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A truck hauls a load at Teck Resources Coal Mountain operation near Sparwood, B.C. in a handout photo.

The Canadian Press

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

Though he expressed concern about the Alberta government's approach to the power market, RBC Dominion Securities analyst Robert Kwan upgraded TransAlta Corp. (TA-T, TAC-N) in reaction to a recent decline in share price.

Citing a total return closer to the average seen in his coverage area, Mr. Kwan raised his rating for the Calgary-based company to "sector perform" from "underperform."

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"That being said, we see limited potential for material upside, outside of a takeover bid, given weak Alberta power market fundamentals and uncertainty for the power market framework," he said.

On Friday, the company reported third-quarter 2016 fiscal results that largely met his expectations. Comparable earnings before interest, taxes, depreciation and amortization of $244-million, topped his projection of $227-million and was significantly higher than the $219-million result of a year ago.

"Overall, the variance to our results was primarily due to stronger-than-expected contribution from the Canadian Coal and the Gas plants, which were partially offset by weaker-than-expected Hydro and, to a lesser extent, U.S. Coal and Energy Marketing results," he said. "Comparable FFO [funds from operations] for the quarter was $163-million, which was modestly below our estimate of $174-million. We consider the results to be broadly in line with our forecast given the stronger-than-expected EBITDA but lower-than-expected FFO, with both of the variances not being particularly material."

However, Mr. Kwan said he continues to wait for an electricity framework to be announced by the Alberta government.

"The company reiterated that it continues to work toward preparing for the various scenarios that may come about as it relates to the Alberta government's framework for compensating stranded coal assets as well as facilitating the transition away from coal-fired generation," he said. "Management believes that the framework will likely be announced by the end of the year, which is in line with Premier Notley's recent statements with respect to delivering a framework for the conversion away from coal sometime this fall. TransAlta noted on the conference call that it expects to receive an announcement from the Alberta government that would provide a high degree of certainty for the Alberta power market moving forward, but not necessarily in the form of a final framework, as management believes that there are likely areas where future consultation and discussion may occur."

Mr. Kwan increased his full-year EBITDA estimate to $1.048-billion from $1.039-billion in reaction to the result. However, for 2017 and 2018, his estimates fell to $1.023-billion and $1.057-billion (from $1.027-billion and $1.061-billion), respectively, due to lower expected realized power prices.

He maintained a price target of $7 for the stock. The analyst average price target is $6.44, according to Bloomberg.

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"We believe that the share price is adequately reflecting the outcomes for various scenarios for Alberta power prices and/or climate change regulations," said Mr. Kwan. "Based on our valuation framework, we believe that the stock price is fairly reflecting our base case scenario for power prices although we acknowledge that there is a wide range of potential scenarios for how the government moves forward with respect to the framework for the electricity market."

"Low spot and hedged power prices in Alberta and Mid-Columbia over the next several years are expected to depress earnings. With an expectation that prices will remain relatively low over the next two years, we do not see any major catalysts that could result in improved valuation. We are incrementally concerned about a slowing of demand growth in the province, which exacerbates the problem of an oversupply situation."

Elsewhere, Scotia analyst Robert Hope upgraded the stock to "sector perform" from "sector underperform." He maintained a target of $6.50.

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Canyon Services Group Inc. (FRC-T) is the "best positioned pumper in a tough environment," according to BMO Nesbitt Burns analyst Michael Mazar.

He upgraded his rating for the stock to "outperform" from "market perform," citing a "relative" call versus its peers.

"While considerable progress still needs to be made to return to profitability, we view FRC as the best-positioned Canadian pumper due to its stronger balance sheet and lower pro forma re-activation costs," said Mr. Mazar. "While we fear the pumpers' historical penchant for activating equipment at the first sign of pricing improvements, the labour market should help impose discipline."

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On Thursday, Canyon Services released third-quarter results that Mr. Mazar called a "tough slog." EBITDA of a loss of $3-million met the consensus projection though lower than the analyst's estimate. Revenue of $62-million also matched the consensus while topping Mr. Mazar's estimate of $55-million.

"FRC introduced a small price increase during the quarter, although it had no material impact on Q3," he said. "The impact on Q4 is likely to be quite muted as well, but could drive a return to breakeven EBITDA. Q1/17 will likely be the first quarter materially impacted by the uptick in pricing."

Mr. Mazar called the current labour market "extremely difficult," adding: "The pressure pumping industry is beginning to show early signs of scarcity. FRC has been trying to add 100 staff since June, but has had difficulty retaining staff while adding new labour. This appears to be partly a result of the shift to variable compensation for field staff, in concert with skilled labour shifting to other industries. We expect the situation to worsen as pumping demand improves."

