Inside the Market’s roundup of some of today’s key analyst actions
RBC Dominion Securities analyst Walter Spracklin made further reductions to his 2023 financial forecast for Canadian National Railway Co. (CNR-T) on Friday to reflect the impact of wildfires and a labour disruption at the Canadian West Coast ports, seeing its full-year guidance now difficult to achieve.
“Our view is that the likely resulting lower volumes and therefore extra headcount are going to pressure margin, and we now see 2023 guidance for mid-single digit EPS growth as at risk (RBC estimate: up 1 per cent; from 5per cent),,” he said in a research note released Friday. “However, our long-term positive thesis remains intact, and we continue to expect the company to deliver on its Investor Day targets for 10-15-per-cent EPS CAGR [compound annual growth 2024 to 2026.”
“We also caught up with CN management [Thursday] who noted four bridges were knocked out of commission (3 due to wildfires, 1 due to flooding) during the quarter, which we expect could negatively impact fluidity and margins in Q2 and during the remainder of the year
Mr. Spracklin is now projecting 2023 earnings per share of $7.54, down from $7.81 previously and “well below” the consensus estimate of $7.83. His 2024 and 2025 expectations slid to $8.68 and $9.73, respectively, from $9 and $10.29 (versus the Street’s $8.67 and $9.62).
“CN last quarter upped its EPS growth guidance to up mid-single digit (from up low-single digit), which we now view as at risk driven by the external factors highlighted above,” he said. “We are modelling for EPS growth of 1 per cent in 2023 (from 5 per cent) and we highlight that we could therefore see management lower guidance during Q2 reporting to better reflect the current operating environment.”
“We note that our EPS growth estimates of 15 per cent and 12 per cent (on 2024 and 2025 EPS, respectively) align with new 3-year guidance for 10–15-per-cent EPS CAGR 2024–26 provided at CN’s recent Investor Day.”
Keeping an “outperform” recommendation for CN shares, Mr. Spracklin cut his target to $174 from $180, exceeding the $165.93 average, according to Refinitiv data.
“Our Outperform rating is based on favourable network dynamics as well as GDP plus growth opportunities and potential for meaningful margin improvement. We also believe the rail sector as a whole has positive fundamentals that we expect to drive long-term growth in free cash flow,” he said.
=====
Barclays analyst Matthew Murphy upgraded a pair of mining stocks on Friday:
* Hudbay Minerals Inc. (HBM-T) to “overweight” from “equal weight” with an $9 target. The average on the Street is $10.01.
“The stock has fallen in recent months and now sits at 0.7 times P/NAV vs peers at 1.25 times,” he said. “We see the shares as being supported by improving production in Peru, integration of Copper Mountain, and the medium-term exploration story, not to mention eventual growth from Copper World.”
* Newmont Mining Corp. (NEM-N, NGT-T) to “overweight” from “equal weight” with a $61 target, down from $62. The average is US$57.40.
“NEM has underperformed the GDX by 15 per cent since the start of 2023,” he said. “It now trades at 1.16 times P/NAV, well below its 3-year average of 1.64 times. While there are still issues including a strike at Penasquito, integration of NCM, and project resequencing, we still see scope for value creation from the NEM-NCM asset mix and upgrade to OW.”
Mr. Murphy also made these target changes, noting: “We expect most of our companies to have slightly better results in Q2, even amidst some deterioration of commodity prices. We remain more constructive on gold than copper as economic deceleration continues.”
His adjustments are:
- Agnico Eagle Mines Ltd. (AEM-N/AEM-T, “overweight”) to US$61 from US$63. Average: US$67.02.
- First Quantum Minerals Ltd. (FM-T, “underweight”) to $26 from $27. Average: $35.01.
- Franco-Nevada Corp. (FNV-N/FNV-T, “underweight”) to US$126 from US$127. Average: US$157.07.
- Lundin Mining Corp. (LUN-T, “equalweight”) to $10 from $11. Average: $11.22.
