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(Tim Boyle/2006 Getty Images)
(Tim Boyle/2006 Getty Images)

Eye on Equities

Time to buy railways, says TD Add to ...

Where should optimistic investors look if they’re betting the U.S. economy has simply run into a soft patch and will re-accelerate into next year? TD Newcrest believes railways - especially U.S. names - are a good bet, and upgraded the sector today to “overweight” from “market weight.”

Most rail stocks offer dividend yields of at least 2 per cent, furnishing a bit of cushioning in these volatile times. They also generally have strong balance sheets and benefit from barriers to entry, TD analyst Cherilyn Radbourne points out. New competitors aren’t likely to crop up overnight.

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Ms. Radbourne points out that the rails are trading at an average multiple of 12 times price to forward 12-month earnings per share. That’s below the group’s historical average valuation range of 12.3 to 15.7 times. “We would suggest that, at current levels, the rail stocks are pricing in some degree of downside risk to earnings,” she said.

Furthermore, “With high single-digit rates of employee attrition, the rails have the ability to adjust their cost structures in the event of lower-than-expected volume growth by simply not hiring. Fuel was an earnings headwind throughout the first half of this year, but has shifted to a tailwind in recent weeks, due to the inherent lag of about two months in most industry fuel surcharge programs.”

Based on her target prices, Ms. Radbourne expects returns of more than 30 per cent for Canadian National Railway Co. and Canadian Pacific Railway Ltd. But she expects even juicier returns of greater than 40 per cent for the U.S. railways, as they’ve underperformed the Canadian rails during the recent selloff.

As such, she upgraded Norfolk Southern Corp. and Union Pacific Corp. to “buy” from “hold.”

Upside: TD has a 12-month price target of $92 (U.S.) on Norfolk Southern , $124 on Union Pacific , and $33 on CSX Corp. She has a price target of $88 on Canadian National Railway and $74 on Canadian Pacific Railway Ltd.

PetroBakken Energy Ltd.’s second-quarter results were well below expectations as production dipped and operating costs rose. Although current production is increasing again, Canaccord Genuity analyst Kyle Preston is doubtful the company will be able to achieve its year-end target rate of 46,000 to 49,000 barrels of oil equivalent per day. He’s also “becoming increasingly concerned” about its debt levels.

Downside: Mr. Preston downgraded his recommendation to “speculative buy” from “buy” but maintained a $20 price target.

Raymond James Ltd. analyst Brad Humphrey is recommending investors buy Detour Gold Corp. , which recently closed a $428-million equity financing and is more than one-quarter of the way towards completing construction of its namesake mine in Ontario. “Well into the construction phase and now fully funded, Detour offers investors an opportunity to gain exposure to a large undeveloped gold asset in a relatively stable mining jurisdiction that is successfully working its way along the ‘de-risking path’,” he said.

Upside: Mr. Humphrey raised his price target by $3 to $45.

EnerCare Inc. reported a slightly better-than-forecast second quarter and should see continued steady growth from its portfolio of installed water heaters, said TD Newcrest analyst Damir Gunja, who upgraded the stock to a “buy.” TD believes the dividend, which currently yields just above 9 per cent, is safe and investors will be well compensated as business fundamentals improve.

Upside: TD raised its 12-month target price by $1.50 to $8.50.

Flint Energy Services Ltd. reported second-quarter results that were well above expectations “and show an improving business that should continue to grow both top-line revenue and EBITDA margins through 2011 and into 2012,” said TD Newcrest analyst Scott Treadwell. “As oil sands construction and drilling-related activity continues, we expect Flint to capture incremental work and continue to benefit from positive catalysts,” he said.

Upside: Mr. Treadwell upgraded Flint Energy to a “buy” from “hold,” and raised his price target by $1 to $17.50.

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