Thursday’s analyst upgrades and downgrades

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

Raymond James analyst Brenna Phelan downgraded Home Capital Group Inc. (HCG-T) in reaction to the Toronto-based mortgage lender and three of its current or former executives being accused by the Ontario Securities Commission of making false and misleading statements to the public.

On Wednesday, the OSC issued a notice of hearing and statement of allegations naming the company and former chief executives Gerald Soloway and Martin Reid as well as current chief financial officer Robert Morton.

Moving her rating for its stock to "market perform" from "outperform," Ms. Phelan said: "We view this formal statement as an incremental negative given 1) charges against the current CFO, which may result in his removal, leaving the company without a CEO or CFO; 2) formal allegations against the founder, still-current board member and significant (approximately 5 per cent) shareholder Gerald Soloway; 3) evidence that the Audit Committee of Board of Directors was made aware of the fraud much earlier than we had previously believed; and, 4) the revelation that Home Capital's underwriting department was falsely documenting that they had completed income verification steps and that this practice was a 'systemic' practice within the group (i.e., the fraud was internal in addition to from external brokers)."

"The OSC has scheduled a hearing for May. 4 to consider potential sanctions which may include 1) prohibiting Soloway, Reid and Morton from trading in securities and/or requiring them to resign positions of officer at any issuer; 2) the requirement for them to disgorge any amounts obtained as a result of non-compliance with securities law; 3) administrative penalties of not more than $1-million for each failure of Soloway, Reid, Morton and HCG to comply with Ontario securities law and/or payment of the costs of the investigations; and, 4) any such other order that the Commission considers appropriate in the public interest. We note that the financial impact of the administrative penalties appear to be manageable relative to our estimate of HCG's $390-million of excess capital."

Ms. Phelan said the most immediate impact from the allegations may be higher financing costs, noting Home Capital receives almost 70 per cent of its funding from the deposit broker network, 5 per cent from institutional deposit notes and the rest from its Oaken branded direct-to-consumer savings accounts and GICs.

"The perception of heightened risk regarding the future leadership and operations of the company may lead to upward pressure on the rate Home Capital must pay on its GICs, the inability to access deposits through its own Oaken brand and/or potentially to the removal of its products from broker platforms," she said. "Our average deposit cost forecast increases by 25 per cent to 2.50 per cent for the remainder of 2017E, moderating to 2.35 per cent in 2018, and our traditional mortgage portfolio growth forecasts declines to negative 7 per cent (from 4 per cent previously) for 2017 and to nil (from 6.5 per cent previously) to reflect constrained access to funding sources and the potential impact of reputational risk on new business growth. We note that that there are risks associated with these forecasts as the impact of reputational risk is difficult to quantify."

Dropping her net interest income estimates, Ms. Phelan's adjusted earnings per share projections for 2017 and 2018 fell to $3.64 and $3.84, respectively, from $4.11 and $4.50 to reflect "higher funding costs and a decline in the Traditional mortgage portfolio of 7 per cent in 2017."

"In contrast to the negative information obtained from the OSC's statement and its impact on our outlook, Home's Feb-2017 OSFI filings, made available this evening, show good growth in its Traditional (non-prime, uninsured) loan portfolio," she said. "While improvement in this metric is one of the critical components needed for a resumption of earnings growth, we believe that the risks outlined above may outweigh this improvement, particularly in the near-term."

Her target price for the stock fell to $23 from $34. The analyst average price target is $28.82, according to Bloomberg.

"Our previously positive outlook on the stock was based on improving underlying business fundamentals, specifically in its non-prime mortgage business, and while recent data points point to improvement , incremental information from the OSC's Statement of Allegations leads us to believe that continued improvement may not be achievable due mainly to an inability to obtain cost-effective funding," said Ms. Phelan.

"We note that the uncertainty around the outcome from these allegations increases forecasting risk."

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"Rapid" improvements in the productivity of U.S. rigs could complicate the Organization of the Petroleum Exporting Countries' efforts to rebalance the crude market, according to Desjardins Securities' energy analysts.

"We still generally believe that higher oil prices are required to support full-cycle returns in most major basins globally, particularly when considering the heavy social toll for oil-exportdependent GCC monarchies," the firm said in a first-quarter earnings preview. "However, the steady increase in U.S. rig counts since last fall, combined with the significant improvements in rig productivity in key U.S. basins, has added to our caution on the potential for a sharper recovery in oil prices in 2018, particularly following the relatively underwhelming start to the physical market rebalance in 2017."

