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Tuesday's analyst upgrades and downgrades

A Rogers Communications Inc. office tower in downtown Montreal.

© Shaun Best/REUTERS

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

Rogers Communications Inc.'s (RCI.B-T) unexpected chief executive officer change brings a level of uncertainty to the company moving forward, said Credit Suisse analyst Robert Peters.

"The departure of CEO Guy Laurence concurrent with [third-quarter] results was surprising," said Mr. Peters. "This change does increase execution risk as Rogers is still in the midst of its 3.0 turn-around and incoming CEO Joe Natale is unable to join the company immediately due to his non-compete from Telus. Despite the issues around his start time, we believe that Mr. Natale's strong background and track record for execution within the Wireless industry will be an asset over the long-term."

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In analyzing the quarterly financials, Mr. Peters said the company's earnings before interest, taxes, depreciation and amortization growth of 3 per cent year over year came off a "strong" performance in its sport media division. Those results offset weaker core financials.

"Softer Wireless EBITDA growth (up 1 per cent year over year) reflected the continuation of elevated handset discounts, which offset stronger average revenue per user growth," the analyst said. "In Cable, we estimate that roughly half of the growth was driven by a one-time vendor rebate. Ex-Media and onetime items, Rogers' core Cable and Wireless business increased 1 per cent year over year, below our 3-per-cent estimate. Despite slower core growth, Rogers remains on track to achieve the low end of its 1-per-cent to 3-per-cent year-over-year EBITDA guidance."

He lowered his 2016 and 2017 EPS estimates to $2.88 and $3.14, respectively, from $2.93 and $3.19, citing "higher other expenses in the quarter as well lower equipment revenue going forward, partially offset by improving subscriber trends."

"We maintain our Neutral rating after updating our model to reflect another quarter of strong subscriber growth at Rogers, balanced by higher handset discounts in Wireless," he said. "While improved subscriber trends can be a positive indicator for future growth, our concern lies with Rogers' ability to maintain its market share in Wireless while demonstrating the promotional discipline needed to grow EBITDA."

Mr. Peters raised his target price for the stock by a loonie to $54. The analyst consensus is $55.05, according to Thomson Reuters.

"The improving subscriber trends highlight the positive impact of Rogers 3.0 but we believe the focus will now shift to increased cost control to help support top-line growth in the Q416 and FY17 in order to achieve Rogers' 1-per-cent to 3-per-cent EBITDA growth," he said.

Elsewhere, CIBC World Markets analyst Robert Bek also raised his target by a dollar (to $57 from $56) with a "sector outperformer" rating (unchanged).

"Although the market tends to not like surprises, and there may be some concern about Natale getting up-to-speed on day-to-day operations given the haste in which the switch was announced (indeed, Natale does not yet have a start date, with board chair Alan Horn taking over the helm in the interim), we do not expect the Street to view the switch as problematic, or a step-down," said Mr. Bek. "Natale is not only a known entity, but also someone who is held in very high regard by the Street, especially from a wireless perspective, which is what drives the story at Rogers.

"As for the quarter, Q3 results continued to display the positive momentum we have seen more recently. Wireless loading was strong once again, with the +114,000 postpaid net adds well ahead of consensus at 69,000. This was coupled with robust 2.1-per-cent growth in blended ARPU [average revenue per user] (to $62.30), also ahead of the flattish result expected by the Street. Cable sub-stats were better across the board, highlighted by a return to positive RGU [revenue generating unit] growth for the first time in nine quarters. Indeed, Rogers is firing on all cylinders from a sub perspective."

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Netflix Inc. (NFLX-Q) has achieved a level of sustainable scale, growth and profitability that is not current reflected in its share price, said RBC Dominion Securities analyst Mark Mahaney.

On Monday, the company reported third-quarter revenue of $2.29-billion (U.S.), which beat the Street's projections. Earnings per share of 12 cents also "easily" topped both Mr. Mahaney's 4-cent estimate and the Street's 5-cent projection.

However, Mr. Mahaney pointed to better-than-expected subscription growth as the chief factor for a 20-per-cent rally after the markets closed. U.S. domestic subs grew by 370,000, versus the Street's 309,000 estimate, while international subs jumped by 3.2 million (versus 2-million). The company's fourth-quarter domestic sub guidance is 1.45 million (versus 1.27 million) and internationally at 3.75 million (3.3 million).

