Thursday’s analyst upgrades and downgrades

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

RBC Dominion Securities analyst Greg Pardy downgraded his rating for Imperial Oil Ltd. (IMO-T), citing proximity to his target price for its stock and higher potential returns elsewhere.

"In our minds, Imperial Oil possesses an admirable upstream portfolio weighted towards low decline assets — dominated by oil sands, including Kearl, Syncrude and Cold Lake — and attractive downstream assets, including refineries in Edmonton, Sarnia and Nanticoke," said Mr. Pardy, who moved the Calgary-based company to "underperform" from "sector perform."

"The company's ace in the deck remains its strong balance sheet and still attractive 2018 free cash flow yield that we peg at 2.5 per cent. The missing element on Imperial's score card — and the one we struggle with given its premium cash flow multiple — has been a lack of sustained upstream operating performance — which has weighed on its cash flow generation and returns."

However, Mr. Pardy called the company's quarterly conference call on Wednesday "useful and refreshingly candid." It came on the heels of a smaller-than-anticipated profit for the quarter as higher costs and a decline in production offset an increased crude prices.

"Rich Kruger, Imperial's President & CEO, acknowledged operational challenges, framed remediation efforts—and conveyed lessons learned," the analyst said. "The company pointed towards a five-year capital program of about $2.0-billion per annum (including $900-million of growth capital). It also updated its annual sustaining capital requirements to $1.0-$1.1-billion — up from $900-million in 2017.

"What surprised us somewhat was Imperial's signal that it would selectively develop liquids-rich natural gas in the Duvernay and Montney, where it has a 50-per-cent interest in 694,000 gross acres. In passing, regulatory approval for Imperial's Aspen (100-per-cent ownership) solvent-aided SAGD development (involving two 75,000 barrels per day phases) could follow during the first-half of 2018, with a commissioning decision to follow."

Mr. Pardy said the company's ability to deliver both cash flow growth (per share) and maintain "sector leading" returns centres on sustained operation performance at the Kearl and Syncrude oil sands projects, which he said has "proven elusive."

"We credit Imperial with revealing its plan to remediate Kearl through increased investment," he said. "As it stands today, Kearl has delivered sustained gross bitumen production rates of about 180,000 barrels per day (at operating costs of $22-24 U.S. per barrel). A move to 200,000 bbl/d of gross production — supported by actions taken including enhanced piping durability and improved ore preparation performance — would drop Kearl's operating costs by about 11 per cent to $20-$21 per barrel. Imperial revealed a $550-million program (gross) to be applied over 2018-19 aimed at boosting Kearl's bitumen capacity from 220,000 bbl/d (gross) to 240,000 bbl/d."

Based on the quarterly results, Mr. Pardy lowered his 2017, 2018 and 2019 earnings per share projections to $1.04., $1.59 and $2.06, respectively, from $1.09, $1.49 and $2.08.

He maintained a price target for Imperial shares of $40. The analyst average is $40.66, according to Bloomberg data.

Elsewhere, Barclays analyst Paul Cheng downgraded the stock to "underweight" from "overweight" with a $38 target, falling from $44.

Saying "clarity is a welcome change," Canaccord Genuity analyst Dennis Fong raised his target to $45 from $40 with a "hold" rating (unchanged).

"We believe the positive operational momentum could take time to build as we would like to see a track record of stronger production (and lower costs) before upgrading our outlook on the company," he said. "However, on the back of the unconventional production growth, additional clarity around Kearl and upside potential we have increased our target price."

"Our largest takeaway was the more proactive take on fixing, optimizing, and debottlenecking Kearl through the use of redundancies in the ore prep process. The company has already completed projects on the surge bins which have brought production to 200 MBbl/d and expects to spend $400-million (net) over the next two years to drive production to ~240 MBbl/d. We believe this is incrementally positive to our thesis and helps alleviate a major concern on the project."

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Despite "decent" third-quarter results and a "constructive" outlook, CIBC World Markets analyst Mark Jarvi downgraded Brookfield Renewable Partners LP (BEP.UN-T).

Mr. Jarvi said Brookfield possesses a "quality, hydro-weighted asset portfolio supporting growing distributions (likely towards the low end of its target range) and a strong management team." However, he moved its stock to "neutral" from "outperform."

"The downgrade is solely on valuation — at the current trading level there's only a modest 8-per-cent potential total return to our target including the 5.3-per-cent distribution yield (shares have rallied 7 per cent since the late September investor day)," he said. "Arguably we could be going to the sidelines too early, as opportunistic M&A could provide a positive catalyst, but we believe it's prudent to take profits at current levels, while BEP.UN digests the TerraForm Power/TerraForm Global deals."

Mr. Jarvi kept a $45 target for the stock. The average is $44.54.

"In our view, the completed TERP transaction and pending GLBL acquisitions provide interesting growth potential in newer markets, albeit adding a bit more complexity to the story," he said. "Deal flow also remains robust and the company has solid liquidity post-TERP closing to act on further opportunistic acquisitions. Beyond M&A, BEP.UN's development activities and organic growth drivers contribute to its steady growth and ability to deliver 5-9-per-cent annual distribution growth — we estimate the next distribution increase will be closer to 5 per cent as BEP.UN looks to moderate its payout ratio."

