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Thursday's analyst upgrades and downgrades

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

Brookfield Asset Management Inc. (BAM-N, BAM.A-T) has "solid" business momentum and an increasing intrinsic value per share "with the passage of time," according to RBC Dominion Securities analyst Neil Downey.

Ahead of a series investor meetings next week in New York, Mr. Downey upgraded his rating for the stock to "top pick" from "outperform."

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"It has taken time, yet, some eight-years post 2008 global financial crisis, industry rationalization has resulted in BAM and several other alternative asset managers seemingly separating from the pack," he said. "We believe BAM's key competitive advantages include its: 1) global reach; 2) size/scale, 3) strong investment track records; and, 4) ability to offer clients multiple funds/investment strategies. These attributes allow for a wide range of investment offerings to clients and they help clients consolidate their manager lists."

Mr. Downey called the company's fee-bearing capital growth "impressive," after a rise of 15 per cent year over year to $108-billion (U.S.) in the second quarter. He noted Brookfield also posted a trailing five-year compound annual growth rate of almost 15 per cent.

"Over the next 12-24 months we believe FBC growth will likely slow, due largely to more modest private fund raising activity," the analyst said. "Over the next twelve months, we expect much of the focus to be upon investing the large amounts of capital that were recently raised for flagship private funds. We believe BAM may be in a position to launch fundraising for its next round of flagship private equity funds by late 2017 or into 2018, which could in turn positively impact the growth rate private fund FBC looking out as far as 2019 to 2020."

Mr. Downey said BAM shares are on RBC's Top 30 Global Ideas list for 2016, but he called its share performance thus far just "okay" compared to key benchmarks. The price has risen 8 per cent in 2016, versus a 5-per-cent rise in the S&P 500, 12-per-cent increase in the TSX Composite and a 10-per-cent total return for the FTSE/EPRA NAREIT Global REIT.

"Somewhat in contrast, we see a business model which has momentum in so far as: 1) H1/16 results were good (operating funds from operations/share was up 40 per cent year over year); 2) our intrinsic value/share estimate is up $2 versus Q4/15; and; 3) our 2016-17 estimated OFFO/ share were revised upward through H1/16," he said. "As such, our conviction in the investment merits of BAM's shares has, if anything, strengthened. Currently at $33, the shares are at a 12-per-cent discount to our $38 IV/share value estimate. We see an attractive entry point for outsized 12-month total return potential, stemming from: 1) high single digit expected IV/share growth; 2) a 1.5-per-cent dividend yield; and, 3) the potential for narrowing of the discount, or convergence between the share price and intrinsic value."

He maintained a price target for the stock of $41 (U.S.). The analyst consensus price target is $40.44, according to Thomson Reuters.

"We have confidence in BAM's business model, which at its core includes the long-term compounding from real-return and private equity investments, levered via the exposure to a fee-based asset management business," he said. "The latter, we believe, benefits from diversified, large and growing pools of both captive and 'sticky' fee bearing capital, and currently appears to have good momentum in private fund raising efforts. Overall, we believe our target valuation is appropriate in light of BAM's high quality asset base and the growing profitability of its asset management platform. We believe there are few, if any, companies that are truly comparable to Brookfield Asset Management and we continue to view BAM's shares as a 'core holding.'"

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"Peer-leading" free cash flow visibility justifies an upgrade for Imperial Oil Ltd. (IMO-T) stock, according to Raymond James analyst Chris Cox.

Also citing "strong" operational momentum and a "clear line of sight" to returning meaningful cash to shareholders, Mr. Cox moved his rating to "outperform" from "market perform."

"Backstopping our improved outlook on the shares is a robust free cash flow outlook, with the ability to cover current dividends and sustaining capital at oil prices as low as $40 (U.S.) per barrel WTI; while this is among the better break-evens in the industry, we acknowledge that many, if not all, of the company's Canadian large cap peers can point to noticeable free cash flow over the coming years," said Mr. Cox. "Historically a very strong operator, with a returns-focused business model and a demonstrated track record of returning cash to shareholders, what we think differentiates the Imperial story versus peers is the clearer line of sight to actually achieving the free cash flow projections that many on the Street forecast for the Canadian large cap energy names. In this respect, we thought the update from the 2016 Investor Day was supportive; guidance on sustaining capital has moved 25 per cent lower to less than $1-billion per year, operational performance at Kearl looks to be very strong and management commentary around Syncrude was similarly encouraging. On balance, the business as a whole seems to be showing strong operational momentum, along with continued strong performance on reducing the cost structure – both supportive of the free cash flow outlook for the company."

