Tuesday’s analyst upgrades and downgrades

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

In response to a "new era in generic drug reimbursement," Desjardins Securities analyst Keith Howlett downgraded his rating for Loblaw Companies Ltd. (L-T) on Tuesday.

The change comes following Monday's announcement of a new five-year savings initiative between the pan-Canadian Pharmaceutical Alliance (pCPA) and the Canadian Generic Pharmaceutical Association (CGPA). Under the deal, the prices of almost 70 of the most commonly prescribed drugs in Canada will be reduced by 25 to 40 per cent as of April 8.

The agreement is projected to provide savings of $385-million in the first year to public payers, which does not include the Quebec government, and up to $3-billion over the next five years.

"Savings to private payers who choose to adopt the government's reimbursement prices could potentially be greater than those realized by the governments," said Mr. Howlett. "Savings announced [Monday] are in addition to those previously negotiated for and by the province of Quebec, estimated at $300-million per year or $1.5-billion over five years."

With the deal, Mr. Howlett reduced the valuation multiple he applies to Loblaw's retail operating earnings before interest, taxes, depreciation and amortization (EBITDA) to 9.0 times from 9.5 times in order to reflect that "we no longer apply a higher multiple to pharmacy than to the grocery business."

"The drug reform announced [Monday] by the provinces (not including Quebec) ushers in a new era of government management of drug costs, enabled by the co-operation of all provinces (including Quebec)," he said.

The analyst reduced his 2018 earnings per share for Loblaw to $4.68 from $4.77, noting: "This reflects the estimated pre-tax impact of reduced generic drug pricing of $165-million (up from $115-million). Our target price is based on 9.0 times (previously 9.5 times) 2018 EBITDA from retail operations, plus the value of interests held in Choice REIT, using our real estate team's 12-month target price of $14.25 (previously $15.00). We also deduct the impact of one additional quarter of drug reform (the impact on 1Q FY19)."

Moving the stock to "hold" from "buy," Mr. Howlett also lowered his target to $76 from $84. The analyst average target price is $79.55, according to Bloomberg data.

"Loblaw has experienced a confluence of headwinds—drug reform ($220-million, our estimate), minimum wage ($190-million), bread price-fixing scandal ($75–150-million), to start) and tax litigation (greater-than $400-million in dispute)," he said.

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The recent weakness in Automotive Properties Real Estate Investment Trust's (APR.UN-T) unit price offers investors an "intriguing" investment profile, said Industrial Alliance Securites analyst Brad Sturges.

Citing its contractual cash flow profile as well as its current discounted valuation and 7.8-per-cent yield, Mr. Sturges raised his rating for Toronto-based REIT to "buy" from "hold."

"We expect that continued execution of the REIT's consolidation strategy of the Canadian dealership property market may act as a positive catalyst for APR's units in the next 12 months," he said. "We estimate that APR has close to $70-million in acquisition capacity based on a 55-per-cent debt to gross book value (GBV) asset ratio long-term target."

Mr. Sturges maintained a target price of $11.50 per unit. The average is now $11.94.

"APR's units trade at [approximately] 11.1 times 2018 estimated AFFO [adjusted funds from operations], below 14.2 times for its Canadian-listed commercial retail REIT peers on average," the analyst said. "In addition, the REIT's distribution yield of 7.8 per cent is 210 basis points (bps) above the 5.7-per-cent distribution yield for its Canadian-listed commercial retail REIT peers. APR's relative peer group includes Canadian REIT's focus on owning and operating commercial properties with either long-term triple-net leases, high single tenant property concentration, or have significant exposure to a single tenant."

Elsewhere, Raymond James analyst Johann Rodrigues initiated coverage of the REIT with a "market perform" rating, calling it a "stable, unique pure-play."

"Automotive Properties REIT is Canada's only public company that owns and operates automotive dealership real estate," said Mr. Rodrigues. "The 39 asset portfolio (1.4 million square feet on 126 acres) is located largely in six major Canadian markets (with Regina filling in for Ottawa in the traditional VECTOM acronym). The cash flows are among the most predictable and stable in the Canadian real estate landscape. Fully leased, the average remaining lease term is 13 years and 90 per cent of leases have contractual 1.5-per-cent annual rent step-ups. All this sustains a healthy 7.6-per-cent yield."

Mr. Rodrigues did not specify a target price for the REIT.

