Thursday’s analyst upgrades and downgrades

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

Though "challenges persist" for Hudson's Bay Co. (HBC-T) following "softer than expected" second-quarter results, Canaccord Genuity analyst Derek Dley increased his target price for the stock, citing the potential for a "'go-private' transaction."

On Wednesday, the Canadian retailer reported adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) of $16-million, falling well below both Mr. Dley's projection of $84-million and the consensus estimate, which was in line with the result from the same period in 2016, of $81-million.

Given the steep miss, Mr. Dley expressed doubt over the company's claim that it expects the bulk of its projected $170-million in 2017 costs savings to materialize in the next two quarters. He said that result is "easier said than done" given the difficult retail backdrop.

"Q2/17 was yet another challenging quarter, and represented the second consecutive large earnings miss," said Mr. Dley. "Adjusted EBITDA declined to $16-million from $81-million last year (and 80 per cent below consensus), as the company continues to face heavy competition from rival department stores, as well as the secular growth from ecommerce shopping, which appears to be accelerating and leaving HBC to play catchup. While we recognize that the company's rent expense is spread out evenly over the course of the year, while revenue and EBITDA are heavily weighted towards the back end of the year, HBC has dug a rather large hole to begin 2017 with EBITDA from the first six months of the year amounting to a loss of $5-million, compared to last year at $143-million. The company did not provide an update on its real estate strategy other than stating it continues to explore valuation creation activities. While there continues to be rumors of a potential 'go-private' transaction, we believe absent this scenario, it would be very difficult to accretively monetize the company's real estate. Given the headwinds previously mentioned, we believe investors should steer clear of investing in department store focused retailers for the time being."

HBC saw consolidated same-store sales decline 1.3 per cent on a constant currency basis. Though its Fifth Avenue stores saw growth of 1.7 per cent, which Mr. Dley called a "bright spot," its department store group (DSG) segment, which includes Hudson's Bay, Lord & Taylor and Home Outfitters, dropped 1.6 per cent.

"The company did not provide an update on its real estate strategy other than stating it continues to explore valuation creation activities," the analyst said. "While there continues to be rumours of a potential 'go-private' transaction, we believe absent this scenario, it would be very difficult to accretively monetize the company's real estate. Given the headwinds previously mentioned, we believe investors should steer clear of investing in department store focused retailers for the time being."

Based on the results, Mr. Dley dropped his EBITDA forecast for 2017 and 2018 to $442.8-million and $519.6-million, respectively, from $533.7-million and $638-million.

Keeping a "hold" rating for HBC shares, he hiked his target to $11 from $9. The analyst average target is $12.40, according to Bloomberg data.

"Our TP represents a blend of our SOTP [sum-of-the-parts] and enterprise value/EBITDA multiple based valuations," he said. "We are rolling forward our SOTP valuation to 2018, resulting in a slightly lower valuation. However, this is offset by an increase in our target EV/EBITDA multiple (reflecting the potential for a "go-private" transaction). Our revised TP represents 11.0 times our $520-million 2018E EBITDA (vs 9.8 times our $534-million 2017E EBITDA previously)."

"While we continue to believe there remains value in the company's real estate assets, until the company demonstrates the ability to monetize these assets, or is to provide visibility around a potential "go-private" transaction as rumored, we believe investors should remain on the sidelines."

Elsewhere, CIBC World Markets analyst Mark Petrie increased his target to $12.50 from $10.50 with a "neutral" rating.

Mr. Petrie said: "The second quarter is relatively unimportant to HBC's full-year, but the continuation of challenging trends highlights the difficulties in the department store industry today, and how the company must achieve significant cost-cutting just to stem the ongoing declines in earnings. Potential corporate actions to surface value are intriguing, but we remain Neutral rated given the significant uncertainty."

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"Coffee and burgers pay dividends," according to Credit Suisse analyst Jason West, who upgraded his rating for Restaurant Brands International Inc. (QSR-N, QSR-T).

In moving Tim Hortons' parent company to "outperform" from "neutral," Mr. West said RBI "fits well" within his "oversupply" thesis  for the sector.

"We are looking for reasonably valued names that can grow earnings in the face of considerable sales and margin pressure, and RBI fits this bill (60 per cent cumulative EPS growth in 2018-19, on our model)," he said. "Our bull case assumes 40-per-cent total return over the next 12 months, including potential $4-5-billion capital return event in late-2018 (16 per cent of market cap)."

