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

Industrial Alliance Securities analyst Elias Foscolos expects a “soft” quarter for TSX-listed energy services and diversified energy companies, believing declining rig counts south of the border should “accentuate” a slow summer drilling season in Canada.

"We believe that this Q3/19 reporting season is likely to have more misses than beats," said Mr. Foscolos in a research note released Friday. "Western Canada experienced a wet summer, resulting in a milder ramp up from spring break up rig counts than usual, with Q3/19 land rigs averaging 129, just 60 per cent above Q2/19 (Q3 rig counts are historically usually more than double Q2). We also expect that completions were quite weak as well.

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"U.S. land rigs averaged 894 in Q3/19, declining 8 per cent from the previous quarter, and exiting the quarter at 836 rigs. The decline in U.S. drilling has several underlying causes, chiefly soft commodity prices, investor demand for higher returns and conservative deployment of capital, and a liquidity squeeze on smaller E&Ps as lenders pull back funds. These issues, which we expect to persist in the near term, should accentuate weak Canadian activity, resulting in quarterly misses through much of the Energy Services/Diversified Energy space."

Based on that view and the concurrent reduction to his rig count estimates on both sides of the border for 2019 and 2020, Mr. Foscolos downgraded a trio of stocks in the Energy Services sector. They are:

High Arctic Services inc. (HWO-T) to “speculative buy” from “buy” with a $3 target, down from $3.30. The average on the Street is $3.70.

Analyst: “Although the recent validation of the PNG LNG Gas Agreement by the government of PNG is a step forward for PNG LNG expansion, there is no near-term visibility for Drilling Services in PNG, with two of HWO’s rigs still in cold stack. HWO is struggling to generate returns to its North American Production Services division, and the Company now has a reduced cash balance since its acquisition of Precision Drilling’s (PD-T) snubbing units back in April.”

Source Energy Services Ltd. (SHLE-T) to “hold” from “buy” with a 70-cent target, down from $1. The average is 68 cents.

Analyst: "We are forecasting an increase in Canadian drilling and completions in 2020, but pricing, margins, and overall profitability remain key issues for SHLE. A high proportion of contracted revenue means that realized pricing will likely not change much in the near term, unless there is a favourable shift in the sales mix, and significant depreciation and interest of 10.5 per cent on the company's senior secured notes should continue to weigh on profitability. We do not expect SHLE to be able to generate meaningful free cash flow in the near term, and the company may have difficulties refinancing its debt when it comes due in December 2021."

STEP Energy Services Ltd. (STEP-T) to “speculative buy” from “buy” with a $2.25 target, sliding from $3. Average: $2.93.

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Analyst: "Weak completions in Canada and the U.S. will have a negative impact on all of STEP's operating segments. The relocation of Fracturing equipment into Texas last quarter was successful, and provided a boost to utilization and margins, but with the decline in Permian rig counts, there is uncertainty for the U.S. fleet. The pressure pumping market remains structurally oversupplied, and STEP has to act as a price taker."

In the Diversified Energy sector, he upgraded Enerflex Ltd. (EFX-T) to “strong buy” from “buy” while lowering his target to $18.50 from $20. The average is $20.25.

"We believe the stock is trading far below what is justified by the backlog," he said.

Mr. Foscolos also lowered his target for the following stocks:

Badger Daylighting Ltd. (BAD-T, “hold”) to $43 from $46. Average: $53.81.

Mullen Group Ltd. (MTL-T, “strong buy”) to $14 from $15.50. Average: $11.92.

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Tervita Corp. (TEV-T, “buy”) to $9.25 from $9.75. Average: $9.10.


In the wake of Thursday’s pre-release of weaker-than-anticipated third-quarter results, Desjardins Securities analyst Keith Howlett lowered his rating for Gildan Activewear Inc. (GIL-T, GIL-N) by two levels to “sell” from “buy,” pointing to the “surprise meltdown of the printwear cash machine.”

“We only recently raised our rating to Buy–Above-average Risk from Hold–Average Risk after 2Q was reported on Aug. 1,” he said. "Management narrowed adjusted EPS to the top half of the prior range at that time. While international printwear sales growth was unusually slow in 2Q, management indicated it improved in June and then again in July. Management stated its projection was for double-digit growth in 2H19. We have a high regard for Gildan’s manufacturing expertise and were encouraged that the proposed target of attaining a 30-per-cent gross margin rate by 2021 was not only chosen by management but largely within its own control.

"Given Gildan’s scale, the sharp slowdown in U.S. printwear sales in 3Q is most likely an industry phenomenon. Gildan was expecting low-single-digit growth of distributor to customer sales (distributor ‘POS’), while actual POS declined by high single digits. Gildan is lowering its end-user demand projection for 4Q by US$70-million, while also anticipating US$100-million of destocking (reducing) of inventories by its distributors."

