Inside the Market's roundup of some of today's key analyst actions
The risk-return profile for Canadian regulated utilities has become much more favourable, according to Raymond James' David Quezada and Frederic Bastien.
Though they caution that investors are in "the early inning" of a rising bond rate environment, the analysts feel valuations have become much more attractive, citing both sentiment and fund flows.
In a research report previewing fourth-quarter earnings season in the sector, the firm upgraded both Emera Inc. (EMA-T) and Fortis Inc. (FTS-T) based on a view "that trading multiples have now contracted sufficiently to reflect the potential for a rising interest rate environment."
"In past rising rate environments average Canadian utility valuations have bottomed at 13-14 times, however, these trough valuations have typically occurred at times when Canadian 10 year bond yields were in the 4-6-per-cent range," the analyst said. "While consensus estimates from the Philadelphia Federal Reserve's Survey of professional forecasters do call for steadily rising rates, they forecast 10-year U.S. Treasury rates remaining below this level for 2018 at 2.8 per cent, 3.3 per cent, and 3.4 per cent respectively (the U.S. 10-year Treasury bond varies closely in line with Canadian 10 year bond rates with a small spread).
"In addition, the Canadian utilities continue to trade at a discount to the U.S. peer group, a divergence from the historical relationship. We see good reasons for a narrowing of this spread, most notably the increased U.S. footprint of several Canadian utilities, and therefore do not expect the Canadian premium to return, however, we also do not believe the Canadian names ought to trade at a discount. We also highlight the spread between Canadian utility dividend yields and Treasury bond rates remains attractive, further mitigating the potential for continued fund flows out of the sector."
Mr. Quezada moved his rating for Halifax-based Emera to "outperform" from "market perform" with an unchanged target price of $51.50. The average target on the Street is currently $51.29, according to Bloomberg data.
He also raised Fortis, based in St. John's, to "outperform" from "market perform," keeping a $50 target, which is 82 cents higher than the consensus.
"Going back to early 2017 we have consistently maintained a neutral stance on Fortis and Emera based on the durable negative relationship between utility sector valuations and bond rates and our expectation of this capping upside in the stocks. While we continue to believe that this relationship will remain intact, we also highlight recent pressure on these stocks as bringing valuations within striking distance of cyclical lows."
They added: "We also highlight that, from an intuitive perspective, we regard Fortis and Emera as large, diversified, low-risk businesses, and see recent pressure in the order of 10-per-cent downward moves in the respective share prices as likely representing the majority of the downside in each case. In fact, we note that even at a 14 times 2018 price-to-earnings multiple, the downside to Fortis stock in minimal, as is the case with Emera at a 13-times multiple (we assume a lower multiple for Emera due to the modestly higher risk profile of the business and historical trading range). Looking to 2019, again under a scenario where multiples contract further, we also see very modest downside in each case in light of solid forecast earnings growth."
In the note, Mr. Quezada also adjusted his target price for shares of a pair of independent power producers. His changes were:
- Boralex Inc. (BLX-T, "outperform") to $28.50 from $26. Average: $25.94.
- TransAlta Renewables Inc. (RNW-T, "market perform") to $13.50 from $15.50. Average: $14.52.
"Despite a disappointing decision on the Massachusetts clean energy RFP, we continue to believe that Boralex sports a robust development portfolio which will drive sector leading growth," they said. "This, coupled with recent weakness in the share price, and a correspondingly attractive valuation supports our view as Boralex as a top pick among the IPPs we cover. We also highlight Polaris infrastructure as top pick with strong recent geothermal drilling results reinforcing our thesis and affirming expansion of the company's San Jacinto geothermal field to the North. We see robust cash flow growth associated with these drilling results as well as potential M&A and future drilling lifting the stock in coming months."
