Inside the Market's roundup of some of today's key analyst actions. This file will be updated often during the trading day so check back for new details.
Despite a decline in the Canadian real estate sector through the last five months, valuations, in both absolute and relative terms, "look the most compelling since early 2010, across all metrics," said Raymond James analyst Ken Avalos.
"We expect a continued 'muddle-along' macro scenario in Canada and have more conviction in REITs/REOCs than we've ever had (since we launched coverage in late 2012)," he said. "Several names with long-term track records of sound capital allocation and [net asset value] per unit growth can be bought at deep discounts to NAV and private market valuations."
In the third quarter, Canadian real estate income trusts and real estate operating companies struggled, with the sector down 4 per cent and now down 1 per cent for the year in total return perspective. This is compared to the drop of 8 per cent for the S&P/TSX composite index (now down 7 per cent on the year). Mr. Avalos went so far as to say it is now "time to overweight the sector."
"The macro call has become increasingly difficult to make as we move through 2015," the analyst said. "At the beginning of the year, we took a 'basket' approach, looking for investors to find large-cap/growth or defence, with a view toward re-evaluating as the year moved on and the macro picture became clearer. But the reality is for us, the picture has become more challenging. We still believe investors should have exposure to the right REIT/REOCs as a diversification tool, but also given lower cash flow risk, defensible income, and strong balance sheets. While we previously recommended investors market weight the sector, we now believe it prudent for both generalist and dedicated investors to overweight real estate equities to their portfolios. We would use the pullback to add high-quality, larger-cap names that rarely trade at such discount."
Due to attractive valuations, Mr. Avalos upgraded the follow companies to "strong buy" from "outperform" ratings: Allied Properties Real Estate Investment Trust (AP.UN-T), Artis Real Estate Investment Trust (AX.UN-T), Canadian Real Estate Investment Trust (REF.UN-T), Killam Properties Inc. (KMP-T) and Tricon Capital Group (TCN-T). He also upgraded RioCan Real Estate Investment Trust (REI.UN-T) to "outperform" from "market perform."
His price targets did not change. They are currently (all in Canadian):
- Allied $45. Consensus: $41.58
- Artis $15. Consensus: $15.63
- CREIT $47. Consensus: $48.89
- Killam $12. Consensus: $11.50
- Tricon $12.50. Consensus: $13.42
- RioCan $28. Consensus: $29.54.
"The relative valuation picture for Canadian REITs/REOCs has been attractive for some time," said Mr. Avalos. "However, the recent pullback (one distorted when compared to fundamentals) has a large part of the sector trading at a substantial discount to historical valuations. The sector as a whole, which has traded at an average 4-per-cent premium to NAV over a 15-year period, now trades at a 7-per-cent discount. Furthermore, 13 of the 20 REITs/REOCs we cover are trading below their 10-year historical average premium/discount. In particular, several high-quality names, including Artis, Boardwalk, CREIT and RioCan, are trading at unprecedented discounts to NAV. It's those blue-chip names with outsized [net operating income] growth and flexible balance sheets that we think investors should gravitate to, as they are rarely ever on sale to this degree."
He added:"On an [adjusted funds from operation] multiple basis, the sector also looks the most compelling since the last recession. The broader real estate sector trades at 14 times (largely in-line with its 15-year average of 13.9 times), a level not seen since mid-2010. Again, 13 of the 20 REITs/REOCs we cover are trading below their 10-year average multiple. With FFO [funds from operations] growth that should continue to average 4- to 5 per cent for at least the next two years, investors can expect 10- to 12-per-cent total returns (assuming flat multiples). In our opinion however, given where the sector is now trading, we believe there could be multiple expansion as investors 1) gain comfort on oil prices and 2) get a better understanding of how wide the discrepancy is between public and private market cap rates."
BMO Nesbitt Burns analyst Brian Quast said he is "taking a break for now" from Detour Gold Corp. (DGC-T).
