Inside the Market's roundup of some of today's key analyst actions
There are "obvious overlaps" between AltaGas Ltd. (ALA-T) and WGL Holdings Inc. (WGL-N) and the combined entity should have "access to a larger set of growth opportunities," according to Desjardins Securities analyst Justin Bouchard.
However, he is unclear how AltaGas will leverage WGL assets to enhance its growth, "especially given our view of the considerable control premium embedded in the offer price (and the resulting share dilution required) to acquire the assets."
On Jan. 25, AltaGas announced the $4.5-billion (U.S.) acquisition of WGL, a U.S. energy infrastructure company. Under the proposed deal, it is offering $88.25 in cash per WGL share, representing an 11.8-per-cent premium over its closing price from the previous day.
"When we try to puzzle together the proposed acquisition of WGL, our conclusion is that the driver of the deal comes down to growth opportunities," said Mr. Bouchard. "As we see it, the strategic rationale is that the combined entity will have a wider and more diverse set of growth opportunities than either standalone entity would have on its own. In our view, there is no doubt that the strategic rationale of this acquisition has merit; however, the acquisition also reduces the diversification of current operations, which would become significantly more weighted to regulated utilities at the expense of power and midstream. That said, for investors with a longer-term outlook, the reduced diversification of current operations is a temporary problem given AltaGas's strategy to reinvest a higher proportion of cash flows into power and midstream projects — over time, this would lead to a rebalanced asset mix. Meanwhile, the benefits of a wider and more diverse set of growth opportunities are forever (or at least indefinite)."
Mr. Bouchard downgraded his rating for AltaGas stock to "hold" from "buy" based on the implied return to his new target price of $32, down from $38. The analyst consensus price target is $36.58, according to Thomson Reuters.
"From our perspective, there are at least two lenses through which to view this deal—either valuing the combined enterprise as a going concern or valuing the assets purchased on a standalone basis," he said. "When valuing the business as a going concern using an absolute valuation methodology (including the value of its future growth opportunities over a long period), the deal is accretive. However, when using relative valuation techniques that focus on the market price of the assets at current market metrics, we believe that ALA paid a substantial control premium to acquire the assets of WGL Holdings.
"We believe investors with long time horizons are more likely to value the merits of the acquisition on an absolute valuation basis (using a discounted cash flow analysis to value to the company—including its long-term growth prospects—as a going concern). And, based on both funds from operations per share and EBITDA metrics, the deal looks accretive—largely because ALA traded at a premium to the price we estimate is being paid for WGL (the higher pro forma leverage also helps to boost pro forma FFO/share). Assuming the dividend payout ratio falls or remains stable, higher pro forma FFO/share allows for an increase in cash flow per share to be reinvested back into the business, which should, in turn, drive a higher terminal growth rate (assuming ALA can develop sufficient organic growth opportunities). As a result, a DCF valuation of AltaGas as a going concern is likely to find a higher valuation as a result of this acquisition.
"The accretion to cash flow per share also allowed ALA to provide attractive dividend guidance (8–10-per-cent dividend growth to 2021) contingent on closing the acquisition; based on our estimates, the dividend guidance equates to a 10.4–per-cent dividend yield ($3.25 per share) in 2021 based on today's share price, which we view as compelling in the context of AltaGas's investment-grade credit rating and long-life energy infrastructure assets. In contrast, investors with shorter-term horizons are more likely to put a larger focus on relative valuation (such as sum-of-parts) and could easily conclude that AltaGas paid full value (and then some!) to purchase WGL. So once again, we see the same dichotomy that was present in the strategic rationale—long-term investors have much more reason to like the acquisition than investors with short- and medium-term horizons."
Elsewhere, Canaccord Genuity analyst David Galison lowered his target for the stock to $33 from $35 with a "hold" rating (unchanged).
"While there appear to be many positives to the acquisition, we prefer to remain on the sidelines until there is more clarity around the ultimate sources of funding as well as more visibility around growth projects and potential earning contributions," he said.
Raymond James analyst Chris Cox lowered his target by a loonie to $34 with a "market perform" rating (unchanged).