MEG Energy Corp.'s (MEG-T) $1.61-billion sale of its 50-per-cent interest in Access Pipeline and 100-per-cent interest in Stonefell Terminal provides a "sufficient line of sight toward a more palatable leverage level for investors," according to Raymond James analyst Chris Cox.
Also citing "visible and meaningful production growth driving a compelling margin expansion story," Mr. Cox upgraded his rating for the Calgary-based oil sands producer to "market perform" from "underperform."
On Thursday before market open, MEG announced the agreement with Wolf Midstream Inc., which also includes a credit of $90-million toward future expansions of Access Pipeline.
"Run-rate tolls in connection with this agreement are $120-million, mapping to an attractive 13.4 times enterprise value-to-EBITDA valuation; of note, this is a good deal higher than the 11-times multiple that Wolf Midstream paid for Devon's 50-per-cent stake in the Access Pipeline in 2016," said Mr. Cox. "Management sees the company trending to a 2-3-times debt to EBITDA metric in 2020; our revised forecasts under strip pricing see the company at 3 times debt to forward EBITDA entering 2020.
"The bulk of the proceeds will initially be directed towards the repayment of the company's US$1.225-billion senior secured term loan, with the remainder earmarked for spending on the 13 Mbbl/d Phase 2B Brownfield expansion which is now slated for start-up in 2H19. Notably, while the transaction adds $120 mln of costs to a company with already relatively thin corporate margins, interest savings of $70-million result in a net cash flow impact of only $50-million."
MEG also reported fourth-quarter financial results on Thursday, which Mr. Cox deemed "solid." Funds flow per share of 65 cents exceeded his projection of 50 cents and the consensus on the Street of 49 cents. That result was largely driven by better-than-expected production of 90,228 barrels per day, topping the estimates of both Mr. Cox (88,000 bbl/d) and the consensus (87,500 bbl/d).
Though he lowered his forward EBITDA projections with the sale, Mr. Cox raised his target for MEG shares to $6.50 from $5. The average target is $6.75.
"Our bullish stance on Boralex is predicated on an enviable development portfolio and our expectation that the company is well on pace to reach a targeted 2,000 megawatts of capacity by 2020," he said. "Potential developments include a 325 MW portfolio in Scotland as part of a JV with Infinergy, 700 MW in France, 100 MW in B.C., a 200 MW wind farm in Quebec in partnership with the Innu First Nation and future opportunities in Denmark and Alberta.
"We believe this ability to identify and secure development opportunities both on a standalone basis and via partnership is a key differentiator for Boralex. Should the company deliver on its 2020 target of 2,000 MW, we believe Boralex will see a 20-per-cent EBITDA CAGR [compound annual growth rate] between 2017-2020 and a theoretical equity value in the low-mid $30 range (from $23.01 currently). What's more, the stock trades at a material discount to the peer group. Accordingly, we reiterate Boralex as our top pick among the power producers in our coverage universe."
Mr. Quezada has a "outperform" rating and target price of $28.50 for Boralex shares. The average target on the Street is currently $25.94.
He also has an "outperform" rating and $28 target for shares of Polaris, which is $2 more than the average among analysts covering the stock.
"The key catalyst we had been expecting from Polaris (strong geothermal drilling results) has now occurred while recent weakness in Boralex's share price makes it attractive at current levels," said Mr. Quezada.
Analyst Andrew Bradford added CES Energy Solutions Corp. (CEU-T) to the list. He has a "strong buy" rating and $8.50 target for the stock. The average is $9.06.
"CES stock is approaching its 52-week low while at the same time we strongly believe it will continue to report positive year-over-year comparables and structurally rising margins for the foreseeable future," said Mr. Bradford. "In addition, its high FCF [free cash flow] yield (Raymond James estimates 8 per cent this year) and 14-per-cent average ROE [return on equity] since 2009 are an attractive combination for value growth. In terms of new products development, some time ago CES adapted its MMH [Mixed Metal Hydroxide] drilling fluid system for drilling under roadways and riverbeds for pipeline crossings, with substantial time savings relative to the standard practice. Recall that MMH fluids increase in viscosity when not being agitated and then liquefy as fluid pumps are re-engaged. This feature lends much greater hole stability and, hence, reduced time. CES now has several crossing projects underway. Further down the pipeline, CES is continuing to advance its fracturing chemistry to improve on the standard for fracturing with briny produced water. We still don't expect a commercial product will be available until early 2019 (this isn't a change from previous expectations)."
