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Tuesday's analyst upgrades and downgrades

Finning International Inc , the world’s biggest dealer of Caterpillar Inc equipment.

Caterpillar Inc.

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

Finning International Inc.'s (FTT-T) current valuation is getting "in the way of a good story," said Canaccord Genuity analyst Yuri Lynk.

Citing "strong" year-to-date relative and absolute share price performance, Mr. Lynk downgraded his rating for Finning to "hold" from "buy."

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"Finning shares have appreciated by 37 per cent year-to-date inclusive of the dividend, compared to the equipment group at 19 per cent and the S&P/TSX Composite Index at 17 per cent," he said. "The gains have been justified, in our view, and reflect the progress management has made reducing overhead and increasing the company's mid-cycle earnings power. However, with Finning shares having achieved our target price and no real improvement on the macro front seemingly imminent (outside of the better Product Support revenue we expect in 2017), we feel the stock is best positioned as a hold at this juncture."

Mr. Lynk said he believes stocks in the equipment group are currently expensive compared to 2017 estimates. He noted Finning is trading at 17 times his full-year earnings per share projection, already at a Street high. The company has historically traded at 14.0 times forward EPS.

Ahead of the release of the company's third-quarter financial results on Nov. 3, the analyst lowered his third-quarter EPS projection by 14.5 per cent to 22 cents (from 26 cents). His estimate is 3 cents lower than the consensus and would represent a12-cent drop year over year.

"Indicators we track continue to point to a difficult operating environment, and we wonder if Finning's stock price might be ahead of fundamentals," he said. " Firstly, Caterpillar (CAT-N) recently reduced its full year earnings outlook for the third time this year and guided that 2017 revenue won't be significantly different than 2016. CAT is seeing construction equipment sales tail off in North America and sees no rebound in mining orders. Secondly, 20 per cent of fleets are still parked in Chile, a key market for Finning, and copper production in the country was flat y/y in Q3/2016 against an easy comparable. Thirdly, Western Canadian construction markets remain weak. Lastly, the UK is a tough market and the 16-per-cent year-over-year depreciation in the pound vis-a-vis the Canadian dollar in Q3/2016 further reduces reported EBIT.

"It's not all bad and looking into 2017, we continue to see $1.42 in EPS. A full year's benefit of management's cost reduction efforts is a good start. Recall, management has reduced SG&A costs by 20 per cent from 2014, the bulk we believe are permanent and have materially increased Finning's mid-cycle earnings potential. Product Support revenue should increase 5.1 per cent next year with Cochilco forecasting a 3.9-per-cent increase in Chilean copper production and CAPP forecasting a 14-per-cent rebound in oil sands mining production. Furthermore, we see good rebuild activity as we wrote about in our Sept. 16."

Mr. Lynk said management has done a good job through the recent downturn, but he believes it is limited in its ability to take further actions beyond cutting sales force.

"With no sign of positive change in end-market demand and the stock having materially outperformed, we wish to move to the sidelines," he said. "A material pull back in the share price could cause us to reassess our recommendation, all else being equal."

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His target price for the stock remains $24. The analyst consensus price target is $25, according to Thomson Reuters.


Raymond James analyst Ken Avalos initiated coverage of Milestone Apartments Real Estate Investment Trust (MST.UN-T) with an "outperform" rating, emphasizing his expectation for strong same property net operating income (SPNOI) and funds from operations (FFO) growth.

"Milestone targets multifamily properties in Sunbelt cities in the Southeast and Southwestern U.S.," he said. "In contrast to many of its public peers in the U.S. and Canada (that invest in the U.S.), Milestone is focused on what we would consider high quality B properties, middle market/workforce oriented housing, and less on newer vintage, Class A properties. The company generally tries to acquire two to four storey, lower density properties, with attractive amenity packages and strong locations near transit corridors or workforce centers. Geographically the focus is on cities/Metropolitan Statistical Areas (MSA) with strong population and employment growth trends. Going-in yields on the property profile Milestone targets generally tend to be modestly higher than A and/or mid-high rise properties, and provide steady rental rate growth. We think the company can acquire between 5.5 per cent and 7 per cent depending on numerous factors, and will look to add 50 to 100 basis points of yield through its management and operational focus."

