Monday’s analyst upgrades and downgrades

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

Investors are "paid (handsomely)" to wait for the benefits from the ongoing diversification of Chorus Aviation Inc.'s (CHR-T) business model, according to Canaccord Genuity analyst Doug Taylor.

Touting its well-defined relationship with Air Canada (AC-T), which he feels should provide some semblance of stability through 2025, Mr. Taylor initiated coverage of the regional airline with a "buy" rating.

"The vast majority of Chorus business still stems from its capacity purchase agreement (CPA) as the operator of the Jazz regional airline," he said. "A 2015 renegotiation of this CPA saw it extended through 2025 but will also see the relationship evolve during that term from a largely fixed-fee-per aircraft model to include more lease-like revenue. It also features a step down in the total level of profit Chorus will recognize during the 2021-25 years (by $60-million per year). The upside is that Chorus will emerge with a more competitive cost structure and a more modern fleet, and we expect its relationship with Air Canada will persist beyond this current agreement.

"We don't believe that Chorus will, or could, suffer an Aimia-like fate. The recently announced decision by Air Canada to internalize its loyalty program and the significant fallout for Aimia, another business spun out of Air Canada like Chorus, does raise the question of whether Air Canada could, or would want to, fail to renew its business with Chorus in a similar fashion. In our view, the answer is no."

Mr. Taylor said that revised deal with Air Canada provides Chorus with the time and opportunity to diversify its business. He believes those efforts are currently "starting to take shape" with the company utilizing higher profit levels from its Air Canada CPA for new initiatives.

"The company has formed or acquired several new operations, including the Voyager contract flying, parts, and maintenance, repair and overhaul (MRO) business (bought in 2015 for $80-million) which have been combined with capabilities within the Jazz operation," the analyst said. "These are small but growing opportunities as Chorus increasingly markets its capabilities to third-party airline operators. More meaningful in the near term will be the recent formation of Chorus Aviation Capital, a regional aircraft-focused leasing business. Leasing will be the primary growth vector for Chorus; the company has a differentiated approach here.

"Chorus' leasing operation is the primary focus for near-term investment. This movement into leasing, which involves a significant degree of capital up front, was funded by a $200-million convertible unit investment by Fairfax Financial which can be levered up to close to $1-billion in aircraft purchases once specific aircraft debt is added (up to 4 times debt/equity). In the few months since the Chorus Aviation Capital arm was formed, Chorus has completed two transactions for 10 aircraft (we estimate a total of $285-million) and claims a strong pipeline of other opportunities."

Mr. Taylor said a key benefit of diversification into leasing is the relative higher valuations commanded by these businesses.

"Chorus' existing business has traditionally commanded a valuation of 4.0 times EBITDAR [earnings before interest, taxes, depreciation, amortization and restructuring] – the more common multiple metric used for airlines but based on arguably inflated CPA profitability – or 7–8 times P/E [price to earnings]," he said. 'Leasing businesses, on the other hand, trade largely based on multiples of earnings (taking into account the offsetting funding cost) of 10–11 times. We believe there will be a benefit to multiples as the lease mix builds but also over time, we think, as more of the CPA revenue is derived from leasing as opposed to fixed infrastructure fees."

Expecting the stock "to continue to re-rate over time," he set a price target for the stock of $9. The analyst consensus price target is currently $8.39, according to Thomson Reuters data.

"Given a 28-per-cent return to our sum-of-the-parts-based valuation, we are initiating with a positive outlook for the shares," said Mr. Taylor. "On our 2018 estimates, this equates to a 6.8 times enterprise value /EBITDAR multiple and 10.6 times based on P/E. Note that Chorus pays a 4 cents per month dividend (6.5-per-cent annual yield) which in our view is well covered by the current level of profitability and rewards investors for waiting the transition to a more balanced portfolio of regional aircraft businesses."

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Though he remains "on the sidelines" for its peers given their Softwood Lumber Agreement  exposure, CIBC World Markets analyst Hamir Patel upgraded his rating for Interfor Corp. (IFP-T), which he calls his preferred commodity lumber.

"Following pricing momentum late in the first quarter, and recent progress with margin improvement initiatives, Interfor remains very much on track for significant earnings growth over the remainder of 2017," said Mr. Patel, moving the stock to "outperformer" from "neutral."