"The natural pushback on this upgrade will likely focus on two key factors: 1) Imperial is a historically defensive story, so this is likely the wrong part of the cycle to get long if you are bullish oil prices (which we are), and, 2) Imperial trades at a premium valuation. With respect to the first point, while there are certainly more levered plays to a rising crude price, we think Street perceptions around the business need to change; this is not to say that Imperial isn't still relatively defensive, but with sizeable growth of upstream production in recent years, we think the Street may be underestimating the upside to rising oil prices in the business model. Further, while the stock outperformed in the early part of the downturn, the stock has noticeably underperformed over the past 12 months and has now traded more-or-less in-line with its peer group since the start of the downturn, despite the consensus view that this is a defensive story."

Mr. Cox emphasized that the "notoriously tight-lipped" company is now speaking more definitively about potential synergies at Syncrude. Coupled with recent results, he said it points to a "step-change" in performance.

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Calling its free cash flow outlook the core focus for investors, Mr. Cox highlighted the company's commitment to cost reductions. He noted per-unit operating costs have dropped 30 per cent since the beginning of the sector's downturn, with management's guidance aimed at a $200-million drop above the operating unit structure.

"Importantly, this has been achieved without any discernable reduction in headcount," he said. "More notably, management is now guiding to a lower level of sustaining capital of $900-million per year, which is down from the previous guidance of $1.2-billion. When combined with the strong operational results at the Kearl project and the expectation for better results out of Syncrude, the strong performance on costs helps support a robust free cash flow outlook, while also improving the sustainability of the underlying business."

"A logical extension of the free cash flow discussion from above is the likely uses of future free cash flow, alongside the company's expected use of proceeds from the sale of the company-owned retail stores earlier this year for $2.8-billion; recall, that package was broken up into separate transactions, with the full package expected to close by year-end. Notably, management commentary on this front indicated a definitive lack of interest in keeping that cash on the balance sheet, especially given a relatively healthy leverage position and attractive access to low-cost debt financing through ExxonMobil. We continue to believe that the company will ultimately take one of two courses of action with the proceeds from the retail business: either use the proceeds to fund potential acquisitions at the bottom of the commodity cycle, or, use the proceeds to kick-start an aggressive share buyback program. Although management hasn't mentioned any specific acquisition targets, it is something they continue to evaluate. Long-time investors in Imperial will recall the period of the mid-1990s – the last time that Imperial went through a free cash flow cycle similar to the one we project over the coming years. During that time, management used free cash flow from the business to gradually grow the dividend, with the bulk of free cash flow being directed toward an aggressive share buyback program; this resulted in the repurchase of more than half of the company's shares outstanding. With growth capex only expected to average $500-million over the balance of the decade, and with the ability of the company to self-fund this growth below $50/bbl, we expect Imperial will likely embark on a fairly aggressive share buyback program over the coming years."

He maintained a target price of $50. Consensus is $45.24.

Elsewhere, the stock raised to "outperform" from "sector outperform" at Alta Corp Capital Inc. by analyst Nicholas Lupick with a target of $50.

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The utilities sector has begun a significant structural change, said Raymond James analyst David Quezada in a research note.

"[Developments] include the proliferation of renewable power, the pressing need for investment in aging grid infrastructure after years of underinvestment, and the beginnings of distributed generation (rooftop solar, for example)," he said. "While we believe attractive investment and growth opportunities exist for the companies in our coverage universe, from an investor's perspective, we must also acknowledge the negative correlation between interest rates and sector valuations and the fact that with a few exceptions, trading multiples are generally at the high end of the historical range. Given our view of potentially rising interest rates pressuring valuations, we believe investors will be well served by a selective approach to the sector with a focus on companies where growth is sufficiently attractive as to offset this risk or relative valuations appear attractive."

Mr. Quezada initiated coverage of Algonquin Power & Utilities Corp. (AQN-T) and Fortis Inc. (FTS-T) with "outperform" ratings. He gave Emera Inc. (EMA-T) a rating of "market perform."

"The utility sector has historically maintained a negative correlation with interest rates – something we believe makes intuitive sense given stable dividend yields, high proportions of regulated cash flows, and generally measured EPS and dividend growth," the analyst said. "Meanwhile, we also highlight that the Canadian utilities in particular are trading toward the high end of their 5 year forward P/E range, something we expect partially reflects strong expected earnings growth driven by recent M&A activity, as well as the current low interest rate environment. As such, while we believe broader supportive trends such as the continued consolidation of the North American utilities sector, as well as rate case opportunities driven by large required investments in the U.S. electrical grid will drive earnings growth, we also acknowledge modest upside remains in terms of the respective trading multiples. In fact, excluding the period where sector valuations recovered from historical lows during the financial crisis, we believe there have been 2 instances where the Government of Canada 10-year bond trended upward for an extended period over the past 10 years during which sector forward price-to-earnings multiples contracted by 2x and 4x respectively. While we do not specifically forecast rising interest rates in the near term, we must acknowledge that a rate increase could occur over our forecast horizon. Therefore, we advocate investors add to positions in names with the most attractive growth profiles (Algonquin), or select cases where we believe relative valuations are favourable (Fortis)."