Desjardins cut its WTI price deck for both 2017 and 2018 to $52.50 (U.S.) per barrel and $55, respectively, from $55 and $60.

The group also emphasized that pipeline network congestion in western Canada is likely to remain a "significant headwind" for AECO natural gas.

"Although we have trimmed our 2018 NYMEX price deck to $3 (U.S.) per thousad cubic feet (from $3.25/mcf) following the disappointing winter heating season as well as in anticipation of a sharp acceleration in associated gas volumes in the U.S. (mostly the Permian), we are considerably less constructive on the AECO side," they said. "We continue to see incremental price pressure in western Canada resulting from the congested gas network … which will likely translate into wider basis differentials relative to NYMEX. We have consequently taken a harder cut at our AECO price deck, moving to $2.85 (Canadian) per thousand cubic feet in 2017 and $2.75/mcf in 2018. The other key point is that we have maintained our FX assumption of 75 (U.S.) to $1 (Canadian), unlike in past updates where we saw a weaker loonie materializing — which helped cushion cash flow revisions despite the downward movement in U.S. benchmark pricing."

In the note, analyst Jamie Kubik downgraded Pine Cliff Energy Ltd. (PNE-T) to "hold" from "buy" in conjunction with the AECO price forecast changes.

"While we see PNE as a unique contrarian investment for leverage to natural gas, we also hold the view that the increasing competitiveness and growth profile from other low-cost gas producers from the Montney in western Canada could see PNE trade at a deeper discount than it has historically, particularly until better visibility on an improvement in AECO pricing materializes," said Mr. Kubik.

He also lowered his target for the stock to 85 cents from $1. The analyst average is $1.16.

The firm also reduced several target prices for stocks in their coverage universe to reflect their expectation of lower commodity prices for 2018.

"In the large-cap space, 1Q17 featured the continued consolidation of the oil sands as CNQ acquired a 70-per-cent stake in the Athabasca Oil Sands Project from Shell and Marathon, while CVE acquired a 50-per-cent stake in FCCL and Narrows Lake from ConocoPhillips," the analysts said. "While there is much speculation surrounding the reason for the exit of international oil companies that are selling down interests in oil sands projects — including debt reduction (Canadian companies tend to be more conservatively financed and therefore have the ability to act opportunistically), increased specialization in a 'lower for longer' world, asset optimization for companies with scalable Permian acreage, concerns over the carbon intensity of oil sands projects — from our perspective, the most compelling driver surrounds the economies of scale and technology. Consolidation of the oil sands allows for increased pricing power (for materials and labour), economies of scale from an operational and G&A perspective (especially with the move to modularization), and substantially increased benefits from technological advances, which should ultimately improve the competitiveness of the oil sands as oil prices rebound."

Among large-cap companies, they lowered Encana Corp. (ECA-T) to $12.50 from $13.75 with a "hold" rating. Consensus is $13.48.

Their changes in the oil sands were: MEG Energy Corp. (MEG-T, hold) to $9 from $10 (versus $8.61 consensus); and Blackpearl Resources Inc. (PXX-T, buy) to $2.25 from $2.50 (v. $2.09).

Their changes among dividend-paying companies were:

- ARC Resources Ltd. (ARX-T, buy) to $24 from $29. Consensus: $25.73.

- Bonterra Energy Corp. (BNE-T, hold) to $28 from $31. Consensus: $31.41.

- Bonavista Energy Corp. (BNP-T, buy) to $5 from $7. Consensus: $5.02.

- Crescent Point Energy Corp. (CPG-T, buy) to $20 from $23.50. Consensus: $21.59.

- Enerplus Corp. (ERF-T, buy) to $16 from $16.50. Consensus: $15.18.

- Peyto Exploration & Development Corp.(PEY-T, hold) to $31 from $39. Consensus: $36.30.

- TORC Oil & Gas Inc. (TOG-T, buy) to $10 from $11. Consensus: $9.98.

- Vermilion Energy Inc. (VET-T, buy) to $60 from $67. Consensus: $59.97.

- Whitecap Resources Inc. (WCP-T, hold) to $12 from $14. Consensus: $14.43.

