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Thursday’s analyst upgrades and downgrades

Workers leave the Suncor oil sands extraction facility near the town of Fort McMurray.


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

Aecon Group Inc.'s (ARE-T) "impressive" fourth-quarter financial results prompted Raymond James analyst Frederic Bastien to upgrade his rating for the stock.

"Underpinning our recommendation and growth expectations through 2018 are the soundness of Aecon's diversified strategy, its rock-solid balance sheet and its leadership position in two of Canada's most promising construction segments — mass transit and nuclear power refurbishment," said Mr. Bastien, who moved his rating to "outperform" from "market perform."

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On Tuesday, the Toronto-based construction and infrastructure development company reported quarterly adjusted earnings before interest, taxes, depreciation and amortization of $65-million, "comfortably" beating Mr. Bastien's estimate of $52-million and the consensus of $59-million. He attributed the beat to "better-than-expected margin contribution from the Infrastructure segment and some insurance recoveries related to the Fort McMurray wildfires."

Adjusted earnings per share of 43 cents topped his forecast of 32 cents and the 40-cent consensus.

"There is beauty in diversification," the analyst said. "Infrastructure results benefited from higher gross profit margin on the Eglinton Crosstown LRT and John Hart hydroelectric power projects. Meanwhile —  and as previously pledged — the Energy business was able to make up lost fabrication and module assembly revenue in Alberta with higher volumes of nuclear and utilities work in Ontario. Ditto for Mining, which replaced a big chunk of civil and foundations work it executed in 4Q15 with higher volume from contract mining and site installation. All of this gives us renewed confidence Aecon will be successful in redeploying its key K+S staff to other vital projects upon completion of the Legacy potash mine."

He added: "With a $4.2-billion order book and healthy balance sheet, Aecon can bide its time. We fully expect management to remain disciplined when responding to requests for its services, especially as the next wave of infrastructure projects begin to roll out later this year. This should not only facilitate the award of jobs that fall squarely within the firm's strike zone, but also ensure volume does not come at the expense of margins. We believe there's another very good reason for Aecon to stay patient: to capitalize on an eventual rebound in oil and commodity markets."

Mr. Bastien raised his 2017 EPS projection to 85 cents from 78 cents in reaction to the results. He also introduced his 2018 estimate of 95 cents per share.

His target price for the stock rose to $19 from $17. The analyst consensus price target is $18.79, according to Thomson Reuters.

"Our valuation is based on an enterprise value-to-EBITDA multiple of 6.5 times our revised estimates for 2017," said Mr. Bastien. "Our target multiple is greater than the contractors' 10-year average of 6.0 times, to reflect the breadth and scale of Aecon's operations, its solid track record of execution and its strong financial position."

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Elsewhere, Desjardins Securities analyst Benoit Poirier bumped his target for Aecon stock to $19 from $18 with a "buy" rating (unchanged).

"We like ARE for its solid balance sheet to pursue further bidding activities and the prospects for EBITDA improvement, mostly through the infrastructure and energy division," said Mr. Poirier. "In addition, ARE is well-positioned to secure work on up to $40-billion of infrastructure opportunities with decisions expected by 2018, which could further reinforce the growing backlog. In the meantime, the 3.0-per-cent dividend yield provides downside protection."


The current commodity price environment remains challenging for Canadian energy companies, according to Canaccord Genuity analyst Dennis Fong, who believes "there are several defensive ways to add oil and gas exposure."

"We favour companies with stronger free cash flow profiles, production growth visibility and a track record of improving operations," said Mr. Fong, in a report in which he initiated coverage of Canadian senior exploration and production (E&P) and integrated companies.

Mr. Fong said Suncor Energy Inc. (SU-T) is his top pick in the large cap energy sector, giving it a "buy" rating and $52 target. Consensus is $47.85.