"With a labour shortage, a large proportion of the industry pressure pumping fleet requiring meaningful capital to go back to work (FRC requires minimal investment) and continuing increases in frac intensity, conditions are set to improve profitability. A meaningful increase in producer spending is the final component necessary to drive a recovery for the pumpers, in our view."

In response to the results, Mr. Mazar did lower his 2016 earnings per share forecast to a 72-cent loss from a 68-cent loss. His 2017 estimate remains a 35-cent loss.

He increased his target price for the stock to $7 from $5.50. The analyst consensus is $7.13, according to Thomson Reuters.

"Canyon trades at a discount of only 8 per cent to replacement value, a considerable premium compared to the pumping group average of a 28-per-cent discount," said Mr. Mazar. "We believe the current valuation is justified."

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CIBC World Markets analyst Paul Holden raised his rating for Genworth MI Canada Inc. (MIC-T), noting "a smaller housing market doesn't mean smaller earnings."

Upgrading the stock to "sector outperformer" from "sector performer," Mr. Holden said: "The balance of risk/reward looks favourable with the stock trading at 0.7x BV [book value]. The valuation multiple contracted significantly since the government announced changes to mortgage eligibility rules. We think the market has overreacted to the news given anticipated insurance rate increases and our expectation that the rule changes should not have much of an impact on claims losses. Job loss is the key trigger for claims losses and our view on employment has not changed. Anticipated catalysts for a higher valuation multiple include: insurance rate increases, stable house prices over the next 12 months and 2017 earnings that are comparable to 2016."

On Nov. 3, Genworth reported third-quarter results that Mr. Holden called "strong" and raised its quarterly dividend by 5 per cent (to 44 cents from 42 cents).

"The company provided an update on the expected impact from mortgage eligibility rules," said Mr. Holden. "Volumes are expected to be down 15 per cent to 25 per cent for high LTV [loan-to-value] mortgages. We had previously assumed a 15-per-cent decline in volumes and now assume 20 per cent. However, the key point to us remains that insurance rates are expected to increase in 2017, forming a majority offset for lower volumes. This is a positive outcome.

"Lower volumes at a higher price (revenue largely unchanged) is net positive to earnings. Rate changes effective for January 2017 are expected and we see actual implementation as a potential catalyst for the stock. Delinquencies in Alberta are trending higher, but a delinquency rate of 22 basis points is below where we originally would have thought the rate would be two years after oil prices collapsed (we thought rates might spike to 50bps-60bps). Losses from Alberta should continue to climb over the next two quarters, but the rate of change to date is not worrisome."

Mr. Holden maintained a target price for the stock of $35. Consensus is $33.06.

"While the mortgage market and mortgage insurance volumes are expected to slow in 2017, we expect rate increases will be a material offset," he said. "From a margin and earnings perspective, lower volumes at a higher price is not a negative outcome, it is positive. House prices may be flat or down marginally over the next two years, but we don't think mortgage rule changes will cause a material housing market correction. We expect Genworth's loss ratio to stay in the 25-35-per-cent range."

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Though the fourth-quarter guidance for Martinrea International Inc. (MRE-T) fell below expectation, BMO Nesbitt Burns analyst Peter Sklar upgraded the stock based on valuation.

On Nov. 3, the Concord, Ont.-based company reported diluted earnings per share of 34 cents, meeting Mr. Sklar's projection and a penny higher than the consensus though toward the lower end of the company's guidance (33-37 cents).

"As we expected, North America earnings was adversely impacted by a negative mix on certain programs," said Mr. Sklar.

Martinrea's fourth-quarter EPS guidance is also 33-37 cents, compared to Mr. Sklar's 36-cent estimate and the consensus of 39 cents.

"The ongoing headwind in Q4/16 is negative platform mix in North America given the heavy exposure to Ford's production cutbacks (Escape and Fusion) and lower volume on some Chrysler programs," the analyst said.

He added: "The company also provided a longer-term outlook. Management indicated that sales will 'flatten' over the next two to three years and expects production revenues (excluding tooling) towards the lower end of the range $3.85 - $4.35 billion. The company provided two factors that will contribute to a relatively flat trend in sales heading into 2018: i) shutdown of the Detroit Hot Stamping facility and sale of the Soest facility will reduce revenues by about $150-million, and ii) a change in Martinrea's assembly business on the new GM Equinox to a fee-based supply arrangement (VAA) will reduce revenues by about $250-million."

