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Thursday’s analyst upgrades and downgrades

Swiss Chalet is owned by Cara Operations Ltd., which is a good dividend-growing company.

Kevin Van Paassen/The Globe and Mail

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

The impact of an increase to Ontario's minimum wage is likely to impact restaurant profitability in 2018, said Macquarie analyst Michael Glen.

In a research report released Thursday, Mr. Glen said the consensus estimates for both Cara Operations Ltd. (CARA-T) and Freshii Inc. (FRII-T), in particular, are not adequately reflecting the headwinds stemming from the increase.

"In particular, we have done a proprietary P&L analysis which illustrates a 500-700 basis points headwind on restaurant level profitability which will impact both corporate stores and franchisees," said Mr. Glen. "While we acknowledge the 7-10-per-cent price increase necessary to offset this cost inflation is not an insurmountable hurdle, consumers are extremely resistant to inflation (particularly at lunch) and we see a 6-9 month transitory position commencing Jan 1, 2018.

"For Cara, given that 55 per cent of its stores are in Ontario, coupled with a large number of corporate stores and heavy positioning in the more labour / capital intensive full-service dining market, we see the most risk to 2018 estimates. For Freshii, while Ontario represents its most important market from a footprint / near-term growth perspective (we estimate 25 per cent of stores), given its single-brand focus, early stage of growth, and focus on fast-casual, we believe the company has more tools at its disposal to help offset the minimum wage headwinds. That said, we have concerns regarding the very aggressive store-growth plan outlined to the market at the time of IPO, and believe this could be pushed back."

Mr. Glen initiated coverage of Cara with an "underperform" rating and $21 target. Consensus is $27.69.

"Our proprietary analysis indicates that Corporate segment EBITDA will decline by 17 per cent in 2018 due to the inflation on the labour expense line, and we believe earnings estimates through at least H1/18 are at risk," he said. "Additionally, we have concerns regarding the impact the labour cost increase will have on Cara's Ontario franchise base, in particular among some of the more marginal brands, and we anticipate a step up in the number of stores requiring temporary assistance due to cash flow issues, coupled with a higher franchise rent assistance and bad debt expense. While the increase in minimum wage will be manageable over the long-term (we estimate a 7-10-per-cent price increase will be needed to completely offset), with Cara and its franchisees heavily positioned in the more labour / capital intensive full service dining market, we believe they will face a more difficult adjustment / transition period versus both QSR and fast-casual peers."

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He gave Freshii a "neutral" rating and $10 target. Consensus is $13.79.

"Our Neutral rating is based on a valuation assessment for Freshii, coupled with a view that the growth projections communicated are aggressive and entail what we consider to be (almost) flawless execution over 2017-19," said Mr. Glen. "While we have a favourable view on the long-term growth profile (and believe there is space in the market to gain share), we see risks embedded in the 2019 store target. Our more conservative slant prefers a valuation which embeds more tempered growth, which we believe comes into play below $8. Of note, the company is targeting 810-840 stores by 2019 versus 332 currently, and progress on this track is the single most important focal point for investors (i.e. represents 85-90 per cent of the bridge to $20-22-million in EBITDA in 2019). We view this as a massive undertaking in terms of both securing new locations at a reasonable cost and engaging new franchisees. That said, we must acknowledge that incremental institutional deals (such as that recently announced with Air Canada) may help backfill any shortfall in store openings, and this may pose the biggest risk to our Neutral rating."

Noting they have less exposure to Ontario, the analyst initiated coverage of MTY Food Group Inc. (MTY-T) with an "outperform" rating and $56 target (versus a consensus of $49.90) and Imvescor Restaurant Group Inc. (IRG-T) with a "neutral" rating and $4.10 (versus $4.45).

"Our stock ratings are non-consensus in nature with the only Underperform on Cara, only non-Buy on Imvescor (multiple expansion has been substantial), and more tempered view on Freshii (consensus is Outperform)," said Mr. Glen. "Also, we are aware our MTY Outperform will be met with pushback, but we have high conviction on the name."

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There are a limited number of potential catalysts for shares of Canacol Energy Ltd. (CNE-T) in the coming months, said Canaccord Genuity analyst Jenny Xenos.

Accordingly, based on both its recent outperformance relative to peers and full valuation, she downgraded her rating for the Calgary-based company to "hold" from "buy."