"Expectations were somewhat low following a rocky Q2 where the company missed on subs," said Mr. Mahaney. "The opposite happened here, with the company unequivocally beating expectations while showing improving fundamentals – the third consecutive quarter of total revenue growth acceleration and a record 36.4-per-cent Domestic Contribution Margin. This was despite worries that the Olympics and the un-grandfathering process from the most recent price increase may have impacted Q3's results. Netflix clearly benefitted from several blockbuster shows that occurred during the quarter, including the sleeper hit Stranger Things and the second season of the international phenomenon Narcos."

Based on RBC's Global Broadband Rollout analysis, Mr. Mahaney said Netflix can build a global subscriber based of almost 160-million by 2020, "assuming a range of adoption scenarios for each of its different markets, from close to 60-per-cent penetration in its U.S. to over 10-per-cent penetration in its 2016 launch markets."

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"There are a lot of puts and takes to this conclusion, but if we are reasonably accurate in this forecast, we see this leading Netflix to generate at least $8 (U.S.) in GAAP EPS and perhaps as much as $10 in GAAP EPS in 2020," he said. "Our stock-picking belief is that a secular growth, high-visibility subscription model with $8-$10 in GAAP EPS power would carry at least a market premium P/E multiple of 20 times, which implies the ability for NFLX to achieve a $160-$200 stock price by 2019."

Mr. Mahaney reiterated his "outperform" rating for the stock and raised his target price to $150 (U.S.) from $130. The analyst average is $117.06, according to Bloomberg.

"Our survey work had suggested that Q3 would be less fundamentally challenging than Q2 – evidence of rising Netflix penetration, evidence of churn abatement, and evidence that Amazon Prime was actually boosting Netflix," he said. "The significant controversy around the stock suggested a gap-up opportunity. Well, that happened…now what? We continue to reiterate Outperform. Thesis being: 1. Dramatic Secular Shift away from Linear TV (1 billion pay TV subs today) to Internet TV (perhaps 100 million subscribers today) – these numbers could swap places; 2. Netflix is the Dominant Subscription Leader – perhaps 8 times more subs than the closest competitor…and this is a scale game; 3. Netflix proving out U.S. Profitability – Contribution Margin rising from 16 per cent in '12 to 36 per cent in '16; 4. Netflix proving our Universal Appeal – 10-per-cent household broadband penetration within 3 years in every market launched; 5. Netflix proving out International Profitability – Pre-'14 Markets scaling like U.S. did; & 6. One of the Best Management Teams on the Net. And we still see up to $10 in EPS by 2020, implying a potential doubling in NFLX shares over a three-year time frame."

Elsewhere, BMO Nesbitt Burns analyst Daniel Salmon raised his target to $115 from $85 with a "market perform" rating.

"Netflix bounced back from last Q's disappointment as quarter-to-quarter volatility balanced out and pushed back on the Bear case with a very strong 3Q report and 4Q guidance," said Mr. Salmon. "That said, we remain on the sidelines as we expect the stock to move back to the high end of recent trading range and we can't yet foresee a next leg to the story in the near term. We expect that will be more likely found on the international side as local language content/improved localization rolls out and potentially boosts sub growth."


Calling it a top-tier small-cap producer, Canaccord Genuity analyst Sam Roach said Gear Energy Ltd. (GXE-T) is currently inexpensive according to most valuation metrics.

He initiated coverage of the stock with a "speculative buy" rating.

"Gear has been given a new lease on life in the past year while many junior E&Ps were acquired, taken private or forced into bankruptcy," said Mr. Roach. "We believe this is a testament to Gear's asset base, management team and strong investor support. Now, with renewed balance sheet flexibility and critical mass, we believe Gear is positioned favourably to grow out of its 'junior E&P' label."

Mr. Roach said Gear is "financed for growth" with an estimated $40-50-million of cash flow and over $20-million in unused bank lines, versus $25-30-million in sustaining capital. He said that should allow for production growth of at least 12 per cent through 2017 with debt reduction of $9-million.

"GXE has good net asset value support and trades at a discount to its small cap peers on most key metrics despite having a stronger-than-average balance sheet, low costs and the ability to grow within cash flow," he said. "Further, GXE trades at a mid-cycle multiple from a historical perspective, but we argue that the stock deserves a re-rating to reflect its stronger balance sheet, higher netback production and deeper asset base."

