Wednesday’s analyst upgrades and downgrades

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

Kinaxis Inc. (KXS-T) took "one step forward, one step back" in the second quarter, according to Canaccord Genuity analyst Robert Young.

However, in response to a reduction in its full-year guidance that coincided with the release of its second-quarter financial results on Tuesday, Mr. Young downgraded the Kanata, Ont.-based provider of cloud-based subscription software for supply chain operations to "hold" from "buy."

"Kinaxis shares have garnered a premium valuation based on a leading combination of growth and EBITDA margin," he said. "This premium multiple is predicated on a high level of predictability and consistent strong execution. With the quarter, Kinaxis has warned that management now sees a lower level of growth in 2017, in part due to a significant customer breach of contract. While this may prove to be a temporary impact, details are vague and uncertainty is increased. We do see continued strength in EBITDA margin given the increased guidance - a bright spot to be certain and one which underscores Kinaxis' premium valuation even at our lowered target."

The company reported subscription revenue growth for the quarter of 21 per cent year over year, missing Mr. Young's expectations.

"The issue in the quarter was a large Asia-based customer who breached its contractual obligations, leading to all related revenue not being recognized in the quarter," the analyst said. "Consistent with the management team's conservative stance on accounting and guidance, Kinaxis also removed related future revenue from its F2017 guidance. This issue negatively impacted subscription revenue in the quarter by approximately $1.0-million. If we ignore this single customer issue, subscription revenue growth would have been 26 per cent year over year, to $25.2-million in line with our original estimate."

"Transition of Pro-services to the channel exacerbates the miss – a good thing but not right now. Total revenue of $32.9-million (up 14 per cent year over year) was below our $35.4-million estimate and consensus of $35.1-million. In addition to the customer issue, total revenue was impacted by lower professional services revenue. This is a very good thing, in our view, albeit a near-term headwind. Channel partners, such as Accenture and Deloitte, are increasing their ownership of customer deployments and implementations, particularly on existing customer expansions. Kinaxis has been driving for this level of partner engagement as it frees up highly trained Kinaxis field engineers for higher margin sales-oriented work. The pace of partners taking on integration work is faster than Kinaxis expected. This is too much of a good thing, too soon. While a near-term revenue headwind, it is a positive trend for the business, in our view. With lower mix of low margin pro-services revenue, Kinaxis is in a good position to expand margins. As well, we expect Kinaxis to benefit from the much wider reach of its channel partner sales organizations."

Kinaxis reduced its outlook for fiscal 2017, expecting top-line revenue of $131-$133-million (down from a previous range of $140-$144-million). Underlying subscription revenue growth of 21-23 per cent is a reduction from 26-28 per cent due to the issue with its Asian customer.

"Kinaxis indicated that it is seeing strong customer interest and that the pipeline continues to be very active," said Mr. Young. "Kinaxis highlighted an increasing contribution from automotive and life sciences, and more recently consumer packaged goods which it describes as 'exceptionally healthy.' Opportunities continue to be well balanced across North America, Asia Pacific, and Europe. Kinaxis sees a TAM of 2,000 companies in its target verticals. With subscription deals now breaking through $5-million annually, this is an estimated $10 billion TAM. We see multiple drivers of a widening funnel including (1) direct sales efforts bolstered by an improving profile, (2) growing unsolicited leads, (3) new contribution from the channel, (4) new opportunities in APAC, particularly Korea and Japan, and (5) existing customer expansion. Moreover, growth continues to come from new wins, with 65 per cent of subscription growth being driven by a healthy pipeline of new customers in the last 12 months (from 60 per cent in F2016) while the remainder is driven by existing customer expansion. In our view, this is a healthy mix."

Alongside the downgrade, Mr. Young dropped his target price for Kinaxis shares to $75 from $100. The analyst consensus price target is $86.55, according to Bloomberg data.

"This is driven by (1) increased risk due to client breach of contract; (2) an increase in our assumption of CADUSD from US$0.725 to 0.788; and (3) estimate changes reflecting lower level of revenue growth," he said. "We also note the (low) risk of impact of a significant customer dispute on new customer wins and channel development. In order to maintain our previous price target and rating, a 10-11 times calendar 2018 estimated enterprise value/Sales or 40 times calendar 2018 EV/EBITDA multiple would be necessary which we believe is too high in the near term. Moreover, the increased value of the Canadian dollar is a further 1 times EV/ 2018E Sales and 5 times EV/2018E EBITDA negative headwind. On the brute force method of revenue multiple for subscription software businesses, we believe that the appropriate multiple is determined by the relative level of revenue, growth and FCF margin."

Elsewhere, Laurentian Bank Securities analyst Nick Agostino downgraded the stock to "hold" from "buy" and lowered his target to $83 from $96.

