Thursday's analyst upgrades and downgrades

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

Though there has been a recent sell-off in utilities alongside a general decline in defensive and income-oriented stocks, Desjardins Securities analyst Mark Jarvi is maintaining a "fairly positive" view on the sector.

Mr. Jarvi initiated coverage of five Canadian utilities, noting they all "have solid growth outlooks with a viable path to EPS [earnings per share] and dividend growth."

"All five stocks have constructive growth outlooks and we believe each of the companies can grow dividends over the next few years, providing investors with solid total return potential," he said. "We include only value from tangible growth opportunities (ie high visibility of capital deployment turning into higher earnings and cash flow per share) in our forecasts and valuations. We believe the companies will continue to backfill growth, particularly beyond 2018; consequently, we believe there is a potential upward bias to our forecast. Furthermore, given that some companies have a history of opportunistic acquisitions, potential M&A will likely occur over time — which we would expect to drive upside to our current forecasts and valuations (we do not build M&A potential into our numbers).

"Additionally, with the recent pullback in the sector, valuations are well within their historical trading range — the current average P/E [price-to-earnings] (FY1) is 16.2 times (16.9x excluding ACO.X) vs a trailing five-year average of 15.9x (17.0x excluding ACO.X). That said, we do not foresee multiple expansion occurring, at least not in the foreseeable future—we want to stress that neither of our Buy ratings are predicated on a multiple expansion. Overall, while the sector might face headwinds through year-end (eg uncertainty on a potential rate hike in December by the Fed, sector rotation, rising bond yields), we believe that at some point investors will return to fundamental analysis. In that context, owning companies that can deliver growth in rate base, earnings, cash flow and dividends and which have manageable risk (operating, regulatory, financing) is where we believe investors should be positioned in this sector."

Mr. Jarvi initiated coverage of the following stocks:

- Atco Ltd. (ACO.X-T) with a "hold" rating and $46 target price. The analyst consensus price target is $48.25, according to Thomson Reuters.

- Canadian Utilities Ltd. (CU-T) with a "hold" rating and $38 target. Consensus is $40.83.

- Emera Inc. (EMA-T) with a "buy" rating and $50 target. Consensus is $53.92.

- Fortis Inc. (FTS-T) with a "buy" rating and $46 target. Consensus is $49.10.

- Hydro One Ltd. (H-T) with a "hold" rating and $24 target. Consensus is $26.65.

On the sector as a whole, Mr. Jarvi said: "The Canadian utility companies have been strong performers over the last decade, providing an average total return of [approximately] 150 per cent versus 58 per cent for the S&P/TSX Composite, and beating the S&P 500 and Dow Jones Utility Average (DJU) which have provided total returns of 93 per cent and 106 per cent, respectively. The average performance over the past 12 months has been solid, but most of the gains were made in the first nine months and the performance has since become lacklustre. Over the last three months, the average total return of the five names under coverage has been negative 7.2 per cent versus 1.9 per cent for the S&P/TSX Composite, 0.4 per cent for the S&P 500 and negative 7.4 per cent for the DJU. We do not believe the recent check-back is related to individual stock fundamentals (ie no change to EPS growth rates). Rather, we believe the recent weakness is primarily attributable to the sudden rise in bond yields, which had created a selloff and rotation away from defensive and yield-oriented stocks to more cyclical sectors, in our view."

He added: "With the recent pullback in the stocks, we believe multiples are at a reasonable level. We have seen the trading multiples for CU and ACO.X improve materially over the last two decades, and even in the past year multiples for these two stocks have increased, thereby narrowing the gap with EMA and FTS. Looking at EMA and FTS, multiples are currently in line with their average over the past five and 10 years. H has been public for only one year so it is difficult to evaluate its current multiple vs its historical range, but it has generally traded at a premium to its peers since it came to market last November. Overall, we do not expect any multiple expansion and we are inclined to believe there is potential for modest multiple compression if the U.S. Fed puts out hawkish commentary when it announces the next rate increase (likely in December 2016)."

