Thursday’s analyst upgrades and downgrades

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

Despite reporting a higher-than-anticipated profit for the eighth consecutive quarter, Desjardins Securities analyst Keith Howlett downgraded his rating for Dollarama Inc. (DOL-T).

Citing recent share price appreciation, Mr. Howlett moved the discount retailer to "hold" from "buy" despite a significant increase to his target price.

On Wednesday, the Montreal-based company reported first-quarter 2018 earnings per share of 82 cents, topping the analyst's projection by a penny and the consensus expectation by 3 cents. It was an increase of 20.6 per cent year over year (from 68 cents) with total revenue rising 10.0 per cent and same-store sales up 4.6 per cent.

"Operating metrics continue to improve, and are impressive," said Mr. Howlett. "Dollarama continues to drive consumer engagement, manage margins, improve productivity and control expenses. The outcome is ongoing improvement in financial performance. Management reiterated its prior financial guidance for fiscal year 2018."

Mr. Howlett expressed surprise over the early indications of success in Central America and parts of South America for Dollarama's relationship with Dollar City, an independent venture which it has the option to acquire in 2020. He suggested it will motivate the company to further "seed" its business model into more international markets and expects it to find "meaningful" opportunity.

"We had modest expectations for the venture, given how poor El Salvador and Guatemala are, as measured by GDP per capita …. In the early going, Dollar City reduced total store count and withdrew from Guatemala entirely," he said. "After a period of reorganizing and putting the foundation in place, growth has been surprisingly robust. Real-time store data is accessible to Dollarama, although Dollarama management is very tight-lipped about all matters related to Dollar City. Online pictures of Dollar City stores reflect a look and feel eerily similar to Dollarama stores in Canada. Within the last nine months, Dollar City has entered Colombia, which has over double the population of El Salvador and Guatemala combined, and GDP per capita of $14,100 (U.S.). There appears to be a total of nine stores now open in Colombia with six in Cali, one of Colombia's three major metropolises, and three in several other cities."

"Dollarama has a lean management team which is fully occupied in expanding the store network to 1,700 locations (currently at 1,108). Management is developing a database of global opportunities, but has largely ruled out acquisition as an avenue of growth. More likely models for international expansion are licensing, franchising or wholesale arrangements. The partnership in Latin America, while arising 'accidentally', may provide a possible model for the future."

With the quarterly results, Mr. Howlett increased his 2018 fiscal EPS projection to $4.29 from $4.27. He maintained a 2019 estimate of $4.95.

His target price for the stock rose to $134 from $120. The analyst consensus price target is $132.53, according to Thomson Reuters data.

"Our target price is based on 28 times forward-four-quarter (previously FY18) EPS plus $10 (previously $0) in respect of international expansion," the analyst said. "Given the company's industry-leading business model and financial returns, plus encouraging early indications from its development partner in Central and South America, we assign a 30-per-cent probability of success within 10 years in one major foreign market."

"The recent entries of Target and Dollar Tree into Canada again demonstrated that abundant capital, a proven business model and a history of strong management do not necessarily travel well to new markets with different competitive dynamics. Dollarama is proceeding prudently outside of Canada given constrained human capital, and the complexity of transporting business models elsewhere. That said, our supposition is that there is a huge global opportunity for Dollarama, and we now include some value for that potential in our target."

Elsewhere, Raymond James analyst Kenric Tyghe increased his target to $140 from $135 with an "outperform" rating (unchanged).

"We continue to believe that management remains very conservative in its commentary on the net impact on average ticket of the fully rolled out credit card payment options," he said. "Our positive thesis on Dollarama is predicated on: (i) expected strong SSS (on strong merchandising and higher price points introduction), (ii) continued execution on productivity and cost reduction initiatives, and (iii) potential further international expansion."

CIBC World Markets analyst Mark Petrie kept his "outperformer" rating and hiked his target to $141 from $125.

Mr. Petrie said: "We continue to see Dollarama as best-in-class with a differentiated business model supporting attractive organic growth and free cash flow generation. The stock has outperformed recently, but we continue to believe DOL has years of growth ahead of it, with Dollarcity (now 79 stores) as a potential lever for decades more."

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Mediagrif Interactive Technologies Inc.'s (MDF-T) recent decline in share price heightens the likelihood of a takeover, according to Desjardins Securities analyst Maher Yaghi.

