Inside the Market’s roundup of some of today’s key analyst actions
The U.S. Securities and Exchange Commission’s action against Tesla Inc. (TSLA-Q) chief executive Elon Musk “tilts the risk/reward” from an investment perspective, according to Citi analyst Italy Michaeli, leading him to downgrade his rating for its stock to “sell/high risk” from “neutral/high risk.”
On Thursday, the SEC accused Mr. Musk of fraud and sought to remove him from his role, saying he made a series of “false and misleading” tweets about potentially taking Tesla private last month.
“We frame this development into two potential outcomes: (1) The action leads to Mr. Musk’s exit; (2) Mr. Musk stays on after settling or prevailing,” he said. "Let’s focus on the first scenario. There’s little question that Mr. Musk’s departure would likely cause harm to Tesla’s brand, stakeholder confidence and fundraising—thereby increasing the risk of triggering a downward confidence spiral given the state of Tesla’s balance sheet, in our view. This of course is an outcome Tesla would want to avoid, but these decisions can become self-fulfilling. For instance, upon any sign of a ‘spiral’ the Board could be compelled to act for the benefit of Tesla’s enterprise by installing new leadership. Bulls might argue for a smooth transition, which is possible but not an outcome we’d necessarily rely on as the base case. Even a smooth transition would likely result in a lower stock price. If a transition isn’t smooth, the Board/new leadership could attempt to take further action by raising capital and/or seeking a strategic partner(s).
“Depending on the severity of the ‘spiral’ at this stage, and with the state of Tesla’s balance sheet, the equity could end up significantly diluted—or even at the extreme the cap structure could be completely restructured. To be sure, this ‘spiral’ risk is quite difficult to quantify and Tesla has managed through challenges in the past. But we do think the SEC escalation introduces a new level of risk for this. For the second scenario, if Mr. Musk ends up staying on, the reputational harm from this might still prevent the stock from immediately returning to ‘normal.’”
Mr. Michaeli said his valuation of Tesla is now a “risk/reward call,” and he’s approach it based on a 50-50 chance of a “bad” or “good” outcome.
“We think even after the post-close stock pullback (to $274), risk/reward is still tilted negatively,” he said.
The analyst dropped his target for Tesla shares to US$225 from US$356. The average target on the Street is US$315.90.
Elsewhere, JPMorgan analyst Ryan Brinkman said the SEC’s moves add to pre-existing pressures facing the electric car maker, leaving the company at risk for other litigation, including shareholder class action suits.
Believing Mr. Musk must remain involved in order to maintain shareholder confidence, he maintained an “underweight” rating.
“We are concerned that decreased confidence in Tesla on the part of investors may impact the company’s ability to raise capital on amenable terms,” said Mr. Brinkman.
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Founders Advantage Capital Corp.'s (FCF-X) $75.8-million acquisition of the remaining 40-per-cent stake in Dominion Lending Centre is a “major reset of its investment story," according to Industrial Alliance Securities analyst Dylan Steuart.
The acquisition is expected to be funded by a combination of 41 million common shares and a $4-million promissory note.
With the doubling of its share count, Mr. Steuart said the move, announced Thursday, shifts the Calgary-based investment company “from an acquisition driven private equity vehicle to what we expect will eventually become a pure-play financial services company.”
He added: “Setting aside the cost of the acquisition, we remind shareholders that DLC has outperformed expectations since FCF’s initial acquisition in 2016 despite the considerable noise in the housing market. Our forecasts of modest growth through to the end of 2019 are maintained as we expect DLC to continue to leverage its dominant market share position and continue to expand its shares within the broker channel, thereby offsetting expectations of an overall slowing of the housing market.”
Mr. Steuart raised his 2019 EBITDA projection to $29.1-million from $19.1-million, due largely to increased DLC contributions.
“However, we believe that the increase in EBITDA contribution is more than offset by the dilution to current shareholders from the proposed transaction,” he said.
Citing “elevated” risk, Mr. Steuart downgraded his rating for FCF shares to “hold” from “speculative buy” and lowered his target to $2.50 from $3 based on the dilution. The average target on the Street is $3.08.
Elsewhere, Desjardins Securities' Gary Ho also lowered his target to $2.50 from $3, maintaining a “buy” rating.
Mr. Ho said: “While we like the narrower focus on DLC and the mortgage broker business, the transaction is dilutive on an EBITDA basis and is financed predominately through equity.”
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Canaccord Genuity analyst Mark Rothschild raised his rating for Summit Industrial Income REIT (SMU-UN-T) in response to its leasing update, which he said “indicates that demand for industrial space in Canada, the GTA in particular, continues to intensify.”
On Thursday, the Toronto-based REIT announced a “very strong” retention rate of 92.5 per cent on 2018 lease renewals of 398,492 square feet, which it said has generated an average of a 9.5-per-cent increase in monthly rates. In the GTA, that jumped to 12.7 per cent.
