Monday’s analyst upgrades and downgrades

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

Penn West Petroleum Ltd.'s (PWT-T, PWE-N) $975-million sale of its Saskatchewan assets was the right move, according to Raymond James analyst Jeremy McCrea.

Mr. McCrea said the sale to Teine Energy Ltd., which included its Dodsland Viking assets, was a "full measure solution" to its debt overhang. Accordingly, he upgraded his rating for the stock to "outperform" from "market perform."

"The sale is a definitive step which will help to change the narrative from constant discussions around its debt towards constructive conversations around PWT's recent performance in its remaining Cardium area," he said. "In recent months we have underscored that PWT has been a consistent performer in the Cardium and, given its success in the Saskatchewan Viking, we believe management when it argues for the potential from the Alberta Viking lands. With an additional 20,000 barrels per day expected in sales before the end of 2016, the PWT that ends 2016 will be very different than the PWT that entered 2016."

McCrea said the Viking assets were projected to produced 13,650 barrels of oil equivalent per day (boe/d) in 2016 and $64-million in FFO (funds from operations). He said the transaction represents "strong value to PWT that investors are likely to find positive" based on either a production multiple ($71,400/boe/d) or cash flow multiple (15.5 times the 2016 estimate).

He added the company has also lowered its pro forma debt position to below $600-million and "meaningfully" lowered its debt multiples.

"PWT lowered its debt/PDP to 33 per cent, well below the industry median of 51 per cent (Bloomberg and company reports), and to a level that should be very comfortable for lenders (typically below 60 per cent)," he said. "Some observers would note that debt/CF [cash flow] is still relatively high at 3.9x in 2017 but this fails to capture PWT's low decline profile at ~19 per cent, which, combined with a renewed capex program, should allow growth to expand much easier and reduce this D/CF figure more into 2018.

Mr. McCrea raised his price target for the stock to $3 from 75 cents. The analyst consensus price target is 75 cents.

"We are highly interested to see how consensus changes their views as the company has been a near-uniform 'sell' for quite some time," he said. "Given the leverage overhang, we suspect investors/analysts have not appreciated the change in operations. As a result, we suspect the share price may take some time to fully reflect the new reality as there will likely be some anchoring in expectations and use of historical costs and capital efficiencies until more due diligence is done. We even admit that given the amount of current and potential asset sales, volatility in crude prices and run in valuation for the sector, our preliminary forecasts and valuation estimate have more uncertainty in place than we would otherwise be able to provide.

"One item we are confident in stating, however, is that the asset sales and changes within PWT's operations have been transformative in nature. For example, although PWT has seen significant layoffs over the past few years, now down to ~600 employees, we understand approximately 50 per cent of the current employees are new, bringing valuable new techniques and experience. We believe that this is a key reason why the Cardium well performances have improved over prior years. With a 10-per-cent targeted production growth going forward (and likely better near-term given a low decline base and well economics that rank among the best in the Cardium with close to 12-month payouts), a repaired balance sheet, and a valuation reflective of near bankruptcy and near uniform dissent, we suspect there is likely considerable upside from the current price. Overall, the stock will likely climb a wall of worry as management demonstrates a renewed capex program but, for the most part, a considerable amount of risk has been eliminated."

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Though its Misery pit has successfully ramped, RBC Dominion Securities analyst Des Kilalea said the second quarter for Dominion Diamonds Corp. (DDC-N, DDC-T) remains "tough" on margins.

He downgraded his rating for the Toronto-based company to "sector perform" from "outperform," citing a challenging outlook for its Jay project, which is an expansion of its Ekati mine.

"With Misery now completed, and ahead of time, focus will swing to the prospects for Q2 and progress on building Jay, as well as the diamond market," said Mr. Kilalea. "On Jay it appears a feasibility study will be ready in 'weeks not months,' according to CEO Brendan Bell; he indicated that it could be out around mid-July. But getting to the minimum 15-per-cent IRR [internal rate of return] the company mentioned in the April. 14 earnings call seems to be proving difficult. Delaying the project a year or more and bringing in benefits of deferred rehab liabilities at Ekati may bridge the gap though we suspect that it will still need an escalating rough diamond price.

