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Tuesday's analyst upgrades and downgrades

Toronto-based Fairfax sponsors and promotes Fairfax India Holdings Corp.

Aaron Harris/REUTERS

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

Fairfax India Holdings Corp. (FIH.U-T) is a "unique" investment opportunity providing "an entry to a dynamic emerging market undergoing transformational change," said RBC Dominion Securities analyst Mark Dwelle.

He initiated coverage with an "outperform" rating.

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"With a large population, good legal system and attractive geography, India is viewed as one of the more attractive emerging markets," said Mr. Dwelle. "The country's 2014 election brought a pro-business leader and plans for wide-ranging reforms many of which are already underway. Fairfax India provides a direct play on the business opportunities that will arise from such change."

Mr. Dwelle emphasized the holding company's "proven and experienced leadership" with well-connected senior management which includes India-based teams "facilitating identification of opportunities and oversight of investees." He said the management group "makes a huge difference and the approach, experience and connections of this team add substantially to the attractiveness of FIH as a vehicle to invest in India."

"Fairfax India's initial investments are in well established businesses with their own track record of success," the analyst said. "These businesses have meaningful opportunities to expand their position within their respective marketplaces and in so doing drive earnings growth and scale benefits. In our view, these would be good businesses in most any market; the fact that they are positioned to benefit from various reforms augments the opportunity."

He set a price target of $14 (U.S.). Consensus is $17.96.

"Fairfax India is a narrowly positioned investment company tasked with doing one thing — investing in attractive Indian businesses," said Mr. Dwelle. "Our speculative risk rating reflects this narrow mandate and the risks inherent in emerging market investments. While we think management has taken reasonable steps to mitigate these exposures, it is the evolving and rapidly changing environment in which FIH invests which leads to this view."

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Stock of RDM Corp. (RC-T) is currently undervalued, according to Canaccord Genuity analyst Kevin Wright.

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He initiated coverage of the Waterloo, Ont.-based company with a "buy" rating.

"RDM Corp is a growing FinTech company that provides cheque scanning and processing software and hardware to global financial institutions in the U.S.," he said. "Revenue is from 1) recurring software as a service-based cheque scanning and processing services and 2) lumpier one-time imaging hardware. Subscription revenue has a higher growth trajectory which has been offsetting the non-core hardware business, a drag on sales. There are few ways to invest in the Canadian FinTech revolution - RDM Corp is one such name and we consider it an undervalued stock; we like its large U.S. customer base of global banks, its profitability, under-penetration of its market, strong balance sheet, an attractive and sustainable dividend and its position as an enabler, not a disrupter, of banks."

Mr. Wright emphasized the company, under chief executive officer Randy Fowlie, has been able to forge "significant" relationships with 40 U.S. banks with a global presence.

"In turn, its bank customers resell RDM's software to large corporate clients," he said. "These relationships and a highly customizable SaaS product with deep functionality pose meaningful competitive barriers.

"We believe that there are opportunities for RDM to expand the product line through acquisitions and to use its existing relationships with large U.S. banks to cross-sell new products. RDM is primarily focused on the U.S. so there are opportunities to grow internationally; its customer base has a global footprint so its organic growth prospects could be meaningful."

Calling its balance sheet "strong" and its dividend "sustainable," he set a price target of $5.50 for RDM shares. Consensus is $5.28.

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"Our target is based on a 9.8 times calendar year 2017 estimate enterprise value to EBITDA, a discount to banking technology peers trading at an average of 13.4x; RDM stock trades at 6.7x 2017 EV/EBITDA, which is undervalued in our view," said Mr. Wright. "We recommend this stock for small cap investors that recognize the value of a sustainable dividend paid by a company with a strong cash position amid low double-digit to high single-digit recurring revenue growth, expanding adjusted EBITDA margins with M&A opportunities, which we consider necessary for long-term success."

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AGT Food and Ingredients Inc.'s (AGT-T) new bulk-export initiative is transformational and capable of delivering substantial earnings growth over the next five years, said Raymond James analyst Steve Hansen.

He said that possibility is currently being overlooked by investors.

"While AGT's fledgling ingredient platform has (justifiably) captured the imagination of most investors in recent years, we believe this same acute focus has overshadowed the strategic momentum building around the firm's recently acquired short-line rail and storage assets," said Mr. Hansen.

He called the 2015 acquisition of short-line railroad and storage-related assets "a bold move," bolstering its origination and sourcing abilities in "the vital" southern Saskatchewan growing region. He admitted he failed to appreciate how those assets would provide the foundation for its bulk-orientated strategy, which "appears poised to deliver healthy revenue/EBITDA gains over the next five years."

