Wednesday’s analyst upgrades and downgrades

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

Laurentian Bank Securities analyst Marc Charbin views Home Capital Group Inc. (HCG-T) shareholders' rejection of an additional equity investment from Warren Buffett's Berkshire Hathaway Inc. (BRK.B-N) as a favourable result, leading him to increase his target price for the Toronto-based company.

On Tuesday, shareholders turned down a proposal from the U.S. company to raise its stake in the company, which called for Berkshire Hathaway to increase its shareholding to 38.4 per cent from 20 per cent.

"The second equity tranche ($246.8-million for 24.0 million common shares) was to occur at a significantly discounted price of $10.30 per share, and thus would have resulted in unnecessary dilution in light of the company's improved deposit base and liquidity position since Berkshire's initial investment was announced," said Mr. Charbin. "While the second tranche was rejected by shareholders, Berkshire remains the company's largest shareholder at 19.99 per cent of shares outstanding."

"We had previously accounted for the cash and dilutive effect of the second Berkshire tranche in our modeling. Removing the transaction from our model, our BVPS increases to $22.10 from $19.46, while our EPS also increases in conjunction with the lower pro-forma share count. Capital remains reasonable as we forecast the company's Tier 1 Capital ratio at 21.6 per cent for 2017 and 22.1 per cent for 2018. We continue to value HCG by applying a 0.9 times price-to-book value multiple, which results in a $20 target on our revised BVPS. A share price closer to our target could be realized as soon as Q1/18, when the company is expected to disclose its 3-year business plan, strategy and targets."

Mr. Charbin maintained a "buy" rating for Home Capital shares with a target price of $20, rising from $17. The analyst average target is currently $16.77, according to Bloomberg data.

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Citing a "more attractive" risk-reward profile and near-term catalysts that drive quarter-over-quarter improvements to its financial results, Beacon Securities analyst Gabriel Leung upgraded DIRTT Environmental Solutions Ltd. (DRT–T).

"We believe the scenario that is playing out is similar to what we saw in 2016 when the stock languished post the Q2 2016 results, but saw a healthy appreciation on the back of improved Q3/Q4 results," said Mr. Leung, moving the stock to "buy" from "hold."

In justifying the move, the analyst pointed to several potential near-term catalysts.

Mr. Leung said: "We would remind investors of several points:  First, the company incurred $3.5-million of costs associated with its annual Connext conference, which will not be repeated in Q3; during the Q2 call, the company noted that it expects to realize 2/3rds of its $32.7-million (U.S.) contract with a Fortune 100 company during Q3/Q4. We anticipate the company could be in position to further increase the scope of this contract with the release of its Q3 results.

"During last quarter's call, the company also alluded to having a very strong pipeline in healthcare, including being very close to finalizing agreements to be a preapproved construction standard for multiple healthcare providers in the U.S.. We'd remind investors that healthcare is the company's highest margin vertical."

He maintained a price target of $6.50 for DIRTT shares. Consensus is $8.36.

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Evertz Technologies Ltd.'s (ET-T) "strong" first quarter is "bucking the trend," according to Canaccord Genuity analyst Robert Young.

On Tuesday, the Burlington, Ont.-based equipment provider to the television broadcast telecommunications and media industries reported record quarterly revenue of $109-million, an increase of 2 per cent from the previous quarter and 25 per cent year over year. The result exceeded Mr. Young's forecast of $101-million and the consensus of $104-million, driven largely by "strong" demand for its software defined video network solutions both in North America and internationally.

Despite higher-than-anticipated expenses, adjusted earnings per share of 28 cents also topped the analyst's projection (24 cents) and the consensus (27 cents).

"Evertz reported FQ1 revenue and EBITDA significantly above our estimates, continuing momentum from last quarter," said Mr. Young. "At the same time, Evertz highlighted strong sales activity levels, record deferred revenue and a robust backlog. The backlog + shipment metric continues to be strong, marking the fifth consecutive quarter over quarter above $100-million.