He said: "While we see a good strategic fit with WGL, where we struggle is valuation, both for the acquisition and the pro-forma entity. At 26 times price-to-earnings, AltaGas is acquiring WGL at the high-end of recent precedent transactions at a time when the utility sector itself is trading at cyclical highs. Added to this, we see valuation for the stock more broadly as a headwind, with AltaGas trading at a premium to each of its midstream, power and utility peers on a pro-forma basis. Offsetting these concerns is a healthy dividend yield of 6.8 per cent, with guidance of 8–10-per-cent growth over the next 5 years. This is supported by noticeable accretion from the WGL acquisition to both earnings and cash flow per share, although this is largely attributable to heavy reliance on debt to fund the acquisition (70-per-cent debt financed). Despite our concerns around valuation, we think downside is limited due to the dividend and forecast growth rate; taking into consideration the lengthy timeline to close the deal (mid-2018 expected close) and we expect the stock will be range-bound over our 12–18 month investment horizon."
Industrial Alliance analyst Elias Foscolos upgraded his rating for Secure Energy Services Inc. (SES-T) to "buy" from "hold" due to recent share price depreciation.
"We believe the decrease in SES's share price since we initiated coverage provides a compelling entry point for investors that might not own SES stock," he said. "We have elected to maintain our financial projections and $12.25 target. Based on the latest closing price, our unchanged $12.25 target now represents a potential 15-per-cent one-year return (including dividends)."
Mr. Foscolos said he expects "upward momentum" and "solid" third-quarter margins to lead to "continued financial improvements."
"Secure is poised to benefit from the rebound in Canadian drilling activity currently underway which drives a substantial portion of the Company's net revenue," he said. "In Q3/16, SES posted net revenue gross margin of 39%, which was the highest in the past two years and exceeded the 37-per-cent attained during 2014."
Calling the release of its fourth-quarter 2016 financial results the next potential catalyst for the stock, Mr. Foscolos said: "We are currently forecasting a slight pullback in Q4/16 gross margin. If SES can deliver the same gross margin percentage as Q3/16, upward revisions will be required."
"Dividend is safe and balance sheet remains strong. SES's 24-cent annual dividend (yield 2.2 per cent) is one of the few in the OFS segment that was not reduced in the past two years. Additionally, SES's net debt is projected at [approximately] 1.2 times 2018 EBITDA, which provides the Company with ample financial flexibility."
His target of $12.25 is lower than the analyst average of $13.47, according to Bloomberg.
"With the pullback in the stock price, SES is now trading at a sub-11 times 2018 estimated enterprise value to EBITDA8 and below the Company's 14.3 times historical one-year multiple," he said.
He initiated coverage of the Toronto-based company with a "market perform" rating, which he said is supported by "a stable production profile and strong balance sheet, but offset by relatively higher costs, and the shortest reserve life among relevant peers."
Mr. Kaip cautioned that IAG shares are "highly levered" to gold prices among its relevant peers, and, accordingly, he expects them to outperform peers in a rising price environment and underperform when gold prices are weaker. He also emphasized shares are "highly liquid" on both sides of the border.
"For those investors looking to position themselves to reflect a short-term positive view on gold, shares of IAG represent a highly liquid leveraged vehicle to take advantage of short-term gold price volatility," the analyst said.
Though he said IAG is trending "in the right direction" on both earnings and free cash flow, Mr. Kaip said the company has had a "mixed track record" in terms of execution.
"IAG has struggled to meet investor expectations on earnings, reporting 10 earnings misses over the last 15 quarters, on an adjusted basis," he said. "However, we note that with higher gold prices year to date, the company appears to be making positive progress on earnings, and has beat consensus in each quarter beginning after Q4/15. The company has also been challenged to generate free cash flow, generating positive free cash flow only three of the last 11 quarters. Again, the company appears to be making positive progress on this front, with FCF trending up over the last four quarters."
