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Thursday’s analyst upgrades and downgrades

A machine moves through a tunnel at the underground Richmont Mines Inc. Beaufor gold mining operation in Val d'Or, Quebec, Canada, on Friday, Sept. 18, 2015.

Valerian Mazataud/Bloomberg

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

The sell-off of Alamos Gold Inc. (AGI-T, AGI-N) in reaction to its proposed acquisition of Richmont Mines Inc. (RIC-T) is "overdone," according to Raymond James analyst Tara Hassan, who suggests using the dip as a buying opportunity.

Shares of the Toronto-based company plummeted 16.1 per cent on Monday after it announced a friendly deal to acquire Richmont in an all-stock offer valued at about $770-million (U.S.).

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Though the stock rebounded slightly on Tuesday and Wednesday with gains of 2.3 per cent and 2.2 per cent, respectively, Ms. Hassan said it was still a victim of "sticker shock" among investors, acknowledging the "price paid to bring RIC into the fold is on the high end compared to current multiples and recent transactions."

"Based on consensus estimates, the acquisition values RIC at 1.4 times NAV [net asset value] and 12.5 times 2017 CF [cash flow] (based on Capital IQ estimates, which include disposed Quebec assets)," the analyst said. "This valuation is above current North American junior and intermediate peers (average of 0.83 times NAV and 9.2 times 2017 price/CF) and recent North American transactions (averaging 1.1 times NAV, ranging from 0.5–1.85 times NAV)."

However, Ms. Hassan suggested the need to look beyond the "headline" numbers.

"While the price tag for RIC is high, we like the acquisition as it improves the geopolitical risk (60 per cent of production now sourced from Canada), adds $80-million cash to help fund AGI's deep project pipeline, enhances AGI's ranking amongst peers on a production basis, and achieves growth through a lower risk option (mine with 10 year operating history, well defined resource, no permitting risk)," she said. "On a quantitative basis, despite increasing the share count by 30 per cent, the acquisition will increase cumulative free cash flow by 120 per cent and boost CFPS [cash flow per share] by an average of 5 per cent over the next 3 years."

Maintaining an "outperform" rating for Alamos shares, Ms. Hassan raised her target price to $12.50 from $12. The analyst average price target is $12.56, according to Bloomberg data.

"We continue to believe the Company is well positioned to outperform intermediate peers given its attractive, self-funded growth profile, clean balance sheet, and a number of key catalysts on the horizon at development assets," she said.

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Tourmaline Oil Corp. (TOU-T) is a "low cost execution machine," according to Macquarie analyst Brian Kristjansen.

Emphasizing its "top-notch track record," Mr. Kristjansen initiated coverage of the Calgary-based intermediate crude oil and natural gas exploration and production company with an "outperform" rating.

"The management team, led by President & CEO Mike Rose, has an exceptional track record, previously building and selling Duvernay Oil Corp and Berkley Petroleum for $5.9-billion and $1.68-billion, respectively," he said. "These companies, and Tourmaline to-date, have demonstrated impressive production, reserve and share price CAGRs [compound annual growth rates].

"The company has posted positive earnings in 11 of the last 14 quarters, averaging a quarterly profit margin of 14 per cent and has generated an average ROCE of 3.2 per cent in the 2014-2016 time-frame (vs. our yield names at 2.7 per cent and small/mids at 0.2 per cent). Management believes that full-cycle profitability will separate the true 'winners' in the sector, though based on our study of full cycle profitability we find the company near the midpoint of our North American coverage universe in 2016 and the trailing 3-years. This is partially attributable to its M&A history (organic full-cycle profitability is better) and should improve further as cash costs continue to grind lower."

Mr. Kristjansen said Tourmaline has grown rapidly since its inception in late 2008 and believes it is now large enough to reduce corporate cash costs.

"These have fallen 27 per cent in the past three years and are forecast to improve another 6 per cent (net of inflation) to 4Q19, on our estimates," he said. "The company's individual well costs have also fallen appreciably, by over 50 per cent in the past five years. The broader application of multi-well drill pads across the asset base should elicit further sequential savings. Current corporate capital efficiencies ($ per flowing boe/d) are the best in our coverage universe."

The analyst is currently projecting production per share growth of 17 per cent in 2018 and 8 per cent in 2019, which he noted is among the best in his North American coverage universe. He called it "admirable given its larger relative size."