Mr. West cited a trio of key reasons for the upgrade. They are:

• The company’s “visible” growth in a low-growth consumer world.
  
  “QSR is emerging as one of the best earnings and free cash flow growth stories in the group, particularly over the 2018- 19 time frame,” he said. “This inflection is likely to be positive for the stock. Admittedly, a significant portion of this EPS/FCF growth is due to refinancing activity. However, we see solid organic growth as well, underpinned by mid-single digit global store growth, modestly positive comps (helped by easing compares in coming quarters), and a longstanding track record of cost discipline.”
  
  
• A favourable risk-reward proposition for investors.
  
  “We are finding it more difficult to see the downside case for the stock,” said Mr. West. “Shares have held flat for the past several months, making valuation more compelling. Valuation becomes significantly more compelling as we roll the model to 2018-19. Further, the most important driver of RBI's organic growth is new store development. In the past, we had been concerned about the feasibility of expanding the Tim Hortons brand outside of Canada. However, given the increased diversity of RBI's portfolio (with the Popeye's acquisition), and some recent development deals at TH, we are now less concerned about a shortfall in global store growth. Further, with RBI's earnings power heading towards $3-plus per share in 2019 and with franchised stories trading at 24 times on average, we see limited downside in the shares at the current price (even if TH or Burger King SSS were to come up short in any given quarter).”
  
  
• A pair of important new data points.
  
  The analyst said: “As part of our analysis two important new data points emerged: 1) RBI's balance sheet should become much less leveraged approximately one year from now, opening up the door to new capital return or acquisition opportunities. We do not think most investors are currently focused on this opportunity. 2) Our conversations with TH franchisees suggest that the recent discord with the corporate office may be settling down and seems unlikely to result in any major changes in the business model (discussed in more detail below). This had been another key concern with the stock.”

Mr. West also believes the stock's valuation is "cheaper than it looks," leading him to raise his target price to $74 (U.S.) from $60. Consensus is $58.17.

"One of the top pushbacks in our investor conversations on QSR is valuation," he said. "The stock trades at 26 times NTM [next 12 months] consensus price to earnings (above peer average of 24 times) and 18 times NTM consensus EBITDA (above peer avg. of 16 times). However, we believe valuation is more reasonable when fully factoring in EPS and FCF uplift from redemption of the pref. shares.

"Consider: QSR trades at 22 times our 2018 EPS, which fully accounts for redemption of the prefs (below most franchise peers despite a stronger unit growth profile). On our 2018 FCF, the stock trades at a 5.5-per-cent yield (100 basis points above peers). We believe the market is too focused on EBITDA at the expense of FCF (which captures QSR's low tax rate, minimal capex spend and refinancing opportunities)."

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Laurentian Bank Securities analyst Marc Chabin raised his target price for shares of Currency Exchange International Corp. (CXI-T) in reaction to a "strong" third-quarter beat driven by sales growth.

On Wednesday, the Toronto-based company reported revenue of $9.9-million (U.S.) and earnings before interest, taxes, depreciation and amortization (EBITDA) of $3.6-million, both exceeding Mr. Chabin's projections ($8.6-million and $3.0-million, respectively).

"With a 44-per-cent year-over-year increase in transaction volume (to 300,073 total transactions), CXI grew revenue by 28 per cent versus our forecast of 12 per cent in a seasonally strong period," the analyst said. "The increase in transaction volume is attributable to growth in transacting locations (19 per cent year over year), and was likely aided by recent strength in U.S. tourism. These results follow strong revenue growth of 23 per cent last quarter, and represent the company's highest year-over-year revenue increase in 10 quarters."

"Having returned to positive operating leverage in Q2/F17 following several quarters of high expense growth, we had expected the majority of expenses related to the company's transition to a bank and the launch of its payments platform had been incurred. We see revenue growth continuing to exceed opex growth into 2018, as this quarter confirms our view that expenses have normalized and should remain fairly steady nearterm."

Mr. Chabin raised his revenue forecast for the company, citing "strong" transaction volumes as well as its revenue performance. However, he did add that the current weakness of the greenback could act as a tailwind for near-term travel activity.

