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Wednesday's analyst upgrades and downgrades

Trican Well Service employees walk towards liquid nitrogen storage tanks at a hydraulic fracturing operation near Bowden, Alta., in this file photo.

jeff mcintosh The Globe and Mail

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

Citing the potential for its Rosebel gold mine in northeastern Suriname, Canaccord Genuity analyst Tony Lesiak upgraded his rating for IAMGOLD Corp. (IMG-T, IAG-N).

Mr. Lesiak moved the Toronto-based company to "buy" from "hold" following a tour of the facility, which he said exhibited improved productivity, throughput and "major" costs savings in most areas of the operation.

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"The company is ahead of schedule to complete the secondary crusher and appears to be able to bring the additional crushing capacity online mid-November," said Mr. Lesiak. "The work on the plant to date has improved the base case 6.9 Mtpa [million tons per annum] throughput at 90-per-cent hard rock to 9.0 Mtpa. Further upside could exist following studies on installing a second pebble crusher, potentially allowing the plant to run at near 10 Mtpa at 90-per-cent hard rock (dependent on the results of internal studies). We believe the key to value maximization at Rosebel, however, remains in the exploration potential of the large land package. Key areas of potential mine life extension lie in saddle zones between current pits, the Overman target, and the recently acquired Saramacca deposit, which is the focus of current exploration efforts and an important source of soft rock feed."

Mr. Lesiak emphasized the fact that the stock has declined 36 per cent in price since August and now trades at a 17-per-cent price-to-net asset value discount to its peers.

"While IMG has been one of the best performers owing to its leverage to gold (2.5x) we believe some of the re-rating has been due to the company's strong cost focus, improved balance sheet and margins, and declining redevelopment risk at Westwood. If IMG keeps up this pace, it may lose some of its torque status," he said. "In any event, exploration potential in IMG is escalating with Rosebel and Boto [in Senegal] clearly in focus. We also note the optionality from the potential development of the Sadiola expansion project and IMG's improved balance sheet to pursue new development opportunities."

Mr. Lesiak raised his target price for the stock to $8 from $7.50. The analyst consensus price target is $6.55, according to Thomson Reuters.

"Our valuation now reflects the previously announced equity financing for gross proceeds of $230-million (U.S.) through the issuance of 44.7 million shares and the subsequent debt early tender offer for aggregate principal of $145.7-million, impacting our per share estimates," the analyst said. "Based on the increased projected return to our improved target price, we are upgrading our IAMGOLD rating … following our recent tour of Rosebel and improved return to target (now 67 per cent) following recent share price retracement."

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Element Fleet Management Corp. (EFN-T) is a "pure-play leader in the attractive fleet management sector," said Raymond James analyst Michael Overvelde.

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Following an Oct. 3 spin-off of its equipment leasing business into ECN Capital Corp. (ECN-T), Element Financial Corp. became Element Fleet.

"We believe it features an attractive combination of organic fee-oriented revenue growth, low funding costs, high leverage potential, limited cyclicality, M&A optionality, integration-related profitability improvement and sustainable competitive advantage driven in part by its leading scale," said Mr. Overvelde.

He said he's "attracted" to the sector, saying it features "a concentrated and stable market structure, fairly high barriers to entry, a revenue mix that is becoming increasingly dominated by service-based fees, limited cyclicality and credit risk, and a low level of outsourcing that represents a long-term organic growth opportunity."

"Element Fleet is positioned as, by far, the largest player in the North American fleet management sector, an industry where scale truly matters," he said. "As a massive buyer of automotive parts, for example, it has established procurement agreements with major suppliers resulting in cost savings that can be shared with clients. By piecing together the already-large vehicle maintenance networks of Element Fleet and GE Fleet, it now has an unparalleled service network that enhances customer convenience. Because it has the biggest fleet of vehicles under management, it has accumulated the largest data set of customer activity information, providing it with more comprehensive benchmarks that can be used when consulting clients on productivity issues. Its size and profitability provide it with a superior ability to fund ongoing investment in technology to remain an industry leader. And we suspect that the size and diversification of its managed vehicle portfolio contribute to the low funding costs that it is able to achieve."