"On the rough market, our view is that prices will soften in the summer with, hopefully, slight firming later in the year. But with a leading bank looking to pull back further from mid-stream funding, risks remain. In Q2 we also see the prospect of a further impairment on Misery rough given dilution and mix, with improvement in the second half. DDC says that Misery will be cash flow positive in the second half of 2017 fiscal year. The dispute with JV partner Archon over some Buffer Zone 2017 capex adds more uncertainty until resolved."

Mr. Kilalea lowered his target price to $11 (U.S.) from $13. Consensus is $16.67.

"We believe that DDC offers attractive medium-term upside through A-21 and Jay," he said. "However, for now, lacklustre prices for smaller goods coupled with a relatively high ($700-million) capex spend are weighing on sentiment around Jay; delaying the project brings Ekati's $350-million rehab liability more into focus. Until we see a credible plan for Jay and better rough prices, we expect the shares to lag peers and we therefore downgrade to sector perform."

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Canaccord Genuity analyst Dennis Fong said the current commodity environment remains challenging for both junior/intermediate and mid-cap energy exploration and production companies.

However, he said there are several ways for investors to add oil and gas exposure defensively through royalty companies.

In initiating coverage of PrairieSky Royalty Ltd. (PSK-T) and Freehold Royalties Ltd. (FRU-T), Mr. Fong said both have "strong" balance sheets and free cash flow generation as well as long-term resource visibility.

Between the two, Mr. Fong said he preferred PrairieSky, which he gave a "buy" rating.

He cited three factors: "1) We believe PrairieSky has near-term catalysts from potential inorganic growth opportunities with its war chest of $200-million. 2) Longer-term, we also like the optionality in PrairieSky represented by the massive (7.7 million acre) fee title land position which could eventually provide significant shareholder return. 3) In the near term, we believe Freehold could also see positive surprises on prior period adjustments (PPAs) from its recent acquisitions (namely from Husky and Penn West) and a potential modest dividend increase with its low 2017 payout of 54 per cent. However, we have concerns over the company's ability to grow production through just attracting third-party activity on its land."

He set a price target of $31 for the stock, saying it's his pick for longer-term shareholder return. The analyst consensus is $26.46.

"PrairieSky could also benefit from an increasing commodity price environment as the company could benefit from 1,800 Boe/d  [barrels of oil equivalent per day] of sliding scale royalty production as WTI increases towards $70 per day," the analyst said. "PrairieSky has traded at a premium compared to both the other oil and gas royalty company and the dividend-paying group."

For Freehold, he gave a "hold" rating and $13 target. Consensus is $14.65.

"We like Freehold, a company with a track record of making opportunistic royalty acquisitions to maintain production (per share)," said Mr. Fong. "In the near term, we believe the company could show higher-than-expected prior period adjustments and audit revenues (these audit revenues occur in higher volume following royalty asset acquisitions). In addition, with the low 2017 estimated payout of 54 per cent, we believe there is a potential for the company to increase its dividend. Freehold has also traditionally traded at a discount on a cash flow basis compared to PrairieSky but at a premium to the dividend-paying group."

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The second-quarter results for Transcontinental Inc. (TCL.A-T) reflect organic growth challenges "across the board," said BMO Nesbitt Burns analyst Tim Casey.

On Friday, the Quebec-based company reported earnings per share of 7 cents, a 93.3-per-cent drop year over year. The company attributed the drop to unusual items of $80-million, including gains on the sale of its consumer magazine publishing activities. Adjusted EBITDA fell 4.7 per cent to $83.1-million from $87.2-million, below the $90.1-million consensus.

Revenue increased to $497.2-million from $490.5-million, due largely to contributions from the acquisition of Ultra Flex Packaging and the appreciation of the greenback against the loonie. However, the result missed the consensus analyst forecast of $502-million

"Organic declines in print & packaging more than offset favourable impacts from acquisitions (Ultra Flex Packaging), currency, and cost efficiencies," said Mr. Casey." Importantly, the packaging division posted negative organic growth due to the loss of a customer (as a result of its sale), inventory balancing at a key customer, and investments in additional capacity. The company recorded an impairment charge of $30-million related to its newspapers in the Atlantic provinces."