He set a price target of $14.50 for shares of Algonquin. The analyst consensus is $13.97.

"Our top pick among the Canadian utilities, we believe Algonquin has an attractively balanced mix of regulated utility and power generation assets as well as numerous promising avenues for growth," said Mr. Quezada. "We also take a positive view of the pending acquisition of Empire District Electric (EDE) on earnings accretion and strategic fit. Accordingly, our estimates indicate AQN will see earnings growth well outpacing that of the utility peer group supporting a targeted 10-per-cent annual dividend growth rate."

For Fortis, he set a $50 target, versus a $48.22 consensus.

"We regard Fortis as a premier diversified Canadian utility and a core defensive holding within the broader energy infrastructure sector," he said. "Our constructive stance is primarily based on our view of Fortis' low risk business and solid growth opportunities supporting an attractive risk adjusted return. Further, we believe the stock's current valuation discount to the Canadian utility peer group is unwarranted and expect it will normalize over time."

Mr. Quezada's target for Emera is $51.50. Consensus is $54.44.

"While we take a positive view of Emera from a fundamental perspective, our neutral stance is largely a call on relative valuation," he said. "We like EMA's pending acquisition of TECO and its attendant investment opportunities as well as the company's strong slate of current and potential transmission projects. However, given Emera's (albeit reduced) exposure to merchant power (16 per cent of pro-forma earnings) we believe the company has a modestly higher risk profile than fellow large cap peer Fortis with similar potential returns. Accordingly, the fact that Emera trades at a premium to Fortis and is trading at the high end of its 5-year trading range, prompts our market perform rating."

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An improved mix and price increase for the iPhone 7 Plus should drive average selling price (ASP) upside for Apple Inc. (AAPL-Q), said RBC Dominion Securities analyst Amit Daryanani.

He increased his target for the tech giant's stock in response to an RBC survey of iPhone purchasing decisions of 6,845 consumers.

"We think demand for the iPhone 7 is robust and ASPs and gross margins will remain stable/see potential upside given mix benefits," the analyst said. "We highlight several key findings from our survey results: 1) 71 per cent of respondents intend on purchasing one of the new iPhone 7 products which compares favorably versus 65 per cent of respondents favoring the latest iPhone during the 6S cycle last year (ASP benefits), 2) Mix shift toward the 5.5-inch model could drive substantial ASP upside: 46 per cent of respondents plan to buy the larger form factor 5.5" iPhone (across 6S+ and 7+ models), up from 38 per cent a year ago (6+ and 6S+), 3) Doubling of entry level storage for the iPhone 7 could dilute ASPs and margins, but we think this should be manageable (approximately 50 per cent intend to purchase mid-tier storage configuration, which is a modest decrease from the prior 6S cycle), 4) replacement cycle – although there are concerns about replacement cycles becoming elongated, our survey suggests there could be stability in this metric, 5) attach rates for ancillary products and services have been trending higher."

"Our survey results indicate a stronger preference for the current iPhone 7/7+ models vs. consumer preferences for the latest iPhone during the 6S cycle, with 71 per cent of respondents planning to obtain the most current iPhone, up from 65 per cent a year ago. We think the mix shift toward the latest model will provide AAPL with ASP tailwinds as current models typically command a $100 ASP differential versus iPhones launched in the prior year. Notably, the iPhone 7+ carries a $120 premium over the iPhone 6S+ and mix shift toward the larger form factor could enable further ASP tailwinds. Lastly, only 6 per cent of respondents intend to purchase the 4" iPhone SE model versus 10 per cent for the iPhone 5S last year; this change should be incrementally beneficial for ASPs as well."

Mr. Daryanani said the iPhone 7 Plus marks the first time a premium model has differentiated itself beyond simply a larger screen or better resolution. He thinks the "comparatively rich" features will lead to mix shift, creating additional ASP tailwinds, adding the survey suggests demand for the premium model could surpass the standard version.

He also said the survey indicated more interest in the Apple Watch following the Series 2 launch.

"While investor focus will likely remain on the iPhone, we think it is worth examining attach rates for ancillary products and services. Our survey suggests increased interest for both the Watch and Apple Pay services," said Mr. Daryanani. "Although other products and services represent a small minority of AAPL's revenue, we think a higher level of interest in other products bodes positively for higher retention of the iOS installed base."

Maintaining an "outperform" rating for the stock, his target rose to $125 (U.S.) from $120. Consensus is $125.98.

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Expressing increased confidence in the growth of Amazon Inc.'s (AMZN-Q) Prime offering, BMO Nesbitt Burns analyst Daniel Salmon raised his fourth-quarter projections, which he noted were already above consensus estimates.