"We adjust our estimates to reflect the assumption that the contract in default will not be reinstated, as well as the revised guidance," he said.

CIBC World Markets analyst Todd Coupland dropped his rating to "neutral" from "outperform" and his target to $82 from $100.

"We are lowering our recommendation ... and don't recommend buying Kinaxis' stock," he said. "Q2 results were below expectations (by 6 per cent) as subscription revenue growth slowed to only 21 per cent (well below our forecast of 30 per cent). This was due to a customer loss. In addition, overall growth of only 14 per cent was lower as professional services revenue is shifting to Kinaxis' sales channel partners. We expect these trends will persist, slowing growth into 2018. Our price target is also reduced ... It assumes our lower forecast and reduced 2018 cash flow per share multiple to a peer average or 28 times, down from 30 times. Investors should wait for these issues to pass for a more attractive entry point.

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Citing valuation and headwinds, Canaccord Genuity analyst Doug Taylor downgraded his rating for Magellan Aerospace Corp. (MAL-T) to "hold" from "buy."

"Magellan reported Q2/17 results Tuesday night that missed expectations," he said. "The miss was again on lower production volume despite a moderate FX tailwind. The updated outlook remains somewhat mixed though we note a slight positive tone around regional and business aircraft markets. That being said, the combination of a higher valuation, near-term FX headwinds and a mixed outlook leads us to take a more natural stance on the name. We see additional upside from the deployment of Magellan's robust balance sheet, however with little visibility to the timing of further M&A, we will evaluate acquisitions when announced."

The Mississauga-based company reported quarterly revenue of $253.5-million, missing the consensus estimate of $256.3-million and represented a drop of 2.8 per cent year over year on a constant currency basis. It blamed the decline on lower North American production volumes.

Normalized EBITDA of $42.7-million also fell below the Street's expectation of $44.5-million and Mr. Taylor's projection of $43.1-million. Earnings per share of 35 cent missed estimate by a penny and the consensus by 5 cents.

However, the company did provide a "slightly improved outlook" according to Mr. Taylor.

He noted: "Management again painted a mixed picture with positive views on the defence market (incl. F-35 program) offset by weak but improved regional and business aircraft. Commercial aircraft is generally solid with the exception of large wide-body, as evidenced by another build rate cut in A380. Airbus and Boeing reaffirmed the narrow body production ramp-up plans, citing an overall robust demand environment. That said, we are increasingly cautious on the ongoing vertical integration by major OEMs with the recent introduction of Boeing Global Services and its push into avionics and other products (e.g. landing gear). This, combined with a potential FX headwind could ultimately weigh on MAL's margin profile."

With the results and outlook, Mr. Taylor lowered his third-quarter EBITDA estimate to $41-million (from $42-million) to reflect foreign exchange headwinds, lower production and slower-than-anticipated margin expansion. His full-year 2017 expectation fell to $189-million (from $193-million).

"Recall that Magellan has a significant amount of revenue in USD, partially hedged by a relatively lower proportion of USD denominated manufacturing costs," he said. "With no hedging programs in place, it means the company is fully subject to any FX movements, which has turned into a headwind since Q3/F16, as opposed to a $58-million tailwind in fiscal 2015 ($26-million in H2/F16). We believe this will have negative implications for both top lines and margins in the near term as the company is unable to pass it on to customers considering the fierce competition and the long-term nature of the existing contracts."

He also dropped his target price for the stock to $22 from $23. The analyst consensus target is currently $23.00.

"Magellan trades at 7.4 times forward consensus EBITDA and 12.9 times forward EPS," the analyst said. "This is at the high end of the recent trading range. Similarly, we now apply an unchanged 7.5x enterprise value/EBITDA multiple to our NTM [next 12 month] estimates, one year out (12-month ending Q2/F19E) to derive our $22.00 target (from $23.00). Our target equates to 7.7 times forward EBITDA and 14.4 times forward EPS using our current model. In comparison to both the U.S. and Canadian aerospace and defense supplier peer group, Magellan continues to trade at a discount valuation (see Figure 4). On NTM EBITDA, Magellan is around 7.4 times while the peers are closer to 9 times. We attribute this in large part to the company's substantially low liquidity, as well as its slightly lower overall top-line growth which is in part a function of a higher degree of revenue exposed to the aerostructures business which is more subject to the pricing pressure from OEMs and Tier I suppliers."

Meanwhile, TD Securities analyst Timothy James downgraded the stock to "hold" from "buy" with a target of $24 (unchanged).

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Laurentian Bank Securities analyst Nick Agostino downgraded Mediagrif Interactive Technologies Inc. (MDF-T) in reaction to lower-than-expected first-quarter 2018 financial results.