Mr. Overvelde is forecasting operating earnings growth of 10 per cent per year through 2018, citing 5-6-per-cent in annual earning asset growth, 8-per-cent growth in fee-based revenues and 4-per-cent opex growth.

He maintained a "strong buy" rating for the stock and set a target of $17. Consensus is $17.75.

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At the same time, Mr. Overvelde initiated coverage of ENC Capital Corp. (ECN-T) with an "outperform" rating, calling it "an emerging company in a mature market."

"Although its current leasing end-markets are mature in nature, we consider ECN to be a growth-oriented company given the growth dynamics of the asset management market it is targeting, its current expansion and acquisition plans, and the track record of its senior management team in aggressively growing similar businesses (e.g., Newcourt Credit and Element Financial), largely via M&A," he said.

Mr. Overvelde does expect near-term earnings and share price volatility as ECN transitions its balance sheet and makes acquisitions to fit its corporate strategy.

"Coincident with its separation, ECN has adopted a new corporate strategy involving a planned transition into a hybrid leasing and asset management company engaged in structuring and managing investment funds for yield-hungry institutional investors," he said. "We expect this transition to involve a partial shift of on-balance sheet exposures into managed funds, and that it will pursue an acquisition of a private debt fund manager in the near term to establish a U.S. Middle-Market Finance presence. While a successful evolution into a less capital intensive, more fee generative and higher [return on equity] business might eventually warrant a higher valuation for ECN, we expect that the risks and earnings volatility associated with the transition process will likely constrain its valuation in the near-term."

He set a price target of $4.40. Consensus is $4.52.

"We expect that ECN's share price will be fairly volatile in the near-term as we believe it could take some time for its shareholder base to transition into the hands of holders that own the stock on its own merits," said Mr. Overvelde. "Immediately following the separation transaction, 100 per cent of ECN's shares were owned by Element shareholders. Any Element shareholders that owned the stock primarily for exposure to its dominant Fleet Management segment now own that business separately as a pure-play and might not have similar interest in owning ECN. Also, we expect that certain holders of the larger-cap Element stock might not have the interest and/or ability to own shares in a company of ECN's size. While the determination to sell ECN for either of these two reasons might be made relatively quickly, we expect that it might take somewhat longer for new shareholder demand to build, resulting in a potential selling imbalance in the very near-term."

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Desjardins Securities analyst Maher Yaghi said he remains "on the sidelines for now" on Amaya Inc. (AYA-T, AYA-Q) following "soft" third-quarter preliminary results and the conclusion of its strategic review.

Mr. Yaghi said investors are likely to be disappointed after the review, released Tuesday, failed to result in a successful bid for the Montreal-based online gambling company or the potential for a merger. Amaya shares fell over 8 per cent on Tuesday in reaction to the news, which included the announcement that talks with potential suitor William Hill PLC have ended.

"The termination of the strategic review indicates that finding a partner or a private equity group willing to pay a premium for AYA shares is not likely to occur in the medium term," said Mr. Yaghi. "Reduced leverage will be needed to become an attractive takeover candidate, in our view."

The company also announced preliminary quarterly revenue of $268-273-million (U.S.), below the consensus projection of $281-million.

"We believe revenues were soft because poker revenues were likely flat to down 2 per cent year over year, similar to the [drop of] 0.2 per cent reported in 2Q16," the analyst said. "This is a key metric for the company's prospects and we have been highlighting it as a reason why we are not bullish on the stock. We think this announcement will be disappointing, as management had indicated on the 2Q16 earnings call that poker revenues had bounced back in August. The company also indicated its quarterly net yield was $110–111, up 4–5 per cent year over year but down about 6 per cent quarter over quarter from $117 versus a decline of 3 per cent quarter over quarter in 3Q15."

