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Tuesday's analyst upgrades and downgrades

A pipeline is pictured at the Kinder Morgan Trans Mountain Expansion Project in Burnaby, B.C.

JONATHAN HAYWARD/The Canadian Press

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

CBOE Holdings Inc.'s (CBOE-Q) $3.2-billion (U.S.) acquisition of Bats Global Markets Inc. creates a more diversified business, said RBC Dominion Securities analyst Andrew Bond.

However, he said it also brings "significantly" more exposure to "highly competitive" asset classes, including multi-listed options and equities.

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"There are real synergy opportunities, but we believe the cultural integration is likely to be the most difficult aspect of the combination," said Mr. Bond. "While the earnings accretion is impactful, we believe it is offset by multiple de-rating as CBOE is no longer as attractive as an acquisition target and its revenue mix is more weighted to lower margin/competitive products."

Accordingly, he downgraded CBOE to "sector perform" from "outperform."

In a separate research note, he upgraded Bats to "sector perform" from underperform."

Mr. Bond called the accretion opportunities for CBOE "meaningful," but he cautioned that possible dilution of culture "cannot be measured."

"CBOE believes it can achieve $50-million in synergies three years after closing. Given this level of savings, we would forecast the deal to be accretive by 18 per cent in year three," said the analyst. "However, the synergies are aggressive and indicate deep cuts to the business. We would also note that CBOE has no experience with large scale acquisitions and integration, so it is difficult to determine how successful CBOE will be in reaching these targets. Generally, we believe the integration will be more difficult than can be demonstrated on the synergy slide of a PowerPoint deck.

"Sometimes the best defence is a good offence, but CBOE could still be taken out. Despite our downgrade of CBOE , we acknowledge the risk of an acquisition remains high, in our view. We believe the deal was a defensive move, as there are unlikely to be any suitors interested in the combined business. The deal is not expected to close until at least H1/17 and a shareholder vote on the deal is not expected for at least 4-5 months according to CBOE, which gives ample time for potential suitors."

He lowered his target price for CBOE stock to $68 (U.S.) from $78. The analyst average target price is $67.86, according to Bloomberg.

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"Our bullish thesis on CBOE was predicated on its exposure to highly defensible products which accounted for 90 per cent of its transaction revenue," said Mr. Bond. "Following the deal, this number is closer to 60 per cent with 30 per cent now generated from cash equities, 8 per cent from multi-list options and 2 per cent from FX. Further, we believe one of the primary reasons CBOE has traded at a premium to the sector is due to its attractiveness as a takeout candidate. In our view, a combined CBOE-BATS is a less attractive business to an acquirer, given its more competitive product mix, cultural differences and larger size."

Mr. Bond raised his target for Bats to $32.50 from $23 in response to the deal. The average is $30.

"Despite the announcement, we believe there remain hurdles to a successful closing, including a potential bid by a competing exchange for CBOE. However, with two large scale exchange deals now in progress and further consolidation likely, we believe sector multiples are going to continue to re-rate higher, which is a positive for BATS, even if the deal is not completed," he said. "Accordingly, while we make no changes to our forecasts at this time, we raise our price target to $32.50 to match the CBOE bid and raise our rating to sector perform."

"The premium was high, in our view, but potential synergies make the numbers work for CBOE. Prior to the announced acquisition we valued BATS at 9.5x 2018 EBITDA, which was in-line with the average of its three closest peers (NDAQ, ENX, BME), and more than 3x below what CBOE paid. We believe for both BATS and CBOE the deal was made more out of necessity and defense than fundamental reasons, which we believe are limited from the combination. While in our view, CBOE itself wanted to fend off acquirers, BATS also saw competition increasing in the already saturated and mature market in which it competes. This is not to say both businesses could not continue to be successful independently; we believe they could. However, the timing was right for both and so was the price with BATS obtaining a more than 20-per-cent premium and CBOE using a mix of its expensive equity currency and cheap debt to fund a meaningfully accretive deal, post-synergies."

Elsewhere, CBOE was upgraded to "neutral" from "underperform" by Credit Suisse analyst Christian Bolu with a target of $67, up from $60. The stock was also raised to "buy" from "neutral" by Buckingham Research Group's Christopher Allen, who raised his target to $77 from $66.