On Tuesday, the Longueuil, Que.-based information technology company reported sales for the quarter of $20-million, below the $20.6-million projection of both Mr. Agostino and the Street. Adjusted earnings per share of 18 cents missed his 27-cent expectation.

"Overall, FQ1 marks the third consecutive quarter of EBITDA underperformance," the analyst said. "With organic sales growth remaining challenged, and increased opex to support existing platforms along with further hiring costs (20 job openings including 15 for new product/feature roll outs for support the Orckestra acquisition) and retention incentives over the next 12 months, we believe margins will remain compressed at the 32-33-per-cent level as witnessed in FQ1 putting a damper on EBITDA/profitability growth."

He added: "Adjusted EBITDA was $6.4-million excluding $257,000 in acquisition-related costs, and below our and consensus estimates. Opex / margin were impacted by increasing growth investment including sales and marketing expenses in support of platform growth, as noted above. We expect EBITDA margins to hold in the 32-33-per-cent range for at least the next 12 months, which drives our lower EBITDA expectations near term, as the company increases investment dollars and integrates Orckestra (negligible margin."

In reaction to the results, Mr. Agostino lowered his full-year 2018 and 2019 EPS projections to 76 cents and 90 cents, respectively, from $1.07 and $1.27, drops of 29 per cent.

"We tweak our F2018 and F2019 sales estimates lower to reflect the FQ1 results," he said. "As well, we lower our forward EBITDA / margins to reflect ongoing elevated opex investments, including elevated advertising spending during the fall/winter months. As such, we model EBITDA margins in the 32-33-per-cent range for F2018 and F2019. We assume a near zero margin contribution for Orckestra over the forecast period, driving the noted margin dilution."

Moving the stock to "hold" from "buy," his target fell to $16.50 from $20. The analyst average is $19.40.

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After three consecutive quarters of better-than-expected financial results, BMO Nesbitt Burns analyst Peter Sklar said he's more confident that Martinrea International Inc. (MRE-T) is "executing a successful turnaround story."

Accordingly, he raised his rating for the stock to "outperform" from "market perform."

"As part of our annual auto parts tour in January, we visited Martinrea's Alfield facility and found the plant was clean and well organized with minimal inventory on hand, which we believe reflects CEO Pat D'Eramo's efforts to streamline operations at the company, particularly in the Metallics business," said Mr. Sklar. "As 'best practices' are expanded to other North American stamping plants, operational improvements should sustain further margin and earnings growth."

On Tuesday before market open, the Toronto-based auto parts maker reported second-quarter diluted earnings per share of 55 cents, exceeding Mr. Sklar's 50-cent projection and the Street's 51-cent estimate. The beat was due primarily to stronger-than-anticipated North American operational improvements.

"We note that North America EBIT margin of 7.7 per cent marked a significant year-over-year increase from 5.6 per cent in Q2/16 and versus our estimate of 6.5 per cent," the analyst said. "On the call, management noted that the U.S. Metallics business experienced the greatest efficiency gains, which we note historically had been the problematic business for the company."

Mr. Sklar bumped his target for the stock to $14 from $11. The average is $14.50.

"We believe that in this plateau auto sales environment, the Canadian auto parts stocks will trade between 4.5 times and 5.0 times forward EBITDA," he said. "While both Magna and Linamar are valued in this range, we believe there is a valuation gap for Martinrea, which is trading at about 4 times our forward EBITDA estimate. As a result, our target price is raised to $14 (from $11), which is based on a projected enterprise value that is 4.5 times (from 4 times) our revised 2018 EBITDA estimate."

Macquarie analyst Michael Glen raised the stock to "outperform" from "neutral" with a target of $13, up from $11.

Mr. Glen said: "The 2Q was further confirmation that MRE's margin recovery story is moving in the right direction. We have opted to upgrade the stock to Outperform as it appears the company's operational improvement plan is on track and gaining momentum."

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Though Valeant Pharmaceuticals International Inc. (VRX-N, VRX-T) had a "solid" second quarter, "challenges remain," said Canaccord Genuity analyst Neil Maruoka.

On Tuesday, Valeant reported revenue of $2.23-billion (U.S.) for the quarter, meeting the projections of both Mr. Maruoka ($2.2-billion) and the Street ($2.23-billion). Earnings before interest, taxes, depreciation and amortization of $951-million topped both the analyst ($929-million) and the Street ($910-billion), due partially to lower expenses.

