Inside the Market's roundup of some of today's key analyst actions
Pershing Square's decision to sell its entire investment in Valeant Pharmaceuticals International Inc. (VRX-N, VRX-T) sends an "untimely poor signal," according to BMO Nesbitt Burns analyst Gary Nachman.
On Monday, Pershing, led by billionaire investor William Ackman, abruptly announced the sale of its entire stake for a loss of more than $3-billion (U.S.). At one time, Mr. Ackman had been one of Valeant's most vocal defenders.
"Understanding Pershing's need to manage its portfolio as it deems appropriate and considering its public endorsement of VRX's new management team that it helped put in place, we still think it's hard to interpret Pershing's decision at this time as anything but a realization that this turnaround situation may end up taking a lot more time and perhaps have greater challenges than originally anticipated," said Mr. Nachman. "The timing of this decision is particularly noteworthy since new management is just beginning to implement a number of its strategic initiatives, including asset sales to help pay down debt, pipeline approvals and new launches, and a primary care effort behind key product Xifaxan to accelerate that product. This was a time when it would have been more ideal for the top shareholder to continue to support these efforts rather than 'throw in the towel' when the stock is so depressed."
Mr. Nachman said the move is unlikely to spark operational changes in Valeant in the near term.
"Pershing Square CEO Bill Ackman and Vice Chairman Steve Fraidin will remain on the VRX board until the upcoming annual meeting but will not stand for re-election. Pershing was instrumental in helping bring VRX's new management in place, and we expect it will continue along the stated path from an operational standpoint. Thus, we are not changing our estimates at this time. We recently lowered our estimates meaningfully after VRX's 2017 guidance."
With a "market perform" rating (unchanged), Mr. Nachman lowered his target price for the stock to $15 (U.S.) from $19. The analyst average target price is currently $19.09, according to Bloomberg.
"Given this latest development, we believe it is prudent to haircut our terminal multiple for VRX and take a more cautious view on the sustainability of the business," he said, adding: "VRX in major transition with a lot of moving parts; very challenging to get comfortable with underlying fundamentals and may take at least a couple of quarters of execution. Significant debt with lack of clarity on deleveraging. Core franchises could have meaningful value but several hurdles remain (e.g., pricing & Walgreens). Business model out of favor and reputational damage remains."
Vermilion Energy Inc.'s (VET-T) structured debt issue "provides added flexibility at a reasonable cost," said Desjardins Securities analyst Kristopher Zack.
On Monday, Vermilion announced the close of its offering of $300-million of senior unsecured notes, due in 2025 at a fixed coupon of 5.625 per cent per annum. The company intends to use the proceeds to repay a portion of outstanding debt stemming from its revolving credit facility.
"While the 5.625-per-cent coupon is above the effective rate of 4 per cent in our prior forecast, we believe that the incremental interest (5 cents per share on an annual basis) is offset by the increased financial flexibility—particularly given the lingering uncertainty in the commodity market and growing expectations for further interest rate hikes," said Mr. Zack. Following the offering, we estimate $1.1-billion of unutilized capacity on the existing $2-billion syndicated credit facility. To that end, we also highlight that the increased financial capacity could provide the backing for additional accretive acquisitions in Europe, although the ultimate timing of such opportunities is difficult to predict.
He believes the company's dividend continues to be well-funded at the strip, noting: "We now forecast a capex-adjusted payout of 71 per cent and 88 per cent in 2017 and 2018 at the current strip, providing considerable support to the current 5.3-per-cent dividend yield. The balance sheet is also in good shape with a [debt-to-cash flow] of 1.8 times at year-end 2017, reflecting a full year of contribution from the Corrib offshore Ireland project, which has continued to achieve solid operational performance."
Mr. Zack increased his 2017 and 2018 cash flow per share projections to $5.94 and $6.77, respectively, from $5.91 and $6.68.
He kept a "buy" rating for the stock and maintained a target of $67. The analyst consensus price target is $61.57, according to Thomson Reuters.
"We would continue to buy the stock, highlighting that the dividend remains well supported at current strip prices — even following the recent pullback in oil prices — and the increased financial flexibility provided by the note offering," said Mr. Zak. "While there seems to be increased investor focus on U.S.-based production recently, we remind investors that VET provides direct commodity exposure outside of North America, with almost 70 per cent of funds flow expected to be driven by Brent oil and European natural gas prices."
In reaction to the deal, RBC Dominion Securities analyst Joseph Spak lowered his rating for Mobileye to "sector perform" from "outperform," calling it a "fair, good outcome" from Mobileye's perspective.
"While ultimately the stock price could have gone higher, this was often a terminal value debate," said Mr. Spak. "We were believers, but discounting for time, risk, automotive volume cyclicality, etc., we believe this is mostly a fair present value level. Further, MBLY has been a battleground stock and the volatility that comes with being a public company is eliminated. We were a little surprised at the timing and that management decided to sell. Crucial to this decision, in our view, is that Intel's Automated Driving Group is being integrated into MBLY and joint efforts will be led by MBLY co-founders CTO Amnon Shashua and CEO Ziv Aviram. This keeps MBLY a significant presence in Israel which we believe was important to management. INTC can help accelerate MBLY's mission of autonomous driving by providing greater resources, learning from their culture and experience in scaling projects."