Separately, it announced the acquisition of a 262,610 square foot logistics facility within the Pearson International Airport Corporate Centre.
Believing his previous valuation of Summit’s portfolio was “too conservative,” Mr. Rothschild moved the REIT to “buy” from “hold” and raised his target to $10 per unit from $9. The average is $9.28.
“Combined with a 5.8-per-cent distribution yield, our $10.00 target price implies a one year forecast total return of 19.0 per cent,” he said. “We are therefore upgrading our rating.”
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The highlight of Brookfield Asset Management Inc.'s (BAM-N, BAM.A-T) investor day was the continued growth in management fees and carried interest, according to Canaccord Genuity’s Mark Rothschild, calling it “dramatic value creation.”
“Management believes that it can double the value of the enterprise over the next five years,” he said. “This growth would be from a combination of an increase in invested capital along with larger private funds that generate significant fees. While we believe that management’s outlook is extremely optimistic, we do acknowledge that we made the same comment five years ago, and they have exceeded those projections. Further, the wind clearly appears to be supporting Brookfield’s growth with newer funds larger than predecessors.”
Though Mr. Rothschild called management’s target of doubling its annual cash available for distribution “overly optimistic,” he added it is “clearly achievable.”
“This would result in substantial free cash flow that could be used to fund further growth, increase dividends, or share repurchases, and would lead to material returns to shareholders,” he said. “Under these assumptions, annual free cash flow including carried interest would total US$5.8 billion, or US$5.73 per share in five years. Assuming BAM’s dividend is increased at 7 per cent annually (in line with past few years), there could be excess annual free cash flow of US$5.0 billion (US$4.93 per share) in five years. Management indicated that a likely use of this excess cash flow would be to repurchase shares.”
Maintaining a “buy” rating, Mr. Rothschild raised his target to US$55 from US$47.50 after increasing his net asset value estimate (to US$49.99 from US$42.83). The average on the Street is US$51.94.
“Clearly, as management fees continue to rise, and BAM makes additional progress on raising new funds, the value of the management fees rises,” he said. “Reflecting the strong outlook presented at the investor day, along with recent commitments, we are raising our estimate of value for BAM’s management fees considerably, which leads to an increase in our NAV estimate and target price. Our target price is set at a 10-per-cent premium to NAV and reflects our belief that BAM can continue to add value through both operating its existing businesses and growing management fees.”
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Canadian railways are becoming "growth stories, which should look more attractive in 2019," said Citi analyst Christian Wetherbee.
“The Canadians are turning into growth stories, as both are focused on volume opportunities led by intermodal and energy,” he said. “We don’t think this growth dynamic is reflected as clearly in CP shares as it is in CN shares and RTM [revenue ton mile] performance has greatly accelerated for CP, thus our preference for CP. The Canadians could move up in our preference as timing shifts ahead to 2019, when the U.S. rails lap tax reform and face tougher volume comps.”
In a research note on North American railway companies released Friday, Mr. Wetherbee raised his third-quarter earnings per share projections for the sector by an average of 2.4 per cent to reflect improved volume growth and pricing. His full-year 2018 and 2019 estimates jumped 1.1 per cent and 3.4 per cent, respectively."
With a “buy” rating, he increased his target price for Canadian Pacific Railway Ltd. (CP-N, CP-T) to US$242 to US$215. The average is US$275.48.
Earlier this week, Mr. Wetherbee upgraded Canadian National Railway Co. (CNI-N, CNR-T) to “buy” from “neutral” after meetings with its management.
“[We] came away constructive that the heavy lifting of fixing its network and adding capacity is largely complete and should pay dividends through robust volume growth, greater fluidity, and lower costs.”
His target rose to US$100 from US$90. The average is US$92.09.
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There is “still a number of shoes to drop” for General Electric Co. (GE-N), said RBC Dominion Securities analyst Deane Dray.
“The GE Bear Thesis gained a fresh burst of momentum as new disclosures of defective gas turbine fan blades drove a 9-per-cent stock sell-off over the past two weeks,” he said. “The prospects for new charges associated with the fan blade issue have unexpectedly added to GE’s already-full plate of looming negatives, including a likely 2018 guidance cut, ongoing SEC and DoJ investigations, potential dividend cut, and price-cost pressures compounded by U.S.-China tariffs and trade war fallout. Although GE is now a smaller percentage of the benchmark for many industrial investors, our number of in-bound calls has ratcheted higher this week with everyone asking whether the stock has finally bottomed. Given the punishing reaction to the fan blade issue, it appears that new incremental bad news is still making the stock go down.”
Mr. Dray lowered his fiscal 2018 and 2019 earnings per share projections by 1 US cent and 3 US cents, respectively, to 93 US cents and US$1 after reducing his margin and organic growth estimates across its portfolio, particularly in its Power segment.