Mr. Salmon estimates there were 76 million Prime members at the end of the second quarter, versus his previous forecast of 74 million. He said 2016, like 2015, has seen 50-per-cent growth in Prime. He now estimates there will be 93 million members by the end of 2016, rising to 163 million by the end of the 2018 fiscal year (or a 37-per-cent compound annual growth rate).

"We believe there remains significant room for expansion of the Prime member base abroad and believe the recent expansion into India should support strong international subscriber growth," he said.

Mr. Salmon called consensus revenue projections for the fourth quarter "too low" and raised his estimate to $46-billion (U.S.) from $45.6-billion, versus the Street's $44.68-billion.

"We believe the deceleration in year-over-year growth the Street is modelling in 4Q compared to 3Q is too severe and believe there is upside to consensus North America and International revenues in 4Q," he said. "Prime Day 2016 results will show up in 3Q numbers, though the benefit this year should not be nearly as great as last year due to the difficult comparison."

Mr. Salmon did not change his "outperform" rating for the stock, while he raised his target price to $900 (U.S.) from $875. The analyst average is $889.53, according to Bloomberg.

"We expect both the North American retail business – driven by Prime – and Amazon Web Services (AWS) to continue to support margin expansion over the coming years, even as Amazon invests aggressively internationally, especially in India," he said.

Elsewhere, the stock was raised to "buy" from "hold" by Argus analyst Jim Kelleher, who said growth prosects are accelerating more rapidly than share price.

His target is $935.

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Dundee Securities analyst Tal Woolley initiated coverage of a series of Canadian retail stocks. They were:

- Jean Coutu Group PJC Inc. (PJC.A-T) with a "neutral" rating and $20 target. Average is $19.21.

- Loblaw Companies Ltd. (L-T) with a "neutral" rating and $76 target. Average is $79.69.

- Liquor Store NA Ltd. (LIQ-T) with a "neutral" rating and $11 target. Average is $11.38.

- Empire Co Ltd. (EMP.A-T) with a "neutral" rating and $20 target. Average is $20.41.

- North West Co Inc. (NWC-T) with a "neutral" rating and $28 target. Average is $29.71.

- Metro Inc. (MRU-T) with a "buy" rating and $52 target. Average is $47.31.

- Alimentation Couche-Tard Inc. (ATD.B-T) with a "buy" rating and $74 target. Average is $76.92.

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Citing the risk-reward for shares of SeaWorld Entertainment Inc. (SEAS-N), Citi analyst Jason Bazinet upgraded it to "buy" from "neutral."

"SeaWorld investors have watched several issues hurt the stock over the last few years," he said. "First, in 2013, SeaWorld began to see competitive pressure from increased investments by Universal parks in Florida. This hurt attendance, but SeaWorld was able to increase pricing enough to generate EBITDA growth. But, in 2014 and 2015, Blackfish's release - and subsequent fallout - caused further attendance and EBITDA erosion. And, in 2016, Latin American attendance declines augmented by pricing erosion and weather again hampered the stock. The EBITDA and FCF decline culminated in a dividend cut on September 20, 2016.

"That's a lot of bad news. Yet, we see a few reasons to take a more positive stance on the shares: 1) Some of the 2016 EBITDA declines are one-off and could revert in 2017 and 2018, 2) The company can use the freed capital to reinvest in park capex and drive attendance in 2018, and 3) Consensus estimates have come down enough to make the risk/reward more interesting, in our view."

On Monday, the company announced it was cut its quarterly dividend from 21 cents (U.S.) to 10 cents, causing a tumble in share price.

However, Mr. Bazinet said it could be an "inflection point" for the equity.

"There are two silver linings, in our view," he said. "First, since the firm suggested it could buy back stock, this suggests the firm did not violate debt covenants (which prevent any sort of capital returns including dividends or buybacks). Second, we believe the company may benefit if the old dividend cash is redeployed toward capex, helping lift attendance in 2018 and beyond."

Expecting continued pricing pressure to be moderated by expense reduction and attendance growth, Mr. Bazinet maintained a price target of $14 (U.S.) for the stock. Consensus is $14.17.

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In other analyst actions:

TMX Group Ltd. (X-T) was raised to "buy" from "hold" by TD Securities analyst Graham Ryding. His 12-month target price rose to $69 from $65. The average is $63.60.

Calfrac Well Services Ltd. (CFW-T) was raised to "speculative buy" from "market perform" at Cormark Securities by analyst Jason Zhang. He kept target of $3.50, versus the average of $4.15.

Mr. Zhang raised Trican Well Service Ltd. (TCW-T) to "buy" from "reduce." He raised his target to $3.25 from $2. The average is $3.38.

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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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