"Beyond the earnings growth this new initiative provides, we also see demonstrative benefits associated with the balance and diversification it brings to the firm's collective growth profile, with all three segments [pulse and grain processing; trading and distribution and food ingredients and packaging] now boasting attractive growth opportunities, in our view," he said. "We also see attractive risk mitigation benefits associated with AGT's ability to protect/insulate downstream pasta margins as it vertically integrates its supply chain into durum wheat. Finally, we also believe AGT's ability to prove out this new bulk-export model in partnership with its Class 1 rail partner could ultimately spawn more growth opportunities as it matures."

Mr. Hansen added: "While still early days, we foresee AGT growing its bulk export volumes by a factor of 4x–6x over the next five years, ultimately scaling up into 2.0–2.5 million metric tonnes of exports by 2020 (versus a 500,000 annualized run-rate in 2015), an opportunity that we estimate could yield an incremental $25–$30-million of annual EBITDA. In the more immediate term, based upon our newly established 2018 estimates, we forecast the firm reaching 1.2 million in metric tonnes of bulk exports, an initiative we believe could yield an additional $15–$20-million of incremental EBITDA."

Mr. Hansen said wet weather late in the summer has pushed back the harvest time. Though he expects "healthy" growth in export volumes, a higher-than-projected yield and quality losses caused him to trim his second-half 2016 and first-half 2017 projections.

His full-year 2016 earnings per share estimate declined to $2.16 from $2.20, while his full-year EPS estimate did rise to $3.05 from $2.89.

Maintaining his "outperform" rating, he raised his target to $46 from $43 to "account for our latest assessment of AGT's new bulk-export initiative, the beneficial growth attributes it provides, and the commensurate rolling of our valuation forward (to 2018) to better capture this underappreciated aspect of the company's evolving story."

The analyst consensus price target is $43.86.

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Transforce Inc. (TFI-T) is "turning the page on a tough year," said CIBC World Markets analyst Kevin Chiang ahead of the release of its third-quarter results on Oct. 20.

"2016 was a challenging year for TFI (and truckers in general) with high retail inventory levels in the U.S. and a soft Alberta economy, which was a higher-margin region," said Mr. Chiang. "That being said, TFI has supported its share price through a SIB and by being active on its NCIB, repurchasing 6.4 million shares year to date. Recall, the company renewed its NCIB recently for another 6 million shares. We continue to see TFI utilize its free cash flow to support its buyback while looking for opportunities to crystalize the value of its courier operations, with the potential spin-off of [its truckload segment] once the business reaches critical mass."

Mr. Chiang said he's seen a stabilization in surface transportation volumes and Canadian freight rates.

"They appear to have found a floor and we should see modestly improving top-line trends in 2017 and TFI continuing to streamline its operations (i.e., growing its brokerage business)," he said. "In addition, TFI's leverage to a growing e-commerce trend remains a bright spot (e-commerce revenues are running at $150-million-$170-million annually but TFI expects this could jump to $270-million by 2017)."

With a "sector performer" rating (unchanged), Mr. Chiang raised his target to $28.50 from $26. Consensus is $27.27.

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Though Leucrotta Exploration Inc. (LXE-X) has been one of the top-performing stocks in Macquarie analyst Tom Hems's coverage universe, he said there's further upside in the shares.

"Leucrotta recently announced that, after a period of limited spending, it has chosen to deploy $26-million through the second half of 2016 to build out infrastructure and drill three Lower Montney wells (two horizontals and one vertical;)," the analyst said. "$17-million will be allocated to tie-ins and related equipment to bring four previously drilled wells on production in 4Q16 and 1Q17. These four wells had combined total test or last on-stream production rates of 3,100 barrels of oil equivalent per day (boe/d). Current corporate production is 1,000 boe/d.

"Leucrotta is well positioned to execute this plan with a cash and working capital balance of $44-million, no debt, and an undrawn $5-million credit facility. Based on recent strip prices, we estimate new drills to payback rather quickly."

With increased activity, Mr. Hems raised his production projections for 2017 and 2018. With those changes, his funds from operations per share estimate rose to 8 cents from 4 cents for 2017.

Maintaining his "outperform" rating, he also raised his target for the stock to $2.75 from $2. Consensus is $2.51.

"Leucrotta is set to more than double production heading into next year as it ties in four wells (mainly into its 100-per-cent owned Doe facility) with significant productive capability," said Mr. Hems. "We will monitor performance of the tied-in Montney wells along with test results from new horizontals (expected 3Q17 tie-in) as upcoming catalysts to provide investors with increased comfort around the potential value of Leucrotta's asset base."