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In a research note on the gold sector, Raymond James analyst Chris Thompson reviewed recent tours of Endeavour Mining Corp.'s (EDV-T) Ity and Agbaou mines in Ivory Coast as well as Asanko Gold Inc.'s (AKG-T) Asanko mine in Ghana.

"Agbaou's importance for EDV (main near-term cash-flow generator) was affirmed, as was the importance of Ity as an important component of EDV's medium term production growth, in addition to Hounde and Karma's development," said Mr. Thompson. "Ity's development/exploration upside as a value driver for EDV shareholders is reflected in Ity's [approximately] 15-per-cent weighting in our NAV [net asset value] estimate (increased from 8 per cent previously). We continue to see Agbaou's nearterm cash flow potential (2017–2018 estimate: $201-million at base case $1,400 per ounce, or 29 per cent of EDV's total 2017–2018 estimated cash flow) as the main source of funds for Ity's development (Capex: $277-million), with Hounde (when production starts in early 2018) and EDV's other operations. For AKG, the Asanko mine's near-term production potential (Phase 1 completed, 2017 production and cost guidance recently released) and Phase 2A expansion plan rank as the paramount near-term value driver for AKG's shareholders."

Mr. Thompson said Endeavour's Ity facility "is not such an Ity bity growth machine," noting: "Whilst small in current annual production, Ity offers medium term growth potential unlocked by a development plan that envisages a transition from heap leach to CIL. After reviewing the EDV's development plan for Ity, we have adjusted our operating assumptions for the mine and now see an operating plan that transition from a 1 mln tonne/annum heap leach (2017E–2019E) to a 3-million tonne/annum CIL processing in-line with feasibility estimates. We anticipate 80,000 ounces of production at an AISC [all-in sustaining cost] of $902 per ounce in 2017 increasing to 160,000 oz of production at an AISC of $725/oz in 2020. We see EDV's development team transitioning over to Ity and a positive investment decision by mid- 2017E after the tabling of a revised feasibility study (anticipated 1H17) that includes maiden resources for Bakatouo, Colline Sud, final permits and a trade-off study that looks at running concurrent heap leach and CIL operations. An important determinant for a positive investment decision at Ity will be the successful completion of ownership discussions to increase EDV's ownership stake (currently 55 per cent) in Ity. RJL estimates a revised NAV5% estimate of $433-million $6.07 per share for 100 per cent of the project (at base case $1,400/oz). We assume EDV's 55-per-cent ownership in Ity in our valuation for EDV."

On Agbaou, Mr. Thompson called it "a lowest quartile low cost mine (and an important cash-flow generator) even as the mine transitions to processing higher quantities of transitional/fresh ore with a drop in milling rate."

He maintained his "outperform" rating for Endeavour stock and raised his target price to $30.75 from $27.75. Consensus is $33.74.

For Asanko, Mr. Thompson kept his "outperform" rating and $6.75 target. Consensus is $6.83.

"We have reviewed AKG's recently released 2017 production and cost guidance and assumptions for Phase 2 (A, B) growth and adjusted our operating assumptions accordingly," he said. "We continue to see Asanko as a low cost mine (2017 estimated AISC of $825/oz) capable of producing 215,000 oz (2017 estimate), 230,000 oz (2018), 275,000 oz (2019/2010), and 460,000 oz (2021E). We note that our 2017 production estimate is conservative and falls below company guidance of 230,000 to 240,000 oz for 2017. We estimate AISC for 2017 of $825 per ounce, which is in-line with guidance of between $810/oz to $840/oz. We anticipate a mine plan that delivers production and cash-flow growth with an increase in processed tonnes and a drop in head grade as Esaase ore is processed (1.4 g/t avg. grade). Clarity on AKG's near-term production potential will be revealed with a revised feasibility study anticipated in 4Q16."

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CIBC World Markets analyst Alec Kodatsky said coal prices continue to surprise, staying stronger for longer than expected.