"The company's relative size (the fifth largest in our coverage universe) and constant focus on efficiency (controlling and lowering costs through direct infrastructure ownership and diversifying price points) has led to top quartile cash costs in our coverage universe in 2018, which we anticipate further improving through our forecast horizon and leading to top quartile profit margins (earnings divided by revenue before royalties inclusive of hedge gains/losses)," the analyst said. "The company's low-costs and high-quality assets also translate to peer leading per flowing barrel efficiencies of less-than $10,000 per boe/d."

Noting the company's shares are "currently stagnating commodity environment and Canadian energy sector malaise, despite reporting positive sequential quarterly results," Mr. Kristjansen set a price target of $40 for Tourmaline shares. The analyst average target is $36.

"Tourmaline has historically traded between a range of 5.4 times and 10.8 times [2018 enterprise value/debt-adjusted cash flow multiple (at strip)], averaging 8.5 times over the past 5 years," he said. "Shares are currently sitting near its 52-week low and a similarly low valuation. Given that the company is estimated to remain a solid earnings generator and grow production per share throughout our forecast horizon we believe its valuation should at least trade on par with its average historical multiple, favouring a higher 9.0 times multiple given the typically inverse relationship between commodity prices and valuations. This is also comparable to its similarly earnings-positive peers."

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Caterpillar Inc.'s (CAT-N) revamped strategy, focusing on an improved customer experience, is likely to pay dividends, according to BMO Nesbitt Burns' Joel Tiss, maintaining his bullish thesis on the stock following Tuesday's analyst day.

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"Although many of the initiatives laid out on Tuesday appear new at first glance, to us it seems more like a rebranding of past programs," said Mr. Tiss. "However, this time it feels very different, and we are confident that management will deliver the goods. The difference is the new CEO, Mr. James Umpleby, who comes across as a hard charging and focused executive. It is clear that he has a strong plan for Caterpillar to refocus on driving profitable growth, and that mediocrity will not be tolerated. One aspect of his strategy that we are particularly keen on is enabling the business leaders to make decisions more quickly, and to have more control of growth strategies. With each group head being new as 2015 or later, it is clear that Caterpillar will not hesitate to make personnel adjustments as it deems necessary.

"The benefits can already be seen in the early days of the transformation as the 2017 outlook calls for 10.9 per cent operating margins on $43-billion in sales versus 10.3-per-cent operating margins in 2015 on $47-billion in sales. To us, this is evidence that the company appears to be running more efficiently. Since 2014, management has taken out $1.5-billion of period cost when normalized for incentive pay, which leaves about $1.2-billion of additional cost reductions moving forward. We expect future cost reductions to provide a nice tailwind for 2018 and 2019."

Mr. Tiss raised his 2017, 2018, and 2019 EPS assumptions to $5.25 (U.S.), $7.00, and $8.50, respectively, from $5.10, $6.76, and $8.00 to reflect "a slightly more optimistic revenue outlook and more benefits to the margin profile from the internal initiatives laid out at the analyst day."

With an "outperform" rating (unchanged), he increased his target price for the stock to $150 (U.S.) from $130. The average is $125.16.

"We still come to peak EPS potential of $16 on about $69 -billion in revenue," said Mr. Tiss. "Again, as with most cyclical companies, it is hard to know how much Caterpillar boosted earnings power since sales peaked in 2012. It usually only becomes clear when volumes begin to recover and we get a better sense of how successful the company has been adjusting its cost structure, gaining share, and addressing customers' needs. The early results from Caterpillar as it emerges from the lows indicate a significantly more efficient and profitable company.

"As we previously mentioned, management was very deliberate in giving vague targets. That is not to say that the strategy was not clear, but assigning precise numbers and metrics to each goal will be difficult. For Caterpillar's shares to move higher, we believe the company will need to demonstrate strong execution and consistent profit improvements. When we take a step back and look at the internal initiatives underway and the fact that we are likely at the bottom of a deep trough, we think the prospects are strong for significant share price appreciation over the next three to five years."

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Canaccord Genuity analyst Michael Graham lowered his financial projections for Blue Apron Holdings Inc. (APRN-N) in response to an appearance by chief executive officer Matt Salzberg at the Code Commerce conference in New York on Wednesday.

Mr. Graham said Mr. Salzberg's commentary in one of his first appearances since a "tumultuous" second-quarter conference call in early August reinforces the meal kit company's near-term challenges and longer-term potential.