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"Strong" underlying fundamentals across all its segments should lead to earnings upside for Tyson Foods Inc. (TSN-N) in the 2017 fiscal year, said BMO Nesbitt Burns analyst Kenneth Zaslow.

Also emphasizing "sustainable" earnings growth through 2018, he upgraded the stock to "outperform" from "market perform."

"The evolution of TSN's strategy, coupled with favorable underlying fundamentals, point to at least $5.00 in EPS in F2017 and sustainable growth in F2018," Mr. Zaslow said. "We have increased our F2016 and F2017 estimates, reflecting: 1) sales growth momentum in its Prepared Foods (i.e., retail sales growth accelerated to 3-4 per cent in its core nine products); 2) upside potential in beef margins, as the US cattle industry is in the early stages of a multi-year expansion; 3) the sustainability of its chicken margin in light of its buy vs. grow strategy, favorable mix shift, low breast meat prices, and benign feed cost environment; 4) the strength of pork packer margins and deflationary pork inputs in light of the fact the U.S. is swimming in hogs; and 5) the effective deployment of cash to shareholders via share repurchases."

Mr. Zaslow said the class-action suit faced by Tyson, accusing it with conspiring with peers to raise chicken prices, will likely not be a factor for several years, noting "the U.S. legal system appears to be established to allow class action anti-trust cases to extend for a long period of time.

"While the plaintiffs' complaint appears primarily circumstantial (i.e., there is no direct evidence to link any individual(s) to a signed or even handshake agreement to collude on prices), we do not expect the case to be dismissed, in part because the plaintiff opportunistically selected a plaintiff-friendly court (Federal District Court in Chicago in the Seventh Circuit)," he said  Second, we estimate that TSN will incur legal fees of at least $5 million per year for the foreseeable future; however, the magnitude of the legal fees is largely a non-event (i.e., $0.01 per year effect on EPS). Third, while it is difficult to take the position of a judge with limited knowledge of the chicken industry (at this time) or to handicap the potential for settlement, we believe that the chicken industry likely will mount a compelling defence based on a series of observations, including but not limited to: 1) chicken production has increased every year since 2001 with the exception of 2009 and 2012, when corn hit nearly $7.00 in 2008 (up more than 40 per cent for the year) and more than $7.50 in 2011 (up more than 65 per cent for the year); 2) an estimated 28 per cent of the U.S. chicken industry (e.g., Pilgrim's Pride, Allen Family Foods, Townsends, Cagle's) filed for bankruptcy between 2008-2011 (note the alleged collusion began in January 2008); 3) the lawsuit focused on Georgia Dock whole bird prices but not the actual parts, including boneless skinless breast prices, which have fluctuated far greater than whole bird prices; 4) beef prices surged to record highs every year from 2011 to 2015, while pork prices hit record levels in 2010, 2011, and 2014; 5) Agristats, in our view, is a backward-looking measure; and 6) there have been wide variances in operating performances among the publicly-traded companies, while TSN remains a buyer of breast meat and has thrived financially in a low breast meat price environment in large part reflecting its buy vs. grow strategy and shift toward value-added products."

He increased his target price for the stock to $84 (U.S.) from $77. The analyst average target price is $77.82, according to Bloomberg.

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In other analyst actions:

Scotia analyst Vladislav Vlad made the following ratings changes:

- Trican Well Service Ltd. (TCW-T) was downgraded to "sector perform" from "sector outperform" with an unchanged target of $3.50. The average is $3.56.

- Canyon Services Group Inc. (FRC-T) was raised to "sector outperform" from "sector perform" with a target of $7.50 (from $7). The average is $6.75.

- Canadian Energy Services & Technology Corp. (CEU-T) was downgraded to "sector outperform" from "focus stock" with a $6.50 target (unchanged). The average is $5.58.

- Savanna Energy Services Corp. (SVY-T) was raised to "sector outperform" from "sector perform" with a $2.50 target. The average is $2.38.

GMP analyst Cody Kwong initiated coverage of Tamarack Valley Energy Ltd. (TVE-T) with a "buy" rating and $5.25 target. The average is $5.04.

Encana Corp. (ECA-N, ECA-T) was raised to "overweight" from "equal-weight" at Barclays by analyst Thomas Driscoll. He raised his target to $14 (U.S.) from $10, versus the average of $12.12.

Twitter Inc. (TWTR-N) was raised to "hold" from "sell" by Evercore ISI analyst Ken Sena with an unchanged target of $17 (U.S.). The average is $12.12.

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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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