Thursday’s analyst upgrades and downgrades

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

Brookfield Business Partners LP (BBU-N, BBU.UN-T) is an "attractive" growth-oriented investment, according to RBC Dominion Securities analyst Geoffrey Kwan.

He initiated coverage of the publicly traded subsidiary of Toronto-based Brookfield Asset Management Inc. (BAM-N, BAM.A-T) with a "sector perform" rating.

"We believe BBU benefits from BAM's very experienced private equity management team and investment team which have a strong historical investment track record," said Mr. Kwan. "We think BBU has the opportunity to leverage the expertise of other counterparts across the BAM platform to source, evaluate and manage investments. We believe BBU also benefits from the linkage with BAM's strong brand with investors. Conversely, while BBU can invest in a broad range of industries, being a part of BAM means it is unable to make investments in sectors that are the focus of other BAM flagship partnerships (real estate/property, infrastructure and renewables). Furthermore, BBU has a contract with BAM requiring BBU to pay BAM management fees and, when earned, incentive fees."

Emphasizing the importance of its diverse portfolio of investments, Mr. Kwan pointed to both monetizations and new investments as key drivers of net asset value (NAV) growth moving forward, pointing to BBU's contrarian investments as material drivers in the next year as well as "solid growth from other investments (e.g., BRK Ambiental and potential growth opportunities, Multiplex results returning to more normalized levels, potential improvements if energy prices continue to improve)."

"BBU's diversified portfolio limits downside risk should there be negative developments at any individual company, industry group or geography," he said. "BBU's investments fall into one of four operating industry segments: Business Services, Industrials, Construction and Energy (we exclude the fifth segment, Corporate & Other). Each of the four operating segments have significant geographic diversification and that three of the four (Business Services, Industrials and to a lesser extent Energy) offer additional diversification as there are multiple companies, each operating within different sub-industries.

"[Its] broad investment scope provides greater opportunities to invest capital (geography, industry, type of investment). BBU is relatively flexible in its ability to search globally for new investments across multiple sectors and make various types of investments (e.g., equity, debt, etc.). However, its key investment constraint is that it is precluded from making acquisitions in industries that would fall within the mandates of its related BAM entities such as real estate for Brookfield Property Partners; infrastructure for Brookfield Infrastructure Partners; and renewables for Brookfield Renewable Partners."

Believing investors with a longer-term investment horizon could find its current price "attractive," he set a $41 (U.S.) target for units of Brookfield Business Partners. The average target on the Street is currently $39, according to Bloomberg data.

"BBU is a principal investing story and has a strong historical investment track record," said Mr. Kwan. "However, valuation is what has us on the sidelines. In the past year, the total return on BBU's units is 47 per cent versus 25 per cent for the S&P500 and 9 per cent for the S&P/TSX Composite. The units trade at a 1-per-cent premium to our estimated NAV and we forecast the units to trade at NAV over the next year. Coupled with our forecast of 14-per-cent NAV growth over the next year, the combination of these two results in a 12-per-cent implied total return, which is in line with the average of our coverage universe."

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Raymond James analyst Chris Cox downgraded Husky Energy Inc. (HSE-T) after it began suspending oil-related operations on its SeaRose FPSO vessel off the coast of Newfoundland and Labrador, which he feels leads to a "less attractive" free cash flow profile for investors.

On Wednesday, Husky announced it was following an order from the Canada-Newfoundland and Labrador Offshore Petroleum Board, a federal-provincial regulator, in response to a close encounter with an iceberg it had last March.

SeaRose FPSO handles the oil volume for the company's White Rose field and has current production of approximately 27,000 barrels of oil per day for Husky. That represents almost 10 per cent of Husky's total production and cash flow.

