's valuation appears 'fair' when compared to global mega-cap consumer peers in the consumer staples world, or large cap restaurant franchised names. A select group of each would point to an average 2016 estimated price-to-earnings of 22 times (versus MCD at 23 times) and dividend yield of 3 per cent (versus MCD at 3 per cent). Our target valuation on 2017 EPS is 23 times (at parity with a group of global consumer staples and franchised restaurant names)."

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In adding Dish Network Corp. (DISH-Q) to Citibank's focus list, analyst Jason Bazinet said the company currently provides good value.

"At $48 a share, Dish offers investors something rare: deep value with little risk," he said. The equity is deep value because it's trading at 50 per cent of fair value. But, it's also low risk because there is mounting evidence that Dish will sell -- rather than operationalize -- its spectrum."

He added: "We believe Dish's spectrum is worth $2 per MHz-POP [megahertz per population] or $41-billion (U.S.). That's akin to $88 per Dish share. In addition, we value the DBS asset at $13 per share (6 times 2017 enterprise value-EBITDA). And, Dish's tax assets are worth $6 per share. All told, the bull-case would peg Dish's equity at $107, above our $94 target price."

The analyst said Dish's aim is likely to sell its spectrum rather than operationalize it. That provides investors "a unique window of opportunity."

"In 2015, Dish traded at $80 per share," he said. "However, two factors have conspired against the equity. First, many investors expect the 600MHz TV station auction to be lacklustre. We disagree and expect spectrum to fetch $2 per MHz-POP. Second, many investors sold Dish ahead of the TV station auction because it's not possible for auction participants (like Dish and Verizon) to pursue M&A. But, as the auction comes to a close (in 4Q16) we expect the M&A premium to seep back into Dish's equity."

Mr. Bazinet updated his financial estimates to reflect: capitalized interest and tax amortization; "slightly" lowered subscriber-related expense growth; a decline in revenue growth and in reaction to first-quarter 2016 results. His EPS forecast for 2016 rose to $2.83 from $2.03. His 2017 projection jumped to $2.58 from $1.92.

He maintained his "buy" rating and $94 target. Consensus is $65.05.

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In other analyst actions:

Cascades Inc (CAS-T) was raised to "outperform" from "sector perform" at RBC Capital by equity analyst Paul Quinn. The 12-month target price is $11 (Canadian) per share.

CDW Corp (CDW-Q) was downgraded to "market perform" from "outperform" at Raymond James by equity analyst Brian Alexander.

Centene Corp (CNC-N) was rated new "outperform" at Cowen by equity analyst Christine Arnold. The 12-month target price is $70 (U.S.) per share.

Community Health Systems Inc (CYH-N) was downgraded to "underperform" from "market perform" at Raymond James by equity analyst John Ransom.

Discovery Communications Inc (DISCA-Q) was downgraded to "hold" from "buy" at Topeka Capital by equity analyst David Miller. The 12-month target price is $31 (U.S.) per share. It was downgraded to "hold" from "buy" at Topeka Capital by equity analyst David Miller. The 12-month target price is $30 (U.S.) per share.

International Paper Co (IP-N) was downgraded to "sector perform" from "outperform" at RBC Capital by equity analyst Paul Quinn. The 12-month target price is $46 (U.S.) per share.

Southwestern Energy Co (SWN-N) was downgraded to "market perform" from "outperform" at Cowen by equity analyst Charles Robertson. The 12-month target price is $13 (U.S.) per share.

VF Corp (VFC-N) was downgraded to "hold" from "buy" at BB&T Capital by equity analyst Corinna Freedman.

WestJet Airlines Ltd (WJA-T) was downgraded to "neutral" from "outperform" at Macquarie by equity analyst Konark Gupta. The 12-month target price is $21 (Canadian) per share.

With files from Bloomberg News