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The Royal Bank of Canada (RBC) logo is seen on Bay Street in Toronto on Jan. 22, 2015.Reuters

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

The recent decline in the unit price for Canadian Apartment Properties Real Estate Investment Trust (CAR.UN-T) presents an attractive entry point for investors, according to BMO Nesbitt Burns analyst Heather Kirk.

Noting CAP REIT's stock has declined 13 per cent in the last three months in comparison to a 4.29-per-cent drop for the S&P/TSX Capped REIT Index, she upgraded her rating for it to "outperform" from "market perform."

"Robust demand for apartments continues to pressure cap rates to the downside," said Ms. Kirk. "Cap rates for high-rise apartments were at a national average of only 4.55 per cent at Q2/16 which is below the REIT's current implied cap rate of 4.85 per cent. Cap rates for tier 1 markets are even lower. According to CBRE's Q2/16 cap rate survey, high-rise A cap rates are at 3.25-4.00 per cent in Toronto and 2.50-3.00 per cent in Vancouver. Tight vacancy rates and robust investor demand continue to drive apartment cap rates to new lows in all markets except Calgary, where CAP REIT has limited exposure. In addition to valuation support, declining cap rates provide CAP REIT with the opportunity to recycle capital at attractive pricing as we saw with the REIT's recent sales of 557 suites in Montreal for $56 million or over $100k/suite."

Noting its "steady and predictable" cash flows, Ms. Kirk said the decline in price has brought CAP REIT to an 8-per-cent discount to net asset value "despite sound fundamentals and downward pressure on cap rates."

"Although we expect some moderation in organic growth relative to the strength of recent years, apartment market fundamentals remain sound with low vacancies and moderate new supply and demand, which are supported by demographics and immigration," the analyst said. "Close to 65 per cent of the REIT's net operating income (at Q2/16) is derived from the Ontario (51 per cent) and BC (12 per cent) markets, which delivered same property NOI growth of per cent and 8 per cent, respectively. Only 6 per cent of NOI is derived from the Alberta market."

Ms. Kirk maintained a target of $32.50. Consensus is $33.19.

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In a research report on Canadian banks, Canaccord Genuity analysts Gabriel Dechaine examined their current valuation and capital ratios through a "downside risk" lens.

"In a [Sept. 14] report, we explored potential downside risk to Canadian bank earnings in an economic downturn, ostensibly triggered by a housing market crash," the analyst said. "We estimated that in a 'realistic' downside risk scenario that Canadian bank earnings could decline by 11 per cent on average, with a range of 9-17 per cent.

"In this report, we take the analysis one step further by evaluating pro forma valuation. Canadian banks currently trade at [approximately] 11 times our 2017 estimated EPS, which is in line to the historical average sector multiple. If we apply our downside EPS scenarios, this valuation climbs to 12.3x on a pro forma basis. On an individual stock basis, relative valuation rankings do not change much on a current vs. pro forma basis, save for [Canadian Imperial Bank of Commerce – CM-T]. Based on our analysis, CM goes from a current discount to peers of 12 per cent to a slight 2-per-cent discount."

Mr. Dechaine added: "Aside from the potential impact on earnings, investors should be aware of how capital ratios can change in a 'realistic' downside risk scenario. Canadian banks have fully adopted the internal models approach (AIRB) to determine risk weightings for their domestic loans. The AIRB methodology is sensitive to credit quality assumptions, whereby in the event of deterioration, risk-weighted assets (RWAs) inflate, which results in greater capital consumption. As a recent example, we estimate that credit downgrades in oil & gas portfolios reduced CET 1 ratios of some banks by [approximately] 20 basis points that, incidentally, represented a larger dollar amount than their actual loan losses in these portfolios. Using the same methodology outlined in our Sept. 14 report we estimate CET 1 downside risk of 70bps, on average, in an economically stressed domestic scenario. We note that most bank CET 1 ratios would remain above 10 per cent in our analysis, which is positive."

In the report, Mr. Dechaine upgraded Royal Bank of Canada (RY-T, RY-N) to a "buy" rating from "hold" and raised his target price for the stock to $89 from $85. The analyst consensus price target is currently $82.57, according to Thomson Reuters.

