Thursday’s analyst upgrades and downgrades

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

Several Canadian provinces have recent provided clarity on the rollout of recreational cannabis legalization, which, according to Canaccord Genuity analysts Neil Maruoka and Matt Bottomley, erases the potential for a potential negative catalyst that would have hurt the near-term fortunes for the industry.

"Several premiers were to air grievances in a statement slated for November," the analysts said in a research note released Thursday. "However, Ontario managed to pre-empt this announcement with its own plan outlining a commercial framework. We believe this may have emboldened other provinces, as well as the federal government, reinforcing a targeted July 1st, 2018 start for the rec market.

"Markets have clearly taken this news as positive, with our Canaccord Genuity Cannabis index up 36 per cent over the past month alone. We believe that there is now a stronger likelihood that the Canadian federal government remains on track to pass legislation before the end of the year. Further, with a clearer framework for the rollout and commercialization of recreational cannabis, we believe that the risks of individual companies achieving our recreational forecasts is also reduced."

Based on what they perceive to be a clearer path to the opening of a legalized market, the analysts now project a 90-per-cent chance that recreational cannabis will be available on July 1, 2018. They'd previously estimated an 80-per-cent chance.

With that change, they tweaked their financial projections for Canadian licensed producers, noting "each LP has different anticipated exposure to the recreational market, these changes will impact individual valuations to varying degrees."

However, based on recent share price strength, the analysts downgraded their ratings for both Canopy Growth Corp. (WEED-T) and Aphria Inc. (APH-T).

Mr. Maruoka lowered Canopy Growth to "sell" from "hold" while raising his target for the stock to $11 from $9.50. The analyst consensus price target is currently $11.86, according to Bloomberg data.

"We continue to believe that Canopy will ultimately emerge as one of the dominant players in the Canadian cannabis space," he said. "However, our hesitation on the stock has largely stemmed from valuation. We believe the new provincial frameworks have been beneficial for Canopy, providing clarity into the roll out of a market where the company is best positioned. However, we expect that there also remain significant barriers, as the provinces will likely seek to capture some or all the retail margin. Nonetheless, we believe that retail money has been flowing into the name, sending the stock to lofty multiples.

"As competition intensifies, we believe that cultivation will become less important as cannabis becomes increasingly commoditized. We therefore believe that capital allocation towards incremental capacity will create less value compared to differentiating a company's strategy. The significant risks of ramping cannabis production have been evident as many LPs have struggled to achieve forecast capacity. Moreover, we see the potential for these challenges to be compounded as companies start cultivating in much larger facilities. As such, we believe there is a risk that LPs may not reach peak production estimates or find a market for product if overall industry capacity grows as forecast. Although the recently announced JV for 1.3 million square feet of greenhouse development gives Canopy more low-cost production, given the uncertainty around ramping this production and capital constraints, we have only incrementally added to our funded capacity estimate for the company (from 160,000 kilograms to 180,000 kg annually)."

Mr. Bottomley dropped Leamington, Ont.-based Aphria to "hold" from "speculative buy" with a target of $8.25, rising from $7. The analyst average is $8.94.

"Over the past several months, Aphria has continued to demonstrate strong operational execution as one of the few profitable LPs to date and with an industry-leading 100,000-kilogram greenhouse expansion plan that is progressing along management's previously disclosed timelines," he said. "However, after updating our valuation for several de-risking industry events and company specific considerations, we believe Aphria's stock (which has seen a greater-than 30-per-cent increase over the past month and a greater-than 70-per-cent increase from its June 2017 lows) has reached a level that approximates its fair value. In addition, Aphria now trades at 11.4 times its funded capacity (versus the peer average of 8.2 times), which is the second highest relative valuation in our coverage universe. Although we believe a premium valuation is warranted, we believe current levels are more indicative of fair value at this time."

On both Aphria and Canopy, the analysts noted: "Based on these updated numbers, Canopy continues to trade at the high end of the range (at 13.8 times) and above Aphria at 11.4 times. While we feel that a premium to peers is warranted, we believe that the recent move in Canopy's stock has led to a lofty valuation. Our revised target price of $11.00 for Canopy reflects a funded capacity of 11.2 times, which is in line with the other large cap comparable (Aphria). We believe better value may be found elsewhere, particularly in the smaller cap names."