"While competitors have seen weak results amidst a challenging spending environment, Evertz has posted solid results with strong shipments + backlog which we believe is led by continued IP product leadership. Customer demand for new Evertz products, principally its IP and software-defined video networking (SDVN) offering and DreamCatcher continues, and is backed by a recent win with a new U.S. customer for a $10-million-plus IP facility. The balance sheet remains strong with net cash of $71.8-million, but there is no sign of a dividend raise. However, we note that Evertz prefers a special dividend as cash accumulates."

Based on the results, Mr. Young raised his sales projections for both 2018 and 2019. He lowered his 2018 EPS projection to 94 cents from $1.03, while his 2019 estimate increased to $1.20 from $1.16.

"We have increased our top-line estimates to reflect the FQ1 strength, which is partially offset by a lowered GM forecast and higher OpEx which drives a modest increase in our EBITDA forecast, while FX impacts lead to lower EPS," he said.

With an unchanged "buy" rating, his target for the stock increased to $20.25 from $19.50. The analyst average is $20.19.

Elsewhere, Raymond James analyst Steven Li raised his target to $19.50 from $18, keeping an "outperform" rating.

"Strong F1Q revenues (up 25 per cent year over year) with solid F2Q first month shipments/backlog suggest demand trends are looking up and bode well for 2Q," said Mr. Li.

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Cascades Inc.'s (CAS-T) operations, organization and balance sheet "are in their best shape in many years, coincident with favourable industry conditions, particularly in containerboard," said Desjardins Securities analyst Keith Howlett

"Our view is that the new era at Cascades has arrived, with the path cleared for focused growth ahead," said Mr. Howlett, following meetings Monday with management and institutional investors. The rumoured liner ($50 U.S. per ton) and medium ($60 per ton) price increases by Georgia-Pacific reflect (at a minimum) strong customer demand and high supplier capacity utilization rates. If the increases are followed by other major players (eg International Paper, WestRock) and implemented through follow-on containerboard and box price increases which are fully accepted by end-user customers, it would be highly beneficial to Cascades (adding on an annualized basis, all other factors held constant, $6 to our target price)."

"Cascades' 2017–22 plan calls for increasing EBITDA margin to 15% (from ~10%). Debt to EBITDA is steadily declining and is likely to be 2.5 times by the end of 2018. The board of directors may consider an increase to the quarterly dividend in 2018, in our view. Cascades' majority shareholding in Reno De Medici in Europe (boxboard) is currently worth $173-million, excluding any control or takeover premium. Cascades has the flexibility to pursue value-creating acquisitions or greenfield investments in its three core businesses."

Mr. Howlett said improvements to the Kingsey Falls, Que.-based company's operations and balance sheet do not appear to be properly reflected in its valuation.

"By this time next year, we expect Cascades to more closely resemble its peer group in terms of EBITDA margin, net debt to EBITDA and dividend yield," he said. "The valuation discount applied by the market to Cascades will, in our view, recede over time. The company is much less complex than it was five years ago, and is focused on modestly growing product segments with room to innovate."

"Cascades was paying down debt with operational cash flow prior to the sale of its shares in Boralex. The Boralex sale in 3Q17 generated $287.5-million after tax. The balance sheet will improve further in 2018, even without, for example, selling the company's majority shareholding in Reno De Medici. It is also expected that Greenpac will commence paying dividends to its partners, including Cascades. This is positive for Cascades' business and financial flexibility. From an accounting perspective, because Cascades now consolidates Greenpac, the dividend will only be reflected as an outflow to the minority partners."

Mr. Howlett kept a "buy" rating for the stock and increased his target to $18 from $16. The analyst average target is $17.46.

"Cascades trades at a discount to its peer group which is excessive, in our view," he said. "The sale of non-core assets and the reduction of debt, combined with an improving asset base and supportive industry conditions, underpin our Buy–Above-average Risk rating."

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Andrew Peller Ltd.'s (ADW.A-T) acquisition of three leading British Columbia wineries could provide its next leg of growth, according to Acumen Capital analyst Brian Pow.

On Monday, the Grimsby, Ont.-based wine producer announced it has signed definitive agreements to acquire Black Hills Estate Winery and Gray Monk Estate Winery and a letter of intent to acquire Tinhorn Creek Vineyards.

