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Wednesday’s analyst upgrades and downgrades

Air Canada planes sit on the tarmac at Pearson International Airport in Toronto in this file photo.

MIKE CASSESE/REUTERS

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

Air Canada (AC-T) laid out a "strong argument for continued outperformance" at its Investor Day on Tuesday, according to Canaccord Genuity analyst Doug Taylor.

He believes the airline revealed new financial targets for 2018 through 2020 that provide medium-term visibility, including EBITDAR margins of 17-20 per cent, return on invested capital (ROIC) of 13-16 per cent and cumulative free cash flow of $2-billion to $3-billion.

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"We think EBITDAR margin targets should be seen as in line with Street forecasts," said Mr. Taylor. "Cash flow and debt reduction targets we view as positive relative to expectations."

"As we think was anticipated, the company provided some qualitative colour around the loyalty program repatriation and some other financial metrics, including a lighter-than-expected up-front cost ($85-million). The company refrained from specific annual benefits, saying only that it believes this internalization program alone should largely erase 300 basis points margin gap versus U.S. peers."

Based on the company's new initiatives and a changing macro environment, including higher fuel prices and a stronger loonie, Mr. Taylor lowered his 2017 EBITDAR projection to $2.761-billion from $2.881-billion (consensus is $2.926-billion). He raised his 2018 estimate to $3.139-billion from $3.011-billion (versus a consensus of $3.195). He also introduced a 2019 estimate of $3.225-billion (versus $3.416-billion).

"With the emergence of multiple ULCCs (e.g. Jetlines and Flair Airlines and WestJet's internal ULCC start-up), we note that Air Canada is increasingly alluding to its options should the threat become more real," he said. "To date, WestJet has taken it upon itself to fight off lower cost entrants. We point to two initiatives recently which suggest Air Canada will defend its market share should more substantial ULCC capacity come online. First, Air Canada revealed for the first time a new 'ULCC' fare class (i.e. below Tango) which it could deploy strategically on certain routes in response to competitive changes. The company also announced a new 'Comfort' fare that tweaks the already available fare classes. Second, Air Canada with its recently revised agreement with its pilots, now has the ability to further expand Rouge narrow-body (beyond the initial 50 planes) on a proportionate basis to mainline growth. Management spoke to the opportunity to use this defensively to combat ULCC entrants in certain markets, including domestically."

Mr. Taylor maintained a "buy" rating for the stock and raised his target to $31 from $27. The consensus average is $29.18, according to Bloomberg data.

"After an impressive run in the stock heading into the investor day, Air Canada shares traded down 1.4 per cent after the event," said Mr. Taylor. "We believe this reflects too much focus on new EBITDAR targets which we saw as in line with our expectations though perhaps lower than some Street forecasts at the margin. There are multiple initiatives which should lead to further margin expansion in 2020 and beyond and should narrow the margin discount vs. peers. We focus more on the cash flow angle which we think supports ongoing outperformance of AC shares in anything but a recessionary scenario."

Elsewhere, Cowen analyst Helane Becker upgraded Air Canada to "outperform" from "market perform" with a target of $40, jumping from $23.

BMO Nesbitt Burns analyst Fadi Chamoun raised his target to $34 from $28 with an unchanged "outperform" rating.

Mr. Chamoun said: "Air Canada's 2017 Investor Day portrayed a business transformation story that continues to have ample value creation runway, particularly in terms of free cash flow, ROIC, and balance sheet delevering. As capacity growth moderates in coming years, we see opportunities to optimize unit revenues while the pipeline of efficiency gains from narrow-body fleet modernization and other initiatives should mute the pace of unit cost inflation, supporting further modest margin expansion. The range of fiscal 2020 profitability/cash flow targets supports value per share in excess of $55."

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"Catching our breath" on Cogeco Communications Inc. (CCA-T), Macquarie analyst Greg MacDonald downgraded the stock to "neutral" from "outperform."

"This stock has come a long way in a short period of time," he said. "We still see two main catalysts; 1) the recent MetroCast acquisition will add 2-3 years of outsized growth, and 2) a sale of the U.S. data centre business is probable and would be accretive to valuation. However, with the stock up 17 per cent in the past three months (versus 2-per-cent comp), we also think the market is now paying in part for these potential catalysts. We are lowering estimates on an FX headwind and expect 2018 guidance to be lowered in the upcoming quarter on same."