"We like Suncor on the back of its production and free cash flow growth combined with its clean balance sheet and focus on returning value to investors," he said. "We expect the company to show annual free cash flow of $7.3-billion from 2017 to 2021, implying a free cash flow yield of [approximately] 10 per cent, while also growing production at a CAGR [compound annual growth rate] of 7 per cent versus the large cap group at 4 per cent (over the same period). We believe Suncor can show further improvements in profitability through its debottlenecking projects and integration of its operations with proximal oil sands operators (like Syncrude). In the near term, we see further positive catalysts from first production at Fort Hills and Hebron (expected near year-end), a potential reinstatement of a share buyback program and continued increases in its dividend. We expect that, after first production at Fort Hills, the company will balance its evaluation of debottlenecking projects, potential synergies with Syncrude (and its other proximal projects), share repurchases and dividend increases."

Mr. Fong gave two other companies "buy" ratings: Canadian Natural Resources Ltd. (CNQ-T) and Encana Corp. (ECA-N, ECA-T).

For Canadian Natural, he set a price target of $47 per share. Consensus is $49.

"We like Canadian Natural as a balanced senior E&P with a track record of shareholder return, capital deployment flexibility and significant free cash flow," he said. "We estimate the company will show average annual free cash flow of $4.7-billion from 2017 to 2021 (on the back of the completion of Horizon Phase 3), implying a free cash flow yield of 10 per cent versus the group average of 7 per cent. The stock trades at an unjustified 0.2-times discount on a 2018 estimated EV/DACF [enterprise value to debt-adjusted cash flow] basis to the group and has positive catalysts from the soon-to-be complete Horizon Phase 3, additional facility optimization (debottlenecking) and dividend increases. We also like management's alignment with shareholders, as insiders hold $1.2-billion of equity (higher than any of its peers) and believe management's track record of capital allocation will contribute to generating strong shareholder returns."

Mr. Fong set a price target of $14 (U.S.) for Encana, versus the consensus of $14.99.

"We believe Encana offers investors exposure to best-in-class liquids production growth with long-term short-cycle potential upside from its extensive positions in the Permian and Montney," he said. "We estimate the company will show production CAGR of 7 per cent over the next five years, nearly double the group average of 4 per cent and CFPS growth of 32 per cent versus the group of 19 per cent. The company also recently strengthened its balance sheet through a combination of asset sales and equity issuances (estimated 2018 estimate debt-to-cash flow of 2.2 times on the Canaccord Genuity price deck versus the group at 0.8 times). In addition, Encana is well-hedged in 2017 with 58 per cent of its oil hedged at $53.56 (U.S.) per barrel and 72 per cent of its gas hedged at $3.13 (U.S.) per  Mcf NYMEX, to manage funding risk in 2017 as it transitions into a self-funding growth entity. We believe the company will execute on its five-year plan, and show significant production (and more importantly cash flow) growth."

Mr. Fong gave "hold" ratings to Imperial Oil Ltd. (IMO-T), Cenovus Energy Inc. (CVE-T) and Husky Energy Inc. (HSE-T).

Calling Imperial Oil "fairly valued, while investing in the future," he set a price target of $45 per share. Consensus is currently $48.22.

"We believe Imperial Oil offers investors a lower-risk opportunity in a company with significant resource in place, but has dialed back its growth strategy to concentrate on optimizing its current assets," said Mr. Fong. "In addition, we expect the company will look to fine- tune the technology it will use for the next leg of production growth. Imperial Oil has a history of returning value to its shareholders through a combination dividend and share buybacks, which we expect will continue with the estimated average of $2.7-billion in free cash flow per year from 2017 to 2021. Imperial also has a clean balance sheet (2017 estimated debt-to-cash flow of 0.8 times versus the group at 1.6 times), and we believe it will continue to evaluate and potentially take advantage of acquisition opportunities in the current commodity price environment."

Mr. Fong set a target of $18.50 for Cenovus shares, while the consensus is $22.73.

"We believe Cenovus controls some of the most-sought-after oil sands resource in the Athabasca Fairway at Foster Creek and Christina Lake," he said. "During the oil price volatility of the last two years, the company right-sized itself to lower cost structure and remain conservatively positioned. We believe the company has a strong balance sheet (after raising $1.5-billion of equity in early 2015 and divesting its fee title royalty assets for $3.3-billion later that year), but that management is prudently concentrating on maintaining balance sheet strength (rather than accelerating growth). While we agree this is the appropriate action given the commodity price environment, we believe the company is fairly valued in relation to its peers given its free cash flow yield of 7 per cent versus the group at 7 per cent and production CAGR of 3 per cent versus the group at 4 per cent over the next five years."

