Inside the Market's roundup of some of today's key analyst actions
A 20-month rig count slide is nearing the bottom, according to Raymond James analyst Andrew Bradford.
"How do we know this?" said Mr. Bradford in a research note on the contract drilling industry. "Without coming across as glib, zero is the floor and we're not far off of it. But more relevantly, crude pricing has been on a constructive trajectory since early February, and natural gas prices have been moving higher across the strip since early March. It's time to begin considering what contract driller equities look like in a recovery scenario."
Admitting he has become more "constructive" on driller stocks through the industry's recovery, Mr. Bradford said the potential for equity upside is inversely proportionate to the company's market cap. He added the "greatest" potential upside lies with, in order, Savanna Energy Services Corp. (SVY-T), Western Energy Services Corp. (WRG-T) and Trinidad Drilling Ltd. (TDG-T).
He upgraded Trinidad Drilling to "outperform" from "market perform" and Western Energy to "outperform" from "underperform."
He also upgraded Ensign Energy Services Inc. (ESI-T) and Precision Drilling Corp. (PD-T, PDS-N) to "market perform" from "underperform."
Mr. Bradford said his prior 2018 estimates were too low, adding: "Investors need to consider what happens to day rates when rigs are oversupplied – like today – but rig demand rises within that oversupplied context – such as what we expect over the next several quarters. The last time we saw anything like this was in the late-1990s and early-2000s. Our examination of previous cycles tells us to expect slow day-rate gains in the early quarters of the recovery, but that day-rate growth will accelerate as high-spec equipment becomes more scarce – late 2017 and 2018 according to our rig count forecasts.
"2018 economics will reflect considerably higher rig counts and rapidly recovering day rates as higher-spec equipment becomes more scarce. In 2016, reported day rates will continue to be high, but rig activity is very low. By contrast, in 2017, active rig counts will have improved, but contract rollovers mean reported day rates will fall considerably. By 2018, however, active rig counts will be more than twice and close to three times current levels, and day rates on high-spec rigs will be on a sharp upward trajectory. Neither 2016 nor 2017 economics will be sufficient to underpin going concern valuations for our covered contract drillers. But 2018 economics will reflect both higher rig counts and rapidly recovering day rates as higher-spec equipment becomes more scarce."
The analyst also adjusted his target prices for contract driller stocks. The changes were:
- Trinidad Drilling to $3.40 from $2.30. The analyst consensus is $2.71, according to Thomson Reuters.
- Western Energy to $4.75 from $2.50. Consensus is $3.41.
- Ensign Energy Services to $7.50 from $6. Consensus is $7.63.
- Precision Drilling to $6.10 from $4.25. Consensus is $6.86.
- Savanna Energy Services (rated "strong buy") to $3.75 from $3.40. Consensus is $2.25.
"Our general approach to setting target prices is to acknowledge that our covered drillers have a long established history of trading between 6.0 times (x) and 7.0x current-year EBITDA," said Mr. Bradford. "We therefore use 6.5x 2018E EBITDA as a starting point and discount this back one year to achieve our one-year-out target prices. If we assume the market has consistent plans for how it will value driller stocks going forward, then the market has more or less priced in our 2018 estimates for ESI and PD. However, the market has taken a more cautious view of SVY, TDG, and WRG. We believe SVY remains mispriced – as small-cap stocks tend to during down markets. But we show in the analysis ... that both TDG and WRG have considerable upside potential in Canadian and U.S. recovering rig markets. We don't believe the market is adequately pricing this potential."
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Knight Therapeutics Inc. (GUD-T) is a "safe haven" for investors seeking exposure to specialty pharma, said CIBC World Markets analyst Prakash Gowd.
He initiated coverage of the Quebec-based company with a "sector outperformer" rating.
"Knight has the resources and flexibility to make return-yielding equity and debt investments while it builds its pipeline of health care products – currently through licensing agreements and partnerships," said Mr. Gowd. "With its current deployable cash balance of $326-million (excluding a recently announced $200-million bought deal), Knight is well positioned to make meaningful acquisitions. We have conservatively modeled $150-million in product acquisitions over four years, starting in 2017.
"Knight has an unencumbered balance sheet free from debt and, thus, has been well insulated from the negative shadow that has been cast upon the sector's highly leveraged players."
Mr. Gowd emphasized Knight is "unique" in the manner in which it builds its product pipeline.
"To supplement the conventional acquisition method, Knight makes strategic debt investments into life science companies and strategic equity investments into health care venture capital (VC) funds to: 1) Earn a return on its investments; and 2) Leverage the partnerships to access their product portfolios," he said. "To that end, Knight has secured the rights to over 20 products, provided roughly $120-million in loans, and made commitments of $137-million in investable cash to nine life science funds."