"Management remains optimistic about the large opportunity in experiential at-home cooking, and believes the company can be the leading brand to offer attractive (and increasingly wide selection of) products," the analyst said. "As a reminder, in its first quarter as a public company, APRN lost customers on a net basis in relation to unforeseen complexities during the rollout of its new product expansion and fulfillment center transition."

"CEO Matt Salzberg outlined the long-term opportunity, talked about being able to coexist with Amazon, and reiterated that the company is working through the complexities of the Linden fulfillment center rollout. In Q2, 3 per cent of national volume was going through Linden. That ramped to 20-25 per cewnt in mid-Q3. The aim is for Linden to be able to handle 50 per cent of volume (which we expect during Q4), as it is the largest and most advanced facility the company operates. The increase in capacity will enable the ongoing product expansion."

Noting "visible signs of product expansion rollout," Mr. Graham added: "We noticed in our own use of the platform that several elements of the product expansion are already available in the market, which we take as a positive sign that Linden progress is on track. While the expansion looks to still be underway, we believe it should be fully realized this year and will set up better forward growth prospects. We believe increased customer options should lead to a stickier customer base with improved revenue and margin per customer."

Mr. Graham lowered his 2017 and 2018 earnings before interest, taxes, depreciation and amortization projections to losses of $145.1-million (U.S.) and $75.5-million, respectively, from losses of $141.4-million and $63.9-million. His sales estimate for 2018 dropped to $1.023-billion from $1.048-billion.

"We are making a few incremental model changes, including modestly trimming customer adds next year and incorporating a previously disclosed one-time charge in Q3," he said. "We continue to view the current headwinds as decidedly temporary, and management's recent commentary reinforces our view that the company is working through the issues at a good pace and can largely complete the transition by the end of the year."

Mr. Graham maintained a "buy" rating and a Street-high $11 target for the stock. The average is $6.06.

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Floor & Decor Holdings Inc.'s (FND-N) valuation reflects "strong" growth prospects, said BMO Nesbitt Burns analyst Wayne Hood.

He initiated coverage of the Georgia-based retailer of hard surface flooring and related accessories with a "market perform" rating.

"We await a better entry point (around $33 per share), which could possibly emerge from a group/market correction or hurricane trade unwinding, an investor sentiment shift that overcorrects the P/E in response to slowing, more sustainable comp-store sales growth, lumpy quarterly EPS growth that could emerge from unbalanced store openings, a secondary offering by certain stockholders (Ares Management owns 48.1 per cent of the common stock and sold shares at $40 in July 2017) that could pressure the stock as it did in July, or possible disruption caused by transitioning distribution centers into 2018, although the last may be the least likely event given the leadership's experience moving D/Cs," said Mr. Hood.

The analyst gave the stock a $41 (U.S.) price target. Consensus is $41.42.

"We see Floor & Decor as operating a proven, differentiated business model, grounded by a seasoned leadership team and board that has built out the foundation to support strong SSS [same-store sales] growth (up an estimated 11.4 per cent in 2017) against double-digit comparisons on unprecedented product innovation in flooring and market share growth," he said. "Our research supports target of 400 stores U.S. stores and 20-per-cent annual store growth, leaving us seeing a 25-per-cent five-year EPS growth rate."

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In other analyst actions:

RBC Dominion Securities analyst Irene Nattel upgraded Empire Co. Ltd. (EMP.A-T) to "sector perform" from "underperform" with a target of $23, rising from $21. The average is $23.10.

JPMorgan analyst Phil Gresh downgraded Imperial Oil Ltd. (IMO-T) to "underweight" from "neutral." He raised his target for the stock to $38 from $36. The analyst average target is $40.43.

Laurentian Bank Securities analyst Ryan Hanley initiated coverage of Argonaut Gold Inc. (AR-T) with a "hold" rating and target of $2.50. The consensus average is $3.70.

JPMorgan analyst Sarah Dewitt initiated coverage of Berkshire Hathaway Inc. (BRK.A-N) with an "overweight" rating and target of $315,000 (U.S.). The average is $290.875.

Wells Fargo Securities analyst Christopher Harris upgraded Raymond James Financial Inc. (RFJ-N) to "outperform" from "market perform" and raised his target to $90 (U.S.) from $86. The average is $88.83.

Bernstein analyst Kevin St Pierre upgraded KeyCorp (KEY-N) to "outperform" from "market perform" with a target of $22 (U.S.), rising from $21. The average is $20.57.

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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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