"Year-to-date, the shares of Canacol have outperformed those of its peers," said Ms. Xenos. "While the TSX Energy Index is down 13 per cent so far this year, Canacol stock is down only 6 per cent. For comparison, some of Canacol's Colombian peers – Gran Tierra, Frontera and Parex (albeit, oil-weighted), are down 32 per cent, 29 per cent and 13 [er cent, respectively, due to lower oil prices and a general lack of interest in international stories.

"While, historically, Canacol stock moved in tandem with oil prices, despite natural gas representing 80 per cent of the company's production mix, the stock has de-coupled from oil prices as management has been successful at telling the Canacol story to the market and delivering on its natural gas strategy in Colombia. Having achieved significant success in the past few years with its natural gas strategy, including over 500 bcf of new discoveries, Canacol is now focused on completing two major pipeline projects over the next 18 months to increase its offtake capacity from the current 90 mmcf/d to 230 mmcf/d by the end of 2018. The company is working on ensuring that it has sufficient productive capacity behind pipe to satisfy commitments to sell 230 mmcf/d of gas for the following 5-7 years. Its balance sheet is fully utilized to fund this significant growth."

After incorporating the company's second-quarter financial results, released on Aug. 10, into her financial model, Ms. Xenos's 2017 cash flow per share projection increased to 51 cents from 45 cents, while her 2018 estimate rose to 69 cents from 51 cents.

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However, her net asset value (NAV) estimate fell to $4.15 per share from $5.14, due largely to lower sales and gas price forecasts.

"Between now and the end of 2018, while we are awaiting completion of the two pipelines and with it, significant increases in sales and cash flow, we expect the company will continue to fully utilize its balance sheet to fund its growth," she said. "Canacol has fully drawn the $305-million available under its credit facility (including the $40-million greenshoe) and has $50-million in cash. Over the next six quarters, we forecast it to generate $166-million in cash flow, while spending $142-million. In addition, Canacol is looking to potentially defer or reduce commitments, postpone some spending, and sell some of its assets.

"While Canacol's balance sheet is currently fully utilized, we forecast the company will be entering 2019 with at least as much cash or more than it has today. We estimate it will be able to start paying down debt in Q1/19 as it becomes due, and once the Promigas pipeline comes on stream, increasing sales to 230 mmcf/d and cash flow to $50-million per quarter."

Ms. Xenos lowered her target price for Canacol shares to $4.75 from $5.15. The analyst consensus price target is currently $4.96, according to Thomson Reuters data.

"With it trading at a full multiple of 5.7 times enterprise value/2018 estimated debt-adjusted cahs flow, we believe the success of the Sabanas gas flowline (to be operational by year-end) is already priced into the stock. The project is fully funded and construction is underway, with limited remaining project risk, as we see it. Even if there is a slight delay, the company has a 'grace period' of about five months built into the sales contracts to allow for the lag. We expect that similar conditions are in place for the completion of the larger Promigas pipeline (expected to be operational by year-end 2018, per management guidance)."

"What could cause the stock price to go higher in the coming months? Exploration success. The company is planning to drill two natural gas exploration wells before the end of the year. Should these wells prove to be successful, we believe there may be some upside to the stock price. Hence, we base our new price target of C$4.75/sh on a slight premium of ~15% to our 2P NAV estimate of C$4.15/sh. The premium implies about a 20% chance of success of converting the 164 bcf of unrisked resource potential targeted by the two wells into reserves at the end of the year."

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Alacer Gold Corp. (ASR-T) could attract increased multiples over the next 12 months with the success execution of its expansion of its Çöpler Sulphide open-pit mine in Turkey and positive updates from its growth projects, according to Raymond James analyst Tara Hassan.

She resumed coverage of the Colorado-based company with an "outperform" rating.

Since the completion of its feasibility project in 2016, Ms. Hassan said the focus of investors has been centered on the funding and execution of the Çöpler expansion, which she deems to be a "criticial" projection. The Sulphide project is projected to result in 175,000 ounces of gold per year over a 20-year mine life.

"While we acknowledge there can be heightened technical risks with the construction and commissioning of any project, particularly with more technically complex ones, our recent site visit to Çöpler confirmed that Alacer has many important components in place to de-risk the project," said Mr. Hassan. "This includes having a construction and operation team in place with extensive autoclave experience, all financing on hand, a sizable sulphide stockpile, an enhanced database to optimize blending of feed, and the majority of the required equipment and plant components on site."