Mr. Casey said he's now projecting EBITDA "erosion" through the 2017 fiscal year.

"Commercial printing continues to face declining volume in direct marketing, while media remains challenged due to a permanently impaired print advertising market," he said. "The packaging division appears to be facing some near-term organic execution headwinds. To protect margins, the company's focus is on cost cutting (organic and merger synergies), pursuing new growth verticals through M&A (i.e., Flexible Packaging), and divesting non-core assets."

Mr. Casey kept his "market perform" rating for the stock, citing the company's asset mix and growth potential. He dropped his target price to $18 from $20.50. The analyst average target price is $19.51, according to Bloomberg.

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In a research note on the previous metals sector following CIBC's annual Canadian mine tour, analyst Cosmos Chiu increased his target prices for a trio of companies.

He increased his target for Alamos Gold Inc. (AGI-T) to $10.50 from $9.50 with a "sector outperformer" rating after a tour of its Young Davidson gold mine in northern Ontario. Consensus is $9.43.

"Alamos shares are less widely owned by the investment community compared to others on the CIBC mine tour," said Mr. Chiu. "There continues to be some concern on capex, but the underground operations showed extremely well, and as Alamos continues to deliver on free cash flow, its shares could benefit from incremental fund flow.

Mr. Chiu raised his target for Detour Gold Corp. (DGC-T) to $33 from $28 with a "sector outperformer" rating after visiting its Detour Lake mine. Consensus is $33.58.

"Detour Lake is clearly a well-run operation, with continuous improvement highlighted by the upgrade of the 410-conveyor, improvement in both milling and mining rates, the processing of fines, and the exploration upside in the Lower Detour Trend," he said. "Detour shares continue to be widely owned by investors and will continue to generate generalist interest."

Mr. Chiu bumped his target for Tahoe Resources Inc. (THO-T) by a loonie to $21 with a "sector outperformer" rating after visiting its Bell Creek mill and Timmins West mine, saying the assets "demonstrated high upside potential." Consensus is $20.58.

"Recently acquired on April 1, 2016, Tahoe has allocated the highest exploration dollars to the Timmins camp within the entire company, highlighting its importance," he said.

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In other analyst actions:

Agios Pharmaceuticals Inc (AGIO-Q) was raised to "overweight" from "neutral" at JPMorgan by equity analyst Anupam Rama. The target price is $62 (U.S.) per share. It was raised to "buy" from "hold" at Canaccord Genuity by equity analyst John Newman. The 12-month target price is $90 (U.S.) per share.

Endo International PLC (ENDP-Q) was raised to "neutral" from "underperform" at Mizuho Securities USA by equity analyst Irina Koffler. The 12-month target price is $16 (U.S.) per share.

Golden Reign Resources Ltd (GRR-X) was rated new "buy" at Beacon Secs by equity analyst Mike Bandrowski. The 12-month target price is 55 cents (Canadian) per share.

LyondellBasell Industries NV (LYB-N) was downgraded to "market perform" from "outperform" at Cowen by equity analyst Charles Neivert. The 12-month target price is $87 (U.S.) per share.

Lydian International Ltd (LYD-T) was raised to "sector outperform" from "sector perform" at Scotia by equity analyst Trevor Turnbull. The 12-month target price is 70 cents (Canadian) per share.

Mountain Province Diamonds Inc (MPV-T) was downgraded to "sector perform" from "outperform" at RBC Capital by equity analyst Des Kilalea. The 12-month target price is $5.75 (Canadian) per share.

Perk.com US Inc (PER-T) was rated new "buy" at Cormark Securities by equity analyst Hubert Mak. The 12-month target price is $8 (Canadian) per share.

TIO Networks Corp (TNC-X) was rated new "buy" at Canaccord Genuity by equity analyst Kevin Wright. The 12-month target price is $2.50 (Canadian) per share.

Waste Connections Inc (WCN-N) was downgraded to "hold" from "buy" at TD Securities by equity analyst Damir Gunja. The 12-month target price is $78 (U.S.) per share.

With files from Bloomberg News