Inside the Market's roundup of some of today's key analyst actions
Citing the abrupt departure of Chief Executive Officer Gregg Saretsky and a reduction in first-quarter revenue per available seat mile (RASM) guidance, Raymond James analyst Ben Cherniavsky downgraded his rating for WestJet Airlines Ltd. (WJA-T) to "market perform" from "outperform."
"After sitting on the sidelines for the better part of three years, we elected to upgrade our WestJet rating to Outperform earlier this year [on Jan. 12]," said Mr. Cherniavksy. "With the stock trading near the same level today, we are downgrading back to a Market Perform rating … We don't take such seemingly capricious flip-flops lightly, but believe that this is the most prudent course of action given renewed uncertainties and our ability to 'get out even' on this call. We remain of the contrarian view that this stock is very washed out, but we see few near-term positive catalysts on the horizon with the possibility of more negatives ones to come. Visibility remains poor as a number of important issues highlighted below need to be resolved. While new leadership offers a fresh start, we need to understand what this change means for WestJet's strategy going forward."
The analyst called WestJet's plans to launch Swoop, a new ultra-low-cost carrier (ULCC), a complex and "particularly polarizing initiative," emphasizing a "tense" dispute with pilots, who see it as an extension of the current fleet while management aims to hire non-unionized pilots.
"All of this, we believe, proved to be the proverbial straw that broke the camel's back, triggering the change in leadership announced [Thursday]," he said. "We are hopeful that the new CEO, Ed Sims, will navigate a mutually-acceptable agreement, but we can't be certain at this point. With Swoop playing a key role in our decision to upgrade the stock in January, we prefer to see how the dust settles on this important issue over the next few months."
Further on Mr. Saretsky's dismissal, Mr. Cherniavsky said: "The abrupt departure of Gregg Saretsky brings to mind a meeting we had with him early in his tenure (2010) where he discussed his ambitious plans to change WestJet's strategy. We recall him telling us of a YouTube video titled Shift Happens, which is a high-impact visual essay about how quickly our world is changing. Mr. Saretsky was sharing this video with his fellow WestJetters at the time as a means of compelling them to embrace the inevitability of change or get out of its way. Ironically, eight years later, it appears to be Mr. Saretsky who was the victim of change. In our view, the board's decision to replace him is an acknowledgement that WestJet's ambitious strategies to grow the airline, explore new markets, penetrate new segments, expand and diversify the fleet, and offer a host of new 'frills' and services has taken its toll on the airline's once-prized culture. The culmination of all this stress was, in our view, the decision among the pilots to form a union last year … which had followed a number of previous fallouts between labour and management over the years."
With the announcement of the departure, the airline also reduced RASM expectations for the first quarter to an increase of 2.5-3.5 per cent, falling from 4.5-5.5 per cent. Domestic ASMs are projected to grow 5.5- 6.5 per cent, dropping from 7.5-8.5 per cent.
"The culprit is bad winter weather which severely impacted operations leading to a series of cancelled flights," said the analyst. "Although such disruptions are clearly evident in the OTP statistics for both of Canada's airlines recently, we remain hyper-sensitive about the need to get RASM up in light of rising fuel costs. This setback, in our view, will call into question these trends and WestJet's renewed goal to deliver margin expansion this year. … WestJet failed to deliver its margin expansion goals last year, making the achievement of the same goal this year paramount to management's credibility. There may be a new chief in charge, but the focus for investors remains the same: after five long years of share price underperformance, WestJet's financial performance must improve."
Mr. Cherniavksy dropped his target price for WestJet shares to $25 from $31. The average target on the Street is currently $27.21, according to Thomson Reuters data.
Though Spin Master Corp.'s (TOY-T) fourth-quarter results were "good," BMO Nesbitt Burns analyst Gerrick Johnson downgraded his rating for its stock, citing its current valuation and a toy industry currently "in flux" as well as "potential early signs of weakness" in its key Paw Patrol product line.
"We continue to admire Spin Master's business ," said Mr. Johnson. "It has a strong portfolio of toys and intellectual property, and the company has proven its ability to achieve superb growth owing to a track record of creativity and innovation supported by solid execution and deep relationships with inventors, suppliers, licensors, and distribution partners. With its strong, visionary, and entrepreneurial management team, its knack for identifying, developing, and marketing hot new toys, and its always impeccable execution stands we expect the company to outperform its peers and to continue to drive revenue and earnings growth despite industry challenges."