He added: "Before the oil price crash, Gear's management team, led by Ingram Gillmore, had grown production per debt adjusted share at a 17-per-cent [compound annual growth rate] over the prior four years. Since then, weak oil prices and tighter lending policies spurred Gear to hit the reset button with financing and the acquisition of Striker Exploration."

Mr. Roach set a price target of $1 for the stock. The analyst consensus is $1.01.

"By virtue of its 60-per-cent heavy oil weighting, GXE has higher-than-average torque to oil prices," he said. "To that end, at $55 (U.S.)/bbl we would expect GXE to trade between $0.95 and $1.25, offering up to 50-per-cent upside from the current share price, and at $65/bbl we expect GXE would trade between $1.40 and $1.80, implying up to 140-per-cent upside."


The market's reaction to New Flyer Industries Inc.'s (NFI-T) third-quarter results "looks overdone," said CIBC World Markets analyst Kevin Chiang.

Shares of the Winnipeg-based company fell 5.8 per cent on Monday after it reported a reduction in its 2016 revenue guidance for its Aftermarkets segment at the same time as "noisy" quarterly delivery results.

"We view this as an overreaction," said Mr. Chiang. "Even if we assume that Aftermarkets revenue is flat year over year in 2017 and margins hold at [about] 20 per cent, this is a $7-$8-million hit to our EBITDA estimate. Applying a 9-10 times EBITDA multiple to this (reflecting retail multiple), this suggests a 4-per-cent hit all else equal. While there is an inherent volatility in New Flyer's quarterly financial results given the impact of mix, we continue to see a positive long-term free cash flow trend. While this will be prioritized in the near-term to deleverage the balance sheet, we expect the company to look to return cash to shareholders (through dividend growth) and find tuck-in acquisitions. While New Flyer does compete in a mature market, we believe its margin expansion story and opportunities to acquire revenue will help bolster the bottom line."

Mr. Chiang did call the guidance change "a negative surprise."
"New Flyer has stated that bus deliveries currently reflect the replacement cycle (versus market growth) and total industry deliveries for heavy duty buses and coach buses are expected to be steady at 5,300 equivalent units and 2,250 EUs, respectively, for the foreseeable future," he said. "The area of growth for New Flyer was in its Aftermarkets division, but here, the company has taken down its revenue growth guidance from up 5 per cent year over year in 2016 to flat. So if we have hit peak earnings, the risk is that New Flyer's earnings multiple will contract."

"Over the past 10 years, New Flyer has traded between 4 times and 8 times current enterprise value to forward EBITDA, averaging 6.7 times during this period. Currently, New Flyer's 2017E EV/EBITDA multiple is 7.8 times. We do not view this as a significant premium to where it has averaged over the past decade, especially given its stronger FCF/earnings profile and improved competitive environment."

Mr. Chiang sees upside to earnings, citing conservative forward estimates, the expectation for continued synergies and the potential for project convergence to positively impact Aftermarkets margins.

"Overall, while we are forecasting $300-million of EBITDA in 2017, we see New Flyer capable of squeezing out another $40-million-plus of earnings from its current revenue run rate," he said. "As such, while the updated Aftermarkets guidance was disappointing, we do not believe New Flyer has hit peak earnings. We see continued upward momentum in its EBITDA and FCF which is supportive of its multiple (and multiple expansion)."

He did not adjust his "sector outperformer" rating for the stock, but he raised his target to $51 from $50. Consensus is $51.99.


RBC Dominion Securities analyst David Palmer thinks it may be "time for a Plan B" for Chipotle Mexican Grill Inc. (CMG-N).

"In light of recent activist interest in Chipotle, we have noticed a significant uptick in the level of investor interest in the stock, with many wondering what recommendations or demands an activist investor might make on a company like Chipotle," said Mr. Palmer. "Recall that in early September, Bill Ackman announced that his firm, Pershing Square Capital Management had accumulated a 9.9-per-cent stake in Chipotle's stock. Since that time, the firm has not communicated its ideas to the public, but given the size the stake, it is likely that Pershing Square has held high-level meetings with management and/ or the board. Ultimately, any turnaround of Chipotle stock will be heavily dependent on the trajectory of the sales recovery -- something that is proving to be more difficult than initially believed. But with a fresh prospective from an activist, we believe there is opportunity to accelerate that pace."