Moving the company's stock to "market perform" from "outperform," Mr. Cox said: "Specifically, the regulator cited a lack of confidence that the company would adhere to its emergency response plans and that the company "needs to convince us that they take these findings seriously and to rebuild our confidence that they are capable of safe and environmentally responsible operations." At this juncture, we believe there is limited visibility with respect to how long it might take for the company to re-establish the regulator's confidence in the company's safety performance, or what steps specifically will need to be taken. As such, it seems unlikely in our view that this suspension will be resolved overnight, and that uncertainty alone appears likely to hurt the shares over the near-term. We have assumed that White Rose will remain shut-in for 2018."

In response to the suspension, Mr. Cox lowered his 2018 revenue projection for Husky to $21.345-billion from $22.044-billion with his EBITDA (earning before interest, taxes, depreciation and amortization) estimate to $3.668-billion from $4.133-billion.

His target price for the stock fell by a loonie to $18. The analyst average is currently $19.15.

"Since upgrading our rating to Outperform in mid-December, shares of Husky have performed strongly, up 17 per cent over this timeframe and outperforming its large cap peers in Canada by nearly 10 per cent," he said. "Key to our initial upgrade of the shares was a view toward material free cash flow generation in 2018; while we still expect the company to generate noticeable free cash flow this year, the likely prolonged suspension of White Rose has a material impact to our near-term forecasts, effectively cutting our 2018 free cash flow forecasts in half (assuming a 1-year outage). Accordingly, with a less attractive free cash flow profile to entice investors to the name, and with limited return to our previous target, we believe it is prudent for investors to take a wait and see approach until greater visibility with respect to the suspension at White Rose can be provided. Accordingly, we are downgrading shares of Husky."

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Though the U.S. retail sector remains "subject to significant disruption" from online competition, Wal-Mart Stores Inc. (WMT-N) sits "very much in control of its own destiny," said Goldman analyst Matthew Fassler.

He raised his rating for the industry giant to "buy" from "neutral" and added its stock to the firm's "American Conviction List."

"The firm's strategic positioning remains compelling – selling consumables to middle-income consumers in small markets. Recent better results notwithstanding, retail is still subject to significant disruption, while Walmart, we think, is still very much in control of its own destiny," said Mr. Fassler. "We expect the mass market to benefit from stronger income growth, and from personal tax reform."

He increased his target price for Wal-Mart shares to $117 (U.S.) from $115. The average is currently $104.59.

"We expect a meaningful dividend hike as the firm redeploys cash from tax savings, and repatriated overseas cash," the analyst said.

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Though a "largely 'under-known' name in the past," investors are starting to discover Village Farms International Inc. (VFF-T), said Beacon Securities analyst Vahan Ajamian.

He initiated coverage of the Delta, B.C.-based company, which is moving from the production of premium produce to cannabis, with a "buy" rating.

"We expect that all companies will undergo a period of ramping up (including Village Farms transitioning to cannabis," said Mr. Ajamian. "However, we believe execution risk is lower for Village Farms than for most of its peers as: its master grower team has 750 years of experience growing a variety of crops – including in this greenhouse specifically; it has proven an ability to grow at scale, at a low cost, and sell to large complex organizations (Costco, Walmart, Loblaws etc.); and it can leverage Emerald's cannabis strains/expertise. Should cannabis pricing ultimately commoditize, we believe Village Farms will be among the best positioned by running a low cost operation."

On June 6 of 2017, Village Farm announced a 50/50 joint venture with Emerald Health Therapeutics Inc. (EMH-X) for large-scale, high-quality, low-cost cannabis production. Under the deal, Village Farms agreed to contribute a 1.1 million-square foot (25-acre) greenhouse facility in Delta, which will be converted to ACMPR (Access to Cannabis for Medical Purposes Regulations)-compliant production and, if permitted, production for the non-therapeutic adult-use market.

"The superior economics of cannabis production (where firms do not have to face international competition) are expected to vastly improve the company's financial profile," said Mr. Ajamian. "Management has forecast being able to generate as much revenue from cannabis in one greenhouse (D3) as the rest of the company combined – and at EBITDA margins as high as 50 per cent."

