Mario Beauregard
Inside the Market's roundup of some of today's key analyst actions
Raymond James analyst Chris Thompson downgraded Newmarket Gold Inc. (NMI-T) in reaction to the announcement from Kirkland Lake Gold Inc. (KLG-T) that it has struck an all-stock $1.01-billion deal to buy the company.
The combined company will be called Kirkland Lake Gold and be based in Toronto.
"Under the all-share transaction, NMI shareholders will receive implied consideration of $5.28 per share based on Sept. 28 (above our $5.00 target), which represents a 1.4 times [price to net asset value] multiple ... or 1.3 times P/NAV based on Thursday's (Sept. 29) close – a valuation we view as fair," said Mr. Thompson, who moved his rating to "market perform" from "outperform. "We believe interloper risk is low given the implied valuation and that [approximately] 23 per cent of NMI shares are locked up in favour of the agreement, and~9 per cent (Luxor Capital Group) have indicated their intention to vote in favour (50 per cent plus 1 required). We believe the combined company will be a strong free cash flow generator with significant exploration and development upside."
Mr. Thompson said the entity is building into a high-grade producer. With an estimated combined production of 510,000 ounces of gold in 2016 and an all-in sustaining costs of $1,050 (U.S.) per ounce, he said the company "would be well positioned relative to its intermediate gold producer peers."
"The combined company is expected to have a strong balance sheet, with a net debt of $157-million (pro-forma company estimate) and be FCF positive (1H16 combined FCF $92-million, company reported)," the analyst said.
He maintained a price target of $5 for the stock. The analyst consensus price target is $5.79, according to Thomson Reuters.
Elsewhere, BMO Nesbitt Burns analyst Brian Quast moved his rating for Newmarket to "market perform" from "market outperform" and lowered his target to $6 from $6.50.
"Without significant synergies from integrating a group of Australian mines with a group of Canadian mines, we find that this transaction is fairly neutral to our valuation, in that the transaction is somewhat dilutive to to 2017 estimated cash flow per share and somewhat accretive to net present value," he said. "We are slightly lowering our target price ... as we homogenise our price target multiples for the two companies, and we expect both companies to trade roughly in line with the market as the transaction progresses."
Mr. Quast also lowered his target for Kirkland to $12.50 from $13.50 (with a "market perform" rating). The consensus is $14.11.
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SNC-Lavalin Group Inc.'s (SNC-T) reduction in its 2016 engineering and construction guidance should be seen as "an attractive buy-on-weakness opportunity" for investors, according to Raymond James analyst Frederic Bastien.
He admitted it was not "the kind of catalyst we expected."
"We were anticipating a decision around the structure of SNC's North American concessions to power the stock price, but instead [Thursday] morning we learned that the firm will record unfavourable cost and revenue reforecasts on two oil and gas projects in the Middle East. As a result, SNC is lowering its 2016 E&C EPS guidance to a range of $1.30 to $1.60 (from $1.50 to $1.70 previously)," said Mr. Bastien. "4Q16 results are forecast to return to a more normal run rate, and discussions are ongoing to resolve the commercial issues in these two jobs (which are being performed for the same client). Management is also sticking to its E&C EBITDA margin target of 7 per cent for 2017, reflecting the actions taken in the past year through its 'Step Change' and 'Operational Excellence' programs."
Mr. Bastien said the guidance alteration can be seen as the first "big" setback for the company since Neil Bruce took over as its chief executive officer in October of 2015.
"Thanks to the various internal controls implemented over the past years, new management can now identify, quantify and address project challenges more rapidly than in the past," he said. "This gives us confidence that: (i) the cost overruns are well understood and conservatively accounted for, and (ii) SNC is better equipped to negotiate its claims successfully. It also helps that the owner/supplier relationship remains excellent and that both parties are collaborating to put these issues past them. This suggests to us that if we ever hear from these two projects again after the 3Q16 call, it will likely be in a positive light."
In reaction to the news, Mr. Bastien reduced his third-quarter earnings per share projection to 17 cents from 56 cents, and, accordingly, his full-year estimate dropped to $2.20 from $2.60. His revenue projections for the year did not change. He also did not alter his 2017 estimates, including EPS at $3.25.
"We are sufficiently comfortable with SNC's newfound discipline, strategic direction and business prospects to leave our 4Q16-4Q17 estimates intact," he said.
Maintaining an "outperform" rating for the stock, he dropped his target to $63 from $65. Consensus is $62.14.
Elsewhere, Desjardins Securities analyst Benoit Poirier reduced his target to $61 from $64 with a "buy" rating.