Mr. Spak believes it is unlikely there will be another bidder for Mobileye, an Israeli-based engaged in the development of computer vision and machine learning, data analysis, localization and mapping for advanced driver assistance systems.
"The deal size limits Tier 1 suppliers so it would likely have to be from another tech player that has a large balance sheet and an interest in the automotive TAM (and arguably one that is behind on efforts)," he said.
He added: "Samsung/Harman International, INTC/MBLY; clearly there is a bid for 'auto-tech' assets. Remaining in our coverage the other players with ADAS/autonomous businesses are Delphi Automotive PLC and Autoliv Inc. DLPH could be a beneficiary here as they have partnerships with both MBLY and INTC and could become a go-to Tier 1 for the INTC/MBLY products. With respect to ALV, bulls will want to place a premium on their autonomous efforts. However, we would be somewhat cautious about doing that to a player we believe is behind from a technology standpoint and now faces a competitor with greater resources. We wouldn't be surprised to see further "partnerships" between automotive companies (ie. ALV, Bosch, Conti, etc.) and tech/semi players (Nvidia, NXP, etc.) as players attempt to join resources to solve autonomous driving."
Mr. Spak raised his target price for Mobileye stock to $63.54 from $57 to reflect the offer. Consensus is $58.63.
"We believe the strategic rationale is sound, merging MBLY's computer vision technology, relationships and access to data with Intel's expertise in computing, data center, AI and connectivity," the analyst said. "INTC is a logical acquirer given they are familiar with MBLY from their joint-work on BMW's autonomous project and INTC joined the MBLY/DLPH autonomous venture. $63.54/share ($15.3bn equity value) is 34-per-cent premium to prior close. Valuation is 18.6 times consensus 2020 EPS. Closing is expected in 9 months, requiring tender of at least 95 per cent of MBLY's outstanding shares."
Elsewhere, Raymond James analyst Tavis McCourt downgraded Mobileye NV to "market perform" from "outperform" without a specified target.
Spectrum Brand Holdings Inc. (SPB-N) presents the investors the opportunity to acquire "high growth at a low price," said RBC Dominion Securities analyst Nik Modi.
He initiated coverage of the Wisconsin-based diversified global consumer products company with a "outperform" rating.
"While Spectrum shares currently trade at 21 times 2018 price-to-earnings (in-line with staples), it remains one of the cheapest names across our household personal care, beverages and tobacco coverage on a growth-adjusted basis," he said. "Spectrum's 2017 PEG [price/earnings to growth ratio] is 1.7, which only sits behind Constellation Brands, Newell Brands and Monster Beverages."
Mr. Modi also touted the company's "best in class capital allocation," noting: "Since the company emerged from bankruptcy in August 2009, the stock has outperformed the market and staples by 416 pp and 431 pp, respectively. We attribute this value creation largely in part to management's ability to acquire undervalued assets and execute on integration. Today, we believe the company has $700-million in M&A capacity and would expect bolt-on or even more transformative M&A in the coming years. Categories of focus include companion pet, home & garden and auto care. We also see the rising rate backdrop as an opportunity for SPB to acquire at valuations that could lead to above historical cash flow accretion levels (as valuations are likely to come down on rising rates)."
Mr. Modi said the potential sale of HRG Group's 58-per-cent stake in the company should be "top of mind" in the near term. In November of 2016, HRG announced it was explore its strategic options, including the possibility of selling its ownership.
"We believe the following scenarios (in order of likelihood) are most probable: 1) SPB shares are floated in the marketplace; 2) HRG Group is purchased and the total 58 per cent is passed through to the new owner; 3) HRG Group absorbs the rest of SPB then dissolves itself; or 4) SPB levers up and repurchases the rest of HRG's stake (the least likely scenario)," he said. "While we acknowledge these scenarios create some near-term uncertainty for the name, we see this transition as a long-term opportunity. HRG (formerly Harbinger Capital) has left somewhat of an overhang on investor sentiment on the name that may ultimately be relieved. Following a transition we believe a floor can be set and investors can begin to appreciate the story for its true fundamental upside potential."
He set a price target of $160 (U.S.) for Spectrum shares. Consensus is $145.45.
"Based on SPB's long-run cash flow potential, a DCF values shares at $160," he said. "Importantly, our base case DCF [discounted cash flow] approach excludes the benefits of FCF [free cash flow] accretive M&A and potential favorable changes in tax policy (SPB pays a 35-per-cent rate, plus the benefit of NOLs). SPB shares also offer a compelling 9-per-cent FCF yield (second only to COT in our coverage) and trade at 18 per cent/33-per-cent discounts to peers on enterprise value/ EBITDA and PEG respectively - discounts we believe are unjustified given the consistent mid-single-digit organic FCF growth we expect from SPB."