He added: "AYA has to make a $400-million deferred payment on Feb. 1, 2017 as part of its acquisition of the Rational Group. The company indicated that the balance of funds set aside for this payment was $144-million as of Sept. 30, up from $129-million at the end of 2Q16. We forecast that Amaya will not be able to generate enough FCF by February 2017 to make the deferred payment and still retain a total secured leverage ratio below 4.75x. Hence, some form of external financing will likely be required to fund this payment. Management has indicated that it is working on finding a non-dilutive solution to this issue. Potential avenues could include securing temporary relief from debtholders; however, until we learn what action the company will ultimately take to secure the funds, it is hard to ascertain the impact on shareholders."

Mr. Yaghi maintained his "hold" rating for the stock, but he lowered his target by a loonie to $22. The analyst average is $25.41, according to Bloomberg.

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The third quarter for the oilfield-services sector is likely to be "modestly softer" than the Street expects, according to CIBC World Markets analyst Jon Morrison.

"Although the third quarter itself was another challenging period and there are endless reasons to be cautious about the current operating environment, we believe a number of positive data points arose over Q3/16 which warrant some positive attention and, in our view, underpin a more constructive backdrop for the broader sector," he said in a research note previewing quarterly results.

"Firstly, North American E&P capex budgets witnessed some modest expansion for the first time in ten quarters. And while the aggregate amount of the spending creep is fairly marginal compared to historical standards, it signals that the market trough is firmly behind us and activity levels should start to tick higher in a number of North American plays. Secondly, we believe oilfield services pricing hit a floor in the quarter and we haven't seen any further degradation across any major onshore service lines over the past eight weeks. And while we remain measured about how quickly things will recover, we believe there are fairly clear signs for some pricing increases starting to unfold in H1/17. And lastly, we are witnessing a growing appetite from a number of producers to start procuring oilfield services equipment and crews under longer-term contracts and with a greater sense of urgency than we have seen in nearly 30 months. As such, while one always needs to be cautious about head fakes and a reversal of fortunes in any early stage recovery, as we highlighted after the Q2/16 reporting season, this is the time when the sector deserves more attention and increased capital allocation, in our view."

Mr. Morrison did not change the ratings for any stocks in his coverage universe. However, he made several target price changes, noting: "On average, we are making 9-per-cent downward revisions to our third-quarter estimates, while we are also making 2-per-cent downward revisions to each of our full-year 2016 and 2017 estimates. We are also increasing our target prices on Canyon, Enerflex, Ensign, Mullen and Trican to reflect the modest improvement in crude prices and strengthening view that 2017 should be a turnaround for the industry. We are decreasing our price target on Western to reflect a tempering in near-term estimates and higher-than-desirable leverage ratios."

There changes were:

- Canyon Services Group Inc. (FRC-T), sector outperformer, to $8 from $7.50. Consensus: $6.79.
- Enerflex Ltd. (EFX-T), sector outperformer, to $18.50 from $17.50. Consensus: $16.36.
- Ensign Energy Services Inc. (ESI-T), sector performer, to $9.25 from $8.75. Consensus: $8.44.
- Mullen Group Ltd. (MTL-T), sector performer, to $19.50 from $18.50. Consensus: $18.09
- Trican Well Service Ltd. (TCW-T), sector performer, to $3.25 from $2.75. Consensus: $3.49.
- Western Energy Services Corp. (WRG-T), sector outperformer, to $4.50 from $5.50. Consensus: $3.71.

"There is no other way of saying it – the macro environment is terrible," said Mr. Morrison. "Oil prices continue to be volatile and visibility for the North American oilfield services sector is near a three-decade low. And while there are endless reasons to be positive about where commodity prices will head in 2017 and how the operating environment appears to be at a trough, today the outlook looks opaque at best.