"While certain segments saw strong year-over-year growth (including B&L international at 17-per-cent growth and Salix at 16 per cent – driven by modest price increases for Xifaxan and early success from its primary sales force strategy), we believe that that there remain some areas of weakness including dermatology (31-per-cent decline) and the impending LOE for products like Syprine and Isuprel," said Mr. Maruoka. "The delayed LOE [loss of exclusivity] for these products again had a positive impact on the company's revised guidance, but we note that this generic competition will be felt eventually, likely in 2018."

With the results, Valeant lowered its full-year revenue expectation to a range of $8.7-billion to $8.9-billion (from $8.9-billion to $9.1-billion), which is in line with the analyst's estimate. It maintained adjusted EBITDA guidance of $3.60-billion to $3.75-billion, which sits above the projections of both Mr. Maruoka and the Street.

Mr. Maruoka raised his revenue projection for 2017 to $8.765-billion from $8.742-billion with adjusted EBITDA of $3.555-billion, rising from $3.533-billion.

"With the delayed genericization of Mephyton, Syprine, and Isuprel (products with annualized sales of $300-million), the impact of a loss of exclusivity (LOE) for these products will be felt in 2018," he said. "We have further reduced our revenue and adjusted EBITDA forecasts for next year to account for this generic impact, and we have also lowered our forecasts for Jublia, which continues to underperform expectations. Finally, we have re-assessed our gross margin assumptions for 2018, lowering our overall gross margin estimate by 90 basis points from 75 per cent to 74.1 per cent. As a result of these changes, we are lowering our 2018 revenue estimate from $9.03-billion to $8.73-billion, and reducing our 2018 adjusted EBITDA forecast from $3.82-billion to $3.63-billion."

Maintaining a "hold" rating for the stock, his target rose to $16 (U.S.) from $14. The analyst average is $16.76.

"Valeant currently trades at 8.6 times enterprise value/adjusted EBITDA based on our 2017 forecast, compared to peers at 11.5 times; our revised target price of $16.00 represents a 8.6 times multiple," he said. "Given Valeant's elevated leverage, lower growth, and higher risk profile, we believe that a discount to the specialty pharma peer group is warranted."

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Credit Suisse analyst Curt Woodsworth initiated coverage of Alcoa Corp. (AA-N) with a "neutral" rating.

"We believe Alcoa shares will continue to trade in tight correlation with LME aluminum prices in the medium term, and thus understanding risk/reward in the commodity price is most critical to the investment buy or sell decision for Alcoa," he said. "That said, we do see scope for Alcoa equity to rerate higher on a multiple basis given its discount to both high quality diversified mining peers as well as pure play aluminum equities such as Norsk Hydro and Rusal. AA is likely to successfully renegotiate is credit facilities by early 2018 which will allow for a more robust dividend policy and likely share repurchase program. We believe AA should trade near 5.0-5.5 times EV/EBITDA off elevated aluminum price levels but likely would trader closer to 6.0 times on a mid-cycle price. Determining midcycle aluminum prices has become more challenging owing to supply side reform in China, which has affected not only S/D fundamentals for aluminum but also raw material input markets such as thermal coal, pet coke, and alumina."

He set a price target of $42 (U.S.). Consensus is $43.91.

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Concerned about its U.S. comparable same-store sales trajectory, BMO Nesbitt Burns analyst BMO Nesbitt Burns analyst Andrew Strelzik downgraded Starbucks Corp. (SBUX-Q)  to "market perform" from "outperform."

"We expect these issues to continue limiting SBUX U.S. comp momentum and a reacceleration likely is needed for the stock to move higher," he said. "We also believe there is risk that SBUX may need to slow the U.S. development pace and incrementally invest in labour hours separate of the partner investments already under way. All in, these factors support ideas that SBUX likely should lower its growth algorithm and trade at a multiple below its historical levels (our target multiple declines to 13.5 times FY18 EBITDA relative to 14.5 times historical average). We are not arguing SBUX's ability to grow over the long term as it likely will continue to deliver consistent comp/EPS growth annually, but the catalyst for the stock is more uncertain and the trajectory of that growth appears likely to be slower."

Mr. Strelzik's target for Starbucks shares is now $56 (U.S.), down from $64. The analyst average target is $64.52.

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In other analyst actions:

National Bank Financial analyst Trevor Johnson upgraded Smart Real Estate Investment Trust (SRU.UN-T) to "outperform" from "restricted" with a target of $36.50. The average is $35.69.

Dundee Securities Corp analyst Frederic Blondeau upgraded Dream Industrial Real Estate Investment Trust (DIR.UN-T) to "buy" from "neutral." Mr. Blondeau's target price rose to $9.50 from $9, compared to the average of $9.17.

Industrial Alliance Securities analyst Jeremy Rosenfield downgraded Pattern Energy Group Inc. (PEGI-Q, PEGI-T) to "hold" from "buy" with a $26 (U.S.) target. The average is $26.92.