"The catch-up trade has been played" for Abbott Laboratories (ABT-N), said BMO Nesbitt Burns analyst Joanne Wuensch.
Asking "what's next?," she downgraded the Illinois-based company to "market perform" from "outperform."
"Shares of ABT have outperformed year to date, increasing 19 per cent versus the S&P500's 6-per-cent increase and the S&P Equipment and Supplies Index's 14-per-cent rise," she said. "Some of this is clearly a catch-up trade, with the stock one of the worst MedTech performers in 2016. But with ABT trading within spitting distance of our price target, the St. Jude Medical acquisition having closed and integration ahead of it, and the Alere acquisition … well, pending, we believe it is likely time for the stock to take a pause. With this in mind, we are downgrading shares of ABT …. Please do not read into this downgrade that there are larger issues at hand; we are simply stepping aside in anticipation of more limited upside relative to other stocks in our coverage universe.
"Shares of ABT are currently trading at 18.4 times 2017 estimate in line the peer group's average of 18.4 times (excluding BAX and EW). It was not that long ago that pro forma ABT was the second cheapest stock in the group, only behind ZBH, but that has certainly changed. It currently runs with the pack, with stocks such as BAX, BCR, EW, and SYK trading at higher multiples and with higher revenue growth rates, while stocks such as JNJ, MDT, and ZBH are trading at lower multiples and with lower revenue growth rates. In fact we could argue that the best 'comp' for ABT at this stage are the large cap, diversified, higher-yielding dividend companies such as MDT and JNJ."
On the delayed $5.8-billion acquisition of Alere Inc. (ALR-N), which led to Abbott filing a request to terminate in December and is now bound for a mid-April court date, Ms. Wuensch said it's likely only the lawyers are benefiting at this point.
"We are being a bit tongue in cheek here, but it does seem to us that Abbott does not want to close the Alere transaction," she said.
"Alere is a very different business today than it was a year ago, reflecting headwinds from the INRatio voluntary recall and Arriva reimbursement revocation: for example, based on Street consensus 2017 estimated revenue forecast declined to $2.42-billion from $2.59-billion and operating income to $423-million from $526-million. In a Scenario analysis, the 13-cent accretion in the first year post close is closer to break even depending on the amount ultimately paid for Alere (assuming it can be renegotiated)."
Ms. Wuensch maintained a target price of $48. Consensus is $47.85.
"This is a long way of saying we believe the catch-up trade in ABT is largely done, and that further upward momentum will come from integration of STJ, execution on its core franchises (including a recovery in its Nutritionals business), and clarity regarding Alere," the analyst said. "Please do not read into this downgrade that there are larger issues at hand; we are simply stepping aside in anticipation of more limited upside relative to other stocks in our coverage universe."
Saying his portfolio is going "even longer the Permian," Credit Suisse analyst Edward Westlake upgraded Occidental Petroleum Corp. (OXY-N) to "outperform" from "neutral."
"This should not be a surprise given this is where the deepest inventory lies and, more importantly, this is where the rate of change of 'revenue adjusted 6mth cum per lateral foot' continues to be strongest," said Mr. Westlake. "Today we are adding OXY into this portfolio. It is not the highest per share exposure to the Permian but we believe it is large enough. OXY also adds an income component to the portfolio (which growth investors may find dilutive but which does add some balance in TSR). OXY should also outperform the Majors on average, another group with which it is often compared."
Mr. Westlake raised his target to $79 (U.S.) from $77. Consensus is $75.
"In a recent report, our U.S. strategist argued that although buyside positioning and revisions were positive, large cap energy still looked expensive (e.g. on NTM price to earnings, price to sales etc.)," he said. "Yet, we believe the deep inventory of low cost reserves is not reflected in valuations, not for OXY, and especially for the overacreaged large cap peers shown earlier. Solving the 'P/E relative' conundrum requires duration – the U.S. large caps will grow and compress multiples, it requires DD&A to fall as lower cost reserves are added each year, and a higher oil price would help (but not that much higher - $60 per barrel would feel a lot different to $50 per barrel). For OXY, the 4.8-per-cent dividend yield (with the S&P at 2.3 per cent) may reflect a fear over the ability to both invest for growth and return cash to shareholders."
In other analyst actions:
Halogen Software Inc. (HGN-T) was downgraded to "market perform" from "outperform" at Raymond James by analyst Terry Tillman without a specified target price. The average target is $12.50.
Alacer Gold Corp. (ASR-T) was raised to "outperform" from "neutral" by Macquarie analyst Michael Gray. He lowered his target to $2.80 from $2.90, versus the average of $3.44.
Guggenheim Securities analyst Michael Morris upgraded Walt Disney Co. (DIS-N) to "buy" from "neutral" and raised his target to $128 (U.S.) from $118. The analyst average target price is $117.81, according to Bloomberg.