"Management knows how to grow high quality production at scale and low cost. The industry is seeing many players announce large scale greenhouse expansions and applying substantial valuations to their shares. Some of these players have not yet sold a gram of production grown in a greenhouse. Accordingly, we suspect some will be hit with challenges in scaling production while also switching building types from indoor to greenhouse. While it will take Village Farms some time to adjust to the specifics of growing cannabis as well, we believe that its team, which has been growing a variety of crops together in the same facility for over a decade promises investors lower execution risk relative to peers – especially since it can leverage Emerald's knowledge (Emerald was originally licensed by Health Canada almost four years ago). "

Emphasizing its "incredible optionality," Mr. Ajamian pointed out that an underlying business currently "pays the bills," which puts the company in an advantageous position compared to many peers.

"Village Farms just recently received analyst coverage and we feel investors are still largely just getting to know this new cannabis story," he added. "The fact that Canopy Growth Corp. (WEED-T) recently announced JVs to convert tomato greenhouses to marijuana in B.C. and in Quebec illustrates to us that Village Farms is blazing a winning trail. In the short-term we believe a supply crunch may result in higher prices for producers. However, in the long-term, the industry may commoditize somewhat. In our view, having run lean, low cost operations growing at scale already best positions Village Farms to be one of the leaders over the longer-term."

Mr. Ajamian set a target for Village Farms shares of $11.  

"With a market cap of just $323-million, Village Farms pales in comparison to its peers. It has a tight share structure with high insider and institutional ownership," the analyst said. "Even after applying what we consider to be very conservative forecasts, we see compelling value at current levels – and we believe licensing could be imminent and act as a catalyst to its share price."

The other analyst covering the stock currently, according to Bloomberg, is Echelon Wealth's Russell Stanley, who initiated coverage with a "speculative buy" rating and target of $8.75 in late December.

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Raymond James analyst Brian MacArthur raised his target price for shares of Arizona Mining Inc. (AZ-T) after an updated preliminary economic assessment (PEA) on its Taylor Deposit in Arizona indicated a longer mine life and resource expansion.

"The updated PEA demonstrated improved economics, an increased mine life, a larger M&I&I [measured, indicated, interferred] resource estimate and significantly higher LOM [life of mine] silver production," said Mr. MacArthur. "We view the PEA update as a positive event, but continue to note that construction and development will require additional financing and permitting. While the potential mix of debt/equity/stream/offtake/partner and timing of attaining sufficient financing is a risk to our current valuation, we continue to believe that AZ is an attractive zinc investment opportunity given the quality of the Taylor deposit as well as AZ's exposure to zinc and rate the shares Outperform."

His target rose to $5.25 from $4.50. The consensus target is $5.61.

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In other analyst actions:

The "honeymoon is over" for Symantec Corp. (SYMC-Q), said Jefferies analyst John DiFucci, who feels its revenue guidance for the 2019 and 2020 fiscal years is unachievable and will almost certainly be lowered. He downgraded the California-based software company to "underperform" from "hold" and dropped his target to $23 (U.S.) from $30. The average on the Street is $31.79.

CIBC World Markets analyst John Zamparo initiated coverage of Premium Brands Holdings Corp. (PBH-T, PBH-N) with an "outperform" rating and $116 target. The average on the Street is $114.28.

National Bank Financial analyst Shane Nagle downgraded Hudbay Minerals Inc. (HBM-T, HBM-N) to "sector perform" from "outperform" with a $13 target, which is 6 cents below the consensus.

HSBC analyst Gordon Gray downgraded Chevron Corp. (CVX-N) to "hold" from "buy" and raised his target to $133 (U.S.) from $125. The average is $130.29.

Evercore ISI analyst Kenneth Talanian upgraded Palo Alto Networks Inc. (PANW-N) to "outperform" from "in-line." Mr. Talanian raised his target price to $180 (U.S.) from $150, while the consensus average is $172.12.