Skip to main content

The Bank of Montreal at Roxton and Dundas in Toronto, OnDELLA ROLLI

Inside the Market's roundup of some of today's key analyst actions

Bank of Montreal (BMO-T, BMO-N) may continue to see "slightly weaker" contributions from its personal and commercial banking business moving forward, said RBC Dominion Securities analyst Darko Mihelic.

However, he said the Street's reaction to the bank's second-quarter results were both "severe" and "somewhat overdone."

The bank reported core cash earnings per share for the quarter of $1.92, below both Mr. Mihelic's projection ($2) and the consensus expectation ($1.92). On a segmented basis, he pointed to P&C results on both sides of the border as the largest driver for "weaker results" relative to his estimates.

In Canada, P&C earnings of $531-million fell "well below" his $590-million projection.

"Slower revenue growth this quarter was partly attributable to lower interchange fees on credit cards," he said. "Domestic mortgage growth of 5 per cent year over year in Q2 remains higher than our 2.3-per-cent assumption but we continue to believe recent developments in the Canadian housing market will likely result in slower loan growth. We forecast modest earnings growth of 2 per cent on average in 2017/2018 for this business."

The bank's U.S. P&C earnings of $260-million was also well off his estimate of $286-million, which he said was "largely driven by a decline in average loan balances (down 1 per cent year over year) and slightly higher PCLs in the U.S. (which at this stage seems more like 'normalization' rather than credit deterioration). We expect loan growth to improve in H2/17 and forecast moderate earnings growth of 5 per cent year over year in 2017/2018 on average for this business."

Based on the results, Mr. Mihelic's 2017 EPS projection dropped to $8.37 from $8.54. His 2018 EPS projection fell to $8.40 from $8.77.

"We have lowered our net interest margin and trading revenue assumptions, which was more than offset by an increase to forecast market sensitive other income," he said. "We increased our provision for credit loss assumptions modestly to 30 basis points in 2018, from 28 bps previously. We have also incorporated a modest buyback assumption of approximately 1.3 million shares per quarter for the next four quarters. We continue to value BMO using a 12.5-times target multiple on our 2018 core EPS and add approximately $3 per share to reflect our estimate of excess capital in approximately one year's time."

He kept a "sector perform" rating for the stock and lowered his target to $108 from $110. The analyst average price target is $102.35, according to Bloomberg data.

"Our price target implies a solid total return of 21 per cent," said Mr. Mihelic. "BMO has been the worst performing large Canadian bank in May and is down 5 per cent (versus peers down on average 1 per cent). BMO trades at a 2-per-cent premium relative to the other large Canadian banks in our coverage on our 2017 core EPS, generally in line with historical averages. We will review relative valuation in more detail once the dust settles after Q2 reporting."

Elsewhere, Desjardins Securities analyst Doug Young called the results a "tough start" to the Canadian banks' earning season.

With a "hold" rating, his target fell to $100 from $102.

"We like BMO's more commercial (versus retail) focus in Canada and its exposure to potential increases in the U.S. Fed funds rate," said Mr. Young. "That said, increased competition in the commercial market could weigh on NIMs and growth over the next year."

=====

Though its "value-added" growth strategy remains in its infancy, there are several tailwinds forming that will benefit CanWel Building Materials Group Ltd. (CWX-T), according to Raymond James analyst Steve Hansen.

"After a difficult winter period, we believe CWX is poised to benefit from a series of developing tailwinds that will drive top line growth, augment its margin profile, and commensurately reduce its payout ratio—an outlook that remains broadly underappreciated by investors, in our view," he said. "At the same time, we reiterate our view that CWX's value-added growth strategy remains in its early innings, portending the likelihood of further M&A."

Citing its "attractive" near-term growth prospects, Mr. Hansen upgraded his rating for the Vancouver-based company to "strong buy" from "outperform."

Mr. Hansen feels weather headwinds are beginning to fade for CanWel, allowing it to benefit fully from the recent acquisition of Jemi Fibre Corp., a forest products company, in the coming quarters.

"As a reminder, severe fall/winter weather heavily impaired Jemi's upstream harvesting operations during 4Q16 and 1Q17, curtailments forced by 55 per cent and 81 per cent year-over-year increases in total precipitation (rainfall/snowpack)—ultimately translating into difficult/prohibitive operating conditions at higher elevations," he said. "To be sure, regional harvest volumes reflect similar headwinds, with total harvest volumes (by all operators) falling a respective 13 per cent year over year and 21 per cent year over year. Given the heavier fixed costs associated with upstream harvesting activities, we believe similar curtailments at Jemi (albeit not quantified) help explain the stall out (and modest reversal) in CWX's gross margin progression."