"Reported All-In Sustaining Costs (excluding royalties) at IAMGOLD have been stubbornly high, and have yet to break $1,000 per ounce in a quarter since 2014. Including royalties into the calculation of AISC would add $50 per ounce to costs, on average. Gold production has remained largely flat, between 170,000 ounces and 230,000 ounces per quarter over the same period, as the company has struggled with the ramp-up of Westwood to full production rates. Looking at initial guidance, and adjusting for asset sales, IAG has also struggled to meet its production targets, and has missed initial guidance three out of the last five years. Positively, IAG exceeded initial 2016 production guidance, based on strong performance from Essakane and Rosebel, and AISC and cash costs are expected to be within guidance for the year."
He set a price target of $4.75 (U.S.) for the stock. Consensus is $4.87.
"IAG trades in-line with the peer average for [price to net asset value] for medium producers under coverage (2016 estimated production 0.2-1.0 million ounces), and below the large producers (2016 estimated production greater-than 1.0 Moz)," he said.
"Relative to historical P/NAV (0 per cent, spot) trading multiples, IAG appears to be trading above the long-term historical average of 0.5 times, currently trading at 0.8 times. However, this may be reflective of a broader trend within the industry, as both the large and medium peers are trading well above trough valuations. This view is supported looking at 1-year forward price to cash flow multiples with IAG trading at mid-cycle valuations based on our gold price forecast."
GreenSpace Brands Inc. (JTR-X) is "on the mark in terms of strategy," said Raymond James analyst Kenric Tyghe.
Emphasizing the Toronto-based organic and natural food company also has "deep" retail relationships and cost advantage to executive the strategy, he initiated coverage of the stock with a "strong buy" rating.
"While the value of Canadian Natural and Organic Foods market has tripled over the past decade, it still only represents approximately 1.7 per cent of total food sales, well below the 4.3-per-cent run rate of natural and organic foods in the U.S.," said Mr. Tyghe. "The growth trajectory of the broader market, driven by an increasingly health-conscious population (whether by choice or necessity), is particularly attractive. Greenspace is, in our opinion, particularly well positioned (and on trend) against this backdrop, given its product portfolio which not only has a leading position in organic baby food and snacks, but also skews toward the fastest-growing organic categories (juices, grass-fed dairy and functional snacks).
"The Canadian Natural and Organic Foods market generates sales of $4.0-billion (according to the Canada Organic Trade Association) with fresh representing approximately 40 per cent of the market. The market segments and categories in which GreenSpace competes are large, readily addressable, and growing at above-average (organic industry) growth rates. This, combined with new program wins and increased shelf space allocation, makes for a compelling proposition in our view."
Mr. Tyghe noted the Canadian market has tripled in size over the past decade, attracting a significant number of new companies and, accordingly, a "highly fragmented competitive landscape." He called Greenspace "a leading consolidator."
"There is an attractive slate of small target companies who simply have neither the capital, nor relationships, to make it to the next level. GreenSpace's legacy brands (Life Choices, Rolling Meadow, Holistic Choice and Nudge) saw organic growth of 97 per cent in fiscal 2016 and we expect 41-per-cent growth in fiscal 017, on further program wins and increased shelf space allocation. We are modelling 140 per cent and 35 per cent topline growth in 2017 for Love Child and Central Roast respectively, reflecting recent distribution wins. GreenSpace's net revenue is expected to increase by 261 per cent, 42 per cent, and 18 per cent in 2017, 2018, and 2019 respectively, which is well above industry average growth rates. GreenSpace's strong topline growth has been accompanied by meaningful improvements in profitability, reflecting significant acquisition synergies and benefits of scale. As revenues continue to rise, we expect GreenSpace to leverage the greater sales volume over fixed SG&A, compensation and marketing expenses to achieve further margin expansion. We are forecasting EBITDA margin expansions of 231 basis points and 76 basis points in 2018 and 2019 respectively, for EBITDA margins of 7.5 per cent and 8.3 per cent."
He set a price target of $2 for shares of GreenSpace. Consensus is $2.18.
"While Greenspace is a leading consolidator of companies with less than $25-million in annual sales, as it continues to successfully execute and build market share (and establish scale) in key organic growth categories, it will almost by default find itself on the radar of large CPG [consumer packaging goods] players," he said. "The large CPG companies have been competing to acquire natural and organic foods brands, utilizing the robust sales growth of these organic brands to complement their muted sales growth in legacy (non-organic) brands (they can manufacture the product, but they can't manufacture the cachet, so they end up buying in the organic darlings). While we acknowledge that the probability and timing are impossible to handicap, a potential takeout represents attractive additional option value relative to our already constructive base thesis."