His revenue growth estimate for 2017 is now 19 per cent, rising from 14 per cent, while his fiscal 2018 projection moved to 15 per cent from 12 per cent.

"Despite slightly higher opex assumptions, our operating margin moves higher in conjunction with our expectation for higher revenue, resulting in an increased F2017 EBITDA margin of 25 per cent (up from 24 per cent) and F2018 EBITDA margin of 30 per cent (up from 28 per cent)," he said.

With a "buy" rating for the stock (unchanged), Mr. Chabin's target rose to $32 from $30, which is based on a 12 times enterprise value to EBITDA multiple on his 2018 estimate and sits in line with its money services sector peers. The analyst average price target is $31.17, according to Bloomberg data.

"Although the FQ3 results reflect CXI's seasonally strongest period, we are very encouraged by the results and believe they provide a strong indication of what to expect in the near term, noting that the summer travel season provides a good indication of CXI's future revenue trajectory," he said. "Following two quarters of strong revenue growth against fairly stable opex, we look for a continuation of this trend, particularly as the company adds further transacting locations. In addition, the company's U.S. payments business is beginning to grow, and may become a positive contributor by fiscal year-end."

Elsewhere, Industrial Alliance Securities analyst Dylan Steuart also raised his target to $32 from $30 with a "buy" rating.

Mr. Steuart said: "It has been a long period of transition as management has worked to integrate the banking operations and some sizeable clients, but it is clear that efforts are beginning to bear positive results. As such, we reiterate our Buy recommendation at this time. Confirmation of additional client expansion in the wholesale channel in the short term combined with stabilization of the expense run rate would lead to upside from our current forecasts."

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The 2018 fiscal year will be a "tough grind" for Major Drilling Group International Inc. (MDI-T), said Beacon Securities analyst Ahmad Shaath.

He downgraded his rating for the Moncton-based company to "hold" from "buy" in the wake of first-quarter results that featured "sluggish" revenue results.

"The dynamics of the current recovery has proven to be more challenging than previous recoveries for MDI," said Mr. Shaath. "Pick-up in revenue has been supported by improvement in activity level however pricing improvement continues to be absent. Coupled with the transitional costs and a challenging labor force environment that MDI is facing, our view on MDI's shares is moving to 'wait and see.'"

On Wednesday, the company reported revenue for the quarter of $80.4-million, falling below both Mr. Shaath's forecast of $89.8-million and the consensus $95.0 million. The analyst said revenue improvement fell below his expectations, particularly in South and Central America.

"While MDI continues to experience improvement in activity 'month by month,' this level of improvement has continued to track below our expectations," said Mr. Shaath. "We are yet to see a significant pick-up in MDI's utilization, which is typically 2-3 quarters leading-indicator of improvement in pricing. This, in turn, is causing margins to continue to be pressured, hence we are taking a more cautious view to our estimates. On the revenue side, we are now expecting revenue growth more in-line with MDI's recent improvement (i.e. low single digit sequential growth), while on the margin side we expect transitional costs and lack of improvement on pricing to keep margins at current levels. Ultimately, for FY18E our revenue is revised to $325.2-million from $390.1-million and adjusted EBITDAS to $18.1-million from $52.4-million."

The analyst lowered his target for the stock to $8.25 from $9, which is the consensus.

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Investors should look past CSX Corp.'s (CSX-Q) guidance revision toward long-term efficiency upside, according to RBC Dominion Securities analyst Walter Spracklin.

On Wednesday, the Jacksonville, Fla.-based railway company, led by new chief executive officer Hunter Harrison reduced its full-year guidance, blaming network disruptions during July and August stemming from the implementation of a Precision Scheduling Railroading model.

It lowered earnings per share growth to 20-25 per cent from 25 per cent. Operating ratio guidance dropped to "the high-end of mid-60s" from the mid-60s.

"Disruptions reflect redesign of operations," said Mr. Spracklin. "CSX now entering execution and refinement stage. The disruptions during July and August reflect the major redesign CSX's operations underwent. With the new model now rolled out, CSX has transitioned to the execution and refinement phase, during which we believe fewer disruptions are likely to occur. Encouragingly, refinements appear to be gaining early traction a sequential velocity and terminal dwell are improving. As such, it appears that CSX has already turned the corner."