Calling it "well positioned across its platform," Mr. Patel said: "With two-thirds of its capacity in the U.S., Interfor is a net beneficiary from the lumber trade dispute as duty-induced pricing gains more than offset the company's duties. At the same time, it is becoming increasingly evident that sawlog prices in the South (currently 40 per cent below 2005 levels) [major input cost] are nowhere near the elusive 'tipping point' the timber REITs often claimed in recent years to be around the corner. We believe stumpage prices in the South will remain flat for an extended period of time given the scale of excess inventory "stored on the stump" in the South. Layer on even higher prices for Southern Yellow Pine (given trade duties), and Southern sawmillers look set to realize margins well above mid-cycle levels for several years to come. While 15 per cent of Interfor's total volumes are directly affected by U.S. countervailing duties, with cedar producers having passed through the cost of duties to the U.S. consumer (based on current prices), IFP's duty exposure is even less than it seems."

Mr. Patel maintained a target price for Interfor stock of $22. Consensus is $22.50.

"Our valuation multiple is lower than the company's historical forward 12 month enterprise value/EBITDA multiple (7.8 times) as we believe the historical multiple is skewed higher due to: 1) the nature of the company's prior acquisitions; and, 2) high investor expectations of future accretive growth opportunities," he said. "While we believe Interfor will continue to expand capacity through accretive M&A, we expect the pace to slow in the near term as the company focuses on optimizing its now expanded mill system."

At the same time, Mr. Patel also upgraded Resolute Forest Products Inc. (RFP-N, RFP-T) to "neutral" from "underperformer."

"Immediately following Resolute's announcement on Thursday that it will indefinitely curtail its #2 paper machine at Catawba, SC (190,000 tons per year of No. 4 coated mechanical) from July 1, several other producers including Verso, Catalyst and West Linn Paper all announced $40 per ton July price hikes across most coated paper and supercalendered (SC) grades," said Mr. Patel." Strong implementation of these hikes would represent upside to our estimates as we had only been factoring in a $25/ton increase in Q4. While we have yet to adjust our production forecast for the Catawba PM#2 closure, we do not expect the shut to materially impact our EBITDA forecast as we suspect the machine was running breakeven at best. According to Pulp & Paper Week, the current price hikes are also being supported by rolling downtime across Verso's platform and perceptions that printer inventories have now been taken 'down to the bone' and that this will spark reloading come July. At the same time, it appears as though European producers are less inclined now to ship as much stateside as large capacity closures on the continent, and a stronger euro, have reduced the attractiveness of the U.S. market."

He kept a target of $5 (U.S.) . Consensus is $4.63.

"We had previously downgraded Resolute on April 22, 2016 when the shares were trading atS$6.39 due to the company's lofty valuation at the time despite looming SLA headwinds," he said. "With Resolute having underperformed the S&P 500 by over 38 per cent over the last 12 months, and now trading 7 per cent below our $5.00 price target, we see limited downside risks and … raise our rating to Neutral."

Mr. Patel also raised Domtar Corp. (UFS-N, UFS-T) to "neutral" to "underperformer" with a $37 (U.S.) target, down from $38. Consensus is $42.27.

"While Domtar has underperformed its pulp and paper peers by 15 per cent to 30 per cent over the last 12 months (in addition to lagging the S&P 500 by 14% over the same period), we see upside risks building from a potential price hike in the core uncoated freesheet business."

He added: "As one of only three fluff producers in the world with more than one fluff mill (Domtar has had two facilities producing fluff since the Ashdown conversion), the company is well positioned to gain share as global customers start to reward the company with more business as existing supply commitments lapse and they seek to diversify a supply base that has become increasingly concentrated following IP's acquisition of Weyerhaeuser's pulp business six months ago."

Mr. Patel downgraded Canfor Pulp Products Inc. (CFX-T) given his belief softwood pulp markets are at their peak.

Moving the stock to "neutral" from "outperformer," he cut his target by a loonie to $13. Consensus is $13.35.

"We have lowered our 2018 EV/EBITDA valuation multiple to 5.25 times (from 5.75 times) reflecting increased uncertainty related to global capacity additions slated to come online over the next few years," he said. "We still see CFX as a good operator and steady free cash flow generator, but with limited catalysts on the horizon, we prefer Mercer in pulp right now given MERC's more-diversified revenue profile (stable energy revenues and European lumber) and the option value upside associated with Mercer's ongoing NAFTA claim against Canada."

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Penn West Petroleum Ltd.'s (PWT-T, PWE-N) new management has the opportunity to reverse to move it back toward growth in 2017 given its "right-sized" balance sheet and "solid" asset base, said Canaccord Genuity analyst Sam Roach.