"Fortunately, with spring weather already normalizing, we highlight that regional harvest volumes have since re-accelerated, increasing a handsome 25 per cent year over year in April—a data point that we expect bodes well for Jemi's 2Q17 operational activity and CWX's consolidated gross margin profile. This trend is further supported, in our view, by the seasonal strength in 2Q/3Q, which typically accounts for 70 per cent of CWX's annual earnings."

Mr. Hansen said "robust" housing starts, which account for 55 per cent of CanWel's business, both in Canada and California provide a "healthy backdrop" for its core distribution and lumber treatment services. He also noted a "solid uptrend" in benchmark lumber and building material prices, which he associated with the softwood lumber dispute.

"We believe CWX remains primed to pursue additional value-added (high-margin) growth and diversification via M&A," the analyst said. "While timing and size remains difficult to predict (M&A is not included in our current estimates), we believe the firm's recent $40.3-million bought deal equity offering likely foretells: 1) further consolidation in Canadian lumber treatment—likely via smaller tuck-ins ($5-15-million) in eastern/Atlantic Canada; and/or 2) a larger U.S.-based transaction ($40-80-million) targeting the western states, one that ideally integrates with its flagship California Cascades acquisition in 2015. In this context, we also highlight management's disciplined track record and ability to execute on strategically accretive deals."

Mr. Hansen bumped his target price for the stock up by 25 cents to $7.50. The analyst average is $7.25.

"Given the constructive backdrop described, we believe CWX shares remain undervalued at current levels," he said. "While the stock's current trading multiple (10.3 times 2018 estimate) remains in-line with its broader peers and historical trading range, we note that current estimates do not account for future M&A — which we deem very likely. More importantly, we note the stock continues to boast an attractive dividend yield of 9.1 per cent — one that we believe is sustainably supported by the strategy and outlook described herein. In this context, we expect CWX shares to re-rate higher in the coming quarters as management executes on its business plan, demonstrates further margin expansion, and drives down the firm's commensurate payout ratio—all milestones that we expect will resonate well with investors over time."

=====

BMO Nesbitt Burns analyst Devin Dodge says Finning International Inc. (FTT-T) is "turning the corner."

"In our view, Finning's financial performance bottomed in 2016 and visibility into a cyclical earnings recovery is improving," he said. "We believe recent cost and efficiency initiatives leave the company well positioned to generate strong incremental margins and believe Finning has significant leverage should demand strengthen beyond our assumed modest improvement. Against this backdrop, valuation appears reasonable and is consistent with the early portion of the previous cycle."

Mr. Dodge initiated coverage of the Vancouver-based company, the world's largest Caterpillar dealer, with an "outperform" rating.

Mr. Dodge believes end-market conditions have "stabilized," and, accordingly, Finning is likely to see the benefits of its cost-improvement initiatives become "more visible" and margins in its Canadian business to rise.

"Profitability in the Canadian business has been under pressure for the last few years as softer demand, competitive pricing pressures on equipment sales and reduced activity levels have more than offset the benefits from the company's cost improvement initiatives," the analyst said. "However, with end-market conditions stabilizing, continued progress from operational initiatives underway and recent wage concessions from a portion of its Canadian workforce, we expect margins in the Canadian segment to push higher. Moreover, we expect revenue growth to be led by product support services which should improve cost absorption and support strong incremental margins in the coming years."

He added: "We're projecting revenues to stabilize in 2017 as increased demand for product support services is offset by softer new equipment sales activities. Beyond 2017, we expect new equipment sales to begin to show improvement underpinned by more favourable end-market conditions but still remain well below prior peak levels. We expect operating income to increase at a CAGR [compound annual growth rate] of 20 per cent over the next three years with approximately half of the improvement attributed to the Canadian business. However, we note that our 2019 EBIT forecast of $473-million is more than 10 per cent below the level of earnings reached in 2014. In our view, free cash flow is expected to moderate from 2016 levels as the working capital tailwinds experienced in recent years is likely to moderate and potentially turn into slight headwind when equipment demand increases."

Mr. Dodge said Finning's current valuation "reflects an anticipated pickup in earnings" and set a price target for the stock of $30. Consensus is $29.13.

"Over the last 10 years, Finning has traded at a forward price/earnings multiple between 8.3 times and 22.6 times with an average of 14.8 times," he said. "Relative to the market, Finning has on average traded at a slight premium (i.e., 4 per cent) premium to the S&P/TSX Composite Index. Since early 2016, Finning's multiple has been on the rise, which we believe reflects expectations that earnings have bottomed and the outlook for Finning's key end markets have shown early signs of improving. Finning is currently trading at a forward P/E multiple of close to 20 times, which represents a 25-per-cent premium to the market."

=====

Despite recent investor concerns following its recent acquisition of Spur Resources Ltd.'s Alberta and Saskatchewan Viking assets, Raymond James analyst Jeremy McCrea believes Tamarack Valley Energy Ltd.'s (TVE-T) valuation is enticing.