- Royal Gold Inc. (RGLD-Q, “equalweight”) to US$124 from US$122. Average: US$147.23.
- Wheaton Precious Metals Corp. (WPM-N/WPM-T, “equalweight”) to US$41 from US$42. Average: US$56.78.
=====
Following in-line second-quarter results, National Bank Financial analyst Zachary Evershed expects Richelieu Hardware Ltd.’s (RCH-T) profitability to improve in the second half of fiscal 2023.
However, after seeing organic growth decline, he warned the Montreal-based company faces “another difficult comp” in the current quarter.
“June 2022 was RCH’s best ever month, and management flags June 2023 was down 10 per cent year-over-year,” said Mr. Evershed. “Despite the expectation of slightly easier comps in the rest of Q3, we lower our organic growth forecast to negative 8.2 per cent year-over-year in Q3/23 (was down 7 per cent).”
“Carrying excess inventory through external warehousing continues to drag on margins, as it represents roughly $6 million per quarter in additional costs. We continue to model inventory reduction in the upper end of management’s target of $60-80 million this year, and management calls for further working capital reduction of approximately $50 million in 2024, which we fine-tune in our model. Given these dynamics, and barring significant volume erosion, the 13.0-per-cent EBITDA margin generated in Q2/23 is expected to be the low watermark in 2023, with slight improvements through the rest of the year. Margin guidance for 2023 is 13 per cent, with 2024 now at 13-14 per cent, slightly cooler than previous messaging that was calling for margins slightly north of 14 per cent.”
On Thursday, Richelieu shares slid 2.7 per cent after it reported revenue of $472.1-million, down 3.2 per cent year-over-year driven by a 4.7-per-cent organic growth and narrowly topping Mr. Evershed’s $468.6-million estimate. EBITDA of $61.5-million and earnings per share of 55 cents both met his estimates ($61.4-million and 55 cents, respectively).
Mr. Evershed said M&A activity keeps “rolling in, complemented by organic initiatives.”
“Following the four acquisitions closed in Canada in Q1/23, RCH completed the acquisitions of Maverick Hardware and Westlund Distributing in the U.S. during Q2/23,” he said. “Additionally, RCH opened a new distribution centre in Minneapolis and continued expansion and modernization projects at its Atlanta, Nashville, Seattle and Pompano facilities. Management notes a very healthy pipeline, and we expect additional tuck-ins in the back half of the year.”
After “minor” changes to his forecast to account for the results, management commentary and its latest acquisitions, Mr. Evershed lowered his target for Richelieu shares by $1 to $48. The average on the Street is $46.
“We reiterate our Outperform rating as we remain bullish on management execution and end-market growth in the long term,” he concluded.
=====
RBC Dominion Securities’ Nelson Ng thinks Algonquin Power & Utilities Corp. (AQN-N, AQN-T) shareholders are likely to have high expectations heading into August, given its ongoing strategic review and another activist shareholder (Starboard Value) lobbying for asset sales.
However, the analyst sees limited share price upside even if the Oakville, Ont.-based company decides to sell a portion or all of its renewables business.
“Over the past quarter, several activist shareholders emerged, including Starboard Value (7.5-per-cent interest consisting of 5.0-per-cent common shares and 2.5-per-cent total return swaps), Corvex (1.7 per cent) and Ancora,” he said. “We believe shareholders generally support AQN’s previously announced strategic review of its Renewable Energy Group. However, due to investment opportunities emerging from decarbonization and energy transition, we believe the company should continue to develop non-regulated renewable energy projects even if AQN decides to divest some or most of its nonregulated renewable assets. We also believe that in the high interest rate environment, it is currently not the best time to divest renewable assets.”
Mr. Ng said his view is supported by Duke Energy Corp.’s (DUK-N) agreement to sell its unregulated utility scale Commercial Renewables business to Brookfield Renewable in a deal valued at about US$2.8-billion.