In reaction to the company's update, the analyst lowered his 2017 EPS projection to $2.19 (U.S.) from $2.34, which implies growth of 21 per cent year over year. His O/R expectation is now 68 per cent, rising from 65 per cent.

Keeping an "outperform" rating for the stock, his target to $64 (U.S.) from $65 to reflect a drop in his 2020 EPS estimate (now $3.95 from $4.02). Consensus is $57.46.

"In our view, the guidance revision is more a factor of the complexity of CSX's network, rather than a deterioration in the long-term potential of the transformation," said Mr. Spracklin. "With management laying out a number of promising initiatives that could drive further efficiency gains, we believe that guidance for 20 per cent to 25-per-cent earnings growth for 2017 is on the right track towards our long-term estimates. As such, we suggest investors look past the Q3 challenges towards the compelling long-term efficiency upside."

He added: "Favorable sector fundamentals to drive long-term growth in free cash flow (and shareholder returns). Our constructive outlook on the rail sector is based on the industry's unique characteristics: 1) limited and rational competition; 2) high barriers to entry; and 3) sustainable growth in demand. We expect these attributes to drive real rate increases, volume growth, and margin expansion over the long-term supported by service improvements, efficiency initiatives, and the implementation of smart technology. With stable capital expenditure requirements and clean balance sheets, we believe that the industry is positioned to generate increasing free cash flow that will in turn drive up shareholder returns through sustained growth in dividends and share repurchases."

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Canaccord Genuity analyst Dalton Baretto added Fortuna Silver Mines Ltd. (FVI-T) to the firm's "Focus List" upon resuming coverage of the company and four of its peers.

Mr. Baretto expressed a preference from "companies with high operating margins, conservative balance sheets, reasonable valuations and leverage to base metals, as we believe that zinc and lead prices are poised to outperform gold and silver prices in the near to medium term."
 
For Fortuna, the analyst has a "buy" rating and $8.50 target price for its stock. The analyst consensus target is $8.04.

"FVI is our top pick in the silver producer space for its strong growth and margin profile, leverage to zinc and lead prices, and conservative balance sheet," he said.

"In addition, the company trades at a discount to its peers, a gap we think will close as Lindero is further developed."

He also resumed coverage of the following companies:

• Pan American Silver Corp. (PAAS-Q) with a “buy” rating and $22 (U.S.) target. Consensus: $20.19.
  
  “We like PAAS for its current profile as a silver-focused producer with a strong secondary base metals revenue stream, its pristine balance sheet and its forecast positive free cash flow,” he said.
  
  
• Coeur Mining Inc. (CDE-N) with a “buy” rating and $11.75 (U.S.) target. Consensus: $11.11.
  
  “We like CDE for its size, liquidity, forecast FCF growth, improved balance sheet and strong leverage to silver and gold prices at a relatively attractive valuation,” he said.
  
  
• Hecla Mining Co. (HL-N) with a “hold” rating and $5 (U.S.) target. Consensus: $5.97.
  
  “HL demonstrates the lowest growth profile of our silver coverage, along with the lowest proportion of its revenue from silver (although we like the base metals exposure),” said Mr. Baretto. “We remain cautious on the company's prospects given the near-term uncertainty with Lucky Friday, and the longer-term uncertainty around San Sebastian, Rock Creek and Montanore. We note the significant premium that HL trades at relative to its peers, and the fact that the current share price reflects full value even at these higher multiples.”
  
  
• Endeavour Silver Corp. (EDR-T) with a “hold” rating and $3 (Canadian) target. Consensus: $4.53.
  
  “We remain cautious on EDR given the recent history of operating issues, the very short reserve lives of the assets, the high overall cost structure, and relatively expensive valuation on a NAV basis,” the analyst said. “EDR remains a good bet for investors who are extremely bullish on silver prices and are looking for significant leverage.”

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Falco Resources Ltd.'s (FPC-X) Home 5 project in Quebec is a "potential company building asset," according to Canaccord Genuity analyst Kevin MacKenzie, who suggests the potential for a merger with the Osisko Group.

He initiated coverage of the Montreal-based junior exploration and development company with a "speculative buy" rating.Falco's 100-per-cent owned Home 5 deposit sits below the Horne Mine, owned by Noranda Inc. from 1927 to 1976, in Rouyn-Noranda, Que. Mr. MacKenzie's base case valuation of the project is a 22-year mine life, producing an average of 303,000 ounces per year of gold equivalent with cash costs of $396 (U.S.) per ounce, and an all-in sustaining cost of $524 per ounce.