"As the only fully occupied portfolio and carrying the longest WALT in the space (13 years), we believe Auto Properties' portfolio is undoubtedly one of the most stable in the Canadian REIT space," he said. "As mentioned, we think this will help support its robust yield and may provide many investors with a safe place to park their capital. However, it appears Canada is finally in a rising rate environment, with the Bank of Canada raising its benchmark rate two weeks ago and likely to do so at least once if not twice more this year. In this type of backdrop, long duration REITs tend to underperform as they are not able to quickly hike rents to capture inflation, as debt costs rise and cap rates (possibly) expand. While the REIT has certain NAV-focused growth initiatives that they may partake in, management likely won't begin these endeavours for a number of years. Given all this, we believe it to be difficult to envision outsized FFO and NAV growth, or corresponding equity outperformance, from Auto Properties REIT in the near-term."

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Raymond James analyst Daryl Swetlishoff believes an "outstanding" fourth-quarter of fiscal 2017 is on tap for Canadian forest products companies after closing out the calendar year with a "bang."

"Forest Products stocks enjoyed strong share price appreciation in 2017, as key commodities (lumber, pulp and panels) enjoyed near double digit percentage gains.," said Mr. Swetlishoff in a research report previewing earnings season. "With cash SPF [Spruces, Pines and Firs] benchmark lumber prices breaking through the $500 (U.S.) barrier 2018 share prices are off to an impressive start; Forest Products stocks under coverage returned 6 per cent year-to-date versus the TSX Index at 1 per cent."

Despite the recent rally, Mr. Swetlishoff said shares prices for the sector continue to discount pricing "far below" current spot levels.

"With solid demand growth and a constrained supply chain we expect markets to remain tight into the spring building season," he said. "While seasonal volatility is always a risk; we expect demand to outstrip supply over the medium-term contributing to elevated commodity pricing and strong earnings and free cash flow."

"With a favourable macro landscape backstopping commodity tailwinds and a near record 4Q17 earnings season on tap (we expect Canfor & Interfor to beat consensus) we advocate investors add to positions."

Accordingly, Mr. Swetlishoff upgraded his rating for Western Forest Products Inc. (WEF-T) to "strong buy" from "outperform" with a target of $3.35 (unchanged). The average target among analysts covering the stock is $83.86.

At the same time, he downgraded Domtar Corp. (UFS-N, UFS-T) to "market perform" from "outperform," maintaining a $52 (U.S.) target, which sits above the $49.92 consensus.

"We are downgrading Domtar from Outperform to Market Perform given the rally in share prices approaching our $52.00 target," he said. "The stock has risen nearly 30 per cent since September of 2017 (vs. the TSX up 8 per cent), as it has tracked the gain in pulp prices. While the company will likely benefit from the tailwind in pulp prices and a lesser extent US uncoated free sheet, we expect that much of this value is in the stock which is now trading at 6.0 times 2018 enterprise value-to-EBITDA, which is well ahead of the pulp peer group at 5.2 times. We look for further clarity surrounding Domtar's potential to convert some mills to containerboard and this could represent a positive catalyst."

The analyst also raised his target prices for the following stocks:

- Canfor Corp. (CFP-T, "outperform") to $33 (Canadian) from $30. Consensus is $30.30.

- Interfor Corp. (IFP-T, "strong buy") to $31 from $29. Consensus is $26.33.

- West Fraser Timber Co. Ltd. (WFT-T, "outperform") to $94 from $88. Consensus is $83.86.

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Aphria Inc.'s (APH-T) $826-million acquisition of Nuuvera Corp. (NUU-X) "repositions it on the global cannabis stage," according to Canaccord Genuity analyst Matt Bottomley.

On Monday, Leamington, Ont.-based Aphria announced the cash-and-stock deal in which Nuuvera shareholders will receive $1 in cash plus 0.3546 of an Aphria share for each share they hold.

"Nuuvera is currently in the midst of expanding and building relationships in international markets, spanning a variety of countries in Europe (as well as Africa and the Middle East), where many medical programs are in the process of being regulated," said Mr. Bottomley. "We believe this deal provides Aphria with what could now be the largest international footprint in the industry, as well as increased technological proficiency through Nuuvera's expertise in extraction, distillation and processing."