However, he said the expiration of its Peace River Oil Partnership (PROP) with its joint venture partner in late 2017 presents a significant near-term headwind.

Given Penn West is also currently trading at a premium to its peers, Mr. Roach initiated coverage of the Calgary-based company with a "hold" rating.

"Over the past nine years Penn West sold greater-than $4-billion of assets to repay debt, but in early 2017 management declared the disposition program complete and laid out plans to grow production greater-than 10 per cent in 2017," he said. "We believe the company is well positioned for a turnaround given its low-risk, low-risk, low decline assets and strong suite of high-return drilling and flooding prospects."

Mr. Roach pointed to waterflooding upside potential in the Cardium and an "untapped" Spirit River drilling inventory as potential opportunities for growth in the future.

At the same time, he said the expiry of the PROP with China Investment Corporation (CIC) could lead to higher capital efficiencies and operating costs in 2018 despite economics of the play remaining "robust."

"Under the joint venture agreement CIC paid $312-million cash and a $505-million carry for a 45-per-cent non-operated interest in Penn West's Peace River assets," said Mr. Roach. "Coincidently, CIC acquired 23.5 million PWT shares for $435-million through a private placement. Since then CIC has carried 90 per cent of Penn West's capital and operating costs in the play; however, that will run out near year-end 2017. Expiration could be a catalyst for consolidation, in our view; however Penn West would likely need external financing if it were to buy out CIC's interest in the partnership."

Mr. Roach set a price target for the stock of $2.10. Consensus is $2.55.

"We like Penn West's balanced asset base and strong fundamentals, and we believe the company's debt problems are in the rear-view mirror," he said. "However, there are near=term headwinds in the expiration of the partner carry in late 2017, and PWT is trading at a premium valuation to other oil-weighted E&Ps. We would become more positive on the stock if Penn West: 1. Demonstrates strong decline management and/or better-than-expected production growth in the Cardium in 2017. 2. Defines a large inventory of Spirit River locations or made a significant discovery on its 700 sections of undeveloped land. 3. Makes an accretive, de-levering transaction that adds defined drilling inventory."

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Raymond James analyst Frederic Bastien raised his target for Brookfield Infrastructure Partners LP (BIP-N, BIP.UN-T) after hosting chief financial officer Bahir Manios for a series of institutional meetings in Vancouver and Calgary between May 23 and 26.

Mr. Bastien said Brookfield's $5.2-billion (U.S.) acquisition of 90 per cent of the operator of Petroleo Brasileiro SA's natural gas pipeline unit (Nova Transportadora do Sudeste SA) could prove to be its best deal since the recapitalization of Babcock & Brown in 2009.

"Although the natural gas pipeline business acquired from Petrobras has only been contributing to results for a couple of months, cash-on-cash yields are reportedly coming in the high teens," said the analyst. "Moreover we were reminded that while BIP deployed $1.3 bln of capital at the onset, it's also earning a return on the $300-million in deferred consideration to be paid in five years (if that's not a sweet deal we don't know what is). We believe both factors make the Street estimates for the business look too conservative, and have adjusted our forecasts upward as a result. Importantly, our revised estimates do not take into consideration the great degree of optionality embedded in NTS. The business is a natural buyer for additional pipeline assets Petrobras may be forced to sell, and could strap on a bit of debt should Brazil's fixed-income markets improve sufficiently over time. We should add that natural gas is only in its early years of adoption in Brazil, creating a long-term platform for organic growth opportunities.

"NTS was made possible by taking an educated bet on Brazil 18 months ago when the economy, currency and political environment were in turmoil, and capital was flowing out of the country. The window of opportunity has rapidly closed since, but with volatility returning amid corruption allegations against President Michel Temer, we believe the partnership could get another chance to buy high-quality assets for value. Management would love, for example, to add 1,500 kilometres of electrical wires to the 4,000 kilometres it underwrote last year. This would get BIP's Brazilian electricity transmission business to a similar size as its Chilean flagship investment, Transelec, once all lines are commissioned by 2020. But with the company batting zero in the past few months as competition returned, we're not holding our breath just yet."

In a research note on the company, Mr. Bastien pointed to a May 22 article in The Globe and Mail which said new rules in the works for S&P/TSX composite index could lead to Brookfield gaining index membership.