"While MDF's declining revenues in recent quarters on an organic basis have reduced public investor appetite for the name, we believe long-term shareholders as well as buyout firms should begin to see MDF shares in a better light following the recent pullback," he said. "The recent mania for takeovers in the Quebec landscape (Canam, Lumenpulse) should also attract interest in the story. We ran an LBO [leveraged buyout] model on MDF, and believe a 20-per-cent premium offer at today's valuation would generate sufficient returns (internal rate of return of 17 per cent) for private equity investors. A 20-per-cent premium is the equivalent of about $18.60 per share. Our assumptions include a leveraged transaction at 4.0 times EBITDA, debt costs of 2.5 per cent and an eventual divestiture after six years at 10 times FCF [free cash flow].

"Recall that in 2010, OMERS acquired Logibec, a technology company where Claude Roy (MDF's current CEO) was CEO. Mr Roy held 23 per cent of the company at that time (similar to what he currently owns in MDF) and had agreed to sell his position. The premium offered for Logibec was 17 per cent, which suggests our 20-per-cent premium assumption is reasonable in our view. That being said, it is possible that the largest shareholders of MDF would want to be patient before considering a sale in order to avoid selling at a historically low price."

On Tuesday, the Montreal-based tech company, which provides e-business solutions to consumers and businesses, reported lower-than-expected fourth-quarter financial results that highlighted "continued challenges in some business lines."

Mr. Yaghi said these issues will make it difficult for Mediagrif to generate organic revenue growth in the coming quarters.

"Organic revenue was down approximately 2.8 per cent as the company is going through a period of transition for a number of its segments, while other units are still showing healthy growth," he said. "However, this is a slight improvement over the 4.7-per-cent year-over-year organic revenue decline the company reported in the last quarter."

Total revenue of $20.0-million narrowly missed Mr. Yaghi's estimate of $20.5-million, while in line with the consensus of $19.9-million. However, adjusted earnings per share of 24 cents fell below his projection of 28 cents and the consensus of 26 cents.

"MDF trades at an attractive free cash flow yield of 8.5 per cent, with FCF [free cash flow] production estimated at $19.4-million in FY18 which, combined with a low net debt to EBITDA of 0.7 times, provides management with a good opportunity set to generate value for shareholders," the analyst said. "The current low stock price could entice management to do more share buybacks but, overall, we expect this program to have little impact on the stock price in the upcoming months. This is because the company can buy only 146,000 shares until the month of August under the current NCIB program, which would represent about 1 per cent of shares outstanding. The company could also increase its dividend as it currently distributes 31 per cent of its FY18 FCF, which we believe could be increased without compromising the 'build and buy' model too much."

Maintaining his "hold" rating for the stock, he lowered his target to $17.50 from $19.50. Consensus is $20.20.

"MDF trades at attractive valuation multiples and the company generates solid free cash flows, which provides flexibility for management to pay down debt, utilize its NCIB and/or retool for further M&A," Mr. Yaghi said. "While valuation is attractive, the stock is likely to trade sideways for several quarters until organic revenue growth stabilizes. We would reevaluate our view if revenue growth resumes or if visibility on additional M&A improves."

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Currency Exchange International Corp.'s (CXI-T) growth story has returned with a "strong" quarter, said Industrial Alliance Securities analyst Dylan Steuart.

On Tuesday, the Toronto-based company reported second-quarter revenue of $7.2-million, topping Mr. Steuart's projection of $6.5-million and representing a 22.5-per-cent increase from the previous year. The analyst pointed to an expansion in its wholesale client base, with transacting locations up 25 per cent year over year, as the key reason for the beat.

Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) came in at $1.5-million , excluding charges related to a managerial shuffle, ahead of the analyst's $1.1-million and up 29.2 per cent.

"Fuelling the top line growth, consumer transactions increased 57 per cent year over year to 212,000 in the quarter, up from 135,000 in the same quarter a year ago," said the analyst. "Again, this is largely driven by the expansion of the wholesale client base. However, over the course of the year, CXI has opened three new retail branches supporting revenue expansion."

Based on the results and additional client additions following the quarter, Mr. Steuart raised his fiscal 2017 revenue forecast to $30.7-million (from $29.8-million), EBITDA to $7.4-million (from $6.9-million) and earnings per share to 62 cents (from 58 cents).