"As part of its joint venture agreement with Çalik Mining, Alacer has an extensive land package both around the Çöpler project and elsewhere in Turkey. Although this ground has received limited attention whil e the Sulphide project took the spotlight, we believe there are near-term opportunities for growth including at Çakmaktepe, a satellite target to Çöpler that we believe could begin contributing ore to the heap leach pad in 2018E, and Gediktepe, a project in western Turkey where a feasibility study is currently underway following a positive prefeasibility study in 2Q16."

She has set a target price of $3.15 for the stock. The analyst consensus price target is $3.01, according to Thomson Reuters data.

"Alacer is currently trading at discount on both a NAV [net asset value] and cash flow basis," she said. "On a price/NAV basis Alacer is trading at 0.62 times and 6.9 times on price/2017 estimated cash flow basis. This compares with global junior and intermediate producing peers trading at 0.79 times NAV and 8.8 times 2017 estimated P/CF. We believe the market is valuing Alacer more in-line with developer peers (global developers currently trading at 0.58 times NAV), despite the company having extensive operating expertise in Turkey and generating cash flow from its heap leach operation. We look for market valuation re-rating as Alacer commissions the sulphide plant."

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AltaGas Ltd. (ALA-T) has a "compelling opportunity inventory across all three of its operational segments from which to steadily increase annual EBITDA and common share dividends," said Beacon Securities analyst Lyndon Dunkley.

He initiated coverage with a "buy" recommendation.

"Since 2010, AltaGas has grown its dividend at a compound annual growth rate of approximately 8 per cent," said Mr. Dunkley. "We expect the company to continue this rate of growth through 2021, with the next increase scheduled to occur in the fourth quarter of 2017. At the current annual level of $2.10/share, AltaGas is yielding 7.7 per cent or 43 per cent higher than the midstream/pipelines peer group average, 77-per-cent higher than power peer group average and near double the utilities peer group average. We believe once the market understands the sustainability of the dividend and high percentage backing by contracted funds flow, AltaGas' share price should increase again to the $34.00 level, which would still represent an above average yield of 6.3 per cent. If AltaGas increases its dividend as expected later this year, AltaGas' yield become nearly unprecedented at the current share price."

"Even with the consistent annual dividend per share increases, AltaGas has maintained a low payout ratio. At an expected payout ratio of 60 per cent for 2017, AltaGas is still below its peer group average."

Mr. Dunkley set a price target of $34 for AltaGas shares. Consensus is $34.13.

"AltaGas' consistent and steady adjusted funds flow from operations growth is not being recognized by the equity market as the company currently trades below the average for the peer group on 2019 expectations," he said. " From $2.32 in 2010, AltaGas grew normalized funds from operations to $3.52 in 2016. During this same period, AltaGas has increased normalized EBITDA from just over $200-million to $701-million in 2016, with expectations for an additional 13-per-cent increase in 2017 to $793-million."

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Though Canaccord Genuity analyst Kevin Wright believes a competing bid for NYX Gaming Group Ltd. (NYX-X) is possibility, he sees the probability as low.

Shares of the Las Vegas-based digital gaming software supplier jumped 107.1 per cent on Wednesday after the company announced it is being taken over by Scientific Games Corp. (SGMS-Q) for $2.40 per share or about $775-million. The proposed offer is for more than double NYX's closing stock price on Tuesday of $1.13.

"As with other M&A observed in our coverage universe since 2016, we would characterize the transaction as a fair but not a stratospheric multiple; global B2B gaming technology peers trade at 12.2 times (2017) and 10.2 times (2018)," said Mr. Wright.

"The biggest unanswered question is whether or not another bidder will emerge. Given an expected closing by Q1/18, and only a 6-cent payment to wait it looks like investors may be betting on a higher bid. We would not rule out a competing offer but NYX has traded at a steep discount to peers for much of 2017 so there has been plenty of time for an offer to emerge; we consider another bid as a low-probability event. Further, even if other potential buyers have been kicking the tires a new bidder would likely require the support of William Hill and potentially Sky Bet which could take time."