"Assessing downside earnings and capital risks is an important exercise for shareholders seeking to gain comfort (or not) with the stocks," he said. "Although we are wary of these types of risks, we are equally wary of overreacting to market noise that may not materialize into actual earnings/capital pressure for the banks. Indeed, with its elevated (and sustainable) dividend yields, reasonable valuations, stable (relatively) regulatory environment, and capability to outperform earnings expectations, we remain positive on the sector. In that vein, we are upgrading RY."

"Factors that support our upgrade include RY's: (1) potential turnaround in relative Canadian P&C earnings performance; (2) decent leverage to rising U.S. rates; (3) relatively strong capital position and appealing capital management program, especially RY's balance sheet optimization program; and (4) based on our analysis, relative resilience both in pro forma valuation and capital terms in a realistic downside risk scenario."

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Air Canada (AC-T) is in a position to re-rate "positively," said CIBC World Markets analyst Kevin Chiang in a research report on the country's airline industry.

"The great comedian Rodney Dangerfield may be best known for his catchphrase, 'I don't get no respect!,'" he said. "When looking at the Canadian transportation complex, the airlines, especially AC, could say the same thing. All AC has done in the last decade is cut its leverage ratio by over one-third from 2009 levels; more than double operating margins from the last peak (2007); and create a path towards sustainable positive free cash flow (FCF), investment grade debt rating, and accelerating its cash return to shareholders. Yet its earnings multiple has barely moved during this period and investors remain lukewarm on the name. So what gives? The biggest pushback we get is around AC's capacity growth."

Mr. Chiang noted Air Canada's strategy for adding capacity over the next several years reinforces "a legacy view that 'excess' airline capacity growth is a sign of irrational behaviour."

However, he said he disagrees with this stance, pointing to a trio of factors: "1) AC has increased its marginal capacity buffer through its cost transformation, especially as it pursues its international growth strategy. It is no longer the marginal producer and there is an increasing margin buffer between AC and other airlines. So AC is no longer the "high cost producer", putting up capacity that is detrimental to long-term earnings, return on invested capital, and the balance sheet. 2) AC, through its lower cost capacity, and WJA, through its growing network, have been able to increase their market share. They are not just layering on more capacity but forcing other airlines, which now have become relatively less competitive, to adjust. The competitive response from these other airlines has been rational. 3) With its new found competitiveness, AC is playing catch up with its capacity. So while we have seen a step-up in capacity growth recently, over the past 10 years (2006-2015), AC's average seat miles (ASMs) have grown at compound annual growth rate of just 3.2 per cent."

Maintaining his "sector outperformer" rating for the stock, he raised his target to $17.50 from $14 and noted a "blue sky" value" of $30. Consensus is $14.42.

"We view the ASMs it is adding as being 'higher quality' and accretive to long-term earnings and ROIC," Mr. Chiang said. "We believe as investors come to appreciate this, combined with the airlines improved earnings profile, increasing FCF as it moves past its peak capex, and declining debt levels, Air Canada is positioned to re-rate positively, with there being significant torque in its share price."

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The third quarter for Canadian oilfield services companies showed improvement amid a still challenging environment, according to Canaccord Genuity analyst John Bereznicki.

"Against the backdrop of a brutal break-up quarter, [Western Canadian Sedimentary Basin or WCSB] oilfield service providers experienced a sequential improvement in activity in Q3/16 despite facing widespread weather-related challenges," he said. "Notwithstanding this seasonal improvement, WCSB activity was well below prior year levels and pricing power was virtually nonexistent in our view."

"Several of the contract drillers in our coverage universe returned iron to work in the third quarter, although we believe incremental spot demand was highly specific, with operators continuing to dictate pricing and seek targeted rig upgrades. We estimate it was very difficult for domestic contract drillers to generate true spot EBITDA in the third quarter, which we believe will be reflected in [Western Energy Services Corp.'s WRG-T] results."

Mr. Dechaine said current domestic oilfield valuations reflect a "protracted" recovery for the sector, with enterprise value to earnings before interest, taxes, depreciation and amortization multiples at mid-cycle versus their 2018 consensus expectations.