Auryn Resources Inc. (AUG-T) is "primed for discovery," said Canaccord Genuity analyst Kevin Mackenzie.
He initiated coverage of the Vancouver-based junior exploration company with a "speculative buy" rating.
"Unlike the vast majority of junior exploration companies, which are currently focused on adding peripheral deposit ounces, converting resources ounces or marketing level exploration, Auryn is focused on making novel exploration discoveries, with the goal of creating real shareholder value in today's market," said Mr. Mackenzie. "What differentiates Auryn from the rest of the juniors? Its proven management team, industry-leading technical team, and catalyst-rich project portfolio. Why is Auryn focused on early stage exploration? Because the structural deficit of discoveries within the industry should place a premium on future discoveries; and with execution, this stage of the project curve yields the greatest return."
"Auryn is led by Executive Chairman Ivan Bebek, and President and CEO Shawn Wallace. Both individuals are well-regarded throughout the industry for co-founding Keegan Resources, now Asanko Gold (AKG-T), as well as Cayden Resources, which was acquired by Agnico Eagle (AEM-T) for $205 million in 2014. This duo of mining entrepreneurs has now raised more than $450-million, and has since attracted a $35-million equity placement in Auryn from Goldcorp (G-T). This placement serves to strengthen our conviction in Auryn's business model, while highlighting the prospectivity of Auryn's assets and strength of its overall team."
Mr. Mackenzie said Auryne's experienced technical team, which he said includes several former global heads and senior geoscientists, is "a senior company exploration engine that has been transplanted into the entrepreneurial framework of a junior exploration company."
"Each individual is a well-respected authority within their field of practice, and contributes to an overall broad range of in-house specializations," the analyst said. "We believe that this differentiates Auryn from the majority of its peers, and greatly increases the probability of discovery."
"Auryn's business strategy is to capitalize on current discounted market valuations to acquire strategic land positions within established or emerging mining jurisdictions," he added." The company's high level project criterion is simple: projects have to be high-grade and/or have significant size potential. Auryn's Committee Bay and Homestake Ridge projects located in Canada, each with greater than 1Moz resource grading 7-8g/t, checks the first box. With the company's Peruvian project portfolio focused on largescale epithermal and porphyry deposits checking the second box. Auryn's project portfolio approach over multiple jurisdictions allows the company to drill 12 months of the year, which both increases the probability of discovery and reduces overall investment risk. Further to that, by focusing on multiple deposit types, over multiple jurisdictions, this has served to significantly expand Auryn's horizon of potential future acquirers."
Mr. Mackenzie set a $5 target for Auryn shares. The analyst average is $4.84.
In other analyst actions:
American Airlines Group Inc. (AAL-Q) was raised to "market perform" from "underperform" by Bernstein analyst David Vernon, who raised his target by $1 (U.S.) to $43. The analyst average price target is $54.33, according to Bloomberg.
Mr. Vernon also upgraded Delta Air Lines Inc. (DAL-N) to "outperform" from "market perform" and raised his target to $61 (U.S.) from $57. The average is $61.31.
Auryn Resources Inc. (AUG-T) was rated a new "speculative buy" at Canaccord Genuity by analyst Kevin Mackenzie with a $5 target. The average is $4.84.
CBS Corp. (CBS-N) was raised to "overweight" from "neutral" at Atlantic Equities by analyst Hamilton Faber with a target of $78 (U.S.), up from $61. The average is $70.26.
FedEx Corp. (FDX-N) was raised to "outperform" from "market perform" at Raymond James by analyst Patrick Brown. He kept a target of $210 (U.S.), compared to the average of $209.30.
Walgreens Boots Alliance Inc. (WBA-Q) was raised to "overweight" from "neutral" at Atlantic Equities by analyst Sam Hudson with a target of $95 (U.S.), up from $91. The average is $94.33.
Mr. Hudson downgraded CVS Health Corp. (CVS-N) to "neutral" from "overweight" with a target of $84 (U.S.), down from $114. The average is $86.83.