"With this said, therein lies the opportunity. Great investments in the oilfield services sector are rarely made by initiating new positions mid-cycle following a bullish run in stocks and while the outlook is still glowing. We have long stated that in order to make adequate risk-adjusted returns within the sector, investors need to be positioned near the bottom of the cycle when the outlook is terrible (or worse), proceed to hold the names through the market malaise, and then be prepared to sell equities and reduce sector weightings once the health of the industry is widely accepted and forward upside potential is compelling. As it stands, we feel like we are near point one in that that three-stage cycle. While there are lots of reasons as to why high-quality names could slide and provide incremental negative short-term beta, we view the bottom as being near and believe now is the time for investors to do their homework and start selectively adding exposure to the space. Overall, we continue to have a bias towards owning higher-quality companies with strong balance sheets, limited to no liquidity concerns on the near-term horizon, strong and logical management teams, leverage to increased spending activity levels, and trade at reasonable valuations. Moreover, we do not believe it is necessary or prudent to "swing for the fences" at this stage in the cycle with the most financially leveraged companies to make a compelling return. Taking this view into account, our current top picks are Precision, Secure, Enerflex and Western."

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There's a "compelling" long-term outlook for the "New Yum," said Credit Suisse analyst Jason West.

Accordingly, he upgraded his rating for Yum! Brands Inc. (YUM-N) to "outperform" from "neutral" in reaction to his takeaways from an Oct. 11 investor day, which discussed the coming spin-off of the company's business in China into a licensed structure.

Mr. West said the update for what he calls the "New Yum" was a "positive surprise" and noted the stock does not currently reflect his optimism. Among the factors he cited were: a higher franchise mix leading to a lower business risk; reduced expenses; lower capex; upside on buybacks and dividends as well as "significant" earnings per share growth.

"Even though we are moderately below management's 2019 EPS target of $3.75 (U.S.), we still see significant value in the stock on our model," said Mr. West. "We see a forward base case for the New Yum stock price in the $80/share range by mid-to-late 2018 (up from $62 in the 'when-issued' market today), driven by EPS growth and some multiple expansion due to rising franchise mix and free cash flow. This $80 share two-year stock price assumes multiple of 16 times our 2019 estimated EBITDA and 23x 2019 estimate price-to-earnings. This suggests a total return of 30-35 per cent over two years when including the annual dividend yield of 2 per cent. While a lot can change in two years, we see relatively low risk to our New Yum earnings model given high-90-per-cent franchise mix, a balanced portfolio across three distinct brands, a broad geographic footprint, and relatively low exposure to SSS [same-store sales] and company-operated margins.

"We note that [approximately] 30 per cent of the EPS growth we have modeled from 2017 to 2019 for New Yum comes from share buybacks, with the balance driven by new unit openings and SSS growth. We also see some room for fundamental upside to our New Yum model, particularly around the Pizza Hut business. We note that this brand has dramatically underperformed peers in recent years and the new Yum structure will put more emphasis on the trends in this business."

He raised his price target for the stock to $96 from $90. Consensus is $97.85.

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In other analyst actions:

Twitter Inc. (TWTR-N) was upgraded to "hold" from "sell" by Evercore ISI analyst Ken Sena with an unchanged target of $17 (U.S.). The average is $16.67.

Wells Fargo & Co. (WFC-N) was cut to "market perform" from "outperform" by FBR analyst Paul Miller with a target of $45, down from $50. The average is $49.57.

CIBC World Markets analyst Stephanie Price upgraded Descartes Systems Group Inc. (DSG-T, DSGX-Q) to "sector outperform" from "sector perform" and raised her target to $33.43 (Canadian) from $28.75. The average is $30.45.

Echelon Wealth analyst Ryan Walker initiated coverage of Auryn Resources Inc. (AUG-X) with a "speculative buy" rating and $4.50 target. The average is $4.83.

Rosenblatt Securities analyst Kirk Adams initiated coverage of Shopify Inc. (SHOP-N, SH-T) with a "buy" rating and $50 (U.S.) target. The average is $46.35.

Editor's Note: In an earlier version of this story, ECN Capital Corp. was incorrectly identified as Element Capital Corp. This version has been updated.

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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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