Mr. MacDonald lowered his 2018 revenue and EBITDA projections by approximately 2 per cent, due largely to the strength of the Canadian dollar. Trading at 81.4 cents (U.S.), it is "well above" both the company's guidance (75 cents) and his projection (77 cents).

"We expect a guidance revision downward this coming quarter to reflect at least a $0.80 CADUSD or EBITDA adjustment of $18-20-million," he said. "U.S. operations now make up about 34% of consolidated results, which is the highest in our carrier coverage universe."

He also does not expect the upcoming quarterly results to be a catalyst for the stock, noting: "Our 4Q17E revenue and EBITDA are in line with consensus at $558-million (up 2.6 per cent year over year) and $251-million (up 1.2 per cent year over year), respectively but our 2018 estimate is 1.5 per cent below. Similar to other cablecos, recent quarterly results have seen some positive subscriber trends but we think the market now expects this. The Enterprise division remains in turn around mode and is unlikely to beat. Consolidation of the MetroCast acquisition is expected in 2-3 quarters."

"Macquarie analysis suggests material scale is now necessary to create value in data centre businesses. CCA admits it is no longer growing this segment; we think it will be sold in the 1-2 year time frame. Our $90 Sum of Parts valuation assumes the Enterprise segment at 7 times EBITDA (data centre business at 10 times and access business at 5 times). At the current price, much of this value accretion is now in the stock."

After lowering his 2017 and 2018 EPS projections by 3 cents and 24 cents, respectively, Mr. MacDonald maintained a $90 target for the stock. The average is $85.54.

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Citing a balanced risk/reward proposition for investors, Credit Suisse analyst Robert Reynolds downgraded Labrador Iron Ore Royalty Corp. (LIF-T) to "neutral" from "outperform."

"Following LIF's Q3 dividend announcement on Sept. 15, LIF will have paid out $2.10 per share of dividends through Q3 (75 cents per share of regular dividends and $1.35 per share of special dividends), well above our initial $1.35 per share estimate from January," said Mr. Reynolds. "We currently estimate only a 5-cents-per-share special dividend in Q4 based on (i) a decline in the iron ore price to $55 (U.S.) per tom; (ii) CAD/USD at 0.82; (iii) no more tailwind from unsold concentrate that IOC had in Q3; and (iv) higher capital expenditures vs. Q3.

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"These factors are partly offset by our forecast for continued elevated pellet premiums at $50 per ton (vs. our estimate for $47.25 per ton in Q3) and grade premium (65 per cent versus 62 per cent) at $16.5 per ton versus $14.4 per ton in Q3."

Based on his iron ore price deck of $57.50 per ton in 2018 and $48 per ton in 2019, Mr. Taylor projects distributions will decline to $1.84 per share in 2018 and $1.37 in 2019.

Mr. Taylor raised his target price for the stock to $23 from $20 based on his higher forecasted 2018 dividend of $1.84 per share (from $1.74) and a lower target yield of 8 per cent (from 9 per cent). The consensus average target is $20.43.

"LIF has averaged an 8.3-per-cent yield since 1997," he said. "We now use 8 per cent to reflect our view that premiums on higher quality pellets and concentrate will be a more sustainable tailwind for IOC's margins given steelmaking capacity curtailments in China."

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Calling Adobe Systems Inc.'s (ADBE-Q) third-quarter financial results, released Tuesday, a "bump in the road," Canaccord Genuity analyst Doug Taylor hopes "this gives us a better buying opportunity."

"Life, business, and yes closing deals at software companies is not linear. Adobe revealed on its call that the firm had mis-executed in the quarter so that booked subscription business was less than expected," said Mr. Taylor. "The stock fell 3 per cent after-hours as traders hit the bid. Stepping back, Adobe did not suddenly see the industry's best competitive moat disappear, nor did competitive products miraculously emerge to disrupt the firm. Instead, this quarter looks to us to be an old fashioned "clients needed more time to decide" kerfuffle. That isn't an excuse, and if we had any real concern about Adobe's fundamentals, especially after this print, it is that we need to be convinced that this firm's salespeople can present the firm as a strategic partner, sell higher in the organization, and therefore land larger ($1-million-plus) deals. Transitions like this are not easy. Zendesk has struggled to move up market, but Salesforce made the shift essentially seamlessly. Therefore, Adobe now has the next few quarters to prove that it is CRM not ZEN. The good news is that we will get a differentiated dose of insight next week as we have management on the road for a non-deal roadshow in Toronto on Wednesday. In the interim, our positive view while ever so slightly jarred, remains intact that this stock has another significant up-leg coming as the firm evolves to become a strategic partner for all things digital marketing. We get particularly interested if investors overreact and sell first and ask questions later."