The deals are for a combined price of $95-million, which Mr. Pow deems "reasonable."

"ADW is a well-run company with great exposure to secular growth both domestically and internationally," he said. "The last time ADW completed the acquisition of a winery was over ten years ago. The benefits of acquiring these three wineries has been understated by the company.

"The purchase price of $94.5-million equates to 11.6 times based off the EBITDA of $8.2-million for the last fiscal year and less than 11.0 times based off the trailing twelve months. Management anticipates that the three wineries can see growth in the low double digits, adding up to $15.0-million of EBITDA in five years. The accounting for this transaction negatively overshadows the merits of this transaction. ADW will report modest declines in gross profit margin, EBITA margin, NI, and EPS over the next 18 – 24 months as they account for the finished goods inventory purchased from the wineries. ADW will also incur one-time transaction costs ($1.2-million in FY/18 and $0.3-million in FY/19)."

Mr. Pow said he anticipates the company's financial results will normalize by fiscal 2020, warning that the accounting treatment in the wake of the deals will "create some noise" over the next 12-24 months. He suggested investors should "look past the impact of these non-cash items and give credence to the strategic benefits that will be accrued."

"The acquisitions increase ADW's presence in British Columbia and expand the quality of the wine portfolio – a move we see as highly strategic," the analyst said. "The acquisitions increase ADW's footprint in British Columbia from 200 acres to 450 acres (excluding leased land). Importantly, the acquisitions leaps ADW to be the top producer of VQA wines in British Columbia with a high quality, complementary wine portfolio. This will position the Company to deliver growth in the coming years with a diverse product offering of both British Columbia and Ontario VQA wines. With its scale and experience, ADW is positioned to help develop the acquired portfolio of quality brands by offering a platform that will strengthen brand reputation and expand distribution. The Company has many opportunities to add leverage at the cost level (procurement, SG&A, operations, viticulture practices, logistics and distribution) as well as the revenue level (access to varietals and higher priced sales mix). We note that two of the wineries are near ADW's Sandhill operation which nicely sets up opportunities for both cost and revenue synergies."

With a "buy" rating, his target price for the stock rose to $14 from $13.50. Mr. Pow is the lone analyst covering the stock currently, according to Bloomberg.

"With its scale and experience, ADW is positioned to help develop the acquired portfolio of quality brands by offering a platform that will strengthen brand reputation and distribution," said Mr. Pow. "The company has many opportunities to add revenue and cost synergies to leverage the brands."

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Credit Suisse analyst Seth Sigman raised his financial estimates for Best Buy Co Inc. (BBY-N) in reaction to Apple Inc.'s (AAPL-Q) launch of its new iPhone X.

"The new technology seems to offer the upgrades that the market was expecting, and with a large install base of older generation users out there it should stimulate some improvement," said Mr. Sigman. "The products also seem to provide incremental accessory opportunities (particularly given the two-sided glass). Key risks include the higher price point and, of course, potential supply constraints initially, though there is nothing that suggests a change for BBY vs. current expectations, and guidance seems to still leave room for potential upside."

"The iPhone 8/8+ offers an upgrade to the sound and picture quality of the 7/7+ and includes wireless charging. The flagship iPhone X is essentially a larger OLED extension of the 8+ without a home button and includes features such as Face Id, animojis and portrait selfie capabilities. Although, some of the features launched [Tuesday] are already offered in competing products, given its popularity we expect sale of Apple products to prevail in the upcoming holiday season."

Mr. Sigman increased his 2017 and 2018 earnings per share projections to $4.04 (U.S.) and $4.29, respectively, from $3.89 and $4.15.

He maintained a "neutral" rating for the stock and target of $60. Consensus is $59.52.

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Source Energy Services Ltd. (SHLE-T) is "well positioned" to execute on its growth strategy, according to Canaccord Genuity analyst John Bereznicki.

He initiated coverage of the Calgary-based producer, supplier and distributer of Northern White frac sand to the Western Canadian Sedimentary Basin (WCSB) with a "buy" rating.