“There have been several large U.S. renewable energy transactions announced in the past year, and we estimate that the transaction multiples were in the 9-12 times EBITDA range,” he said. “The most recent transaction is Duke Energy’s sale of its non-regulated commercial renewables business for $1.05 billion ($2.8 billion including tax equity and debt), which reflects roughly 9 times EBITDA. ... We currently value AQN’s Renewable Energy Group by applying a 12 times EBITDA multiple, but if we apply a 9-times EBITDA multiple to AQN’s renewable portfolio and value its interest in Atlantica Sustainable Infrastructure using the latest closing share price, our sum-of-the-parts value would be $7.21. As a result, we believe that spinning out or divesting the Renewable Energy Group may not lead to a sustainable higher AQN share price. We recognize that using some sale proceeds to fund stock buybacks could support a higher share price in the near term.”
While he lowered his 2023 earnings per share estimate “modestly” by 2 US cents to 56 US cents to “reflect weak North American wind resources in Q2/23,” Mr. Ng reiterated a “sector perform” rating and US$9 target for Algonquin shares. The average is US$9.48.
Elsewhere, iA Capital Markets’ Naji Baydoun kept a “speculative buy” rating and $13 target.
“Although a sale of AQN’s water utilities could be completed at a premium to current valuations (we calculate $2.0-4.0/share of value at 30.0 times P/E or 2.25 times rate base), this would likely dilute the Company’s remaining portfolio quality, growth profile, and valuation,” said Mr. Baydoun. “As for 2025 run-rate EPS expectations, we believe that $0.75-0.90 is optimistic and would likely require substantial share buybacks to achieve; large share repurchases would likely limit AQN’s ability to invest in organic growth, and we estimate that ~$0.60-0.65 of annual run-rate EPS by 2025 is more realistic (with some upside from buybacks). Overall, we continue to see activist shareholder involvement in AQN leading to the pursuit/execution of strategic initiatives to unlock shareholder value in the near term.”
=====
Calling it a “high risk/high reward play on pain,” Stifel analyst Andrew Partheniou initiated coverage of ZYUS Life Sciences Corp. (ZYUS-X) with a “speculative buy” recommendation.
The Toronto-based company is developing cannabinoid drugs to alleviate pain associated with a variety of conditions, including osteoarthritis and bone cancer. It went public through a reverse takeover with Phoenix Canada Oil Company Ltd. on June 19.
“Its founder, President and CEO Brent Zettl has been pursuing drug commercialization using a cannabinoid formulation for 23 years, with his previous endeavor culminating in the largest takeover in the cannabis industry at the time,” Mr. Partheniou said. “With a successful Phase 1 already completed and multiple data points suggesting efficacy, we believe its lead drug candidate, Trichomylin, is well positioned to offer investors an attractive risk/reward opportunity, given the large market size of chronic pain targeted and the potentially short timeframe of 1-2 years to reach a meaningful catalyst. Hence, we outline a positive bias in our outlook for ZYUS.”
Currently the lone analyst covering the stock, he set a target of $4, representing upside of 308.2 per cent from Thursday’s closing price of 98 cents.
“We leverage a 10-year, two-stage DCF to capture the value of Trichomylin for cancer-related pain, leaving osteoarthritis and its two other potential drug candidates as upside optionality,” said Mr. Partheniou. “Our commercialization assumption is in 2029 in the US only, with a conservative treatment cost of approximately $5 per day, less than branded NSAIDs and popular opioids. We expect a good adoption rate, given the safety profile of the drug, matched with its potential to be opioid sparing, achieving blockbuster status within its first three years. We assume a 0-per-cent terminal growth rate, a 10-per-cent WACC and a probability of success factor of 17 per cent to account for completing Phase 1 but in the difficult area of chronic pain.”
=====
In a report previewing second-quarter earnings season for Canadian energy services providers, ATB Capital Markets analyst Tim Monachello said the sector is “oversold” and “a U.S activity bottom could unlock significant second-half upside.”