Touting its "attractive" long-term fundamentals, Mr. Avalos added: "We think Class B apartment fundamentals in the company's focus markets will remain relatively strong. Rental rate growth in the REIT's workforce oriented portfolio should continue to be in low to mid-single digits in the intermediate-term. Admittedly, supply concerns continue to weigh on investors' minds, and rents have slowed nationally, but most of this is Class A/luxury product and is less relevant to Milestone's value-oriented product.

He said Milestone can deliver SPNOI growth of 3-5 per cent through 2017, based largely on mid-single digit rental growth across its portfolio and "manageable" expense growth. Those "solid" results should translate into single-digit core FFO growth, he added.

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"With the impact of new acquisitions ($50-million per quarter), we expect Milestone to deliver 6-per-cent FFO growth in 2016 and 8 per cent in 2017," said Mr. Avalos.

"Generally speaking, we don't expect sizable changes in portfolio performance given its mature nature and the steady macro outlook within the company's markets. Given job/population growth expectations in Milestone's top 5 markets, we expect rental rate growth to range between 3–5 per cent across the company's portfolio, with Houston the key exception. Though Dallas should remain solid, we do expect marginal slowing from strong current rental rate growth levels. Nashville, Atlanta, the company's Florida markets and San Antonio should continue to generate 3% plus rental rate growth within the Milestone portfolio. On the operating expense side, we don't expect dramatic changes, to the up or downside. Property taxes continue to be the primary source of pressure on the operating expense line, but the company will continue to mitigate that as best as possible by challenging assessments or any appeal mechanisms."

He set a price target for the REIT of $21 per unit. Consensus is $23.09.

"The senior management team has been involved in the acquisition, operation and disposition of apartment assets for over 20 years," he said. "The company has a track record of generating strong returns for investors. Since going public the REIT has delivered 25-per-cent-plus annualized total return to shareholders (versus the TSX Capped REIT Index's 11-per-cent total return)."


Based on a "significantly" lower forecast, Canaccord Genuity analyst Yuri Lynk downgraded Petrowest Corp. (PRW-T) to "sell" from "speculative buy" prior to the release of its third-quarter results on Nov. 10.

"We expect yet another weak quarter due to extreme weather that will once again push improved bottom-line performance into the future," said Mr. Lynk. "We have long flagged the risk of having as much as 50 per cent of EBITDA coming from the Site C project. We are seeing these risks come home to roost. In short, our confidence in our forward estimates is low as the company struggles to expand into other end markets. At the same time, the balance sheet remains stretched, limiting Petrowest's financial flexibility. We believe risks outweigh potential upside, and we are adjusting our rating accordingly."

He lowered his quarterly revenue and earnings before interest, taxes, depreciation and amortization estimates by 34 per cent and 53 per cent, respectively, to $49-million and $5.5-million. The latter is well below the consensus of $7.2-million.

"We believe heavy rains and flooding in the Fort St. John area and the Grande Prairie region reduced the company's ability to work in the quarter," the analyst said. "We note Western Energy Services (WRG-T) lost 227 of its 940 operating days due to weather. Similarly, Calfrac Well Services (CFW-T) noted weather-related challenges that have continued into Q4. Most disappoint to us is that weather-related negative earnings surprises are becoming the rule rather than the exception."

Mr. Lynk's full-year 2017 and 2018 estimates also dropped. His 2017 revenue and EBITDA estimates declined 3 per cent and 16 per cent, respectively, to $275.9-million (from $283.2-million) and $34.4-million (from $40.7-million). His 2018 estimates are down 6 per cent and 22 per cent, respectively, to $252.9-million (from $270.2-million) and $26.4-million (from $34.1-million).

"While Site C continues to move along, albeit delayed, we believe Petrowest's attempts to further penetrate the infrastructure markets could prove difficult," he said. "The company was not selected for the Calgary Ring Road and competition on other projects we are tracking is high. Meanwhile, drilling activity remains depressed (year-to-date activity in B.C. is down 44 per cent year over year), and we are now expecting a more modest recovery.