"Our prior outlook for a rapid two-quarter decline back to long-term prices now appears to be far too conservative. In the past 10 years there have been two met coal price spikes: 2008 and 2011," he said. "We would note that in both cases the jump in prices related to acute and substantial supply disruptions to the market caused by severe weather events in Australia. These weather events materially impacted roughly 30-per-cent of seaborne supply for months, with several more months required before supply fully recovered to pre-event levels.

"We have looked at the response of met coal prices from past peaks in 2008 and 2011 as a case study for how prices historically evolve. Assuming that spot prices have now peaked at the $300 per tonne level, we have recalibrated our forward pricing assumptions to emulate the past price behaviour back to long-term levels of $125/t. This analysis has been complicated by several factors, including having a limited data set of similar events, the impact of the global financial crisis on 2008 prices (which caused a dramatic price decline as credit markets and trade froze), a comparatively slower global economic growth environment and an arguably different supply environment where no significant, prolonged supply disruption has occurred. Therefore, we still take a more conservative approach to our pricing outlook than the episode when prices unfolded from the 2011 peak."

On Wednesday, Teck Resources Ltd. (TCK.B-T, TCK-N) updated its coal guidance, raising its fourth-quarter realized price expectations to $200-$205 (U.S.) from $185.

"We believe Teck highlighted a revised price realization outlook to better outline for the market the impacts of 1) the recent transition in order book composition towards an increased amount of market price (i.e., spot) linked sales and 2) the current significant spread between spot prices and the quarterly contract settlement," said Mr. Kodatsky. "Coal pricing continues to remain stronger for longer than we anticipated, and in light of this we are taking the opportunity to re-evaluate our coal price assumptions going forward.

"We now assume that first-quarter 2017 HCC contracts settle at $300 (U.S.) per tonne – a slight discount to current spot levels, noting a formal settlement may be several weeks away. Based on past pricing recoveries (using 2008 and 2011 price spikes as examples) we now assume a slower but steady decline in prices to $185/t in Q4/17, leading to an average 2017 HCC price of $228/t (up from $135/t). Similarly, our average 2018 HCC price is now $147/t, up from $120/t."

With those changes, Mr. Kodatsky's 2017 cash flow per share projection for Teck rose to $8.76 (Canadian) from $5.44.

He also raised his target price for the stock to $44 from $33 with a "sector outperformer" rating (unchanged). Consensus is $30.80.

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Canaccord Genuity analyst Tony Lesiak raised his target price for stock of IAMGOLD Corp. (IMG-T, IAG-N) in response to its investor day, which he said focused on cost containment and growth.

"While IMG appears to have a number of brownfield (Sadiola expansion, Falagountou East and West satellite deposits and heap leach option at Essakane, Saramacca and Rosebel regional) and greenfield (Cote Lake) opportunities, the strong balance sheet (cash of $722-million, net cash of $237-million) also provides external options," he said.

Mr. Lesiak stressed the importance of IAMGOLD's Cote Lake gold mine project in Gogama, Ont., noting the company expressed frustration over the market not giving it value. He said they called it an "exteremely attractive" asset.

"Management also indicated their goal to achieve a 15-per-cent IRR [internal rate of return] for the project in the upcoming PFS [pre-feasibility study] slated to be completed in mid-2017," said Mr. Lesiak.