The recent share price sell-off for Domtar Corp. (UFS-N, UFS-T) represents a buying opportunity for investors willing to look past short-term weakness, said RBC Dominion Securities analyst Paul Quinn, who touted "solid" near-term fundamentals for its core paper and pulp segment.
Despite Thursday's release of fourth-quarter financial results that fell below his expectations, Mr. Quinn raised his rating for the Montreal-based company with "outperform" from "sector perform."
Domtar reported normalized EBITDA for the quarter of US$141-million, missing both the analyst's estimate (US$154-million) and the consensus (US$159-million). Normalized earnings per share of 64 US cents also missed targets (79 US cents and 80 US cents, respectively). The company also announced a non-cash goodwill impairment charge of US$578-million associated with the personal care segment.
"Domtar cited a weakened market outlook due to growing pressures in the healthcare and retail markets over the last year," said Mr. Quinn. "The declining U.S. birth rate has resulted in 'big brands' increasing the amount of promotional activity (i.e., everyday discounts) to generate demand. Higher fluff pulp prices (up 16 per cent year over year in Q417 vs. Q416) also contributed to additional margin compression. Pressure was also seen from Europe as government remunerations for adult incontinence products were reduced."
"For Q417, Domtar's net debt-to-total capitalization ratio stood at 28 times (up 200 basis points quarter over quarter) and net debt to LTM [last 12-month] EBITDA was unchanged at 1.7 times. Even with the 4.8-per-cent dividend hike, increasing the quarterly dividend from $0.415 to $0.435 per share, we continue to believe that Domtar has more than enough financial flexibility."
Mr. Quinn maintained a target price of US$50 for Domtar shares. The average target is currently US$46.93.
"We like Domtar's efforts over the past 10 years to reposition the business away from commodity paper but still retain a dominant market position," he said. "Domtar has been able to leverage cash flows from a declining business to relatively more attractive markets such as specialty papers, market pulp, and personal care. Given a solid balance sheet, we also see Domtar potentially leveraging existing assets (i.e., papermachine conversion) to also make an entrance into the NA containerboard market.
"Domtar's shares have typically traded at the lower end of the range of EBITDA multiples seen for the broader paper & forest product complex (which is not unwarranted given its exposure to the UFS market, smaller size, lower liquidity, and lower geographic diversification). Prior to the sell-off post Q417 results, Domtar had seen a significant run-up in its share price and was trading at 6.5 times our 2018E EBITDA estimate (well above its 5-year average forward multiple of 5.0 times and near the midpoint of the typical 5.0 times to 8.0 times valuation range of NA Paper & Forest Products companies). We believe the share price sell-off represents an opportunity for investors willing to look past short-term weakness. Given the goodwill impairment, continued headwinds for Personal Care should not be a surprise. That said, near-term fundamentals appear solid for the core Paper and Pulp segment and the current valuation looks more attractive."
Meanwhile, Stephens Inc. analyst Mark Connelly upgraded Domtar to "overweight" from "equal-weight" with a US$55 target.
Raymond James analyst Daryl Swetlishoff lowered his target to US$48 from US$52 with a "market perform" rating (unchanged).
"Despite the pullback in the share price since then, we remain Market Perform rated on Domtar as we believe headwinds in the personal care segment and uncertainty surrounding the shifting business model will continue to dominate the rhetoric," he said. "We find comfort in the company's ability to generate considerable free cash flow, further evidenced by a 4.8-per-cent increase in the dividend and with recent strength in pulp prices and to a lesser extent uncoated freesheet expected to provide relatively strong 1Q18."