The San Jose-based tech giant reported total revenue for the quarter of $1.84-billion (U.S.), exceeding Mr. Taylor's estimate by $26-million and representing 26-per-cent growth year over year. It reported operating margins, earnings per share and operating cash flow of 38.0 per cent, $1.10, and $704-million, respectively, which were "nicely ahead" of the analyst's projections of 35.7 per cent, $1 and $479-million.

"Operating margins (38.0 per cent, up 450 basis points year over year) and operating cash flow ($704-million in Q3 and up 38 per cent year-to-date) were particularly strong; 88 per cent of revenue came from recurring sources, up from 86 per cent last quarter and 83 per cent in Q3/F16; Adobe is seeing a strong pipeline of joint enterprise customers stemming from its partnership with Microsoft; notable wins with Adidas, HSBC, Kellogg's and others were called out; Adobe MAX, being held next month, should serve as a catalyst as Adobe's strength in creative content will be front and center with likely new product, partnership and customer announcements," said Mr. Taylor.

"Experience Cloud bookings in the quarter came in below expectations as management called out larger, multi-product deals as contributing to elongated sales cycles - management noted that these were not competitive losses and this in no way alters the long-term outlook for the firm and its products."

With the results, Mr. Taylor hiked his target for the stock to $170 (U.S.) from $165 with a "buy" rating. The average is $163.41.

Elsewhere, Credit Suisse analyst Michael Nemeroff raised his target to $170 from $160 with an "outperform" rating (unchanged).

Mr. Nemeroff said: "Most competitor notes this morning will likely discuss the Q3 Digital Marketing billings miss in excruciating detail (due to large deal slippage), but we would note that Digital Media's billings strength more than offset the other segment's minor miss, and is a much more important driver of the business, which is why we remain positive on Adobe's business overall. However, we believe investor sentiment heading into ADBE's Q3 print was very high, possibly too strong, which could cause the shares to dip in the near-term, but we would see that as a good buying opportunity, particularly given the strength in qtrly cash flow, which drives our valuation. Specifically, the company's highly profitable Creative Cloud business continues to outperform, driven by healthy net-new subscriptions, solid customer retention, increased adoption of enterprise services, continued ARPU uplift, and international strength. More importantly, we believe the strength in Digital Media will continue for several qtrs, at least, as mgmt can tap into multiple vectors of growth, including continued ETLA conversions, further penetration of its large piracy base, international opportunity, pricing leverage, and high-potential segments like education."

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In reaction to a lower-than-expected loss from Hurricane Harvey, Credit Suisse analyst Ryan Tunis raised his rating for Progressive Corp. (PGR-N) to "neutral" from "underperform."

On Tuesday, the Ohio-based insurance company posted a 2-cent (U.S.) quarterly loss with 90 per cent of its August catastrophe costs linked to the storm.

"While PGR may still opt to rethink its reinsurance strategy or add some growth capital to its balance sheet which would come at some additional cost, we see less risk that PGR will face debt/total capital or premium/surplus constraints in the coming months that that could jeopardize the substantial growth opportunity that remains in store for PGR," said Mr. Tunis. "The company comes away with about $225-million more equity capital (capable of funding about an estimated 3 months of 2018 auto growth) and presumably more catastrophe protection than we expected for the rest of hurricane season given that the company does not appear to have exceeded its $50-million home retention from Harvey."

Mr. Tunis raised his 2017, 2018 and 2019 earnings per share projections to $2.37, $2.75 and $3.00, respectively, from $2.26, $2.60 and $2.78, noting he longer assumes any preferred debt issuance to fund growth.

His target for the stock rose to $48 from $42. The analyst consensus price target is $48.14, according to Thomson Reuters data.

"In an industry that has historically had relatively elastic demand, and contrary to what we have seen at some peers in this rate taking cycle, PGR has adequately demonstrated through 2017 that growing and improving margins are not mutually exclusive goals. PGR has shown its ability to thrive from disruption. As we crawl to the end of this frequency driven loss cost spike where the whole industry was tested, PGR emerged with not only a much larger policies in force base but also much less underlying margin volatility than competitors, a testament to the company's underwriting talent."

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Post Holdings Inc. (POST-N) has become a compelling investment, according to BMO Nesbitt Burns analyst Kenneth Zaslow.