"Cote Gold is expected to benefit from access to a major highway and power grid (some power capital may be required depending on scale). Development flexibility also improved earlier this year through the purchase of Sanatana's (STA-X) 50-per-cent interest in the adjoining Watershed property. A provincial Environmental Assessment Decision is expected by the end of 2016, with a PFS expected mid-2017. Favourable results would launch a feasibility study, with a potential construction decision by YE2018. In terms of timing we believe a year end 2018 investment decision for Cote Lake may actual work well for IAMGOLD. The Sadiola sulphide project would be up and running assuming an early 2017 construction decision for that asset. The drill program at Saramacca will have been completed and the outlook for Rosebell will be well defined. The ramp up to full production at Westwood will have also have been largely completed and the heap leach option at Essakane well understood. More importantly management will have a better sense of their financial position with another two years of FCF ($80-million and $90-million at $1,300 gold) in the till and a better view on the gold price trend. At that point in time, if gold were to be near $1300 with an upward bias and Cote Lake were to have a 13% IRR, we strongly believe management would approve development. Given this view, we believe it is prudent to start including more value for the Cote Lake asset. We have increased our valuation from a nominal $25-million option value to $190-million which still includes a 75-per-cent risk discount. Upon confirmation of the project economics mid 2017 we would expect a further re-rating of the asset in the market. De-risked, we estimate that Cote Gold could be worth $760-million (U.S.); an incremental $1.65 (Canadian) per share to our valuation."

Based on a higher valuation for Cote Lake, Mr. Lesiak bumped his target to $7.50 per share from $7 with a "buy" rating. Consensus is $6.63.

"Shares of IMG have performed well, outperforming peers by 7 per cent and 11 per cent in the last month and three months, respectively, despite the weaker gold price," he said. "The company currently trades at an 8-per-cent discount to peers on a P/NAV [price to net asset value] basis (versus 20-per-cent discount in September). We believe share outperformance could continue with numerous potential re-rating catalysts pending."

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The failure of Eli Lilly & Co.'s (LLY-N) experimental drug to treat patients with early dementia due to Alzheimer's in a large clinical trial lowers the company's long-term growth prospects, according to BMO Nesbitt Burns analyst Alex Arfaei.

The stock dropped 11 per cent to a two-year low on Wednesday following the company's announcement that Sola failed to meet its goal.

Calling the announcement a "meaningfully negative event," Mr. Arfaei downgraded the stock to "market perform" from "outperform."

"Clearly, the results are a negative surprise given our 75-per-cent estimated probability of success," he said. "We'll learn more about the reasons for the trial's failure at CTAD. Nonetheless, this is also negative for the amyloid hypothesis of AD. We suspect that one of the explanations vs. more positive data (e.g. Aducanumab) may be that Sola did not lower beta-amyloid sufficiently. We note that Lilly has a number of other assets in its Alzheimer's pipeline that may prove more efficacious than Sola, including two BACE inhibitors and an antibody that seems similar to Aducanumab. Nonetheless, we are lowering our risk adjusted forecast for Lilly's Alzheimer's pipeline from $6-billion in 2024 to $2-billion.

"We are now below Lilly's guidance: Following Sola's failure and the $150-million fourth-quarter 2016 R&D charge, Lilly should now finish 2016 below its EPS guidance. Importantly, we are below the company's 2015-2020 revenue growth guidance of 5 per cent partly because of more conservative assumptions for the diabetes franchise. We expect modest revenue growth in 2017 as Lilly's growth drivers (e.g. Tatlz, Trulicity and Baricitinib) may barely offset the decline of the mature franchises."

Mr. Arfaei lowered his target price for the stock to $64 from $91. The analyst average price target is $86.71, according to Bloomberg.

"Nonetheless, Lilly's revenue mix is improving, and Lilly is on track to achieve its margin expansion objective, i.e., opex as a percentage of revenue to decrease to 50-per-cent or less by 2018," the analyst said. "We've lowered our revenue forecast and our estimates are now notably below consensus; however, we now also expect lower costs in 2017. Overall, we remain cautious on Lilly's diabetes and mature franchises, and believe that Sola's failure significantly lowers Lilly's longer-term growth prospects."

Elsewhere, the stock was downgraded to "neutral" from "overweight" by Atlantic Equities analyst Steve Chesney with a target of $72, down from $99.

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In other analyst actions:

Canacol Energy Ltd. (CNE-T) was raised to "buy" from "neutral" at Global Securities Colombia by analyst Agustin Vera without a specified target. The analyst average is $5.62.