"1Q reporting kicks off on April 26 with the large caps; while cash flows are expected to look better year-over-year, the key focus will remain on sustainability and balance sheet maintenance," they said. "Overall, cash flows should generally look much better relative to 1Q16, which effectively represented the trough of the energy commodity price cycle when both crude oil and natural gas benchmarks bottomed. In comparison, 1Q17 oil prices were broadly in line with our forecast, which has minimized estimate revisions for the oil-focused producers under coverage. And despite the previously noted challenges in the natural gas market, both NYMEX and AECO benchmark prices increased meaningfully year-over-year as storage levels were reasonably well-contained this winter despite marginal support from heating demand — a stark contrast to the 2016 experience when the surplus exploded to near-record levels. Despite the improved commodity price environment, we expect a significant emphasis on sustainability to persist given the substantial headwinds still facing both oil and natural gas during a period of relative supply abundance. Relative balance sheet strength has certainly improved over the past 12 months, due in large part to higher cash flows and equity financings by some companies but also to a steady diet of M&A and a modest thawing of the structured debt market (including the convertible market)—providing options to diversify exposure; we expect debt repayment to continue to be the priority for free cash flow going forward, at least until a broader recovery in pricing materializes.

"And while 1Q typically represents the busiest quarter from an operational perspective given the winter drilling season, we expect minimal adjustments to production and capex guidance at this point with spring break-up still underway. Perhaps more importantly, we suspect there is limited conviction in commodity prices — which will likely temper the appetite to boost spending plans for the time being. The recovery in pricing and activity levels has also led to increased pressure on services. We suspect this could lead to cost creep on the capital side, potentially offset by delays in obtaining crews—which could temper both capital and production expectations in certain cases."

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There are familiar themes hanging over the Canadian power and utilities sector as it heads into first-quarter earnings season, according to Raymond James analysts David Quezada and Frederic Bastien.

"As has been the case in recent quarters, the news headlines continue to be dominated by U.S. tax reform, the Trump administration's ongoing attempts to de-claw the Obama era climate regulations and a continued focus on bond rates," they said in a research note previewing the quarter.

The pair added: "As it relates to the power and utilities sector, key elements of President Trump's campaign included significant corporate tax reform and the reduction or elimination of climate regulations including the Clean Power Plan. While tax reform was ostensibly a negative (we believe it would have a modest impact to the utilities we cover) and the rollback of CPP arguably the removal of what would have been a boon to the sector, the failure to pass the American Health Care Act has cast doubt on these potential developments. To be clear, we continue to expect some degree of tax reform, however, we note divisions in the Republican Party and the walking back of previously indicated targets (i.e. a 15-per-cent tax rate) suggest these changes are far from a foregone conclusion."

Mr. Quezada downgraded a pair of companies ahead of the release of financial results.

He lowered TransAlta Renewables Inc. (RNW-T) to "market perform" from "outperform" based on share price appreciation. He noted the stock is up 12 per cent in the year to date and within 7 per cent of his target price of $17, which did not change. The analyst average price target is $15.50.

The analyst dropped his rating for Innergex Renewable Energy Inc. (INE-T) to "outperform" from "strong buy" "due to lack of visibility on where the company's medium term growth will come from."

He maintained a price target of $17.50. The average is $16.44.

"While we remain confident in management's abilities to secure attractive projects, we believe the prevailing outlook falls shy of meriting a Strong Buy rating," he said.

On the sector as a whole, the analysts said: "Our models point to quarterly earnings, FFO [funds from operations] or CAFD [cash available for distribution] per share estimates that are generally in-line with consensus expectations. As we have often stated, with either regulated or long term contracted revenues, earnings for the power and utility companies we cover tend to be stable over time with short term variations often weather related – something we generally expect to normalize over time. We do not predict any material share price moves related to 1Q17 results but rather look for changes to the companies' respective outlooks or changes to development/construction pipelines as the most important pieces of news."

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Shares of Canadian Pacific Railway Ltd. (CP-T, CP-N) "offer interesting value at current levels," said RBC Dominion Securities analyst Walter Spracklin.

On Wednesday after market close, CP reported first-quarter earnings per share of $2.50, a penny ahead of the consensus projection and 4 cents below Mr. Spracklin's expectation.

"There were no major variants as all key metrics came in consistent with our expectations from price, to volume, to O/R (operating ratio)," he said. "Overall, a solid quarter for CP."

 Saying an inflection point is "in play," Mr. Spracklin added: "Key to our thesis is that CP is currently seeing a volume inflection, and this was reaffirmed by management, which guided to a mid-single digit volume growth rate for Q2/17, up from the flat rate we saw in Q1 and perhaps a touch higher than the 3.8 per cent  we had been calling for. Driving this are: 1) building momentum in Grain; 2) easier comps in Crude; and 3) the new K+S potash mine coming on-line in Q3."