The analysts also raised their target prices for the following stocks:

- Emblem Corp. (EMC-X, "speculative buy") to $2.50 from $2.25. Consensus is $2.45.

- Supreme Pharmaceuticals Inc. (FIRE-X, "speculative buy") to $2.15 from $2. Consensus is $2.27.

- Cronos Group Inc. (MJN-X, "speculative buy") to $3.50 from $3. Consensus is $3.88.

- OrganiGram Holdings Inc. (OGI-X, "speculative buy") to $3.60 from $3.10. Consensus is $3.96.

- Hydropothecary Corp. (THCX-X, "speculative buy") to $3.40 from $3.10. Consensus is $3.60.

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U.S. media companies are suffering from both a steady dip in cable network subscribers and increased competitive pressures, said Guggenheim analyst Michael Morris, leading him to downgrade a trio of prominent stocks.

Predicting its investments in direct-to-consumer video service and long lead times will likely weigh on investor sentiment in the near term, Mr. Morris lowered Walt Disney Co. (DIS-N) to "neutral" from "buy" with a target price of $102 (U.S.), down from $122. The analyst average target is $112.67.

"Our updated outlook reflects our increased caution toward pay-TV ecosystem trends and concern that investor expectations for the financial contribution from the company's content cycle are too high," said Mr. Morris.

Expressing heightened caution toward advertising growth and increased pressure from digital video rivals, Mr. Morris dropped AMC Networks Inc. (AMCX-Q) to "neutral" from "buy" with a target of $60 (U.S.), down from $73. The average is $64.12.

The analyst also dropped Viacom Inc. (VIAB-Q) to "neutral" from "buy" with a target of $25 (from $37), citing risk of lower fee revisions and carriage losses.

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Echelon Wealth Partners analyst Douglas Loe gave "Top Pick" status to Immunovaccine Inc. (IMV-T), a Halifax-based clinical-stage biopharmaceutical company.

"IMV performs well year-to-date, in part from overall sector attractiveness, but substantively from its own [DepoVax ] pipeline advances as well," he said. "Our shift to Immunovaccine as a 2017 Top Pick is driven in part by our underlying positive regard for its DepoVax platform, regard that is well supported by existing Phase I/II data in our view, and our expectation that clinical updates and/or partnership advances can positively create market value by end-of-year.

"There is no substantive change in Immunovaccine's pipeline priorities since our last update in Aug. 2017, and key pipeline assets continue to be a DepoVax formulation of the cancer antigen survivin (DPX-Survivac), initially targeting ovarian cancer in partnership with high-profile cancer immune therapy developers Incyte (INCY-Q) and Merck (MRK-N), as well as the firm's respiratory syncytial virus (RSV)-targeted DepoVax/SH protein formulation DPXRSV, for which positive immune responsiveness data was reported back in Oct. 2016."

Mr. Loe has a "speculative buy" rating and $2.75 target for the stock. Consensus is $2.36.

"Year-to-date, IMV shares have generated strong returns of 66.2 per cent despite modest share price recalibration since May 2017 and we believe returns have been generated through seminal pipeline advances on the firm's lipid-based, water-free antigen formulation platform DepoVax, for which multiple Phase I/II clinical initiatives – mostly in cancer and infectious disease – are either ongoing or about to be," he said.

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Expressing concern over the effects of rising costs of doing business in the U.S. home furnishing retail space, Credit Suisse analyst Seth Sigman downgraded Williams-Sonoma Inc. (WSM-N) to "underperform" from "neutral."

Mr. Sigman said the need for elevated investment makes it difficult to balance sales and margins, which he said the company has shown over the past two years.

"We assume growth rate will be constrained, versus market's assumption that there will be some rebound," he said. "WSM planned 2017 as an investment year, and we believe that will continue into 2018. We model [a] revenue increase of 2.3 per cent in 2018, similar to the last two years (versus consensus of a 3.5-per-cent increase), and EBIT margin a 20 basis point decline (versus consensus flat) due to lower gross margin/higher expenses.