"Unlike traditional LPs, we believe Nuuvera has uniquely positioned itself along the value chain, focusing on extraction and processing of cannabis. We view this to be a differentiated strategy that should separate the company as it addresses the medical markets in Canada and internationally and compliments Aphria's expertise in leading low-cost cultivation. After bringing Nuuvera's international reach into the mix, Aphria will now have exposure to Germany, Italy, Spain (markets with particularly attractive medical opportunities, in our view), in addition to Israel, Malta, Uruguay, the UK and Lesotho. By combining Aphria's industry leading capacity and cultivation expertise in Canada with Nuuvera's extensive global presence and processing capabilities, we believe Aphria is positioning itself as a leader among Canadian Licensed Producers with respect to its international strategy."

Mr. Bottomley feels the acquisition further legitimizes Aphria's medical strategy, noting: "In addition to its international reach, management believes that Nuuvera will help strengthen its extraction, distillation and processing capabilities as the company plans to penetrate global medical markets. We believe having a competitive advantage in the formulation and processing of cannabis will become increasingly important as many of the opportunities outside of Canada will likely compromise only medical markets for some time. Further, we believe that the company's focus on extraction and value-add products will ultimately be a better hedge against cannabis commoditization and pricing pressure over the long-term. Further, Aphria previously entered into an agreement with Shoppers Drug Mart to become the supplier of medical cannabis to what is currently the largest pharmacy chain in the country (should Shoppers received a sales license from Health Canada). The acquisition of Nuuvera could further legitimize Aphria as a leading producer of medical cannabis to existing and future strategic partners (which we believe will continue to enter the space)."

With the deal, the analyst increased his fiscal 2020 revenue and EBITDA estimates to $558-million and $210-million, respectively, from $436-million and $180-million.

His target for Aphria shares jumped to $26.50 from $23.50 with a "speculative buy" rating (unchanged). The average is currently $24.97.

Elsewhere, GMP Martin Landry upgraded Aphria to "buy" from "hold" with a $25 target, rising from $22.

AltaCorp Capital analyst Keith Carpenter lowered his target for Aphria shares by a loonie to $35 based on the dilutive effect of the additional shares. He maintained a "speculative buy" rating.

Mr. Carpenter said: "Aphria has been increasing its sights on the international market, and given the vast potential of demand that we expect from that market, we believe the acquisition of Nuuvera is a good strategic fit. We previously stated that it's reasonable over the long-term to envision 2 per cent of that collective international population to be users of medicinal marijuana, each consuming the equivalent of 0.8 grams per day. We had mentioned above that 20+ countries are actively pursuing medicinal marijuana, but in reality, in the coming years, we would expect many more countries to enact legislative change that would add to that potential demand. Aphria is building a solid productive foundation that is expected to be the low cost leader. To augment that potential by adding advanced relationships and pathways to sales into multiple international jurisdictions, places Aphria is a solid position to become the volume leader amongst its peers."

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Canada is "at the table" in the online gaming sector, according to Echelon Wealth Partners analyst Ralph Garcea, who expects an acceleration in growth for a market he projects will expand to $75-billion (U.S.) or more by 2025.

"According to gaming industry consultants, H2 Gambling Capital ('H2GC'), the global online gambling industry's (including online poker, casino, sports betting, bingo, lotteries and skill-based, and other games) gross gaming revenues ("GGR") has grown from $8.2-billion (U.S.) in 2003 to $44.3-billion in 2016," said Mr. Garcea. "GGR is defined as rakes plus bonuses, promotions, overlays and loyalty rewards, less prizes or winnings. We estimate that the combined global online gambling GGR could grow to $75-billion by 2025 for a compounded annual growth rate ('CAGR') of 6.1 per cent. The overall global gambling market (including land-based and tribal casinos) is expected to exceed $600-billion by 2025. We estimate that online gambling should go from 8 per cent of overall GGR in 2010 to 20 per cent by 2025; and that mobile should go from 12 per cent of online GGR in 2010 to 55 per cent-plus by 2025."

In a research report on the state of the growing sector, Mr. Garcea initiated coverage of a trio of TSX-listed companies involved with online gaming, noting "from a Canadian perspective, there are several different ways to invest in the global online gambling and lottery industries."

"Sentiment towards the gaming industry as reflected in the exhibit below has been mixed (to say the least!) over the past three years, with September 2017 marking a recent bottom," he said. "We believe this is reflected by increased chatter regarding industry consolidation which should fuel further excitement in the sector. The larger Canadian names all fared very well in 2017 with TSGI returning 54 per cent, ITX 53 per cent, NYX 89 per cent, and PBL returning 114 per cent, fueled by consistency of results, acquisitions, and a general normalization of sentiment towards the Canadian gaming players."