On Wednesday after market close, the Toronto-based company reported normalized earnings per share of 25 cents, up 9 cents from the same period in fiscal; 2016 and exceeding the projections of both Mr. Johnson (23 cents) and the Street (20 cents). Revenue jumped 30 per cent to $441-million, also topping the $421-million estimate of both the analyst and the consensus.
"We were concerned to see an 18-per-cent drop in sales in the Preschool/Girls segment in the company's 4Q17 results," said Mr. Johnson. "This segment is driven by Paw Patrol, the company's most important and profitable line (we estimate 20 per cent of sales and 33 per cent of operating profit). While management explained the decline as a result of timing shifts, explanations tend to become more prevalent when a toy line approaches the end of its life cycle."
On the industry, as a whole, Mr. Johnson added: "Among toy industry executives we've spoken with, there is a high level of concern regarding the performance of the toy industry in 2018. The Toys "R" Us (TRU) bankruptcy, changing nature of retail, underperformance of movie toys, and the new light-speed at which kids' tastes change has created the highest level of trepidation and uncertainty we have seen in years, perhaps since the onset of the "Great Recession". The TRU situation is top of mind in the industry. And we believe the disruption caused by this important retailer's chapter 11 filing in the U.S. last fall was more significant than we think investors realized. Toys "R" Us already announced the closure of 180 stores on January 23 (half Babies "R" Us, Half Toys "R" Us). Much speculation abounds as to what may happen with TRU at this point, from additional store closures to liquidation. Liquidation of inventory owing to store closures should put pressure on toy shipments in 2018 for all toy companies."
Lowering Spin Master to "market perform" from "outperform," Mr. Johnson maintained a target of $63 for its shares, which is a loonie higher than the average.
Spin Master currently trades at 22 times 2019 consensus EPS estimates (20.6 times BMO), which is a premium to the group (19 times Street, 15 times BMO)," he said. "While we believe Spin Master deserves a premium owing to its growth opportunities, we see little room for multiple expansion at this point."
In the wake of "solid" fourth-quarter results, Canaccord Genuity analyst Yuri Lynk upgraded CanWel Building Materials Group Ltd. (CWX-T) to "buy" from "speculative buy.'
"We continue to view CanWel as an attractive investment given (1) its 8.7-per-cent dividend yield, (2) high degree of insider ownership, and (3) upside potential afforded by management's plans to consolidate the highly fragmented treated wood industry," said Mr. Lynk. "Overall, the dividend payout ratio is improving while the balance sheet is in fair shape with a debt-to-EBITDA (2018) ratio of 2.9 times. Therefore, we felt the speculative qualifier to our rating was no longer appropriate."
On Thursday, the Vancouver-based company reported adjusted earnings per share of 9 cents, up 5 cents year over year due to "solid" organic growth and accretive acquisitions. Revenue increased 29 per cent from the same period in 2017 to $276-million, exceeding Mr. Lynk's expectation by 7 per cent. Adjusted EBITDA ($13.4-million) and margin (4.8 per cent) also topped his projections ($12.7-million and 5.0 per cent).
"Management did well to drive 120 basis points of year-over-year EBITDA margin improvement by remaining focused on cost control and product mix while capturing the benefit of rising construction material pricing," said Mr. Lynk. "These higher prices, especially for lumber, helped to drive 25-per-cent year-over-year organic growth in the US and 8-per-cent year-over-year organic growth in Canada. In the U.S., the California Cascades platform continues to perform well."
"FCF [free cash flow] in 2017 was $24-million as working capital - typically a major cash flow drag in recent years - consumed only $2-million of cash. The dividend payout ratio on FCF was 157 per cent in 2017, and we see it improving to 98 per cent this year. Should this play out, we see CanWel's valuation multiple improving as doubts surrounding the sustainability of the dividend are clearly prevalent given the stock's nearly 9-per-cent yield."
Mr. Lynk maintained a target price of $7.50 for CanWel shares. The analyst average target is $7.66.