"The company controls its supply chain from mine site to well site and pioneered the use of unit trains to transport proppant in Western Canada," said Mr. Bereznicki. "Source also enjoys a strategically located terminal network and 'last mile' logistics capabilities that make it well suited to manage the vast distances, extreme seasonality and relatively limited infrastructure of the WCSB relative to the U.S. oilfield. We believe this provides Source with a strong incumbent market position and the ability to build upon its 35-per-cent share of a growing $900-million WCSB proppant market."

"Despite a generational downturn in 2015-16, producers have continued to increase frac intensity in search of better returns. This has skewed overall well cost toward completion activity, and has driven proppant volumes upward on a per-well basis. We believe this will result in 2017 WCSB proppant demand easily eclipsing the previous high water mark set in 2014 despite a far more challenging commodity price environment. Even in a sideways well count environment next year, we believe WCSB proppant demand can grow by 15–20 per cent year over year. In our view, these secular tailwinds complement Source's cyclical upside potential for investors."

Mr. Bereznicki emphasized the company's senior management team, possessing more than 75 years of "relevant" experience, is supported by a board with a "deep and diverse" base of knowledge.

"Source's leadership is also well aligned with its shareholders, with insider ownership of 39-per-cent post IPO," the analyst said. "We also expect Source to exit 2017 with net debt to TTM [trailing 12 month] EBITDA of 2.3 times after executing on an organic capital program of $29-million this year, leaving it well positioned to fund further growth in 2018. Thematically, the company's core strategy is built around maintaining its leadership position by leveraging its existing infrastructure and logistics expertise and adapting to changing customer needs. To this end, Source recently acquired additional Northern White mine and processing capacity, and is strategically bolstering its transload capacity and last mile capabilities in the WCSB."

The analyst set a price target of $9 for Source shares. The average is currently $12.75.

"Shares of Source are down 36 per cent since its recent IPO, driven by commodity price headwinds and growing fears of looming U.S. proppant oversupply. While Source does not operate in isolation of the US proppant market, we nonetheless believe investor fears of the company being subject to "back-up" risk are likely overblown due to a relative lack of demand for 100 mesh sand in the WCSB and to CN main line access limitations. We believe Source remains well positioned to leverage its established market leadership longer-term given its integrated logistics platform and strong in-basin sales profile. Our target price is based on a 2018 estimated enterprise value/EBITDA multiple of 6.0 times, which approximates the TTM [trailing 12 month] average of the company's U.S. peers as well as the median trading range of the domestic oilfield sector based on consensus estimates."

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In other analyst actions:

Predicting "many years of robust growth," Loop Capital analyst Anthony Chukumba initiated coverage of Amazon.com Inc. (AMZN-Q) with a "buy" rating and $1,200 (U.S.) target. The average target is $1151.63.

Phillip Securities analyst Kang-Wei Ho initiated coverage of AT&T Inc. (T-N) with a "buy" rating and target price of $41.70 (U.S.). The analyst average target is $41.56.

Argus Research Corp analyst James Kelleher initiated coverage of Lam Research Corp. (LRCX-Q) with a "buy" rating and $196 (U.S.) target. The average target is $193.53.

Beacon Securities Ltd analyst Kirk Wilson initiated coverage of Horizon North Logistics Inc. (HNL-T) with a "buy" rating and $2.30 target. The average is $1.96.

Clarus Securities Inc. analyst Jamie Spratt initiated coverage of Golden Reign Resources Ltd. (GRR-X) with a "speculative buy" rating and 80-cent target. Consensus is 55 cents.

"Golden Reign Resources is advancing its high grade San Albino property in Nicaragua toward 40,000 ounces per year of low cost gold production which we believe can be scalable," said Mr. Spratt.  "We believe that a high grade open pit mining scenario will put the San Albino project at the bottom end of the industry cost curve with our estimated AISC [all-in sustaining costs] of $537 (U.S.) per ounce, resulting in $15 – $20-million in annual FCF.  With the current 1.0 million ounce AuEq global resource defined on only a 3.5km2 area, we believe there is a clear opportunity to define 5.0 million ounce of potentially open pittable resource on the 138km2 land package.  We see GRR as a unique combination of near-term, high margin production and exciting exploration sizzle."