Citing improved near-term fundamentals, above-average top-line growth, earnings power from recent acquisitions and valuation expansion opportunities, Mr. Zaslow raised his rating for the St. Louis-based company, which manufactures several well-known cereal brands, to "outperform" from "market perform."

"POST should generate above-average top-line growth reflecting 1) a more favorable portfolio mix (foodservice, breakfast, protein) with higher exposure towards the perimeter of the store; 2) a deeper focus on niche sub-segments with strong share positions and category dynamics (e.g., refrigerated side dishes, bagged/value cereals); and 3) distribution opportunities from acquisitions (e.g., RTD protein shakes in UK, geographic distribution expansion of refrigerated side dishes on west and east coast, greater urban penetration for MOM, greater foodservice penetration)," said Mr. Zaslow.

The analyst said recently acquisitions, including a $1.5-billion (U.S.) deal for Bob Evans Farms Inc. announced Tuesday, create upside for its earning power, which he said reflects "1) higher sales growth potential (e.g., improved category mix, diversification benefits); 2) distribution opportunities (e.g., side dishes in the U.S.); 3) broader and deeper foodservice relationships; and 4) cost synergies/efficiencies."

He added: "Post announced that it will acquire Bob Evans for $1.5 billion, or 15 times enterprise value/EBITDA (12.5 times including $25-million of synergies), as Bob Evans will generate approximately $107-million in EBITDA on $437-million of sales (34-per-cent foodservice, 20-22-per-cent sausage, and around 40% retail side dishes). The transaction, which is expected to close F2Q18, provides a stronghold in refrigerated potatoes, an opportunity to strengthen its foodservice business through working with Michael Foods, and distribution opportunities for its high growth retail portfolio using Consumer Brands' national retail relationships. Notably, we are encouraged by POST's ongoing focus on niche opportunities within larger categories (e.g., refrigerated side dishes, bagged/value cereals) to generate above-average growth and retain strong share positions."

Mr. Zaslow raised his target for the stock to $106 (U.S.) from $89. The analyst average is $100.29.

"POST's portfolio mix and execution should create ongoing steady multiple expansion, while portfolio refinement over time creates valuation optionality," he said. "First, we believe that better execution and portfolio mix should continue to benefit POST valuation, as its valuation has improved from below 10 times in 2012-2014 to 10-11 times in 2015-2017. Second, we believe that further portfolio actions (e.g., asset sales, spinoffs) over the next 24 months could enhance POST's valuation over time. In addition, with the reorganization, we believe that POST's Private Brands and retail cheese businesses may become divestiture candidates, while Post's foodservice operation, which appears undervalued relative to other comps, may benefit from corporate action over time."

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In other analyst actions:

TD Securities analyst Cherilyn Radbourne upgraded Toromont Industries Ltd. (TIH-T) to "buy" from "hold" with a target price of $65, rising from $48. The consensus average is $58.75.

Credit Suisse analyst Ilkin Karimli downgraded Africa Oil Corp. (AOI-T) to "neutral" from "outperform" with a target of $2, falling from $2.80. The average is $2.69.

Morgan Stanley analyst David Risinger upgraded Pfizer Inc. (PFE-N) to "overweight" from "equalweight" and raised his target to $39 (U.S.) from $35. The consensus target is $37.71.

Mr. Risinger downgraded Allergan Plc (AGN-N) to "equalweight" from "overweight" and dropped his target to $228 (U.S.) from $284. The average is $270.06.

Raymond James analyst Savanthi Syth upgraded American Airlines Group Inc. (AAL-Q) to "outperform" from "market perform" with a $58 (U.S.) target. The average target is $56.

Ms. Syth upgraded Southwest Airlines Co. (LUV-N) to "outperform" from "market perform" with a $65 (U.S.) target. The average is $66.59.

She downgraded United Continental Holdings Inc. (UAL-N) to "market perform" from "outperform" without a specified target. The average target is $79.07.

Buckingham Research Group analyst Scott Krasik initiated coverage of Activision Blizzard Inc. (ATVI-Q) with a "buy" and $79 (U.S.) target. The average is $70.46.

Mr. Krasik also initiated coverage of Electronic Arts Inc. (EA-Q) with a "buy" rating and $143 (U.S.) target. The average is $126.95.

He also gave Take-Two Interactive Software Inc. (TTWO-Q) a "buy" rating and $120 (U.S.) target, versus a consensus of $98.89.

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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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