"While the large-cap S&P/TSX Energy Equipment & Services (STENRE) Index is up 7 per cent since the Sept. OPEC announcement, our price-to-book analysis suggests the sector is still generally trading at 2009 trough levels," the analyst said. "We believe this creates a compelling opportunity for those looking to play a longer-term oil price recovery.

"We are revisiting our estimates and target prices ahead of the Q3/16 earnings season, although there are no changes to any of our recommendations. These revisions generally reflect our preference for oilfield service providers that: i) are positioned to benefit from an ongoing secular increase in frac intensity; ii) have inherent operating leverage that can allow them to generate EBITDA torque in the absence of pricing power; and iii) have significant exposure to attractive regions such as the Montney, Duvernay and Permian."

He raised his target prices for the following stocks:

- Canadian Energy Services and Technology Corp. (CEU-T, buy) to $6.25 from $5.50. Consensus: $5.42.

- Calfrac Well Services Ltd. (CFW-T, hold) to $3.50 from $3.25. Consensus: $4.09.

- Canyon Services Group Inc. (FRC-T, buy) to $7.50 from $7. Consensus: $6.75.

- Secure Energy Services Inc. (SES-T, buy) to $12 from $11.50. Consensus: $11.33.

- Trican Well Service Ltd. (TCW-T, speculative buy) to $4 from $3.25. Consensus: $3.38.

Mr. Bereznicki's targets declined for these stocks:

- ENTREC Corp. (ENT-T, hold) to 30 cents from 35 cents. Consensus: 48 cents.

- Total Energy Services Inc. (TOT-T, buy) to $16 from $16.25. Consensus: $15.78.

- Western Energy Services Corp. (WRG-T, hold) to $2.75 from $3.75. Consensus: $3.90.

"For those seeking high beta to recovering oil prices, we continue to recommend CEU, TCW and TDG," he said. "For those wishing to take a more defensive posture, we continue to advocate SES, FRC and TOT. We believe investors should stay focused and 'buy the dips' to build a core portfolio of names."

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Desjardins Securities analyst Jamie Kubrik said Advantage Oil & Gas Ltd.'s (AAV-T, AAV-N) low cost structure and improving well productivity underpin "solid" third-quarter results.

On Wednesday, Advantage released a better-than-expected quarterly operational update. Cash flow per share of 24 cents beat the Street by a penny, while production of 35,760 barrels of oil equivalent per day was also above the consensus of 35,170 boe/d.

Mr. Kubrik said improvements to the company's capital efficiency are noticeable and should lead to lower sustaining capex going forward.

"Test rates on AAV's eight-well 5-16 pad demonstrated exceptional productivity (120 million cubic feet equivalent per day), with volumes from this pad capable of supporting production until end 2Q17," he said. "Well costs are also down considerably from previous years, which, when combined with improving productivity, points toward stronger capital efficiencies going forward for the business."

"We see AAV being free cash flow positive in 2016 and 2017, while growing production per share faster than its peers — this is an impressive outcome amidst (what has been) a highly challenging period for gas prices. Our estimates see AAV generating positive free cash flow in 2016 ($30-million), while growing production at 48 per cent per debt-adjusted share. While this growth slows to 18 per cent in 2017 based on our estimates, the company continues to have an attractive forward growth trajectory and one of the best cost structures in the business—we see AAV as one of our top picks."

Mr. Kubrik raised his cash flow per share estimates for 2016 and 2017 to 86 cents and $1.18, respectively, from 81 cents and $1.11.

He also raised his target price for the stock by a loonie to $11. Consensus is $10.50.

"The operational execution from Advantage has been spot on in 2016," he said. "We continue to see the stock as a top idea and maintain our buy rating."

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Gazit-Globe Ltd.'s (GZT-T, GZT-N) evolution from a holding company should improve its valuation over time," said Canaccord Genuity analyst Mark Rothschild.

"Gazit-Globe Ltd. offers investors the ability to own a globally diversified portfolio of high quality supermarket-anchored shopping centres," he said. "The company is led by a talented and highly aligned management team that has significant experience in its various markets."

Mr. Rothschild initiated coverage of Israel's largest real estate investment trust, which has traded on the TSX since 2013, with a "hold" rating.