Regardless, Mr. Sklar moved his rating to "market perform" from "underperform."

"In terms of our thesis, we believe Martinrea shares are most susceptible to equity valuation pressure from the themes challenging auto valuations (peak auto, Brexit, technology disruption) as the company maintains a significant amount of debt on its balance sheet," he said. "Currently, Martinrea's net debt as a percentage of its enterprise value is 52 per cent, versus 16 per cent for Magna and 27 per cent for Linamar.

"Our $7.50 (unchanged) target price is based on a projected enterprise value that is 3.9x (from 3.5x) our revised 2017 EBITDA estimate. The stock has declined considerably over the last few days and is currently below our target price. As a result, we are upgrading Martinrea."

The analyst consensus price target is $11.94.

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AutoCanada Inc. (ACQ-T) has "stalled out," said CIBC World Markets analyst Mark Petrie.

Following the release of its third-quarter results, Mr. Petrie downgraded the stock to "sector underperformer" from "sector performer," noting a negative return to his target.

On Nov. 3, AutoCanada reported earnings before taxes, depreciation and amortization were down 11 per cent year over year and 23 per cent lower than the Street's forecast. Earnings per share dropped 21 per cent and missed by 30 per cent.

"ACQ had a tough [first half of 2016], with same-store sales and gross profit down 3 per cent and 5 per cent, respectively, but M&A kept EBITDA up 14 per cent year over year," said Mr. Petrie. "Furthermore, Alberta new car sales in June were actually positive, and there was some optimism that we had hit bottom. Since our last report, we saw a confluence of negative industry data, and same-store metrics took a step down (Q3 same-store sales down 9  per cent and gross profit down 11 per cent).

"AutoCanada is unfortunately over-indexed to geographies and brands that are underperforming the market. The struggles in Alberta show no sign of abating and the domestic OEM struggles out west (and dealers' ability to source light trucks) are no secret; these are likely to carry over into 2017, keeping down New car sales (and related Finance & Insurance). Used car gross profits are up slightly, but are a small segment, and consumer financing has tightened. Parts, service and collision (now up to 41 per cent of gross profit) has been negative all year, and we believe customer-pay volumes will continue to be challenged."

Following the third-quarter miss and anticipating an even worse fourth quarter, citing October industry sales down 5 per cent, Mr. Petrie lowered his full-year EBITDA projection to $90-million (from $103-million). Expecting the company's struggles to continue into the second half of 2017, he lowered his estimate for that year to $99-million (from $118-million).

"Capex remains controlled, cash flow is solid, and covenants were loosened, giving ACQ some flexibility, but we do not envision more than a few large deals per year in the near term," he said.

Mr. Petrie lowered his target price to $18 from $24. Consensus is $26.68.

"It is difficult to see Alberta recovering or ACQ materially growing earnings over the next several quarters," he said. "We believe there remains downside from here and not a lot of upside in the near or medium term. To get more positive, we would need to see macro conditions significantly improve; a major OEM win occur, like purchasing a Ford dealership, or collapsing the GM or Honda structures; or have ACQ outperform industry trends. While these are all possibilities, the macro environment looks negative and is hard to predict, winning Honda earlier this year did not actually help the stock very much, and ACQ has consistently underperformed the market rather than outperform. The industry and company took another step down in Q3 and a recovery in 2017 seems like a remote possibility. We like the dealership business model and believe ACQ has a valuable asset base, but would prefer to not own the stock at this point in the cycle and with significant uncertainty remaining around the magnitude and pace of an economic recovery in the West."

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Raymond James analyst Ken Avalos upgraded InterRent Real Estate Investment Trust (IIP.UN-T) based on its potential for net asset value creation as well as a recent decline in price.

"InterRent REIT has been the strongest apartment REIT for the past 18 months from a fundamentals perspective," said Mr. Avalos, who raised his rating to "outperform" from "market perform." "InterRent has had seven straight quarters of 4-per-cent-plus stabilized property NOI [net operating income] growth and is on pace for near 20-per-cent FFO [funds from operations] per unit growth this year, after posting 8-per-cent growth last year. Perhaps most importantly, the REIT has grown NAV 10-per-cent annualized over the last two years. All metrics lead the pure-play Canadian apartment space."

He added: "Management has been restocking the redevelopment pipeline following the completion of its LIV project. The REIT has a solid runway of assets where in-suite renovations can generate a 15-20-per-cent ROI [return on investment]. Furthermore, we believe that the REIT has intensification potential in Ottawa and Toronto of at least 7,000 suites (which will be built out over the next decade). All of this is accretive to NAV and is potential value creation activity typically not mirrored by peers in the sector."