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Laurentian Bank of Canada (LB-T) is a "good dividend story," according to Canaccord Genuity analyst Bart Dziarski.

Initiating coverage of the stock with a "buy" rating, Mr. Dziarski noted its 5-per-cent dividend yield is 0.7 per cent greater than average of the Big Six and 2 per cent higher than the S&P/TSX composite average.

"LB has delivered a dividend compound annual growth rate [CAGR] of 8 per cent since 2007, 300 basis points greater than the Big Six average," he said. "The company's low 40s dividend payout ratio is at the low end of its target payout range of 40-50 per cent, suggesting flexibility to continue increasing its dividend. We are forecasting an 8-per-cent average dividend growth rate in 2016 and 2017."

In justifying his rating, Mr. Dziarski said: "Our positive outlook on LB is predicated on: 1) positive momentum in the company's Transformation Plan, which could result in the stock re-rating; 2) LB's attractive dividend yield; 3) our belief that LB's credit position is a strategic advantage; and 4) LB's attractive valuation."

He noted that the Transformation Plan, released in January, aims to improve return on equity from 12 per cent currently to 14 per cent in 2019 and 17 per cent in 2022.

"We believe the successful execution of this plan could result in a multiple re-rating for LB and a narrowing of its current 25-per-cent forward [price-to-earnings] discount to the Big Six Canadian banks," said the analyst. "Three consecutive quarters of results consistent with the plan and a recent acquisition have created positive momentum towards plan execution."

"We expect LB's favourable historical credit performance relative to the Big Six and CWB to continue considering: 1) LB's oil and gas exposure is small; 2) LB's lending footprint within Canada is primarily in Ontario/Quebec; and 3) residential mortgages are a bigger component of LB's loan book. Thus, LB's plan to "move up the risk curve" into higher-margin products (e.g., commercial loans) to increase risk-adjusted earnings makes strategic sense to us."

Mr. Dziarski set a target price of $54 for the stock. The analyst consensus price target is $52.50, according to Thomson Reuters.

"LB is currently trading at an 8.5x forward P/E and a 1x price-to-book, below its historical average of 9.5x forward P/E and 1.1x P/B ratios," he said. "LB is also trading at a 25-per-cent forward P/E discount to the Big Six, higher than the 13-per-cent historical average discount. Historically, when LB has traded at these discount levels, the stock has outperformed the Big Six by 3 per cent on average over the subsequent three, six, nine and 12-month periods."

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RBC Dominion Securities analyst Elvira Scotto raised her target price for Kinder Morgan Inc. (KMI-N) in reaction to higher financial estimates and multiple expansion stemming from recent midstream M&A activity and "what we view to be a more challenging permitting environment."

The potential for expansion of the Trans Mountain pipeline was among the factors she cited in justifying her changes.

"A recent Bloomberg article noted that Canadian PM Justin Trudeau plans to approve at least one pipeline project with KMI's Trans Mountain Pipeline the most likely," she said. "The Government in Council has a Dec. 20, 2016 deadline to issue final approval and we expect comments on provincial permits from B.C. in early 2017. We now expect the expansion to come online year-end 2019 and we increased our valuation to fully incorporate the project."

She also emphasized the potential sale of its carbon dioxide (CO2) business, saying: "We believe that a sale of KMI's CO2 business would be viewed positively for the stock, assuming a reasonable sales price, as a divestiture would (1) remove a significant amount of commodity price exposure, (2) allow KMI to repay debt immediately, and (3) reduce KMI's future capex needs by $1.5-billion (U.S.), by our estimates. We estimate that KMI may be able to sell its CO2 business for $6-billion ... A $6-billion sales price would not affect our valuation (that is the value we assign to CO2 in our sum-of-the-parts analysis), however, we estimate that KMI's leverage would improve to 4.6x at 2017 year-end vs. our base case estimate of 4.9x. While the transaction is dilutive to discounted cash flow per share given the lower effective multiple, the improved leverage and reduced future capital needs would allow KMI to restart dividend growth faster than our base case estimate, which we believe would be a catalyst for the stock."

Mr. Scotto raised her 2016 and 2017 EBITDA projectioins to $7.252-billion and $7.496-billion, respectively, from $7.251-billion and $7.529-billion. She also increased her dividend per share estimates for 2018, 2019 and 2012 to $1, $1.60 and $2, respectively, from 50 cents in all three years. Her 2016 projection of 50 cents did not change.