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MedReleaf Corp.(LEAF-T) is "standing tall among industry leaders," according to Canaccord Genuity analyst Matt Bottomley.

Noting its "solid existing footprint and expansion underway," he initiated coverage of the Markham, Ont.-based producer of cannabis-based pharmaceutical products with a "buy" rating.

"With one of the first ten cultivation licenses issued by Health Canada and a strategic relationship with Israel's first regulated producer of medical cannabis (Tikun Olam), we believe MedReleaf is currently an industry leader within the existing Canadian medical market on several fronts," he said. "MedReleaf is among the largest LPs in the space today (i.e. market caps in excess of $1-billion), and currently ranks second in the industry in terms of trailing revenues, volumes sold, and capacity built (and producing) to date.

"Further, based on a review of MedReleaf's most recent quarter and industry data tracked by Health Canada, we estimate that the company captured 17 per cent of the Canadian medical market for the quarter ended June 30, 2017 – second only to Canopy Growth Corp. However, the company's current market capitalization is 68 per cent lower than the largest LP in the space, and in line with peers with lower trailing sales/volumes, built capacities and market share."

Mr. Bottomley also called MedReleaf an industry leader through "its large assortment of products and novel offerings," which are produced in one of few Good Manufacturing Practices (GMP) licensed facilities in the country. He said that "could become increasingly important to secure international opportunities)," adding the company is also one of the lowest cost producers among indoor cultivators in Ontario.

"Management believes that its attention to product quality and consistency is one of the primary reasons it has achieved favourable pricing in the existing medical market," he said. "We estimate that the company's average sales price per gram is 10-per-cent higher than the current industry average. In addition, the company has one of the widest product offerings, which includes dried bud, oil extracts, oil capsules, and a recently introduced topicals line."

Though bullish on its current spot in the industry, Mr. Bottomley did warn there are execution risks involved.

"Although MedReleaf has currently executed on a significant first mover advantage, and has one of the largest operations in the industry today, we estimate the company will require additional capacity in order to maintain its market position over the long run," he said. "We estimate MedReleaf will see its current market share of 17-per-cent decrease to 11 per cent of the combined medical and recreational markets as additional capacity and competition comes on line. At this assumed normalized market share, we forecast the company will require greater-than 90,000 kilograms of capacity over the long term in order to meet our estimates. Currently, the company has a capacity under construction of 35,000 kilograms, and a balance sheet that we believe can likely support a total of 52,000 kilograms. Although we do not forecast that MedReleaf will require a capacity above this level until FY2021, with lead-times in excess of 12 months to get a sizable facility up and running, we believe the company will need to begin to source expansion opportunities over the next twelve months in order to safeguard its current market position.

"In order to reach our 90,000-kilogram estimate, net of its cash available for future expansions, we believe the company will need to raise/invest $89-million for further capital expansions over the medium term, which we see as one of the larger risks to our forecasts and valuation."

Emphasizing its "compelling" growth profile, Mr. Bottomley set a price target of $15 for its shares. Consensus is currently $13.30, according to Thomson Reuters data.

"We believe MedReleaf's most relevant peers today are the three other large cap names in the LP space (Canopy, Aphria and Aurora)," he said. "In addition to its adjusted funded capacity, MedReleaf currently trades at a 12.1 times two-year forward EV/EBITDA multiple (versus peers at 15.2 times) and a 4.0 times two-year forward EV/Sales multiple (versus peers at 5.3 times). In our view, the company should currently trade more in line with peers and potentially at a premium once fully funded to our estimates."

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Canaccord Genuity analyst Raveel Afzaal initiated coverage of EcoSynthetix Inc. (ECO-T), a Burlington, Ont.-based renewable chemicals company, with a "speculative buy" rating.

"EcoSynthetix manufactures a proprietary, bio-based adhesive to help substitute harmful, non-renewable adhesives used in a wide variety of industries," said Mr. Afzaal. "ECO is in the early stages of growing in the wood vertical by substituting out formaldehyde from the wood industry. This promising opportunity is core to our investment thesis. It also has a legacy business ($18-million revenue, cash flow positive but low growth) in the paper vertical focused on reducing petroleum-based glue (SB latex) from the paper and packaging industry."

Mr. Afzaal believes EcoSynthetix has the "best" solution currently commercially available to completely eliminate formaldehyde usage. He also noted there's a big potential market for its products given the push by U.S. big box retailers to eliminate usage as regulations tighten.

"Following a leadership change in 2015, the company narrowed its focus from 36 verticals to five verticals," he said. "It is currently spending the majority of its resources 75 per cent) to grow its presence in the wood vertical using an adhesive called DuraBind. We believe the value proposition offered by EcoSynthetix to the wood industry is much stronger (and multi-pronged) relative to the paper vertical, where it was focused primarily on cost savings. In the wood industry, an adhesive made up of urea and formaldehyde is used to bind wood particles together. However, in the U.S., there are increasingly stringent regulations limiting the use of formaldehyde, as it can be emitted in the air if the wood gets wet, and reputable agencies such as the U.S. EPA are drawing probable links between formaldehyde and severe health risks (including cancer)."