Calling it a market leader in online poker backed by the stability of its PokerStars platform, Mr. Garcea gave The Stars Group Inc. (TSGI-T), formerly Amaya Inc., a "buy" rating.

"The Stars Group has a stranglehold on the global poker marketplace, which comprises only 6 per cent of total iGGR [internet gross gaming revenue], and is continuing to roll out its BetStars product and PokerStars Casino offering, with the former in infancy stage. We expect TSGI to continue organically and inorganically investing in its sportsbook product and eat into the market share owned by its peers. Given its 115 million customers on the PokerStars platform, it will not be hard to cross-sell a fully developed, mobile-accessible sportsbook product."

Believing The Stars Group is "now a story of customer acquisition and cross-selling of products" as it leverages its PokerStars customer base to build other endeavours, including its BetStars sportsbook offering, the analyst set a price target of $40 for its shares. The analyst average target is $32.77.

"In the poker market, it's liquidity that matters most and PokerStars has the highest liquidity and tournament payouts in the world," said Mr. Garcea. "Greater liquidity attracts more players, which translates to bigger tournaments, larger payouts, and lower probability of player collusion."

Calling it a leading supplier of instant lottery tickets globally, Mr. Garcea also initiated coverage of Winnipeg-based Pollard Banknote Ltd. (PBL-T) with a "buy" rating.

"In 2015, the North American lottery market yielded revenues of roughly $77.5-billion (U.S.) and although not tracked publicly, we estimate the North American charitable gaming market yielded revenues of roughly $30-billion," the analyst said. "La Fleur's World Lottery Almanac estimates that the worldwide lottery market generated revenues of approximately $276-billion in 2015 and we believe the worldwide lottery ticket manufacturing industry to be roughly $700-million, measured in terms of annual revenue and related services to lotteries, with North American lottery ticket manufacturing representing $440-million of the total global market.

"According to La Fleur's, the worldwide instant ticket sales market has been growing at a five-year CAGR (2011 to 2016) of 2.9 per cent, and now comprises over 60 per cent of total lottery sales in the US. Pollard entered the instant ticket printing business in 1985 and has grown into a leading supplier that competes head-to-head with two large global competitors – IGT and Scientific Games. PBL's revenue is derived from long-term contracts (typically 3 to 5 years) with renewal extensions of several years. Pollard completed the $25-million installation of its new in-line printing press in Ypsilanti, Michigan, in 2017. Online lottery offerings (known as "iLottery") will be an important pillar for future growth, particularly in the U.S. where only a handful of jurisdictions sell lottery products online. PBL's acquisition of Innova Gaming Group closed in August 2017 – integration is underway."

He set a target of $24 for Pollard shares. The analyst consensus is $20.33.

"Only three players supply instant tickets to customers worldwide (including Pollard). The other two major competitors, Scientific Games and International Game Technology PLC (IGT) are diversified businesses and are focusing more on the gaming equipment market through hardware and service sales; recent consolidations by both parties are proof of this," he said. "The instant ticket industry has high barriers to entry; all three players (including PBL) are enjoying an oligopoly due to: (i) significant capital investment (and in-house expertise) required to fund and manage printing presses; and (ii) existing players having deep relationships with customers that are secured by credibility (and a reluctance to partner with anyone else). The charitable games industry is a much more fragmented, competitive space in the U.S. with many small companies offering a narrow range of products. Arrow International (Private) is the largest charitable games player, and has been growing through consolidation of the market."

Mr. Garcea also initiated coverage of Jackpotjoy PLC (JPG-LON, ITX-T) with a "buy" rating. U.K.-based Jackpotjoy is the parent company of The Intertain Group Ltd., and operates a trio of online gaming segments – Jackpotjoy, Vera&John and Mandalay.

"Jackpotjoy has a dominant position in the European bingo marketplace, which comprises only 4 per cent of total iGGR, and is continuing to roll out its bingo and casino offerings in new jurisdictions," he said. "We expect JPJ to continue organically and inorganically investing in its casino & bingo products and to continue to prove its dominance as a global leader in online bingo.