“Energy sentiment has weakened through 2023 on significantly lower natural gas prices (following an unexpectedly warm winter) and headwinds facing crude prices (as the market continues to weigh the relative impacts of a potential global recession on crude demand against OPEC+ actions to support price and the potential impact of relatively range-bound North American crude production),” he said. “Even with this relatively tepid macro backdrop and a moderate softening in U.S. activity levels, we believe the North American energy services complex remains well positioned for a significant and sustainable inflection in FCF generation in 2023; across our Canadian SMID-cap coverage universe, we forecast an aggregate 235 per cent year-over-year increase in FCF generation in 2023, with the aggregate net leverage ratio falling to roughly 1.0x by year-end 2023 from 1.9x at year-end 2022.
“Meanwhile, valuations remain near all-time lows, with the median FCF yields across our coverage at roughly 24%/28% in 2023/2024. Still, sentiment often directs funds flows in the service sector, which begs the question: ‘What’s the catalyst?’. We believe the largest and most visible catalyst for the service sector will be a bottoming in U.S. rig activity levels, which our channel checks suggest is likely to occur in Q3/23. We believe stabilizing U.S. rig activity would signify a meaningful reduction in the downside risk for investors, and it could unlock meaningful upside as the market turns its focus to pricing in the sizable and sustainable FCF generation of the industry in a relatively range-bound activity environment.”
After adjusting his estimates to reflect minor reductions in our U.S. rig activity forecasts, Mr. Monachello made a pair of target price reductions to stocks in his coverage universe:
* Cathedral Energy Services Ltd. (CET-T) to $1.30 from $1.50, below the $1.87 average, with an “outperform” rating.
* Enerflex Ltd. (EFX-T) to $13.75 from $14 with an “outperform” rating. The average is $14.30.
The analyst also named three top picks in the sector. They are:
* Akita Drilling Ltd. (AKA.A-T) with an “outperform” rating and $3.75 target. Average: $3.75.
“AKT has been among the worst performing stocks in our coverage universe (down 27 per cent year-to-date) despite no material change to our full-year estimates since November 2022, when we raised estimates,” he said. “We believe AKT’s recent share performance is, in part, a reflection of weak sentiment and limited funds flow in the sector over recent months. With that in mind, we continue to believe that AKT is among the most undervalued companies in the North American energy sector and that it could also be among the best positioned for a laggard-to-leader trade in an improving sentiment environment, which we believe is likely to materialize in H2/23 as U.S. industry activity bottoms. While AKITA is not completely insulated from the recent softness in U.S. activity levels, its U.S. fleet is comprised almost entirely of tier-one assets in the Permian basin, and according to industry data, AKT’s Q2/23 average U.S. rig activity was up roughly 5 per cent quarter-over-quarter and remains at its highest post-pandemic level (14 rigs). Adding to AKITA’s insulation from U.S. activity weakness is its material Canadian operations, for which we anticipate increasing margins through H2/23 as its rigs roll onto higher market rates. Most importantly though, AKITA is now generating meaningful FCF from its operations (roughly $27-million in Q4/22 and Q1/23 combined before working capital investment), and we forecast it will generate roughly $39-million/$31-million of FCF before/after working capital investment in 2023.”
* CES Energy Solutions Corp. (CEU-T) with an “outperform” rating and $4.50 target. Average: $4.08.