"In tandem with the snap back in volumes, management also expressed optimism with regards to the company's opportunity to drive higher margins with the increased volume. Not surprisingly, management reiterated its 'high-single digit' 2017 EPS growth guidance (despite flat growth in Q1) - and we are in fact seeing room for the company to come in above that guidance (our new estimate calling for just under 12-per-cent growth in 2017)."

Citing the volume inflection and "the opportunity for incremental margin," Mr. Spracklin bumped his 2017 and 2018 full-year EPS estimates to $11.50 and $12.75, respectively, from $11.45 and $12.64.

With an "outperform" rating (unchanged), his target for the stock rose to $226 from $224. The analyst average is $222.77.

"CP shares present as the cheapest rail in the group at 15.8 times compared to the peer average at 17.1 times," he said.

Elsewhere, CIBC World Markets analyst Kevin Chiang did not change his "outperformer" rating or $220 target.

"We continue to see CP bridging the valuation gap relative to its peers with its volume growth inflecting positively, improving labor relations, a more consistent shareholder return program, and strategy to grow the top line," he said.

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Calling its Ibalizumab drug a "game changer," CIBC World Markets analyst Prakash Gowd initiated coverage of Theratechnologies Inc. (TH-T) with an "outperformer" rating.

"This will be a first-in-class drug for multi-drug resistant HIV (MDR HIV) when it likely receives approval later this year, and will fulfil an urgent need in the treatment of patients," said Mr. Gowd. "Given the scarcity of options to treat MDR HIV, we expect rapid uptake of ibalizumab and forecast peak sales of $446-million.

"We expect value appreciation between now and FDA approval of ibalizumab. Small-cap biotech stocks are typically milestone-driven. Specifically, stocks react to clinical, regulatory and commercial events. Theratechnologies' stock has already moved in response to clinical development success with ibalizumab. The next key milestone will be the near-term BLA filing, followed by the potential approval later this year. We recommend investors position themselves well in advance since we expect a valuation run into approval as the market gains comfort with the likelihood of ibalizumab being approved and commercialized in the U.S.."

Mr. Gowd said its lone commercialized drug, EGRIFTA, provides "steady" cash flow to support its growth initiatives. He noted EGRIFTA "is the only FDA-approved product for HIV-associated lipodystrophy (metabolic disorder related to HIV treatment)."

"It is profitable on a standalone basis and will provide the cash flow to support corporate expenses and the launch of the company's second product, ibalizumab, in the U.S.," the analyst said. "Theratechnologies has already expanded its commercial effort in preparation for the launch. EGRIFTA sales are expected to also benefit, with new 2017 guidance of $44 million-$46 million in sales."

He set a price target for the stock of $10. Consensus is $6.77.

"While Theratechnologies already has EGRIFTA on the market, the majority of its future value comes from its ability to bring ibalizumab to market and meet sales expectations," the analyst said. "Our DCF projects cash flows until 2030 to capture ibalizumab's entire lifecycle. Beyond 2024, unless the company is successful in bringing in other products, cash flows are projected to decline due to the loss of exclusivity. We assume a terminal growth rate of 0 per cent and discount rate of 10 per cent to derive our price target (base case) of $10 per share. Our upside and downside projections derive valuations of $15.60 and $3.80 per share, respectively."

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Saying it's "turning over a new leaf," Canaccord Genuity analyst Jenny Xenos initiated coverage of TransGlobe Energy Corp. (TGL-T) with a "speculative buy" rating.

"Since the Arab Spring began in late 2010 – early 2011, the TransGlobe stock has underperformed its peers due to political and economic struggles in Egypt, exacerbated by a significant decrease in crude oil prices," said Ms. Xenos. "During this time, the company prudently reduced its investment in the country, conserving cash and focusing on cost-cutting initiatives, which resulted in production declines and reduced profitability, hence negatively affecting the stock's performance.

"Since then, the political and economic situation in Egypt has improved and stabilized. The political upheaval has subsided and a new government is now in place. The country has embarked on a program of reform to restore investor confidence, with the IMF's seal of approval (including a $12-billion loan). The full float of the currency was adopted in November 2016, nearly eliminating the currency black market, increasing remittances and improving liquidity in banks. As a result, Standard & Poor's has upgraded its economic outlook for the country from negative to stable, with Moody's and Fitch also having a stable outlook. On the back of this, Egypt issued a $4-billion Eurobond at the end of January that was three times oversubscribed. In addition, the finance ministry reported that foreigners purchased more than $3.3B of treasuries to mid-March, with investors appearing to be returning to the Egyptian debt market due to improved conditions and cautiously rising business confidence. (We say 'cautiously' as there is still much to be done to restore the economy to growth and improve investor confidence.)."