"The team running the S&P/TSX composite has put forth a proposal that would make it easier for dual-listed stocks that trade more heavily on U.S. exchanges to meet the threshold for index inclusion up North," he said. "The rules, which could be in place as early as September, could create demand for an incremental 13 million units of BIP and put upward pressure on price through 2H17. Beyond this initial expected lift, we are agnostic to index membership since the unit price would respond more closely to fund flows (which can be a mixed blessing)."

After the meetings, Mr. Bastien raised his funds from operations per unit projections for 2017 and 2018 to $3.20 and $3.55, respectively, from $3.15 and $3.50.

He maintained an "outperform" rating and bumped his target to $48 (U.S.) from $43. Consensus is $42.44.

"When we launched research coverage of Brookfield Infrastructure on Feb. 26, 2013, its units traded at an implied distribution yield of 4.3 per cent and a forward EV/EBITDA multiple of 13.1 times," said Mr. Bastien. "Coincidentally, the partnership is trading at similar valuations today, despite owning a much larger and more predictable portfolio of infrastructure assets. We argue the utility-like attributes of BIP's growing asset base, combined with the high single-digit to low double-digit cash distribution per unit (CDPU) growth that we forecast through 2020, support the use of a much lower target yield than ever before. We settled on 4.0 per cent, which represents the mid-point between the units' 5-year average of 4.4 per cent and the average yield of 3.6 per cent for Canada's three lowest-yielding regulated utilities (Fortis, Hydro One and Canadian Utilities). This effects a new target price of $48.00 for BIP, up from $43.00 previously."

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Canada Goose Holdings Inc.'s (GOOS-T, GOOS-N) top and bottom line fourth-quarter 2017 earnings beat demonstrated "both its top line momentum in a tough retail tape as well as earnings seasonality," said RBC Dominion Securities analyst Brian Tunick.

Though it reported a quarterly loss of 15 cents per share, Mr. Tunick feels "direct momentum is likely to provide the juice for GOOS to exceed its conservative mid- to-high teens sales and 25-per-cent-plus net income guidance."

The analyst said: "In a softlines space desperate for growth, Canada Goose stands out given multiple levers to support a high-teens top line in the coming years, including 1) highly productive footage growth toward 30-50 units longer term (from 2 today); 2) double-digit ecommerce gains as country-specific sites are rolled out (off a base of 4 today); 3) 6-8-per-cent wholesale gains thanks in part to 3-per-cent price increases; 4) geographic expansion; and 5) select new category growth as Canada Goose expands into a three-season business," he said. "Looking out, we expect that Canada Goose can put up a 19-per-cent top line CAGR [compound annual growth rate] through 2022, with overall revenues approaching $1-billion from $384-million today."

"Taking control of the growth, as Canada Goose shifts the business towards Direct from primarily wholesale today. We expect that Direct can approach 48 per cent of total sales by 2021, with split equally between ecommerce and stores. This compares to an estimated 75 per cent/25 per cent wholesale/Direct mix today. With secular concerns about the wholesale channel, we look favorably on Canada Goose's taking control of its growth trajectory from here."

Mr. Tunick pointed to four direct drivers for the company's growth moving forward. They were:

- Retail store expansion. He said: "With our view that Direct outperformance is likely to be the driver of top line beats in the GOOS model, our focus is on store-level productivity as footage growth picks up. We expect that in the next 2-3 years, the focus will be on store growth in highly productive, tourist cities such as London and Paris (mirroring the online push). Over time, management expects overall productivity to taper down towards $2000/sq. ft. as newer markets are explored, which could prove conservative given the strength of the initial locations."

- E -commerce growth, calling it "equally important to direct growth."

- Category expansion as it moves to become a three-season business. Mr. Tunick said: "the Canada Goose customer seems most willing to consider Canada Goose's foray into the lightweight jacket, gloves, and parkas categories – categories we do not consider unreasonable given their "above the waist"/cold-weather positioning. This customer affinity appears to be taking hold in 4QF17 results, with management calling out the strongest response yet to its lighter-weight down and spring assortments to date."

The analyst raised his earnings per share projections for 2018 and 2019 to 50 cents and 62 cents, respectively, from 45 cents and 57 cents.

"While GOOS's growth undoubtedly comes at a price, we see several upside drivers to our model as the strong productivity and higher margin Direct channel grows faster than what we have forecasted," he said. "Should Direct exceed expectations, we see an upside scenario pointing to 75 cents in fiscal 2019. If our upside scenario plays out, we could see a stock price approaching high-C$30s."