"We spoke with a big box retailer that evaluated over 140 different types of technologies and concluded that EcoSynthetix offers potentially the most viable solution to eliminate formaldehyde altogether. This comment has been echoed by notable R&D firms focused on wood adhesives, such as Chimar Hellas S.A. and FPInnovations. Based on our due diligence call with Chimar Hellas, the company's representative stated '..at the moment, it appears to the board manufacturers that EcoSynthetix is at the fore front of innovation in this arena and offers the best solution that is commercially available to eliminate the use of formaldehyde altogether."

He set a price target of $3. Consensus is $3.74.

"The company's products are currently in the early adoption phase, which makes predicting future financial performance and intrinsic value of the company challenging," the analyst said. "Secondly, its product needs to be mixed with other more water resistant adhesives before being applied. Hence, fluctuation in the price of these adhesives can impact the cost savings offered by ECO."

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Believing a premium valuation is sustainable, RBC Dominion Securities analyst Mark Mahaney upgraded Yelp Inc. (YELP-N) to "outperform" from "sector perform."

"We fully admit -- there were bigger dips on YELP earlier this year, and current valuation isn't trough," he said. "But we have a mini-dip here, and current valuation is highly reasonable – 15 times 2018 EBITDA matches the Median Multiple of the past three years. And our outlook for a 30-per-cent 3-year EBITDA CAGR [compound annual growth rate] strongly supports this multiple, we believe. More importantly, core Advertising Revenue and Metrics Growth trends appear to have re-gained consistency. Improved salesforce execution and new revenue streams (RAQ, Reservations) suggest that that current Ad Revenue growth rates are sustainable. And easing comps into 2018 will help. And when all is said and done, the Local Advertising TAM [total addressable market] remains very sizeable ($150-billion) and should support a "Multi-Billion Dollar Bully." And YELP continues to have strategic value."

On Wednesday, the San Francisco-based tech company's shares dipped in post-market trading after it said it expects 2017 revenue to fall given lighter-than-expected fourth quarter. It is forecasting $839-million to $844-million in revenue, falling below the Street's expectation of $861.5-million.

For the third quarter, it reported earnings per share of 9 cents and $222-million in revenue, topping the consensus expectation of a 2-cent loss and $221-million.

"Yelp posted a Beat Q3, though a lowered Q4 outlook caused 5 per cent after-market slide," said Mr. Mahaney. "We view the lower entirely to the Eat24 sale. Looking at core biz fundamentals & metrics, we see consistency, and as salesforce execution improves and new opportunities materialize (Request A Quote, Yelp Reservations, etc.), we believe premium growth is sustainable."

Mr. Mahaney raised his target to $55 (U.S.) from $36. The analyst average is $45.76.

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There were not big surprises in goeasy Ltd.'s (GSY-T) third-quarter financial report, according to Desjardins Securities analyst Gary Ho.

However, he believes the company's update on the impact of new accounting standards, known as IFRS 9, should remove a material overhang on the stock.

"3Q17 results were in line with preliminary results released last week (which were above consensus)," he said.

"Two new items worth noting: First, the update on IFRS 9 was less punitive than what investors were anticipating, in our view. Management expects the allowance for loan losses to increase from the current 6.1 per cent of loans receivable to a range of 8.6– 9.6 per cent (favourable versus our 10.3-per-cent estimate). Many had feared the allowance would more than double under the new rules. We believe this was a key concern among investors. Second, management upped its 2017 and 2019 guidance on loan portfolio growth and operating margins while reducing net charge-off expectations. New 2020 targets point to the current loan portfolio doubling while generating a solid 20-per-cent-plus ROE. We increased our estimates to reflect the new guidance, which was somewhat offset by the dilutive impact of the convertible debt (small adjustment to our model)."

Mr. Ho raised his 2017 and 2019 earnings per share projections to $3.05 and $4.51, respectively, from $3.02 and $4.16. His 2018 estimate remains $3.66.

He maintained a "buy" rating for the stock, increasing his target to $39 from $37. The average is $41.

Mr. Ho said: "Our investment thesis is predicated on: (1) management executing on future targets, given its solid track record on meeting or exceeding past targets; (2) with the exit of two incumbents, the non-prime consumer lending market is underserved, in our view, which creates a unique opportunity to expand; (3) with scale, the business could generate a 20-per-cent-plus ROE; and (4) we expect double-digit dividend growth over the next few years."

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In other analyst actions:

RBC Dominion Securities analyst Nelson Ng upgraded Crius Energy Trust (KWH.UN-T) to "outperform" from "sector perform" with a $11 target. The average target on the Street is $11.65.

TD Securities analyst Meaghen Annett downgraded Sleep Country Canada Holdings Inc. (ZZZ-T) to "hold" from "buy" and lowered her target to $41 from $45. The average target is $42.33.