"Jackpotjoy should grow to £225-million-plus in 2018, with Vera&John adding £75-million-plus. Approximately 80 per cent of revenues come from regulated jurisdictions with the UK and Nordics representing 80 per cent of total revenue. JPJ is primarily a bingo focused company, with 66 per cent of revenues represented from this gaming vertical, with casino representing 28 per cent of its revenues. Growth in mobile has been impressive and now represents roughly half of total revenue and more than half of new customer acquisitions. A Latam rollout of its bingo platform (organic or inorganic) could take the Company past the £350-million revenue run-rate by 2019 or sooner. We note that 90 per cent of the Jackpotjoy segment's revenues came from players that joined in 2015 or earlier – a sticky demographic."

He set a price target for its shares of $20. The average on the Street is $18.

"Longer term, we expect a slight margin compression as geographical expansions take play, however, the dip should be temporary as investments in opex should provide healthy returns and increased cross-selling thereafter," he said.

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HIVE Blockchain Technologies Ltd. (HIVE-X) is well positioned to outperform its peers moving forward, according to PI Financial analyst David Kwan.

Citing its low-cost operations in "politically stable" jurisdictions and its strategic partnership with cryptocurrency mining leader Genesis Mining Ltd., which he called a "key competitive advantage," Mr. Kwan initiated coverage of the Vancouver-based firm with a "buy" rating.

"HIVE is leveraging Genesis' extensive cryptocurrency mining experience and expertise as well as benefitting from their cheap power costs, access to their leading edge technologies, and lower operating and equipment costs amongst other things," said Mr. Kwan in a research report released Monday.

"Genesis owns over 25 per cent of HIVE and has two representatives on the Board. We believe Genesis has a strong financial incentive to make HIVE a success."

The analyst warned that investing in the cryptocurrency and blockchain space is a risky proposition given the "exceptional" volatility seen in both cryptocurrency and share prices. Believing "the roller coaster ride is likely to continue," he expects regulatory uncertainty to persist in the near term.

However, Mr. Kwan said Hive stands out in the space noting: "Some of the key attributes of a successful miner are cheap power, a cool climate, and a politically stable jurisdiction. With operations in Iceland and Sweden and its partnership with Genesis, we believe HIVE checks all of these boxes and will be one of the lower cost miners, enabling them to generate stronger margins and cash flow in the good times and better weather the down times."

The analyst set a price target of $5.25 for Hive shares.

"HIVE is one of the larger cryptocurrency miners globally and has secured an exclusive partnership with a world class partner in Genesis Mining," he said. "The Company also has a strong organic growth profile and superior margins aided by its low cost structure that should help it better weather any sector-related headwinds relative to its peers. With the key merits we have previously discussed and given HIVE is (one of) the largest and most liquid names in the space (which has helped it get included in some blockchain ETFs, as noted below), we believe HIVE should trade at a premium valuation to its peers.

"However, we note that there are relatively few publicly traded cryptocurrency miners and with little to no historical financial information as well as (third party) forecasts, doing a relative trading valuation analysis at this point is not practical/possible."

Elsewhere, GMP Securities analyst Deepak Kaushal initiated coverage with a "speculative buy" rating and target of $5.35, believing the company offers investors unique exposure to the blockchain sector and its Genesis partnership will prove to be a competitive advantage.

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In other analyst actions:

GMP analyst Martin Landry initiated coverage of CannTrust Holdings Inc. (TRST-CN) with a "buy" rating and $17 target. The average on the Street is $10.90.

TD Securities analyst Aaron MacNeil upgraded Trinidad Drilling Ltd. (TDG-T) to "buy" from "hold." Mr. MacNeil raised his target to $2.50, which is 7 cents less than the consensus, from $2.

Cormark Securities analyst Richard Gray upgraded Torex Gold Resources Inc. (TXG-T) to "buy" from "market perform" with a $19 target, up from $13. The average is $21.

TD Securities analyst Daniel Chan initiated coverage of Enghouse Systems Ltd. (ENGH-T) with a "buy" rating and $74 target. The average is $66.40.

AltaCorp Capital analyst Thomas Matthews downgraded Prairie Provident Resources Inc. (PPR-T) to "sector perform" from "speculative buy" and lowered his target to 55 cents from 60 cents. The average is $1.23.

Exane BNP Paribas analyst Jeff Stent downgraded Colgate-Palmolive Co. (CL-N) to "underperform" from "outperform" and dropped his target to $70 (U.S.) from $90. The average is $76.61.