"Petrowest's financial flexibility is quite limited. We estimate the company will have $60-million in net debt at the end of Q3/2016 or 7.2 times TTM [trailing 12-month] EBITDA. Petrowest has already received a waiver from its lenders that is good until Nov. 10. We believe a new debt structure could be announced at that time although, again, this is something that appears to be taking longer than we anticipated."

Mr. Lynk lowered his target price for the stock to 20 cents from 45 cents. Consensus is 82 cents.


Calling Stryker Corp. (SYK-N) third-quarter "winners," BMO Nesbitt Burns analyst Joanne Wuensch upgraded the stock to "market perform" from "underperform."

"Our downgrade of Stryker was predicated on the thesis that 1) its valuation was full, and EPS beats would be needed to sustain it; 2) Zimmer Biomet's franchise would be recovering and in a share regain mode, making it more difficult for Stryker to take share (making it more difficult to beat and sustain its valuation); and 3) the implementation of orthopaedic bundled payment programs would become a headwind," said Ms. Wuensch. "This thesis is no longer applicable, and we are therefore revisiting our rating, upgrading SYK shares ... Addressing each of these in turn. Stryker has done a very good job of delivering results, particularly in the 3Q16, leveraging its diversified portfolio. While there were some gives and takes in the quarter, it is one of the few that has shined this earnings season. We anticipate the upcoming analyst event to be a positive catalyst, alleviating concerns regarding the product and pathway as 2017 begins. In regard to returning competitive vigor, this doesn't seem to be so in the near term - although we need to keep an eye on it as Zimmer Biomet works through its supply chain issues. Last, but certainly not least, while bundled payments are here to stay, and even expand into other surgical procedures, as of now they are not providing a headwind to the medical device product pricing (although this, too, needs to be monitored)."

Ms. Wuensch said, under her thesis, "the 'winners' will continue to be rewarded." However, she said: "Current valuation (trading at 18.1 times 2017 estimate versus the group's 16.7 x, excluding BAX and EW), management's penchant for acquisitions (we liked the SAGE acquisition, less so Physio Control, and share repurchases are on hold), and seemingly limited operating leverage hold us back from becoming more aggressive."

She maintained her target price of $125 (U.S.). Consensus is $126.90.


Though its third-quarter results met expectations, Desjardins Securities analyst Bill Cabel said a lack of visibility on its future growth keeps him neutral on TransAlta Renewables Inc. (RMW-T) at its current trading level.

On Monday, the Calgary-based energy company reported adjusted earnings before interest, taxes, depreciation and amortization of $83-million, narrowly missing Mr. Cabel's $84-million projection though ahead of the $81-million consensus estimate. Adjusted free cash flow per share of 25 cents fell in line with his expectations.

"Overall, the assets are performing well. RNW should be able to deliver on its 2016 adjusted EBITDA and CAFD (adjusted FCF) guidance of $365–390-million (our estimate is $391-million) and $210–235-million (our estimate is $226-million), respectively," the analyst said.

He added: "While RNW does not hold conference calls, its parent TransAlta Corporation (TA-T, TAC-N) is scheduled to hold its call on Friday, Nov.  4  … At this point, we do not expect any material comments that might impact the very near-term outlook. We believe TA will provide more visibility on future dropdowns and growth initiatives once it has greater clarity on the outlook in Alberta for coal retirement and renewable procurement (hopefully by year-end 2016)."

Maintaining a "hold" rating for the stock, he raised his target to $14 from $13.75. Consensus is $14.58.

"Beyond the South Hedland project, which is progressing as expected (mid-2017 COD), visibility on growth is limited, and it is difficult to predict when further dropdowns/acquisitions might arrive and allow us to see more upside from current levels," Mr. Cabel said.


Noting its improved free cash flow generation and near-term seasonal tailwinds, Citi analyst Alexander Hacking upgraded Vale SA (VALE-N) to "neutral" from "sell."