"In at least the last decade, restaurant stocks have been fertile ground for activist investors and private equity turnaround specialists. Firms like 3G Capital Management (who has previously engaged Pershing Square in its turnaround of Burger King) have championed strategies that involved a combination of 1) overhead cost reduction, 2) refranchising, and 3) financial leverage. These tactics have served as a vehicle for value creation by reshaping businesses into leaner organizations with highly profitable and sustainable long-term growth algorithms. In most cases, these transformations have been rewarded by the markets with multiple expansion, particularly in instances where management teams have been able to accelerate revenue growth."

Mr. Palmer said the company must decide whether it will maintain its growth spending with the hope of a rapid recovery or pullback.

"Those hopes are largely accounted for in our $595 upside scenario which reflects an 800 basis point margin recovery, 46-per-cent EPS growth, and a 33 times bull case 2018 estimated EPS," he said. "If the slow recovery continues, we believe the company can achieve our $465 base case target through a pullback in spending. If the company were to implement this Plan B strategy, we believe CMG could reach $465 in one year based on 25 times 2018 EPS of $18.69 (18 per cent year over year). This 25 times multiple assumes the company achieve a steady state algorithm in 2019 of 3-5-per-cent same store sales, MSD unit growth, and double-digit EBIT growth that— together with superior free cash flow generation — leverages to 15-18-per-cent EPS growth. Though $465 would not be the rapid share price appreciation some investors are hoping for, this alternative method may become the base case if the sales recovery remains lacklustre."

He added: "The results from our survey (conducted two weeks ago) show the chain underperformed its peers on relative quality and affordability by 100 and 150 bps, respectively. That said, Chipotle has outperformed the fast casual category with improvement in healthiness and taste scores by 250bps and 165bps, respectively. Interestingly, 50 per cent of consumers still indicate they avoid eating at the chain. This is up from 39 per cent two years ago and is roughly even with the 52 per cent avoid/reject rate from six months ago. This consumer avoidance -- in spite of the Chiptopia program this past summer -- is one reason another direction in marketing and spending may be needed."

Ahead of the release of its third-quarter results on Oct. 25, Mr. Palmer lowered his 2016 earnings per share projection to $3.54, a drop of 77 per cent year over year and 13 cents less than the consensus, from $4.59. His 2017 estimate moved to $10.42 from $12.04, an increase of 194 per cent from the previous year and 32 cents higher than the consensus.

He maintained an "outperform" rating for the stock but lowered his target to $465 from $485. The consensus is $433.96.

"Our estimates imply that Chipotle's ongoing sales declines, food safety investments, and traffic initiatives will result in trough earnings this year. It was heartening to hear that Chipotle's scores on certain brand attributes are improving," said Mr. Palmer. "We are optimistic that margins can begin to recover in 2017, particularly if food cost inflation remains benign as we expect. Chipotle's restaurant-level economics remain best-in-class despite recent brand damage. Digital ordering remains a significant future opportunity and the company seems to be testing ways to revamp its second make line."

Elsewhere, Raymond James analyst Brian Vaccaro downgraded the stock to "underperform" from "market perform," expressing concern that the lost sales from the E.coli outbreak "could prove to be more permanent in nature." He did not specify a target price.


Acumen Capital analyst Brian Pow initiated coverage of Hardwoods Distributions Inc. (HWD-T) with a "buy" rating and $22.75 target. Consensus is $25.75.

"The company recently completed a transformative acquisition of Rugby Architectural Products for $107-million U.S. (excluding potential long-term incentives of up to $13-million)," said Mr. Pow. "Rugby was a turnkey acquisition that increased Hardwoods' U.S. presence and expanded its scale considerably on the Eastern seaboard. Following the Rugby acquisition, management estimates that Hardwoods has 10-per-cent market share of the North American hardwood lumber and sheet goods market (with variation between regions). This provides Hardwoods with significantly more scale than its competitors that operate one or more distribution centres and a small number of competitors that operate distribution centres in multiple regions. No competitor has the same geographic reach throughout North America as Hardwoods."


In other analyst actions:

Yahoo! Inc. (YHOO-Q) was cut to "hold" from "buy" by Needham analyst Laura Martin. She maintained a $40 (U.S.) target, compared to the $44.02 analyst average.

Teck Resources Ltd. (TCK.B-T) was upgraded to "outperform" from "sector perform" by National Bank analyst Shane Nagle. He also raised his target to $35 (Canadian) from $25, while the average is $25.61.

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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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