He said Knight, like Paladin Labs Inc., plans to focus its marketing outside the United States. He called avoidance of that market "positive," noting the U.S. is a highly competitive and challenging environment with "increasing scrutiny from multiple angles."
"This strategy follows a path with which management is deeply familiar, reducing execution risk," said Mr. Gowd.
He set a price target of $9.50 for the stock. Consensus is $9.47.
"Knight is a unique specialty pharma company in that it is part financial investment company and part pharmaceutical company, has a pipeline of products, and aims to deploy capital to acquire future products but without taking on debt," he said. "Knight's committed cash for VC investments will be deployed over the next five years and the last of its current loan investments will only mature by 2022. As such, a significant portion of the company's value will come from these financial assets and conventional valuation approaches such as EV/EBITDA or P/E are unsuitable. To capture the different elements that comprise this company, we use a sum-of-parts methodology that encompasses two main segments: 1. Financial Assets (cash, equity holdings and investments, and loan portfolio); and, 2. Pharma Business (currently marketed, pipeline and acquired products)."
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The current valuation for Stingray Digital Group Inc. (RAY.A-T) is "attractive" and should provide good downside protection, according to Desjardins Securities analyst Maher Yaghi.
He initiated coverage of Stingray, which provides business-to-business multi-platform music and in-store media solutions, with a "buy" rating.
"It is difficult to characterize Stingray within the context of a specific industry," the analyst said. "We view the company as an edge-operator within several industries that are undergoing change — a blend of a technology company, content distributor and an entertainment provider. The company characterizes itself as a music streaming provider; however, we note that it does not sell directly to consumers like other pure-play streaming providers (such as Spotify or Google Play Music), but rather sells to businesses. In short, Stingray is predominantly a B2B [business to business] provider of curated music as opposed to a B2C [business to consumer]. In addition, Stingray's products are primarily delivered through TV, whereas other streaming services reach their customers principally through the Internet or mobile services. Moreover, Stingray's model for music is linear streaming (ie not on-demand), allowing the company to carry a lower cost structure for its content compared with on-demand music streaming companies."
He added: "Since its inception in 2007, much of Stingray's growth has come from M&A activity, with the company realizing 23 acquisitions since that time. Management also intends to continue rolling out its 'build and buy' strategy over the foreseeable future. Stingray mostly operates in Canada, but is looking to expand internationally through M&A and organic channels. We view Stingray's products as valuable insofar as they allow TV service providers to offer a more robust value proposition to their customers at a modest cost. With an international cable industry that has not reached maturity yet, we believe significant growth opportunities remain for the Montreal-based company."
Mr. Yaghi said the company's "large" proportion of recurring revenue has allowed it to focus on expansion internationally. He views this approach as "highly" accretive due to its ability to export its curated music services at a low margin cost.
"We currently forecast revenue CAGR [compound annual growth rate] of 11 per cent over the next two years, supported by international organic growth and potential monetization of the mobile platform," the analyst said. "We believe the company can maintain its current margins as its B2B focus should protect it from competition from larger direct to consumer music streaming companies."
Calling the company's growth prospects "attractive," Mr. Yaghi is forecasting revenue growth of 25 per cent in the 2016 fiscal year, 14 per cent in 2017 and 4 per cent in 2018. He projects EBITDA growth of 8 per cent, 19 per cent and 4 per cent, respectively.
He set a price target of $9.50. Consensus is $10.
"The relatively early stage of the company's international cable expansion allows it to grow at double-digit rates organically, with additional upside potential from M&A," he said. "Competitive threats from larger players exist, but we believe Stingray's B2B focus should enable it to manage these market dynamics."
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Painted Pony Petroleum Ltd. (PPY-T) is now "playing with the best," said Raymond James analyst Jeremy McCrea.
"With emerging signs that the outlook for natural gas is improving, interest in gas weighted names is naturally picking up," said Mr. McCrea. "Traditionally, the go-to lean gas names (nondividend) have been Advantage and Birchcliff given their low cost structure and strong execution however we believe that Painted Pony deserves to be in the discussion, especially when looking at its 2017 and PDP [proved-developed-producing] FD&A costs.
"Overall, there are many misconceptions regarding PPY's cost structure and its ability to generate positive funds flow in a low price environment. The last few quarters have seen a combination of AECO/Station 2 pricing distortions and higher costs associated with the lead up to the commissioning of the AltaGas Townsend facility. Moreover, backward looking PDP costs do not reflect PPY's improving production profiles and costs – especially as the company tests the merits of doubling its frac intervals to 38 stages. Obviously, the outlook on gas prices heading into winter will remain a key factor in determining PPY's cash flow position; however, we believe a detailed understanding of PPY's cost structure and the accounting methodology of Townsend facility agreement with AltaGas finds a more robust business model than the market generally believes."