In the latest update to Credit Suisse's "Top Picks" list released Friday, analyst Anita Soni named Nexa Resources S.A. (NEXA-T) her selection in the industrial metals sector.
The list includes up to three stock picks from each of the firm's Canadian research analysts based on a 6- to 12-month time horizon.
Nexa, a zinc mining company based in Brazil which made its TSX listing debut in November, is Ms. Soni's lone pick for the sector, rising from No. 2 previously. It replaced First Quantum Minerals Ltd. (FM-T), which she removed from the list.
"NEXA is the newest entrant into the North American base metals universe," she said. "We rate NEXA Outperform owing to our bullish view on zinc into 2018 and NEXA's exposure to zinc at 60 per cent of revenues. Our view is predicated on a positive supply-demand scenario after closures of zinc mines in 2015, following a period of prolonged low prices. NEXA offers stable production and low costs from its existing operating assets and can maintain current production levels for at least five years on our estimates."
Ms. Soni has a target price of $23 for Nexa shares. The average target on the Street is $29.44.
Among precious metals companies, Ms. Soni added Goldcorp Inc. (GG-N, G-T) to the list as her No. 2 pick, behind Agnico Eagle Mines Ltd. (AEM-N, AEM-T). She removed Newmont Mining Corp. (NEM-N) from the list.
"GG currently sits below its peers in 2018 on price-to-cash flow (7.8 times versus 8.4 times peer average), P/OpCFa (11.9 times vs 13.3 times peer average) and offers a strong free cash flow (FCF) yield (3.5 per cent vs 3.0 per cent North American peer average)," she said. "GG has reestablished a good operational track record by achieving 2016 and 2017 production and AISC guidance. Production growth of 18 per cent to 2.90Mozs in 2020 is second best in its peer group, with the added benefit of FCF over both years."
She has an "outperform" rating and US$19 target for Goldcorp shares. The average is US$17.55.
Ms. Soni also has an "outperform" rating and US$62 target for Agnico. The average is US$54.40.
"AEM is a top pick for its strong exploration and project pipeline, which leads to a growth pipeline without the need for M&A and strong balance sheet and operating track record, which makes it less leveraged to gold price moves than peers," she said. "AEM has delivered on our expectation for it to outperform 2017 guidance and we see the company as well positioned to also improve its 2018 and 2019 outlooks heading into the new year. AEM is also one of the few companies we cover that has added to our NAV per share estimate over the past two years."
Seeing better fundamentals from Twitter Inc. (TWTR-N) following Wednesday's release of its fourth-quarter results, RBC Dominion Securities analyst Mark Mahaney upgraded the social media company to "sector perform" from "underperform."
"Last quarter, we wrote that while fundamentals were getting less worse, it was unclear whether they were getting better. Well, they're getting better," he said.
"Which means that our Underperform call was wrong. Here's how they are getting better: 1) 12-per-cent DAU [daily active user] growth on an 11-per-cent comp is a clear positive and likely reflects a lot of successful product innovation at TWTR – e.g. expansion of 140 to 280 character limit. 2) Record high 42-per-cent EBITDA margin – suggests long-term model leverage. 3) Implied Q1 outlook for double-dig Ad Revenue growth – this was our biggest surprise; speaks to growth sustainability for near/medium term. 4) Commentary that salesforce attrition improving – TWTR better situated going into '18 than into '17. 5) $550-million in '17 FCF -- there is a clear cash flow story here. There's also a basic point here that rising tides lift (almost) all boats, and Internet Advertising is a Tsunami. To get more constructive on TWTR shares, we'd like to see a compelling entry point (perhaps 10 times EV/EBITDA) and/or clear evidence that TWTR can sustain double-digit Ad Rev growth in '19 and beyond. At some point, that would almost certainly require an improvement in TWTR MAU [monthly active user] growth rates from current levels."