"WSM is unique in our group, as on paper it has more control of its destiny, with its own brands and deep sourcing operations. But, change is happening around WSM. Online players are obviously taking share and changing the investment requirements. Even indirect players like Wayfair are altering price perception and consumer expectations - more on that later. On the brick and mortar side, off price players are also growing significantly, and capturing a disproportionate amount of the growth."

Maintaining his financial expectations for the San Francisco-based company, which sit below the consensus on the Street, he also kept a target price for the stock of $44 (U.S.). Consensus is $50.16.

"WSM stock price is up 18 per cent from its August low," he said. "That's happened four other times in the last two years, only to reverse. Additionally, while we are making a longer term margin structure call today, we do see some risk into the competitive Q4 period, with guidance embedding a significant operating margin improvement vs recent periods. There is upside potential from lower tax rates as seen in the past, but unless combined with a better sales/ margin balance, we don't think the stock will get credit."

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In a research note on North American transportation companies, Credit Suisse analyst Allison Landry said capacity across all modes "is tight."

"Freight rates are rising in a market that rivals that last seen in late 2013/2014," she said. "With the painful end of that story still fresh in memory, current fundamentals appear to be supported by more sustainable cyclical freight growth - as opposed to (what seemed like at the time) an unending tap of U.S. crude production."

Ms. Landry did remain bullish on the railway industry, noting: "The move in TL spot rates serves as further confirmation of our thesis that a cyclical acceleration in rail pricing is well underway … Rail stocks continue to outperform the S&P in the 'mid-freight-cycle' - as the driver of upward EPS revisions shifts from second derivative volume improvement to core pricing gains. Overall, we think the group remains attractive relative to broader industrials - and specifically would put incremental money to work in UNP and KSU."

The analyst updated financial estimates for railway companies in her coverage universe, which led to target price for stocks.

Her changes were:

• Canadian National Railway Co. (CNI-N/CNR-T, “neutral”) to $83 (U.S.) from $85 based on lower 2018 earnings expectations. Consensus: $84.91.
• Canadian Pacific Railway Ltd. (CP-N, CP-T, “outperform” to $187 (U.S.) from $186. Consensus: $180.63.
• Norfolk Southern Corp. (NSC-N, “outperform”) to $143 (U.S.) from $133. Consensus: $128.48.
• Kansas City Southern (KSU-N, “outperform) to $122 (U.S.) from $121. Consensus: $113.25.

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In other analyst actions:

Desjardins Securities analyst Raj Ray downgraded Kirkland Lake Gold Ltd. (KL-T) to "hold" from "buy." He raised his target by a loonie to $20. The analyst average target is $18.

Scotia Capital analyst Benoit Laprade downgraded Canfor Corp. (CFP-T) to "sector perform" from "sector outperform" with a target of $24.25, up from $22.50. The analyst average target is $23.38.

Mr. Laprade also downgraded West Fraser Timber Co. Ltd. (WFT-T) to "sector perform" from "sector outperform" and raised his target to $76 from $69. The consensus average is $70.67.

Scotia's Ovais Habib downgraded Kirkland Lake Gold Ltd. (KL-T) to "sector perform" from "sector outperform" with a target price of $17.50, up from $17. The average is $17.89.

Scotia's Jeffrey Fan downgraded Shaw Communications Inc. (SJR.B-T) to "sector perform" from "sector outperform" with a target of $30, falling from $32. The average is $30.15.

Dundee Securities Corp analyst Tal Woolley upgraded Alimentation Couche-Tard Inc. (ATD.B-T) to "buy" from "neutral" with a $70 target. The average is $74.

CIBC World Markets analyst Jeff Killeen upgraded Pretium Resources Inc. (PVG-T) to "outperform" from "neutral" with a target price for the stock of $18, up from $15.75. The average is $19.34.

GMP analyst Ian Gillies initiated coverage of Source Energy Services Ltd. (SHLE-T) with a "buy" rating and $14 target. The average target is $13.72.

Traverse Energy Ltd. (TVL-X) was upgraded to "buy" from "hold" by GMP analyst Robert Fitzmartyn, who raised his target to 65 cents from 40 cents. The average is 60 cents.