"Despite this negative surprise, we maintain our positive stance on SNC as we still see several short-term catalysts ahead, including (1) the award of several infrastructure contracts in Canada (Finch LRT, Gordie Howe Bridge), and (2) the divestiture of the North American (ex Highway 407) capital portfolio in 3Q16," said Mr. Poirier. "In our view, these catalysts outweigh the possibility of another material revision to our E&C EBITDA margin estimates in 2017 (we currently expect 6.5 per cent)."
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Expecting a higher fourth-quarter benchmark met coal price and increasing his 2017 expectations, Raymond James analyst Alex Terentiew raised his target price for stock of Teck Resources Ltd. (TCK.B-T, TCK-N)
"While met coal prices in the spot market have rallied hard since the end of July, more than doubling to $210 per ton, they have stabilized over the past few days, with talk of new production in China and elsewhere gathering momentum," the analyst said. "The rapid rally in prices and uncertainty of future production growth in China seems to have made 4Q benchmark negotiations difficult, with buyers and sellers unable to agree on a price. Nonetheless, we think the current market tightness and higher prices may persist for another few months, before sufficient new supply enters the market or demand moderates."
Mr. Terentiew raise his fourth-quarter benchmark hard coaking coal price projection to $175 per ton from $112. It is a significant increase from the third-quarter benchmark of $92.50.
"Sustainability of production cuts in China will drive future prices," he said. "The reduction in coal mine operating days in China to 276 from 330 (announced in April) underpins the rise in prices, although with domestic total coal production down 10 per cent year to date to August, and prices up, the government's objective of removing excess capacity seems to have been met, and perhaps overshot. It will now be a matter of finetuning, we think, with targeted easing of restrictions already being implemented, seeking to improve profitability of the domestic coal mining and steel industries, without reversing the gains made to eliminate excess capacity.
"Production problems elsewhere also helped prices (Anglo's Grasstree and South32's Illawarra mine, and rail damage on the Missing Link rail line in Australia), but restarts or incremental output should also be expected. Teck bumped its 2016 guidance by 1 Mt on July 28, Jindal Steel & Power Ltd. restarted output at its Wongawilli mine in July (100 kt/month), Mongolia's Tavan Tolgoi announced intentions to reopen the mine (although it has a history of challenged foreign investment), and Canada's Brule PCI coal mine restarted last week (1 Mt in 2014). We expect that with prices leaping higher, many companies are also looking to get incremental tonnes into the market quickly, capitalizing on the rally. Longer-term, India's Ministry of Steel said it is looking at reducing dependency on imported coal from 100 per cent to 60 per cent, and with India accounting for roughly 15 per cent of seaborne demand, this ambitious plan, if implemented, could dampen future seaborne demand."
With the changes, Mr. Terentiew's 2016 and 2017 earnings per share estimates rose to $1.31 and $2.25, respectively, from 88 cents and $2.25. His net asset value per share projection rose to $15.01 from $13.91.
He kept his "market perform" rating for the stock and bumped his target to $27 per share from $21. Consensus is $20.43.
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Citing improving debt metrics and the fact that its $1-billion (U.S.) equity offering removes it "from balance sheet bucket," Citi analyst David Zutter upgraded Encana Corp. (ECA-N, ECA-T) to "buy" from "neutral."
He made the change ahead of the company's anticipated analyst day on Oct. 5.
His target increased to $13 (U.S.) from $10. The analyst average is $10.75, according to Bloomberg.
Elsewhere, CIBC analyst Arthur Grayfer also upgraded the stock, moving his rating to "sector performer" from "sector underperformer."
Mr. Grayfer: "Our upgrade is predicated on two factors: 1) that the incremental buyer of the stock continues to focus on the potential upside from Encana's Permian assets which offer over 2,500 to 5,000 premium locations (10,000 potential unrisked locations over 146,000 acres of high-quality land) and is comfortable with the risk profile of the company given the relative valuation to other Permian comps; and 2) while 2017 still looks like it has a significant funding shortfall, the financing bridges the gap into the following year and sets up a more sustainable business (a key takeaway we expect from the upcoming investor day). We estimate WTI prices have to be $55 (U.S.) in 2018 for Encana to cover our capex estimate of $1.5-billion, as well as D/CF of less than ~3.0x. While 2018 still doesn't look fantastic from a leverage perspective, we think the foundation is being laid for increased interest for those focused on the company's fundamentals beyond being 'cheap Permian.'