In reaction to the results, Mr. Mahaney raised his 2018 revenue estimate by 11 per cent to US$2.74-billion and his adjusted EBITDA projection by 17 per cent to US$1.05-billion.
Accordingly, his target for the stock jumped to US$31 from US$18. The average on the Street is US$26.19.
Believing a merger with CBS Corp. (CBS-N) is looking increasingly likely, RBC Dominion Securities analyst Steven Cahall raised his rating for Viacom Inc. (VIAB-Q) to "sector perform" from "underperform."
"We've been fundamentally negative on Viacom for 2 years believing its networks are more at-risk than peers to a deteriorating ecosystem, despite recent valiant management efforts to course correct," he said. "While there are signs of improvement we still think getting to long-term OI growth is a bit of a leap of faith. However, arguing about it is a fool's errand because the merger with CBS is back on. We see the probability of a deal as high because Shari Redstone is not the definition of insanity, i.e. she's not going to do what she did 18 months ago and expect a different outcome. Rather, we believe CBS and Viacom leadership will hash this out and probably merge at or near market prices since the market is a reasonably honest broker of valuations. We shift our valuation framework on Viacom as such."
Mr. Cahall raised his target for Viacom shares to US$35 from US$23. The average among analysts covering the stock is $33.39.
"We raise our target ... as we move away from a normative assessment of ecosystem risk to more direct peer-based comps," he said. "This is further supported by our modestly more constructive view. With a deal likely in the coming months, we think recent transaction multiples will support Viacom's board's argument to merge at-market prices. Using a 15-per-cent discount to 20th Century (on EV/Sales) in the DIS deal we raise our Paramount valuation from $3-billion to $4-billion (still a punchy 38 times calendar 2019 EBITDA). We apply $2-billion to the Viacom18 stake per the recent transaction. Most notably we increase our Media Nets NTM [next 12-month] EBITDA multiple from 5.5 times to 6.5 times, or 30-per-cent discount to DISCA's purchase of SNI. This sums to Viacom at $35 per share and is what we think the board is likely to demand with CBS or other suitors. There's no precedence for a going concern getting taken under, and with these transaction multiples to boot we see no reason why a deal at market rates doesn't transpire."
In other analyst actions:
JPMorgan analyst Phil Gresh upgraded Suncor Energy Inc. (SU-T, SU-N) to "overweight" from "neutral." Mr. Gresh raised his target price to $49 from $47, which sits below the consensus average of $51.34.
CIBC World Markets analyst Paul Holden upgraded Great-West Lifeco Inc. (GWO-T) to "neutral" from "underperform" with a $36 target (unchanged). The average target is $37.50.
Raymond James analyst Ben Cherniavsky upgraded Blackline Safety Corp. (BLN-X) to "outperform" from "market perform" and hiked his target to $6 from $4.50. The average is $7.13.
Macquarie analyst Kate Sloan downgraded Africa Oil Corp. (AOI-T) to "neutral" from "outperform" with a target of $1.56, falling from $2.32. The average is $2.16.
CIBC World Markets analyst Cosmos Chiu upgraded Alacer Gold Corp. (ASR-T) to "sector outperform" from "neutral" and raised his target to $3.50 from $2.75. The average is $3.26.
Bank of America Merrill Lynch analyst Lawson Winder upgraded Lundin Mining Corp. (LUN-T) to "buy" from "underperform" with a target of $11, up from $7.75. The average is $9.51.
OceanaGold Corp. (OGC-T) was cut to "hold" from "buy" by Global Mining Research analyst David Cotterell, who lowered his target to $3.40 from $3.90. The average is $4.87.
RBC Dominion Securities analyst Biraj Borkhataria upgraded Chevron Corp. (CVX-N) to "sector perform" from "underperform" with a target of US$125, rising from US$115. The average is US$134.29.