He initiated coverage of the Calgary-based oil and natural gas company with an "outperform" rating.

"Given its share price of late, most investors wouldn't expect that Tamarack Valley was the EPAC 'Top Junior Producer' winner of 2017 (with past winners DeeThree and Raging River)," said Mr. McCrea. "Year-to-date TVE has fallen by 29 per cent (versus the S&P TSX Capped Energy Index down 11 per cent) with investors expressing varying concerns – with no consistent answer.

"We believe that the Viking acquisition (and purchase price) had investors questioning the reasoning for anther core play, leading to uncertainty around the inventory and future profitability in its base Cardium portfolio. Combined with that is what appears to be a 'buyers strike' in Canadian energy and that TVE likely lost some of its earlier investors as the company transitioned to a mid-cap company, the equity has come under pressure. Despite these concerns, when we run Tamarack through our five-point checklist (assets economics, growth, leverage, valuation and market sentiment), we can give it above average marks in four of the five categories (with market sentiment showing likely no resolve until greater macro issues are known)."

On the Viking acquisition, Mr. McCrea said investors "may have missed that quality of inventory and scope that was purchased" if they relied solely upon an enterprise value-to-debt-adjusted cash flow evaluation.

"Overall, we believe that Spur had the second best well economics in the Viking region (just behind Whitecap) – despite even the gassier nature of the wells," he said.

Mr. McCrea set a $3.75 target for the stock. Consensus is $4.60.

======

Expecting improved well results moving forward, Mr. McCrea also initiated coverage of Petrus Resources Ltd. (PRQ-T) with an "outperform" rating.

"Since listing on the Toronto Stock Exchange on Feb. 8, 2016, Petrus has been hit by a series of events – both of its own making and outside of its control – that has resulted in it lagging the index," he said.

"Petrus has lagged the broader market year-to-date with its share price down 26 per cent versus the TSX Capped Energy Index down 12 per cent. The fall in AECO prices, widening differentials, and negative sentiment on Canadian E&Ps (especially junior names) have weighed on the share price and, as a result, we believe that investors may have missed the changes occurring within Petrus. These include a significant change in well completion designs, a deleveraging process through asset sales and equity financings, and, with the completion of the PRQ 2-5 facility expansion later this year, increasing cash flow margins."

"Investors should be familiar with Yangarra (YGR-T), which was one of the top performing stocks in 2016 and remains one of the best performing names year to date. Yangarra has book-ended PRQ's land base with two prolific wells and we suspect that the changes PRQ has made to its well design, similar to what YGR did eight months ago, will likely produce higher productivity and profitability wells and begin to change investor perception on the name – especially given the current valuation. Whether investors look at valuation on an EV/DACF basis (4.2 times), EV/PDP (1.3 times), or our preferred NAV + risked upside basis, most would agree the company is inexpensive after looking at the new company."

He set a price target of $3.50. The consensus is $3.75.

"Our upside model is centered on Petrus' Ferrier assets," he said. "PRQ has provided no details on well economics and well performance for its Foothills and Glauconite play and did not direct capital to the plays in 2016 leading us to believe that the company sees little interest in the plays beyond existing production, which is captured in the base PDP [proved developed producing] value. While we do not apply an upside value to PRQ, in another operator's hands these plays would likely attract capital. As a result, we expect that PRQ would be able to sell the assets for a premium to PDP."

=====

PrairieSky Royalty Ltd.'s (PSK-T) new resource upside is "compelling," according to Canaccord Genuity analyst Dennis Fong.

He raised his target for the stock following the company's investor day in Toronto on Wednesday, which he said "showcased expectations for third-party development and the ability to return free cash flow to shareholders."

"We were particularly surprised by the Duvernay where we saw strong productivity results," he said. "We estimate PrairieSky has 891 net sections of prospective land which translates into a risked value within our CNAV of $163-million or 69  cents per share ($912-million unrisked or $3.83 per share). The Duvernay more recently has garnered $1,700 per  acre, proximal to PrairieSky's lands, from a recent Alberta land sale, and management mentioned that it had been working closely with a potentially large (and active) lessee which could help show production growth going forward."

With a "buy" rating (unchanged), he increased his target by a loonie to $35. The average is $33.15.

Elsewhere, RBC Dominion Securities analyst Shailender Randhawa upgraded the stock to "outperform" from "sector perform" with a target of $38, up from $34.

=====

In other analyst actions:

Cormark Securities Inc. analyst Jason Zhang initiated coverage of Source Energy Services Ltd. (SHLE-T) with a "buy" rating and $15 target. The average is $15.67.

Follow related authors and topics

Authors and topics you follow will be added to your personal news feed in Following.

Interact with The Globe