Maintaining a “sector perform” rating, his target fell to US$13 from US$15, noting “as the rising negative sentiment overhang further stretches the valuation discount.” Consensus is currently US$16.54.
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CannaRoyalty Corp.'s (CRZ-CN) $25-million acquisition of 180 Smoke, a vape store chain with 26 Canadian locations, is “near perfect timing,” said Canaccord Genuity analyst Matt Bottomley.
“Although 180’s existing vape operations already provide moderate revenue contribution (relative to its purchase price), CannaRoyalty believes the real value behind this acquisition rests in the potential to transition the company’s current brick-and-mortar locations into licensed cannabis dispensaries throughout Canada,” he said. “With Ontario (40 per cent of the Canadian market) recently announcing plans to pivot to private sector retail while limiting each Licensed Producer to one retail location, we believe CannaRoyalty’s timing couldn’t be better. Further, CRZ estimates that 80 per cent of existing 180 Smoke customers are also cannabis users, which could help secure an established customer base should it obtain additional cannabis retail licenses in Canada.”
Believing CannaRoyalty is “moving closer to an inflection point,” Mr. Bottomley raised his target to $8.75 from $8, keeping a “speculative buy” rating.
“We believe investors should keep a close eye on the integration of the company’s acquisitions of River Distribution and FloraCal Farms,” he said. “With these acquisitions hitting the books, we estimate CannaRoyalty could achieve a top-line annualized run-rate of more than $50-million by the end of Q3/18, and management indicated that it is targeting exiting the fiscal year with a run-rate of greater than $100-million.”
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Cameco Corp.'s (CCO-T, CCJ-N) initial Tax Court of Canada victory in its long-standing dispute with the Canadian Revenue Agency is a “positive” for the company, said Raymond James analyst Brian MacArthur, adding: “we believe it will be relevant in determining the outcome for subsequent years and reduces risk related to the CRA dispute.”
Maintaining an “outperform” rating, he raised his target to $18 from $16. The average is $15.34.
“We believe Cameco provides investors with lower-risk exposure to the uranium market given its diversification of low-cost mines,” he said. “These mines are supported by a portfolio of long-term contracts that provide some downside protection in periods of depressed spot uranium prices while maintaining optionality to higher uranium prices. In addition, the company has multiple operations curtailed that can be brought back should uranium prices increase.”
Separately, Mr. MacArthur said the ruling could be a “positive readthrough” for Wheaton Precious Metals Corp. (WPM-N, WPM-T) in its dispute.
He hiked his target for Wheaton shares to US$28 from US$26, keeping an “outperform” rating. The average is US$27.71.
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Citing an “attractive” valuation, CIBC World Markets Chris Couprie upgraded Invesque Inc. (IVQ.U-T) to “outperformer” from “neutral.”
“There are still challenges for U.S. seniors housing operators in both retirement homes and skilled nursing facilities,” he said. "IVQ has been diversifying these risks by adding new operators, entering new asset classes (e.g., medical office buildings), and partnering with developers for new construction product.
“Despite the industry backdrop, U.S. seniors housing REITs have performed well year to date, outpacing the price return of IVQ by 1,550 basis points on average. U.S. seniors housing operators have performed even better. Based on the work we have done using Centers for Medicare and Medicaid data, we do not believe IVQ’s operators are necessarily any more worse off than the overall industry. Recent underperformance may partly be attributed to a dislocation caused by former Mohawk unitholders seeking liquidity from their previously illiquid investment (former Mohawk unitholders accounted for 14 per cent of float when the deal closed). As a result of this selling pressure, we believe the current price implies that IVQ’s seniors housing NOI [net operating income] will be 7 per cent below our forecast. If the market is correctly pricing in the NOI decline, then we believe that the dividend would still be sustainable as the payout ratio should not exceed 100 per cent.”
Mr. Couprie maintained a target of US$9.50, which exceeds the consensus of US$9.05.
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AltaCorp Capital analyst Chris Murray initiated coverage of Horizon North Logistics Inc. (HNL-T) with an “outperform” rating and $3.60 target, which tops the consensus of $3.24.
Mr. Murray said: “As Horizon continues to diversify its revenue streams, we see an opportunity for a positive response in share prices, however, we remain cognizant that each of the Company’s business lines is likely to see different outcomes and performance.”
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In other analyst actions:
CIBC World Markets downgraded TFI International Inc. (TFII-T) to “neutral” from “outperformer” with a target of $52, rising from $47. The average is $49.86.
Calling it “fundamentally expensive,” Deutsche Bank analyst Jonathan Arnold initiated coverage of Brookfield Renewable Partners L.P. (BEP-N, BEP.UN-T) with a “sell” rating and US$28 target. The average target on the Street is US$33.25.
GMP analyst Anoop Prihar initiated coverage of Tervita Corp. (TEV-T) with a “buy” rating and $12.50 target.
David Leeder