"We remain conservative in our forecasts, which are driven by expansion of the retail and wholesale banknote business, while assigning little contribution from the payments segment at this time. Considering the indications that wholesale client growth was added subsequent to the quarter, expected transaction margin improvement via interbank currency fees with the bank license, and payoff from the build of the payments business, we are expecting modest upticks in growth and margins in F2018," he said. "As such, we forecast an increase in revenue growth in F2018 of 18 per cent, up from the forecasted 15-per-cent revenue growth in F2017, reflecting a full year of contribution from further client additions expected following the banking charter approval."

He bumped his target for the stock to $30 from $28 with a "buy" rating (unchanged). Consensus is $30.50.

"Given the strong quarter and favourable valuation we continue to see solid upside to current valuation," said Mr. Steuart.

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DAVIDsTEA Inc.'s (DTEA-Q) "reset" year has begun with an inventory clearing process, said BMO Nesbitt Burns analyst Kelly Bania.

On Wednesday, the Montreal-based reported first-quarter fiscal 2018 earnings per share of a 4-cent loss, a penny better than the analyst's estimate. Comparable same-sales dropped 5.7 per cent, versus Ms. Bania's expectation of an 8-per-cent drop.

"Comps improved toward the end of the quarter and are tracking  down low-single digits into F2Q18 (ahead of our expectations), though management is focused on clearing still excessively high inventory (sales up 9.4 per cent year over year versus average inventory per store up 39 per cent)," she said. "DTEA also announced that CFO Luis Borgen will be departing (effective 7/31) and a search is under way for a replacement.

"While a search also remains under way for a new head of merchandising, holiday 2017 buying is already likely largely complete. And while the goal of 2Q is to clear excess inventory (supported by deep promos at the company's summer clearance promotion), this year's holiday outlook is supported by: 1) a 20-25-per-cent reduction in SKUs [stock keeping units] across all categories (note: tea led sales growth in the quarter with growth 12 per cent in fiscal first-quarter 2018 and where the top 20-per-cent SKUs generate the majority of sales with accessories up 6 per cent and food/beverage dow -3.2 per cent); 2) continued focus on digital capabilities, including a new website launching in 3Q; and 3) investing in training/ people (with focus on increasing average transaction). Additionally, the company continues along the path of growing its HRI (Hotel, Restaurant, Institution) business, store refreshes, and adding traffic counters."

Ms. Bania made some adjustments to her financial forecast for the 2018 fiscal year based on the results. Her merchandise same-store sales growth forecast moved to a 2.7-per-cent decline from a drop of 4.3 per cent, while her revenue estimate rose to $228-million from $225-million. Her 2019 revenue estimate increased to $238-million from $235-million.

"We make minor tweaks to our model, including slightly stronger 2Q comps, but maintain our forecast for second-quarter gross margin percentage pressure given our expectation for deep discounts," the analyst said. "Our full-year forecast is largely unchanged as the majority of earnings is generated in the key fourth quarter."

Ms. Bania kept her target for the stock of $5.50 (U.S.). Consensus is $7.93.

"We believe DTEA's modern in-store experience, innovative culture, attractive market positioning, and a track record of solid new-store returns in Canada bode well for the company; yet, with executional challenges, slowing store growth, a lack of visibility into sales trends, and product assortment issues, we rate the shares Market Perform," she said.

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Credit Suisse analyst Jason West raised his target price for McDonald's Corp. (MCD-N) after his U.S. franchise channel check revealed "continued" momentum.

"Our U.S. franchisee contacts reported solid business trends in second quarter to-date," said Mr. West.  "Franchisee SSS [same-store sales] have been running above the levels seen in 1Q, with each month showing sequential improvement. Most of our contacts saw their strongest SSS in the first week of June (mid-single digit range on average) and are optimistic that they can sustain that momentum.

"Following these checks, we have raised our MCD U.S. same store sales estimate to an increase of 3 per cent from a 2.5-per-cent increase, bringing us in line with consensus. We note that SSS compares ease considerably in 2Q versus. 1Q (360 basis points), so we should not be surprised to see improving trends. However, we were encouraged by the overall tone of MCD operators, which suggests the recent sales improvement is due to more than just easing compares. Further, operators spoke to traffic-led growth, which is a change from recent quarters, which have been driven primarily by check growth."

Maintaining his "outperform" rating for the fast food chain's stock, his target price jumped to $165 from $157. Consensus is $153.79.

"While the stock may look expensive on an absolute basis, we note MCD trades in line or at a discount to most of its franchise peers," said Mr. West. "We see room for modest multiple expansion as franchise mix rises and SSS potentially surprise to the upside. Key risks include increased competition and execution on refranchising targets."