The analyst gave Husky a target of $17. Consensus is $19.05.

"We believe Husky has done an admirable job in re-shaping the portfolio and adding a pipeline of shorter- to medium-cycle projects," said Mr. Fong. "The stock trades at a significant discount to the rest of the group (1.4x discount on 2018E EV/DACF versus the large cap group average), which could narrow on the potential reinstatement of the dividend. We believe the stock is fairly valued on the lower (respective) implied free cash flow yield of 6 per cent versus the group at 7 per cent and production CAGR of 3 per cent versus the group at 4 per cent over the next five years. We believe management may have to balance paying a modest (less meaningful) dividend and funding larger, long-term growth projects within cash flow in the near term. While the company currently has one of the cleanest balance sheets (2017E D/CF of 0.9x vs. the group at 1.6x), we believe management is being prudent and averse to adding any debt, therefore moderating the company's potential growth profile as compared to the group."

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Though he called its fourth-quarter financial results "a modest negative development," BMO Nesbitt Burns analyst Peter Sklar raised his target price for Linamar Corp. (LNR-T).

On Wednesday after market closed, Linamar reported normalized earnings per share, excluding forex gains and a lower tax rate, of $1.55. The result was below both the estimates of both Mr. Sklar ($1.68) and the Street ($1.65.)

"The shortcoming of earnings versus expectation was due to weaker results in the auto parts segment (18 cents per share below our estimate, after excluding foreign exchange gains)," he said. "Similar to the previous quarter (Q3/16), management attributed the weakness to Linamar's exposure to Ford (where Linamar has traditionally over-indexed) and the negative impact of the Ford production cuts during the quarter. We note that during Q4/16, production volumes for the Ford Fusion were down 29 per cent year over year and for the Ford Escape were down 23 per cent. Although Linamar does not provide platform exposure detail, these are mainline vehicles for Ford, for which we assume Linamar could have considerable powertrain and driveline content."

With the results, Mr. Sklar lowered his full-year 2017 earnings estimate to $7.72 per share from $7.92. His 2018 estimate moved to $8.29 from $8.31.

"We do note that Linamar reported a considerable increase in launch backlog from $3.9-billion at the end of Q3/16 to $4.8-billion at the end of Q4/16; however, this was largely due to the inclusion of Montupet's backlog, which was previously excluded," he said.

"While reported earnings appeared to be strong, after taking into account FX gains and a transitory lower tax rate, earnings were below expectation. However, Ford's volumes were down considerably on certain key platforms in Q4/16, and Linamar's earnings should recover to more normalized levels in the coming quarters as inventories on those platforms are now in much better shape."

With an unchanged "market perform" rating for Linamar shares, he increased his target price to $65 from $55 "based on a projected enterprise value that is about 5 times (from 4.3 times) our revised 2017 EBITDA estimate and is 4.4 times (from 3.7 times) our revised 2018 EBITDA estimate." Consensus is $64.57.

"We continue to remain neutral in terms of our investment recommendation with a Market Perform rating for Linamar and the other Canadian auto parts suppliers under our research coverage," Mr. Sklar said. "While Linamar should generate a notable growth rate over the next few years due to its substantial backlog and strong track record of execution, we believe the auto parts sector will continue to be under pressure from concerns surrounding peak cycle in the U.S., investor sentiment toward new technologies such as the penetration potential of battery electric vehicles, and from concerns about the potential disruptive effect if the Trump administration were to introduce a border adjustment tax."

Elsewhere, TD Securities analyst Brian Morrison downgraded the stock to "hold" from "buy" while raising his target by a loonie to $68.


Gibson Energy Inc. (GEI-T) "has a strong end to a challenging year," said Industrial Alliance analyst Elias Foscolos.