Maintaining a "sector perform" rating for the stock, she raised her target price to $25 from $21. Consensus is $23.44.

"We would become more bullish on (1) sale of CO2 business at 6-7x EBITDA, (2) accretive, de-leveraging acquisition, (3) announcement of accretive growth projects, (4) faster than expected de-leveraging, (5) faster than expected dividend growth or share repurchase," she said. "We would become more bearish on (1) dilutive acquisition, (2) slower than expected de-leveraging, (3) no line of sight to dividend growth or share repurchase."

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The 2017 guidance for Vecima Networks Inc. (VCM-T) signals it will be a "transition year" for the Victoria-based tech company, said CIBC World Markets analyst Todd Coupland.

On Monday, Vecima reported fourth-quarter 2016 results which met expectations. It reported sales of $24.4-million, compared to Mr. Coupland's projection of $22.5-million. Earnings per share of 16 cents exceeded his 13-cent estimate.

"The issue was that 2017 guidance was 20 per cent below revenue expectations," the analyst said. "We had previously downgraded Vecima on an upcoming product transition and slowing growth expectations on May 12. This outlook for 2017 has affirmed that downgrade."

The company expects a drop in sales for 2017 to $85-million to $95-million from $108-million in 2017. EBITDA is now projected to be $23-million to $28-million, in line with Mr. Coupland's $25-million forecast.

In response to the guidance change, Mr. Coupland reduced his full-year 2017 EPS projection to 55 cents from 87 cents.

He also reduced his target price for the stock to $10 from $13 with a "sector performer" rating. Consensus is $12.50.

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Noting sales trends "keep getting weaker," Credit Suisse analyst Robert Moskow downgraded J.M. Smucker Co. (SJM-N) to "neutral" from "outperform."

"Our thesis that Smucker would raise its cost savings targets to address its unwieldy overhead structure has played out as we expected," said Mr. Moskow. "However, we underestimated the hit to sales from difficult comparisons to last year's extensive new product launches and we fear that we underestimated the level of reinvestment it will take to revitalize the struggling pet food division. In addition, we feel less comfortable recommending this stock at a time when the company's key commodity inputs have bottomed and no longer provide material opportunities for margin benefits."

Mr. Moskow said "there is no easy answers" for the recent decline in pet sales, noting: "Last year's big new product launches (Dunkin k-cups, Natural Balance, and Milk Bone brush chews) continue to perform well with consumers, but the gap in the new product pipeline for fiscal 2017 is bigger than we expected. Several of the smaller new product launches in pet snacks failed to gain traction; declines in the Nature's Recipe have largely offset Natural Balance's success, and the declines in dry dog food continue to accelerate because the company did not have an entry in the premium segment of the grocery channel. Management's decision to launch an entirely new brand in this segment rather than reformulate Kibble and Bits implies a higher cost and higher risk than our original expectations. With all of these challenges hitting at once, we think management will have to lower its profit guidance again for the pet division, and we expect management to lower its long-term sales growth algorithm for pet food to 1-2 per cent (from MSD currently) during its CAGNY conference presentation in February. From what we can tell, consensus appears to anticipate some but not all of this bad news."

Mr. Moskow lowered his 2017 and 2018 EPS projections to $7.64 and $8.14, respectively, from $7.73 and $8.52. His target price for the stock fell to $145 (U.S.) from $158. Consensus is $151.27.

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In other analyst actions:

Canacol Energy Ltd. (CNE-T) was cut to "buy" from "action list buy" by TD Securities analyst Shahin Amini with a target of $5.50 (unchanged). The analyst average is also $5.50.

Gran Tierra Energy Inc. (GTE-T) was raised to "action list buy" from "buy" by Mr. Amini. His target of $5.50 did not change, versus the average of $5.29.

Leerink Partners LLC analyst Geoffrey Porges downgraded Gilead Sciences Inc. (GILD-Q) to "market perform" from "outperform" and cut his target to $94 (U.S.) from $112. The consensus average is $102.65.

Atlantic Equities LLP analyst Sam Hudson downgraded Dollar Tree Inc. (DLTR-Q) to "underweight" from "neutral" and cut his target to $68 (U.S.) from $87. The average is $92.90.

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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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