“CEU shares are down 5 per cent year-to-date, which is roughly in line with the sector and slightly better than the average U.S.-drilling-cycle-exposed company in our coverage,” he said. “CEU has a diversified (drilling and production), low-capital-intensity exposure to the North American energy service complex, with just a roughly 10% (ATBe) weighting to dry gas drilling across its drilling fluids operations. In addition, CEU produces consumable products that are not as susceptible to industry surpluses as higher-capital-intensity, equipment-based businesses. Taken together, we believe CEU is relatively well insulated from U.S. activity declines, and we do not anticipate any material margin pressure. CEU’s operational exposures are supportive of our view that the Company is in the midst of a low-risk and sustainable free cash flow inflection. CEU’s free cash flow generating profile has a healthy track record, though it has been absorbed by the rapid pace of working capital investment required to support its roughly $1.0-billion in annual revenue growth since 2021. This pace of growth has materially slowed, and CEU is now in the early innings of excess free cash flow generation, having generated roughly $55-million in excess free cash flow in Q4/22 and Q1/23 combined ($0.22 per share), and we forecast it will generate roughly $175-million of FCF in 2023 (before dividends and repurchases, $0.69 per share).”
* Total Energy Services Inc. (TOT-T) with an “outperform” rating and $18 target. Average: $15.67.
“While TOT’s shares are down roughly 1 per cent year-to-date, it remains one of the best risk/return propositions in our coverage,” he said. “From a risk perspective, TOT’s diversified exposures to four primary business lines (contract drilling, well servicing, rentals and trucking, and gas compression and processing), including both cyclical drilling-exposed businesses and more stable production-exposed verticals within the energy services complex, and three countries (Canada, the USA, and Australia) helps to both diversify risk and provide opportunity for capital allocation optimization between service lines. In addition, TOT has a pristine balance sheet, with just 0.4 times net leverage at June 30, 2023 (ATBe), down from 1.1 times at June 30, 2022. TOT’s strides to deleverage its balance sheet have now shifted its focus on returning cash to shareholders, which has largely been comprised of share repurchases over recent years, with roughly 1.4 million shares repurchased YTD (3.3 per cent of outstanding at YE2022) and a reduction in its total share count of 13 per cent since 2017. TOT also reinitiated a dividend in Q3/22 and increased it by 33 per cent in Q2/23 to $0.08 per share quarterly ($0.32 annualized, 3.3-per-cent yield). Given TOT’s healthy track record of free cash flow generation and its strong leverage position, we believe TOT is well positioned to both allocate capital to high-return, low-risk opportunities and increase returns to shareholders, through both growing dividend payments and share repurchases.”
=====
In other analyst actions:
* Bernstein’s Bob Brackett raised his Barrick Gold Corp. (GOLD-N, ABX-T) target to US$20 from US$19.50 with a “market perform” rating. The average is US$23.09.
* TD Securities’ Brian Morrison reduced his Canadian Tire Corp. Ltd. (CTC.A-T) target to $210 from $215, keeping a “buy” rating. The average on the Street is $196.
* BMO’s John Gibson raised his Mattr Infratech (MATR-T) target to $22 from $14.50, maintaining a “market perform” rating. The average is $20.22.
“MATR stock has been on quite the run, up 4 times over the past calendar year and nearly 40 per cent year-to-date ... We are updating estimates along with our target price to $22.00 ($14.50 prior), which reflects higher multiples for its pro forma businesses and increased sales proceeds for its PPS segment,” he said. “We reiterate our Market Perform rating but recognize the company’s remaining end-markets are strong, while its balance sheet (estimated more than $100-million of net cash post PPS sale) leaves it with flexibility to pursue additional organic/inorganic growth opportunities.”
* Credit Suisse’s Edlain Rodriguez cut his Nutrien Ltd. (NTR-N, NTR-T) target to US$55 from US$50 with an “underperform” rating. The average is US$77.30.
“Volumes for the June quarter have been subdued as buyers remained skittish and have only purchased what’s necessary,” he said. “Fertilizer prices have declined steadily throughout the quarter and are below managements’ indications provided during the 1Q23 earnings calls. Since the end of March, the benchmark Tampa ammonia price is down 35 per cent, NOLA urea is flat, U.S. cornbelt potash price is down 7 per cent, and U.S. Gulf DAP price dropped 25 per cent. This is despite June quarter being the seasonally strongest quarter.”
David Leeder