The analyst said he has a "growing comfort" that the company is amassing the necessary number of wells required to reach capacity at its Townsend facility. Accordingly, he adjusted his production projections closer to the company's 2017 guidance. He moved his estimate to 47,107 barrels of oil equivalent per day (boe/d) from 42,122.
He also raised his cash flow per share projection for 2017 to $1.73 from $1.65. His 2016 projection of 63 cents did not change.
Mr. McCrea also raised his price target for the stock to $8 from $6. Consensus is $7.77.
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RBC Dominion Securities analyst Robert Wetenhall initiated coverage of BMC Stock Holdings Inc. (STCK-Q) with an "outperform" rating, touting its proprietary business model, "strong" competitive position, "solid" growth prospects and "disruptive" approach to product innovation.
In December of 2015, BMC merged with Stock Building Supply Holdings to become the second-largest distributor of lumber and building materials in the United States. Mr. Wetenhall said the merger accelerated revenue growth, increased buying power and allowed for the leverage of fixed costs.
"STCK is a one-step distributor that expedites job site execution for both R&R contractors as well as local, regional, and national homebuilders by providing both support services and materials," the analyst said. "This bundled approach to the business extends from project planning through installation management, resulting in a shorter cycle time at less cost for the customer. The broad set of capabilities that defines this customized approach to client service is difficult to replicate, which differentiates STCK from commodity distributors of lumber and building materials."
Mr. Westenhall said the company's Ready-Frame product, which is shipped pre-cut to a job site, is a "better mousetrap," reducing cycle times, labour costs and waste.
"We expect that the combination of strong underlying demand trends, market share gains, and an active M&A pipeline will drive average revenue growth of 9.3 per cent annually from $2.8-billion (pro forma 2015) to $3.7-billion (2018 fiscal year estimate)," he said.
His adjusted EBITDA projections for 2016, 2017 and 2018 are $184-million (up 42 per cent year over year), $232-million (up 26 per cent y/y), and $26-million (up 13 per cent y/y), respectively.
Calling the company's current stock valuation "attractive," Mr. Westenhall set a price target of $22. Consensus is $21.50.
"STCK is trading at a 2016 fiscal year estimated TEV [total enterprise value]/EBITDA multiple of 9.4 times compared with the peer group average of 10.2x," he said. "Our price target of $22 (14-per-cent implied upside) is based on an TEV/EBITDA multiple of 10.5x. We believe that STCK should trade at the high end of the historical range (7.0x to 11.0x) for building product companies due to the company's proprietary business model, a strong competitive position, solid growth prospects, and a disruptive approach to product innovation."
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In other analyst actions:
Agrium Inc (AGU-N) was raised to "buy" from "hold" at Stifel by equity analyst Paul Forward. The 12-month target price is $103 (U.S.) per share.
AMN Healthcare Services Inc (AHS-N) was rated new "buy" at Lake Street Capital Markets by equity analyst Matt Blazei. The 12-month target price is $46 (U.S.) per share.
BRF SA (BRFS-N) was raised to "overweight" from "neutral" at JPMorgan by equity analyst Pedro Leduc. The 12-month target price is $14 (U.S.) per share.
Cliffs Natural Resources Inc (CLF-N) was raised to "overweight" from "neutral" at JPMorgan by equity analyst Michael Gambardella. The target price is $7 (U.S.) per share.
Diamond Offshore Drilling Inc (DO-N) was raised to "buy" from "Accumulate" at KLR Group by equity analyst Darren Gacicia. The target price is $33 (U.S.) per share.
Micron Technology Inc (MU-Q) was raised to "outperform" from "neutral" at Robert Baird by equity analyst Tristan Gerra. The 12-month target price is $18 (U.S.) per share.
Newcastle Gold Ltd (NCA-X) was rated new "speculative buy" at TD Securities by equity analyst Daniel Earle. The 12-month target price is $1.50 (Canadian) per share.
Signature Bank (SBNY-Q) was downgraded to "neutral" from "overweight" at Piper Jaffray by equity analyst Peyton Green. The 12-month target price is $146 (U.S.) per share.
Spectra Energy Partners LP (SEP-N) was rated new "buy" at Stifel by equity analyst Selman Akyol. The 12-month target price is $50 (U.S.) per share.
Targa Resources Corp (TRGP-N) was rated new "hold" at Stifel by equity analyst Selman Akyol.
Weatherford International PLC (WFT-N) was raised to "buy" from "accumulate" at KLR Group by equity analyst Darren Gacicia. The target price is $7.25 (U.S.) per share.
With files from Bloomberg News
David Leeder