"Given the in-line nature of the quarter, we are leaving our 2018 and 2019 estimates largely unchanged," he said. "Our forecast calls for an 8-per-cent EPS CAGR [compound annual growth rate] between 2017 and 2019 driven by a full year's contribution of the Honsador acquisition, continued increases in B.C. log prices, volume growth in the U.S. as housing starts continue to improve, and elevated lumber prices. On the call management noted 2018 was off to a solid start weather-wise (which is key for CanWel's logging operations) and that pricing remains favourable."
Petrus Resources Ltd. (PRQ-T) possesses too many positive attributes to ignore, said Raymond James analyst Jeremy McCrea.
Accordingly, he raised his rating for the Calgary-based energy company to "outperform" from "market perform" in response to Thursday's release of its fourth-quarter financial results.
"As mid-cap names struggle for investor attention, junior E&P names are facing an even more difficult challenge, despite a number of positive accomplishments," he said. "For 2017, PDP NAV [proved developing producing net asset value] per share is up 37 per cent, profitability is top tier at $0.16 per dollar spent, FFO [funds from operations] per share is up 50 per cent with PPS up 12 per cent; yet the share price has fallen 65 per cent (XEG: down23 per cent).
"For 2018, although spending will be reduced, we believe the profitability of the company will continue to improve, especially after seeing the latest Cardium result that has produced 1,200 barrels per day of oil (10 days). This step change in completion again utilized 82 stages over a 1.0 mile lateral (vs. the past couple 2-mile wells that used 105 stages). Although PRQ's interest in this YGR well is only 15 per cent, we expect many more follow-up wells to come. Much like Yangarra (YGR-T) in late 2016, investor sentiment for small-cap names was paltry; however, with YGR delivering positive well economics (similar to what PRQ is now achieving), YGR's stock has been the best performing name in both 2016 and 2017. As such, we are upgrading PRQ to Outperform."
Mr. McCrea maintained a $2 target. Consensus is $2.71.
Americas Silver Corp. (USA-T, USAS-N) is currently undervalued on all metrics of valuation, according to Laurentian Bank Securities analyst Barry Allan, who expects it to experience a re-rating as its operational and development milestones are achieved.
He initiated coverage of the Toronto-based miner with a "buy" rating.
"Americas Silver is undervalued compared to its peer group either as a measure of share price multiple of NAV [net asset value] or cash flow, or as a measure of market capitalization per ounce of silver equivalent resources," said Mr. Allan. "We judge this valuation discrepancy may be a failure to grasp the significance of either the new San Rafael mine or the potential of the San Felipe project. However, we judge that as operating cash flow stabilizes quarter-over-quarter and once the market sees the contribution being made by the new San Rafael mine, the valuation gap should narrow."
Mr. Allan set a target price of $8 for the company's shares. The average on the Street is $8.28.
"Americas Silver has dramatically altered its corporate culture over the last two years, has successfully achieved commercial production at a key new mine, and has two additional development assets to augment future production and cash flow," he said. "In addition to exposure to silver prices, Americas Silver offers good exposure to the current shortage of world zinc supply."
Cantor Fitzgerald analyst Matthew O'Keefe initiated coverage of Sabina Gold and Silver Corp. (SBB-T) with a "buy" rating.
"Sabina is set to start construction of its Back River gold project in Nunavut," he said. "The initial project should produce ~250koz of gold annually for 12-years and has an IRR of 26 per cent. There is considerable upside from additional resources and ongoing exploration. The project's strong economics, advanced & permitted status, safe jurisdiction and significant upside potential make Sabina an attractive investment for investors and gold producers as well."
He set a target of $3.40, which is above the $3.12 average on the Street.
In other analyst actions:
Berenberg Equity Research initiated coverage of Endeavour Mining Corp. (EDV-T) with a "buy" rating and target of $28.33. The average target is $33.14.
GMP analyst Michael Dunn upgraded Baytex Energy Corp. (BTE-T) to "buy" from "hold" with a target of $4.50, which is 15 cents higher than the average.
TD securities analyst Avery Haw assumed coverage of Caribbean Utilities Company Ltd. (CUP.U-T) with a "hold" rating and $13 target.