On Tuesday, Gibson reported fourth-quarter earnings before interest, taxes, depreciation and amortization of $77-million topped Mr. Foscolos's projection by $3-million. Core revenue of $1.414-billion was an increase from $1.205-billion in the previous quarter and ahead of the consensus projection of $1.313-billion.

"Q4/16 Core revenue (excluding wholesale and elimination) was $5-million below our projection," he said. "The variance was primarily due to lower-than-expected revenue from the Propane segment. If we eliminate this as it is now a discontinued operation, Core revenue was essentially aligned with our projection with strength in the Infrastructure segment compensating for weakness in the Logistics segment. We expected that the Wholesale segment's EBITDA would not improve until Q1/17, however, the Company noted that propane sales assisted in bringing the segment's profit to a more normal level."

Based on the results, Mr. Foscolos increased his target price for Gibson shares to $22 from $21.50, which implies a 22-per-cent potential upside return. Accordingly, he upgraded the stock to "strong buy" from "buy."

The analyst average price target is $20.62.


Pure Industrial Real Estate Trust (AAR.UN-T) had a "nice finish" to 2016, said BMO Nesbitt Burns analyst Heather Kirk.

On Wednesday, the Vancouver-based REIT reported fourth-quarter funds from operations per unit of 10 cents, in line with both Ms. Kirk's estimate and the Street as well as flat year over year. Led by its Canadian portfolio, same property net operating income rose a "solid" 2.8 per cent.

"Strong industrial fundamentals across North America supported by e-commerce-driven demand for distribution facilities is expected to 1) drive solid 2017 organic growth and 2) maintain downward pressure on cap rates in support of net asset value," said the analyst. "A 900,000 square foot distribution centre on Torbram Rd in Toronto is reported to be selling at a low- to mid-4-per-cent cap rate, highlighting depth of demand and historically low cap rates for well-located, modern distribution facilities."

Ms. Kirk said she expects a new $40-million, 330,000 square foot development in Richmond, B.C., should be completed by the end of the second quarter of 2017 with revenue generation by the end of the year. She also predicted additional developments to begin through 2017, including south of the border with expansion of FedEx sites.

"The REIT's estimated $200-million of liquidity provides capital to pursue strategic acquisitions and development opportunities," she said. "We expect the REIT to be active recycling capital through 2017 to crystallize value, improve portfolio quality, and re-balance geographic exposure away from Alberta."

Ms. Kirk raised her target price for units of Pure Industrial to $6.45 from $6. Consensus is $5.98.

She did not change her "outperform" rating.

"AAR is our favoured industrial REIT as a result of its asset quality, strong balance sheet, development pipeline, and outlook for higher organic growth," the analyst said. "We expect fundamentals in the industrial sector to remain solid, supported by strong e-commerce-driven demand for distribution centres. Robust buyer interest continues to drive cap rate compression in support of NAV."


CEIBA Energy Services Inc.'s (CEB-X) operations took a step back in the fourth quarter, said Canaccord Genuity analyst John Bereznicki.

He downgraded his rating for the Calgary-based company to "hold" from "speculative buy."

"After posting solid results in Q2/16 and Q3/16, CEIBA unexpectedly generated negative EBITDA in the fourth quarter as a result of factors that we view as both transitory and structural," said Mr. Bereznicki. "While we expect CEIBA to benefit from a fundamental recovery this year, we believe the company's Q4/16 results (and our reduced cash flow estimates) will create increased balance sheet strain that could limit the company's longer-term growth prospects."

He added: "We believe CEIBA will have to curtail its capital spending significantly this year and aggressively manage its working capital as fundamentals recover, potentially limiting its longer-term growth prospects."

Mr. Bereznicki's target for the stock dropped to 20 cents from 30 cents. Consensus is 28 cents.


In other analyst actions:

DH Corp. (DH-T) was downgraded to "hold" from "buy" at Industrial Alliance by analyst Dylan Steuart, who lowered his target to $25.50 from $26.50. The analyst average is $24.72, according to Bloomberg.

SEMAFO Inc. (SMF-T) was upgraded to "sector outperform" from "sector perform" by Scotiabank analyst Ovais Habib with a target of $5.25 (unchanged). The average is $6.05.

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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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