"Currently, Gazit's shares trade at a significant discount to net asset value (NAV) which, in our view, reflects a number of factors, chiefly its holding structure, as most of the assets are held through publicly traded subsidiaries," he said. "In order to improve the valuation, management's goal is to increase the proportion of direct property ownership to more than 50 per cent (from 18 per cent). We believe that to the extent management is successful in executing its strategy, the discount to NAV will narrow. However, in its current structure we expect the shares to remain well below NAV."

Mr. Rothschild said that change in strategy won't produce immediate results, adding: "While we believe that management's goal of owning at least 50 per cent of assets directly will make Gazit's shares more attractive, it is uncertain how this will be completed. Additionally, there are a number of factors that could make it difficult for Gazit to achieve this goal. The EQY and FCR shares have been held by Gazit for a number of years, and the tax implications of selling the shares may limit the company's portfolio restructuring options. Further, the high leverage and the fact that Gazit's shares trade at a discount, could make it difficult to acquire properties accretively. Lastly, even if the directly held real estate exceeds 50 per cent, it is not clear if that number would be a significant catalyst to improve the valuation materially."

He set a target price of $14.50 for the stock. The analyst average is $15.30, according to Bloomberg.

"Although there is no true comp for Gazit, the company trades at a significant discount compared to North American shopping centre REITs," said Mr. Rothschild. "Gazit is trading at 12.0 times 2017 estimated funds from operations, below North American and European shopping center REITs (16.9x average)."

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Desjardins Securities analyst Michael Markidis resumed coverage of Pure Industrial Real Estate Trust (AAR.UN-T) following the closing of its $144-million equity offering.

The net proceeds from the offering are set to be used toward the $277-million acquisition of a pair of portfolios.

"The first package of assets, which is being acquired from Artis REIT (AX.UN-T, Buy,C$14.50 target), includes eight properties in Alberta totalling 1.2-million square feet," said Mr. Markidis. "The $171-million purchase price (approx. $145/sf) represents a going-in cap rate of 6.3 per cent. A conditional agreement has also been reached with respect to a 1.6-million square-foot portfolio located in what AAR has referred to as "core markets in the southeastern U.S." The $81-million price tag ($50 U.S./sf) is expected to provide an attractive initial unlevered yield of 6.9 per cent. To us, this suggests that AAR may be taking on some near-term leasing risk. Closing of both portfolios is expected in 4Q16."

Mr. Markidis said Pure Industrial's leverage has "notably improved" in recent months.

"At the outset of the year, AAR's net/debt to EBITDA was running at just over 9 times," he said. "The successful completion of the Vaughan Fedex development in April combined with two subsequent equity offerings totalling $300-million have brought this figure down to 7.1x on a pro forma basis."

Mr. Markidis maintained a "hold" rating for the REIT and raised his target to $5.75 from $5.50. Consensus is $5.83.

"AAR is taking advantage of a strong cost of capital to grow its portfolio," he said. "We see the Alberta portfolio as an opportunistic acquisition from a motivated seller (at a fair price) and we look forward to receiving additional detail on the U.S. assets."

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In other analyst actions:

Morgan Stanley analyst Benny Wong downgraded Husky Energy Inc. (HSE-T) to "equal-weight" from "overweight" and lowered his target to $20 from $21. The average is $19.39.

JPMorgan analyst Jeremy Tonet initiated coverage of Pembina Pipeline Corp. (PPL-T) with an "overweight" rating and $47 target. The average is $44.

Citing a lack of catalysts, Jefferies analyst Jeffrey Holford downgraded Pfizer Inc. (PFE-N) to "hold" from "buy" and lowered his target to $36 (U.S.) from $39. The average is $39.

Bank of America/Merrill Lynch analyst Colin Bristow upgraded Merck & Co. Inc. (MRK-N) to "buy" from "neutral" based on expected market dominance of its Keytruda lung cancer treatment drug. His target rose to $70 (U.S.) from $57, versus the average of $68.

EXFO Inc. (EXFO-Q, EXF-T) was raised to "Buy" from "Hold" at GMP by analyst Deepak Kaushal. His target increased to $5 (U.S.) from $4.15. The average is $4.65.

Citi analyst Ashwin Shirvaikar upgraded Computer Sciences Corp. (CSC-N) to "buy" from "hold" and raised his target to $61 (U.S.) from $49. Consensus is $53.45.

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