Mr. Wright lowered his rating for NYX to "hold" from "buy," citing the likely completion of the deal. He did emphasize the potential upside if a competing bid emerges.

"Given the low exposure that Scientific Games has to digital, we think that anti-competitive hurdles are low," he said. "Licensing could take some time given the jurisdictions in which NYX operates; however, we do not think it is an impediment but it could pose potential delays to a Q1/18 closing target."

The analyst lowered his target price for the stock to $2.40 from $2.75 to reflect the bid. Consensus is $2.56.

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Raymond James analyst Kurt Molnar expects the market to react favorably to Chinook Energy Inc.'s (CKE-T) operational update from four new wells drilled on its Birley/Umbach property.

Though he cautioned that he needs to see actual production profiles to "understand their relevance better," Mr. Molnar upgraded the Calgary-based company to "market perform" from "underperform."

On Wednesday, Chinook released test data from the wells. Mr. Molnar called the headline results "strong."

"The first of these wells is expected on production in October, with the balance in December," he said. "IP30 and beyond data will be critical to watch to understand the sustainable implications of this early information."

"These wells continue to be indicative of a play that is materially levered to gas (versus liquids) while historical cash costs (and even forward guidance) for Chinook have been at the high end of what we view as necessary for lean gas stories to be competitive on marginal economics versus the best of their peers and to provide full cycle returns on capital that are strong enough to consistently exceed the cost of capital."

He raised his target price for Chinook shares to 30 cents from 25 cents. Consensus is 49 cents.

"We continue to believe that Chinook will need to raise new equity capital before the end of this coming winter drilling season and that the marginal economics of these wells (when on production) will be critical to determine if such capital will be available, and at the cost of what order of per share dilution," he said.

"We frankly think there is simply too much gas trying to get egress out of the B.C. market, which impacts all producers there, but is most dangerous to those with cash costs that are higher than their regional peers. This continues to be our structural concern about the Chinook equity premise."

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Citing recent share price appreciation, Mackie Research analyst Andre Uddin lowered his rating for Helius Medical Technologies Inc. (HSM-T) to "hold" from "speculative buy."

"HSM has had a good run and is up 187 per cent since we initiated coverage on June 29, 2016," said Mr. Uddin. "HSM now boasts a market cap of $320-million, yet there is very little clinical data generated to date, albeit the clinical outcomes for a small number of patients treated with PoNS [portable neuromodulation stimulator device] has looked promising.

"Investors in this sector should always consider balancing risk vs. reward in stock selection, particularly, for companies with an upcoming binary outcome. HSM is currently conducting a pivotal trial with its neuromodulation device PoNS, with the results expected in late September or early October – an upcoming binary outcome. While the science of PoNS is exciting, we don't have much clinical data to handicap the trial. There is risk that the placebo rate is high for this traumatic brain injury (TBI) pivotal trial. The Wisconsin University trial results also have yet to be released. Hitting the endpoints in the pivotal trial should send the stock much higher whereas missing should send the stock down."

Mr. Uddin feels there is little regulatory risk for the Pennsylvania-based company if its TBI test fails, however he said he's planning to "stand on the sideline" until the results are released.

"We should note that we don't believe there is regulatory approval risk of PoNS given that it is a class II device, but we believe it could be much harder for HSM to market the device if there isn't a statistically significant clinical benefit shown in the TBI pivotal trial," he said.

Mr. Uddin maintained a price target of $2.70 per share. The analyst consensus target is $2.55.

"Treatments involving the brain remain an undiscovered frontier for medicine – products in this therapeutic field offer potentially high risk/high reward opportunities," the analyst said. "The upcoming pivotal results are binary and should determine if the PoNS device can disrupt the medical device field."

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In other analyst actions:

Calling it a "global leader of a high-barrier-to-entry business," TD Securities analyst Aaron MacNeil initiated coverage of ShawCor Ltd. (SCL-T) with a "buy" rating and $33 target. The consensus average is $32.36.

Buckingham Research Group analyst Matthew Harrigan initiated coverage of Netflix Inc. (NFLX-Q) with a "buy" rating and $214 (U.S.) target. The average is $188.17.

Scotia Capital analyst Ovais Habib initiated coverage of Leagold Mining Corp. (LMC-T) with a "sector outperform" rating and $5 target. Consensus is $6.60.

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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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