"The end goal of the vast majority of junior development companies is to be acquired by a more senior operator," said Mr. MacKenzie. "In Falco's case there is certainly some arm waving to be done in that regard (Agnico Eagle, Goldcorp, mining consortium) with additional emphasis to be placed on the industry's narrative of asset scarcity and North American focused M&A. While we don't rule out the potential for longer-term M&A or a strategic investment, we view the Horne 5 project as a potential company building asset, from which Falco could develop the industry's next mid-tier producer. This could include developing satellite operations within the Rouyn-Noranda mining camp, and/or growth via M&A. We also highlight the potential to merge Falco with another Osisko Group company, namely Osisko Mining who is advancing to production the Windfall Lake project in Quebec."

"Given the tenure and track record of the management team, we are of the opinion that Falco has the capacity to develop the Horne 5 project into a company building asset. We note that this strategy aligns well with that of the overall group of Osisko related companies, in which the consolidated corporate goal is to build shareholder value through project development and district scale organic growth. We note that Osisko Gold Royalties currently holds a 13.2-per-cent interest in Falco, and has a back-in agreement on a silver and/or gold stream via 1-per-cent transferable NSR and $10-million loan. Towards our projected $200-million silver stream … we note that Osisko Gold Royalties currently has $100-million in cash. Beyond increasing the limits of its drawn $200-million credit facility and/or raising additional equity, we note that Osisko Gold Royalties could source the balance of funds from its $65-70-million in projected annual income (CG valuation), or via the proceeds from the potential repurchase of its 4-per-cent Brucejack stream by Pretium Resource (CG base case valuation of $119-million U.S.)."

Mr. MacKenzie set a price target of $1.75 for Falco shares. Consensus is $1.91.

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Macquarie analyst David Lipschitz initiated coverage of Alcoa Corp. (AA-N)  with an "outperform" rating and $55 (U.S.) target. Consensus is $43.36.

"We believe Alcoa's upstream segments will stay profitable on our price forecasts," he said. "We expect the aluminum segment and cost improvement initiatives should help keep healthy margins. In the meantime, capacity reductions in China, especially illegal cuts, are expected to be more significant."

Mr. Lipschitz also initiated coverage of Freeport-McMoRan Inc. (FCX-N), giving it a "neutral" rating and $16 (U.S.) target. Consensus is $15.22.

"We believe the copper market has tightened, but we feel we are still oversupplied in the medium term," he said. "Copper remains one of our favourite longs on a four- to five-year basis, driven by inadequate mine project development and a brightening demand outlook. While this may not seem much of an opportunity at today's prices, our Global Commodities team expects the fulfilment of our macro view of a slowing China to be sufficient to provide some decent entry points. As for the company's Indonesian operations, a framework with the Indonesian government has been agreed to, however uncertainty around a price for the divestment to 49 per cent remains. Outlook remains uncertain and we would wait for a pullback to invest in FCX."

He also gave a "neutral" rating to Century Aluminum Co. (CENX-Q) with a $19 (U.S.) target. Consensus is $15.

"Century Aluminum is a pure play aluminum producer that operates four smelters in the U.S. and Iceland," the analyst said. "The increased value added production the company has added along with the cost cuts they have achieved leads us to expect the company to generate significant cash flow based on our forecasts for aluminum prices through 2018."

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In other analyst actions:

Scotia Capital analyst Tanya Jakusconek downgraded Dominion Diamond Corp. (DDC-N, DDC-T) to "sector perform" from "sector outperform" with a target of $14.25 (U.S.), down from $14.50. The consensus target is $14.35.

D.A. Davidson & Co analyst Tom Forte initiated coverage of Shopify Inc. (SHOP-T, SHOP-N) with a "neutral" rating and $115.61 target. The average is $137.63.

Scotia Capital analyst Orest Wowkodaw upgraded Labrador Iron Ore Royalty Corp. (LIF-T) to "sector outperform" from "sector perform" and raised his target to $23 from $20. The average target is $19.83.

Veritas Investment Research Co analyst Darryl McCoubrey initiated coverage of Kinder Morgan Canada Ltd. (KML-T) with a "buy" rating and $19.50 target. The average target is $21.06.