With an "outperform" rating (unchanged), his target jumped to $33 from $25. Consensus is $27.31.

Elsewhere, Credit Suisse analyst Christian Buss called the quarterly results "strong" and said they demonstrate "the power of the company's multiple diversification initiatives."

Maintaining an "outperform" rating and increasing his target to $33 from $26, Mr. Buss said: "In particular, we are compelled by diversification of: 1) channels into an eCommerce-led DTC strategy (up 175 per cent year over year); 2) products into three-season cool and wet weather product; and 3) manufacturing away from inefficient contractors toward owned-facilities. We are increasingly comfortable with expectations for sustained 20-per-cent-plus adjusted EBITDA growth over the next several years."

BMO Nesbitt Burns analyst John Morris bumped his target to $33 from $28 with an "outperform" rating.

"We are encouraged by the company's ability to grow top-line revenues more than expected," said Mr. Morris. "Further, FY4Q Adjusted pro forma EPS of a loss of 14 cents was above our forecast of a 19-cent loss. DTC revenue came in above expectations at $36-million, above our forecast of $17-million. The top-line revenue beat was noteworthy considering that revenues had already been pulled forward into FY3Q given high wholesale demand. Guidance is likely conservative but in line with expectations."

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Calling it "an internet value story with several paths to value creation," Credit Suisse analyst Paul Bieber upgraded eBay Inc. (EBAY-Q) to "outperform" from "neutral" upon assuming coverage of the stock.

"While eBay remains a turnaround story, Marketplace growth is stable and has the potential to accelerate in 2H17/2018, driven by platform changes and product innovation," he said. "Stubhub growth is attractive, and the Classifieds business is underappreciated by the Street given a direct European comp with a healthy multiple. Given Classified/Stubhub asset value, our analysis suggests the Marketplace is undervalued at 13 times versus retail comps at 18 times."

"eBay is a rare value story with several paths to value creation including: 1) potential monetization of classified and/or Stubhub businesses, which we estimate could be worth $9.5-billion-$12.8-billion (or 25-35 per cent of current enterprise value) given attractive comp multiples; 2) potential Marketplace Gross Merchandise Volume (GMV) acceleration driven by structured data, new product experiences and investments in marketing; 3) improved transaction rev. growth driven by uptake of promoted listing ads; and 4) more aggressive share repurchases (could add 10 cents to '18 EPS)."

He set a price target for the stock of $44 (versus a previous target of $34). Consensus is $35.32.

"eBay currently trades at approximately 15 times 2018 Non-GAAP EPS versus a retail comp group that trades at 18 times. For context, the retail comp group will likely grow 2017 revenue at approximately 3-4% vs. eBay at approximately 5 per cent. However, given the potential for accelerating growth in 2H and 2018 and secular tailwinds for eBay versus secular headwinds for the retail comp group, we think eBay should trade at a premium to the retail comps."

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RBC Dominion Securities analyst Randall Stanicky downgraded Perrigo Company PLC (PRGO-N) to "underperform" from "sector perform."

"The core U.S. Consumer business is facing 'structural' headwinds that we think will continue to largely offset new launch growth," he said. "Our analysis shows that growth in U.S. Consumer has been flattish on a TTM [trailing 12-month] basis since 2014 and that coincided with a meaningful acceleration in base business erosion adding a 6–7-per-cent headwind. We think that base business headwind is a 'new normal' that has potential to get worse as pressure on pricing and share continues. That, combined with PRGO's now bigger base business against fewer new launch opportunities from category switches, will make the company's recently lowered 2–4-per-cent revenue growth target, which is already a meaningful deceleration from the historical 5–10 per cent, difficult to achieve. More near-term, challenging cough/cold comps will introduce an additional hurdle to reversing growth over the next year. We have lowered our 2017–19 EPS estimates further largely on the back of lower Consumer forecasts, with growth driven by capital deployment, while our EBITDA is largely flat."

"The pressures being seen in the Generics business are well understood but we think they will get worse. PRGO's generics business had benefited from a lack of meaningful competition for years, which had allowed the company to over-earn. That has clearly begun to change. But as generic approvals continue to ramp, we expect the pressure on margins to remain steady and introduce headwinds that we do not think the current pipeline can offset. This creates an annual EPS headwind that other parts of the business will have to absorb, and at 34 per cent of operating profit this segment is still an important contributor to valuation."

Mr. Stanicky lowered his target to $60 (U.S.) from $66. Consensus is $76.79.