"DGC has had an exceptional run this year, spurred by notable operation improvements as well as cleaning up the balance sheet," said Mr. Quast. "BMO Research still considers DGC to be one of the better vehicles to play the falling Canadian dollar, but the current valuation simply isn't compelling enough to retain an outperform rating at present."
Accordingly, he downgraded the stock to "market perform" from "outperform."
Mr. Quast noted BMO has dropped its long-term gold price assumption to $1,200 (U.S.) per ounce from $1,250. Though he said that move has lowered target prices for the sector's equities, changes in foreign exchange assumptions have "offset the change in the gold price estimate to some degree."
For Detour, his target of $16 (Canadian) was unchanged, compared to a consensus of $17.50.
He added: Key catalysts for the stock include third quarter production results, but more importantly, a revised [life of mine] plan for Detour Lake is expected in early 2016, and this will incorporate several value-enhancing projects, such as Block A and the segregation of fines project, amongst others."
Ahead of third-quarter results in the precious metals sector, Desjardins Securities analyst Michael Parkin lowered his metal prices for both the near and medium term.
"We expect gold to be range-bound around the $1,150 (U.S.) per ounce level in the near to medium term, and we then see the potential for gold prices to begin to rise in support of needed investment in existing mines and/or new mines so as to be able to support global production levels," he said.
He added: "We have adjusted our long-term silver price to $19 (U.S.) per ounce from $21.25/oz, which results in a long-term gold/silver ratio of 69.7 times. We continue to view silver to be a more volatile metal in the medium term, with a lower likelihood of a supply response on weaker metals prices due to the fact that the bulk of global mine supply is in the form of by-product metal."
In response to the forecasted drop in silver, he downgraded his ratings for three companies:
- First Majestic Silver Corp. (FR-T) to "hold" from "buy." His target for the stock dropped to $5.50 from $8.50. Consensus is $12.77.
- MAG Silver Corp. (MAG-T) to "hold" from "buy." His target fell by 50 cents to $11. Consensus is $13.86.
- Mandalay Resources Corp. (MND-T) to "buy" from "top pick." His target is now $1.30, down from $1.50. Consensus is $1.30.
Mr. Parkin said he expects every metal producing company, with the possible exception of Primero Mining Corp. (P-T), to report a decline in earnings quarter over quarter.
"However, on a year-over-year basis, we expect an improvement in earnings per share from our entire coverage universe, which speaks to the success achieved in some of the optimization and cost-reduction programs initiated by these companies; however, they were also likely aided by weaker currencies and the weak oil price," he said.
The analyst added: "[Detour Gold Corp. (DGC-T)] is our preferred name going into the third quarter 2015 earnings period," he said. "We expect DGC to report record production in the third quarter with lower costs quarter-over-quarter, and potentially provide details supporting expectations for an even stronger fourth quarter. We believe DGC is capable of delivering at or near the upper end of its production guidance for 2015 and should generate significant [free cash flow] at spot prices."
The top customers of Western Energy Services Corp. (WRG-T) have reduced their rig demand "significantly more" than the rest of the industry as a whole, according to Raymond James analyst Andrew Bradford.
Based on that drop, he lowered his estimates for the Canadian-based drilling contractor and downgraded his rating for its stock to "underperform" from "market perform."
"It is the same customers that we would typically refer to as 'blue-chip' that have dragged down WRG's Canadian rig activity of late; companies like, Canadian Natural Resources Ltd., ARC Resources, Devon and Pengrowth," said Mr. Bradford. "For a variety of company-specific reasons, seven of WRG's top 10 customers have reduced activity by more than the industry. While the industry rig count is down 51 per cent year over year, Western's typical top 10 customers have reduced activity by 60 per cent (70 per cent if you exclude Progress). Even though demand from its top 10 customers has fallen faster than the market as a whole, it says something about WRG's franchise that its rig counts within these customers fell by less than their total rig counts – excluding Progress Energy, which has transitioned away from double-derrick rigs."