Prior to the release of its third-quarter results on Monday, Mr. Avalos maintained a target price of $8 per unit. Consensus is $8.49.

"The REIT hit an all-time high in August ($8.65) but has pulled back 16 per cent since then (vs. the TSX Capped REIT Index's 7-per-cent pullback)," the analyst said. "As such, the REIT finally trades at a discount to NAV again. We think strong fundamentals will continue at the SPNOI and FFO lines and NAV growth will continue to lead the sector. The REIT reports 3Q16 earnings Monday. We'd advise investors to accumulate units at these levels and hold on for what should be a strong 2017."

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Citi analyst Alexander Hacking initiated coverage of Teck Resources Ltd. (TCK.B-T) with a "neutral" rating, "seeing a very significant cash generation near-term at current coal prices but are cautious on a 12-month view after a 400-per-cent-plus rally in the stock and with the Citi commodity team's bearish 2H17 outlook for met coal prices."

"Relative to the 4Q benchmark price of $200/ton, Citi's commodity team expects coking coal prices to retreat to an average of $134/t in 2017 and $102/t in 2018 as China relaxes its production policy and additional supply from Australia and the U.S. comes online," the analyst said. "If prices were to hold near the 4Q benchmark level of $200/t, we see significant upside to estimates and believe shares could trade as high as $46/sh."

Mr. Hacking added: "The short-term spike in coking coal prices is generating a significant cash windfall. The stock is trading on [approximately] 20-per-cent FCF [free cash flow] yield on $200/ton coking coal and 30-per-cent on spot $275/ton. The company is substantially deleveraging with every passing month (and moving closer to a return to investment grade)."

He set a target of $30. Consensus is $28.72.

"Teck's management team has a clear focus on building long-term shareholder value," said Mr. Hacking. "Despite challenging markets in recent years, Teck has managed to reduce costs and fund construction of Fort Hills while avoiding major asset sales or equity issuance. We have confidence the management team will continue to exercise thoughtful and disciplined capital allocation."

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In other analyst actions:

CIBC World Markets analyst Cosmos Chiu raised his rating for Royal Gold Inc. (RGLD-Q) to "sector outperformer" from "sector performer." He raised his target to $90 (U.S.) from $88. Consensus is $90.96.

Pembina Pipeline Corp. (PPL-T) was raised to "outperform" from "sector perform" at Alta Corp Capital analyst Dirk Lever. His 12-month target price rose to $46.00 per share from $42.50. The analyst average is $44.78, according to Bloomberg. The stock was also raised to "buy" from "hold" by GMP analyst Ian Gillies with a target of $45 (up from $40).

Detour Gold Corp. (DGC-T) was downgraded to "sector perform" from "outperform" at RBC Capital Markets by analyst Dan Rollins. His target price fell to $35 from $45. The average is $32.97.

Fairfax Financial Holdings Ltd. (FFH-T) was raised to "buy" from "market perform" by Cormark analyst Jeff Fenwick with a target of $800 (unchanged). The average is $778.30.

Gear Energy Ltd. (GXE-T) was rated a new "buy" by Beacon Securities analyst Lyndon Dunkley with a target of $1.35. The average is $1.08.

Suggesting regulatory pessimism is "overdone," Credit Suisse analyst Omar Sheikh upgraded Time Warner Inc. (TWX-N) to "outperform" from "neutral" with a target of $107.50 (U.S.), which did not change. Consensus is $102.28. Mr. Sheikh said: "We think the market is being too pessimistic about the regulatory review process for the AT&T transaction, which we believe has a good chance of being approved. Even if the deal is somehow blocked, strong underlying business trends and the potential for other offers in the future are likely to limit the downside."

Morgan Stanley analyst Rajeev Lalwani initiated coverage of Alcoa Corp. (AA-N) with an "equal-weight" rating. He set a target of $19 (U.S.), versus the average of $24.85. Cowen analyst Anthony Rizzuto initiated coverage of the stock with a "market perform" rating and $29 target.

GMP analyst Michael Urlocker initiated coverage of BSM Technologies Inc. (GPS-T) with a "buy" rating and $2 (Canadian) target. The average is $1.96.

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About the Author
Globe Investor Content Editor

David Leeder is a content editor in the Report on Business. He was previously Deputy Sports Editor and Weekend Digital Editor at The Globe.  He holds an undergraduate degree from McMaster University and a graduate degree from Ryerson University. More

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