"To be clear, we continue to struggle with the risk profile for the company given the leverage, very aggressive growth plans in the Montney which may materially affect AECO, and valuation (10.1x 2017 strip enterprise value to debt-adjusted cash flow versus Canadian large caps at 9.4x), but we understand the remarkable potential from the Permian and expect that as long as investor enthusiasm remains high for the play, our underperformer rating was likely going to be wrong. While Encana is cheaper than its Permian peers (2017 EV/DACF of 8.3x versus its Permian peers at 10.8x on consensus estimates), only 15 per cent of current production comes from the Midland Basin and Montney growth is a big part of the near-term plans, which is why we aren't convinced the stock rerates to the same multiple as some of the U.S. Permian names."
His target rose to $12 from $8.
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In reaction to its investor day, RBC Dominion Securities analyst Robert Kwan raised his target for Brookfield Infrastructure Partners LP (BIP-N, BIP.UN-T), saying it is capitalizing on multiple trends and opportunities to drive value.
"BIP reiterated its focus on taking a contrarian investing strategy in order to drive growth moving forward," said Mr. Kwan. "In particular, the company emphasized that it continues to see attractive opportunities in out-of-favour geographies like Brazil where it can leverage its experience (BIP has operated in the country for more than 100 years) and ability to bring in capital quickly through institutional partners via private funds along with direct co-investments in order to close transactions in BIP's favour. The company noted that it is focused on acquisition opportunities where there is less competition (i.e., not auction processes), which can come about due to the presence of a motivated seller (e.g., highly levered) that values BIP's ability to move quickly with confidence in funding. BIP has complemented this investment strategy by monetizing mature assets at high valuations (e.g., sale of Cross Sound Cable and Ontario Transmission) to finance growth in opportunities that yield higher returns."
Mr. Kwan said the spotlight was on its energy and communications infrastructure segments at this year's event.
"On top of acquisitions, the platforms are really paying off for organic growth. While BIP has certainly grown through acquisitions, we believe that the partnership establishing a number of business platforms has been a very important part of the growth profile. As part of our pipeline and midstream coverage, we have long talked about a company's ;infrastructure footprint' as being an important driver of high-return organic growth and BIP has many of the same attributes as we think about the U.K. distribution assets (the connections footprint allowing BIP to grow through smart meters to those same customers) along with NGPL, which was highlighted during the Investor Day presentation, and a couple of major projects totalling almost $300-million to expand that system."
With an unchanged "outperform" rating, he bumped his target to $39 (U.S.) from $37 "to reflect upward valuation revisions in the Energy and Communications Infrastructure segment." Consensus is $35.09.
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In initiating coverage of Klondex Mines Ltd. (KDX-T), CIBC World Markets analyst Jeff Killeen said "the price is right … for now."
He set a "sector performer" rating for the stock.
"We foresee opportunity for KDX to drive shares higher by several mechanisms: resource/reserve expansion at Fire Creek/Midas to support higher mine rates, optimizing True North now that a re-start decision has been made and the re-start of Hollister," said Mr. Killeen. "In this regard, our preliminary estimates indicate adding Hollister could have a 20-per-cent positive impact on our overall KDX valuation and cash flows.
"We anticipate a wealth of news flow over the next 12 to 18 months with asset-wide exploration drilling ongoing, True North coming online and a possible re-start at Hollister. Re-starting True North likely comes with lingering market concern until an operating track record is established, but KDX's plan seems achievable given a focus on higher grades over higher volumes. We regard successful re-starts in Canada and Nevada as primary catalysts for KDX shares over the medium term."
Mr. Killeen set a price target of $8. The average is $8.02.
"With Fire Creek and Midas grades ranking towards the top of current operating mines globally, a low cost profile and a strong balance sheet ($22-million in debt versus cash of $37-million), we see potential for KDX to realize organic growth and drive NAV and cash flow expansion," he said. "That said, we expect KDX will trade in line with peers until greater certainty around profitability of re-start operations is realized."
He added: "Trading at a discount on a price-to-cash flow basis for the bulk of the first half of 2016 despite beating market expectations in 2015, KDX shares have largely closed the gap to peers and now trade near fair value, in our opinion, at 8 times our average forward CFPS estimates versus peers at 9x. We see KDX shares at a justifiable premium at 1.7x our 5% NAV of $4.11/share (at $1,300/oz gold) versus peers at 1.1x as we are confident of reserve growth in Nevada and the market appears to hold the same view."
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In other analyst actions:
Enbridge Income Fund Holdings Inc. (ENF-T) was raised to "sector outperform" from "sector perform" by National Bank analyst Patrick Kenny. He raised his target price by a loonie to $37. The average is $35.46.
Arizona Mining Inc. (AZ-T) was given a new "speculative buy" rating by TD Securities analyst Craig Hutchison. He set a target of $3.75, compared to the average of $3.41.
David Leeder