Ms. Xenos set a price target for the stock of $3.50. Consensus is $2.72.

"We believe the company has turned the page with its return to growth and profitability," she said. "It now has a diverse portfolio of extensive development opportunities in Egypt and in Canada and exploration opportunities in Egypt. The overall risk profile of the portfolio has also improved substantially. As a result, we have a positive outlook on the story and the stock.

"TransGlobe's shares are trading at a discount to their international and Canadian junior and intermediate peers. We believe at current prices, the stock does not reflect significant upcoming growth, improved profitability and exploration upside. We recommend buying it at current depressed levels, ahead of significant growth forecast in 2017 and 2018, in addition to potential exploration catalysts, which could unlock value for the stock."

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Citing a more balance risk-reward proposition, Citi analyst Jason Bazinet upgraded Discovery Communications Inc. (DISCA-Q) to "neutral" from "sell."

"In May, 2016 we downgraded Discovery to sell," he said. "Our premise was simple: media firms that lack material U.S. sports and news – like Discovery, Scripps, and Viacom – were likely to be left out of emerging dMVPDs [digital multichannel video programming distributors] offers. Over the past year, Discovery's shares traded sideways but have lagged both the market and all media peers. Consensus estimates, however, have held up: the Street expects high single digit EPS growth through 2018 (better than both Viacom or Scripps)."

Mr. Bazinet raised his target price for the stock to $30 (U.S.) from $27. Consensus is $28.18.

"Based on our analysis, we see little chance of material downward revisions to the Street's EPS forecast. And, since Discovery is one of the fastest EPS growers in the media space, we think its current multiple (about 11 times 2018 EPS) is too punitive," the analyst said. "As such, we retain our 12.0-times target multiple and are rolling our valuation to 2018. As a result, we are increasing our target price."

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With the industrial safety market growing, Raymond James analyst Ben Cherniavsky recommends investors purchase shares of Blackline Safety Corp. (BLN-X).

"Although difficult to quantify precisely, the returns on investments that businesses make in safety have proven to be very high," he said. "Indeed, corporate spending (investing) in this area has been growing for many years and is expected to remain strong well into the future. We see this as a strong secular tailwind to the Blackline story."

Mr. Cherniavsky initiated coverage of the stock with a "strong buy" rating.

"Supporting our positive investment thesis are Blackline's innovative Loner Products and success demonstrated to-date in the vast and growing Work Alone Market," he said. "Additionally, Blackline is now in the early innings of disrupting the portable gas detection market (again) with its G7 product line, which we believe will become a much more important growth driver for the company. Finally, our confidence in Blackline management is a critical (if not the most important) component supporting our positive stance. This is based on the tremendous success of BW Technologies, the predecessor company built and sold by Blackline's CEO Cody Slater, with much of the same management team in place today."

The analyst set a price target of $4.50. He is the lone analyst covering the stock, according to Bloomberg.

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In other analyst actions:

Roxgold Inc. (ROXG-T) was raised to "buy" from "speculative buy" at Canaccord Genuity by analyst Rahul Paul with a target of $2 per share. The analyst average is $2.21.

Goldman Sachs Group Inc. (GS-N) was raised to "overweight" from "neutral" at Atlantic Equities by analyst Christopher Wheeler. His target fell to $252 (U.S.) from $254. The analyst average is $243.96.

Starbucks Corp. (SBUX-Q) was raised to "buy" from "hold" at Stifel by analyst Mark Astrachan with a $67 (U.S.) target. The average is $64.27.

Molson Coors Brewing Co. (TAP-N) was downgraded to "market perform" from "outperform" at Cowen by analyst Vivien Azer. His target fell to $105 (U.S.) from $120. The average is $115.45.

Time Warner Inc. (TWX-N) was downgraded to "hold" from "buy" at Pivotal Research by analyst Brian Wieser with a target of $107.50 (U.S.) per share. The average is $105.50.

Monness, Crespi, Hardt & Co analyst James Cakmak downgraded eBay Inc. (EBAY-Q) to "neutral" from "buy" without a specified target. The average is $35.61.