"We downgraded Vale to Sell in 2014 on the thesis that 2014-16 would be a cash crunch, and this now appears to be in the rear-view mirror," said Mr. Hacking. "Chinese steel production and iron ore prices have surprised on the upside this year – and we likely missed the cyclical floor in Vale, which now looks like 1Q16. Structurally we still have residual concerns that Chinese steel demand may decline over the next decade."

He raised his target price for the stock to $7.30 (U.S.) from $4.40. Consensus is $6.19.

"This multiple is relatively high but cyclically appropriate given that Citi is modeling $45/ton iron ore vs long-term of $55/ton, in our view," the analyst said.


In other analyst actions:

CIBC World Markets analyst David Haughton initiated coverage of Lundin Gold Inc. (LUG-T) with a "sector outperformer" rating and $7.30 target. Consensus is $7.79.

National Bank analyst Travis Wood initiated coverage of Vermilion Energy Inc. (VET-T, VET-N) with an "outperform" rating. Suggesting its free cash flow profile could be close to $1-billion by 2020, Mr. Wood sees Vermilion delivering 5-year CAGR (compound annual growth rate) of 9.5 per cent. He set a Street-high price target of $66 for the stock. The analyst average is $57, according to Bloomberg.

Brian Bagnell at Macquarie cut RMP Energy Inc. (RMP-T) to "neutral" from "outperform." He lowered his target to 90 cents from $1.50. The average is $1.13. Elsewhere, Michael Charlton at Industrial Alliance upgraded the stock to "buy" from "hold" and raised his target to $1.20 from $1.05.

Canadian Western Bank
(CWB-T) was rated a new "hold" by TD Securities analyst Lemar Persaud with a target price of $27 per share. Consensus is $26.46.

Alcoa Inc. (AA -N) was downgraded to "neutral" from "outperform" at Macquarie Research by analyst Anthony Young. His 12-month target price is $21 (U.S.), down from $34. The average is $31.04.

Chevron Corp. (CVX-N) was upgraded to "overweight" from "equal-weight" by Morgan Stanley analyst Evan Calio, who boosted his Street-high target to $130 (U.S.) from $113 (U.S.). The average is $115.

Allegion PLC (ALLE-N) was raised to "outperform" from "inline" at Imperial Capital LLC by analyst Jeffrey Kessler. His target price fell to $72 (U.S.) from $79 per share. The average is $76.30.

Brocade Communications Systems Inc. (BRCD-Q) was upgraded to "outperform" from "sector perform" by RBC Dominion Securities analyst Mitch Steves based on its organic potential and M&A valuation floor. He raised his target price to $14 (U.S.) from $11. The analyst consensus is $10.21. Mr. Steves said: "We think that Brocade makes sense as a strategic asset to the right operator or CEO (Hock Tan as a solid operator), which would lead to mid-single-digit accretion for the acquirer (35-per-cent-plus operating margin potential). M&A in the space (most notably ELX) should help put a valuation floor; in addition, with Brocade's operating margin in the 20s today we see the asset working up to the mid 30s. Beyond the M&A valuation floor, we think Brocade is continuing to gain share within the IP networking segment post Ruckus as it continues to attack and gain share from the federal vertical. This organic revenue growth and EPS potential could lead to $1.10-plus in EPS in FY17E and we think this would lead to multiple expansion as well (11x average could increase to 12-14x)."

RBC Dominion Securities analyst Jonathan Atkin downgraded Level 3 Communications Inc. (LVLT-N) to "sector perform" from "outperform" after its third-quarter earnings failed to meet expectations. He did raise his target to $63 (U.S.) from $58. Consensus is $58.92. Mr. Atkin said: "The current share price largely reflects deal expectations and we see more catalysts elsewhere in the sector."

Citing its agreement to sell the company to Blackstone Group LP in a $6.1-billion (U.S.) deal, TeamHealth Holdings Inc. (TMH-N) was lowered to "sector perform" from "outperform" by RBC Dominion Securities analyst Frank Morgan, who lowered his target price for the stock to $43.50 from $61. Consensus is $45.07.

Guggenheim Securities analyst Eric Wasserstrom downgraded Mastercard Inc. (MA-N) to "neutral" from "buy." He did not specify a target, while the consensus is $117.07.

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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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