He added: "Since 2012, WRG had enjoyed an average 1,300 bp premium to industry drilling rig utilization; however, we believe this premium was reduced to nil over the past two quarters, primarily as a function of customer-related activity volatility. Our forward estimates include a return to a 1,000 bp utilization premium by [the fourth quarter of 2016]; we expect that WRG will accomplish this as a result of: 1) WRG's proportionately high exposure to the high spec double rig market; 2) we think it's probable that at least some of WRG's traditional 'blue-chip' customers elevate their drilling programs over the course of the next year; and, 3) we expect WRG will be successful in transitioning many of its idled rigs to new customers, which we have already seen evidence of."
Mr. Bradford maintained his $5 (Canadian) target price. The consensus is $7.07.
"We continue to believe that WRG has a high spec fleet in Canada, and should be a relative beneficiary when activity returns or it is able to transition its rigs to more active customers," he said.
Stock of Tesla Motors Inc. (TSLA-Q) "appears to fairly balance mid-term assumptions with execution risk," said RBC Dominion Securities analyst Joseph Spak.
He initiated coverage of the stock with a "sector perform" rating.
"The company is disrupting the auto industry and has eyes on other industries, notably energy storage," said Mr. Spak. "It's also a classic story stock which can make an investment decision qualitative versus quantitative. In our view, this places extra emphasis near-to-mid-term on expectations and delivering on target."
He added: "Tesla is essentially learning how to become a manufacturing company on the fly. While we don't have meaningful reason to doubt Tesla can eventually get to their targets, doing so in a timely matter without some growing pains could prove challenging. Failure to hit near-term objectives may not impact the long-term view, but could hold back the stock or provide a more favourable risk/reward entry point."
He set a price target for the stock of $280 (U.S.). Consensus is $299.56.
"We believe the market is implying [approximately] 420,000 to 480,000 deliveries in 2020 with Tesla Energy revenue of $1 to $2.5-billion," he said. "That may not leave a lot of room for upside. To get more constructive, we need either greater confidence that project timelines can be met, storage is bigger sooner, or a more favourable risk/reward to account for some concerns."
Elsewhere, the stock was downgraded to "neutral" from "outperform" by Robert Baird analyst Ben Kallo. His target price fell to $282 from $335 per share.
"With limited visibility to positive catalysts until the release of the Model III prototype, we are moving to the sidelines," said Mr. Kallo.
In other analyst actions:
Abbott Laboratories (ABT-N) was raised to "overweight" from "equal-weight" at Barclays by equity analyst Matthew Taylor. The target price is $52 (U.S.) per share.
Harman International Industries Inc (HAR-N) was rated new "underperform" at Jefferies by equity analyst Dan Dolev. The 12-month target price is $90 (U.S.) per share.
Interfor Corp (IFP-T) was raised to "top pick" from "outperform" at RBC Capital by equity analyst Paul Quinn. The 12-month target price is $20 (Canadian) per share.
Lazard Ltd (LAZ-N) was raised to "buy" from "hold" at Sandler O'Neill by equity analyst Jeffery Harte. The 12-month target price is $56 (U.S.) per share.
Morgan Stanley (MS-N) was raised to "outperform" from "sector perform" at RBC Capital by equity analyst Fiona Swaffield. The 12-month target price is $39 (U.S.) per share.
Parkway Properties Inc (PKY-N) was downgraded to "market perform" from "outperform" at Wells Fargo by equity analyst Brendan Maiorana.
PMC-Sierra Inc (PMCS-Q) was downgraded to "neutral" from "outperform" at Wedbush by equity analyst Betsy Van Hees. The 12-month target price is $10.50 per share. It was also downgraded to "hold" from "buy" at Craig- Hallum by equity analyst Christian Schwab with a 12-month target price of $10.50.
Trustmark Corp (TRMK-Q) was raised to "market perform" from "underperform" at Hovde Group by equity analyst Kevin Fitzsimmons. The 12-month target price is $24 (U.S.) per share.
With files from Bloomberg News