With the results and in reaction to management's revised 2019 guidance and his reduced growth expectations for 2020, Mr. Howlett lowered his 2019 and 2020 earnings per share expectations to US$1.65 and US$1.90, respectively, from US$1.96 and US$2.42.

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His target for the stock plummeted to $40 from $57. The average on the Street is $54.30.

“The printwear channel is reliant on demand from the promotional products channel, and it is possible that economic anxiety has caused some companies to reduce discretionary spending,” said Mr. Howlett. “We currently have no information as to how Gildan is doing relative to the industry, and as to whether its fashion basics business is keeping pace with other market leaders such as Next Level and Bella + Canvas (both privately held).” We are reducing our rating to Sell (from Buy)."

Elsewhere, Stifel cut the stock to "hold" from "buy" with a US$30 target, down from US$44.

Bank of America Merrill Lynch reduced it to “underperform” from “buy” with a US$30 target, down from US$58.

RBC Dominion Securities analyst Sabahat Khan lowered his target to US$30 from US$36 with a “sector perform” rating.

Mr. Khan said: “The Q3 results shortfall and the expected weakness in Q4 are attributable to challenging trends in the imprintables channel both in the U.S. and in international markets, and are driven by: 1) weaker end-user demand in the imprintables channel, which is attributable to a soft macro backdrop (historically, the imprintables channel has been directionally tied to GDP growth); and, 2) distributor inventory destocking, which we believe is reflective of lower end-user demand and the ongoing pullback in cotton prices (more on this below). The $220-million aggregated sales impact reflected $50-million of shortfall in Q3, and $170-million in Q4. Management indicated that the retail channel initiatives (branded and private label) are on track and that the guidance revision is not associated with trends in that channel.”

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Analysts at Raymond James expect to see margin expansion and higher earnings and cash flows from TSX-listed precious metals producers in the third quarter “driven by top line growth from higher average gold and silver prices.”

“However, given quarter-over-quarter price declines in the base metals (particularly copper and zinc) we note that operations with by-product credits are expected to see an increase in by-product cash costs and AISC [all-in sustaining costs]," they said. "We also note that we expect higher AISCs quarter-over-quarter for our coverage companies that have 2H19 weighted sustaining capital programs.”

In a research note previewing earnings season, the firm raised its rating for Barrick Gold Corp. (GOLD-N, ABX-T) to “outperform” from “market perform” with a US$22 target. The average on the Street is US$20.07.

“While Barrick’s preliminary 3Q19 production results were marginally lower than expected partly due to restrictions at North Mara, we note that Barrick continues to expect 2019 production to be at thehigh end of the range (5.1 to 5.6 Moz) while costs are forecast to be at the lower end of the forecast,” they said. “Given we continue to believe Barrick is achieving synergies at the Nevada JV, the Acacia takeover has been completed, and the implied return as the shares are down about 15 per cent from their peak, we are upgrading Barrick to Outperform. We note Barrick plans to provide its 5 year guidance when it reports on Nov. 6.”

At the same time, in order to reflect its “strong” third quarter, the firm raised its target price for shares of Centerra Gold Inc. (CG-T) to $15.50 from $15 with an “outperform” rating (unchanged). The average is $13.95.

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Citi analyst Adam Spielman expects both the release of its third-quarter financial results and the U.S. Food and Drug Administration ban on non-tobacco flavours to be “quite difficult” for Altria Group Inc. (MO-N).

Regardless, Mr. Spielman raised his rating for its stock to "hold" from "sell" on Friday, pointing to both its current valuation and the expectation that cigarette volumes will rebound as e-vapor volumes slid.

The analyst thinks the FDA will likely take "aggressive action" against e-vapor and other tobacco products when it publishes its Final Guidance in late October or early November.

"We think it is reasonably likely there will be a blanket “ban” on all non-tobacco flavors on all newly deemed products, including e-vapor, post 2007-cigars, and new products like modern oral. We expect this because (1) Pres. Trump said that on e-vapor, all flavors other than tobacco would be banned; (2) the FDA believes flavors are an important driver of youth usage; and (3) up to now the FDA has been playing catch-up, and it needs to get ahead of the next (possible) wave of nicotine usage to try to prevent it. We think the simplest, most logical thing would be to 'ban' all flavors.

"We also expect the agency to reiterate its desire to 'advance' a ban on menthol in cigarettes. (We think there is a small chance the agency could also mention wintergreen in smokeless, which would be entirely new.)."

Mr. Spielman also predicts Altria's results, scheduled to be released on Oct. 31, to exhibit "weak" volumes, including an 11-per-cent decline in cigarette shipments.

"We expect EPS will hit consensus due to very large pricing and margin gains, but we don’t see this as a high quality, sustainable route to growth," he said.

However, though he remains “conservative” with his financial estimates, Mr. Spielman nudged higher both his 2019 earnings per share projection (US$4.19 from US$4.17) and his target price for Altria shares (US$46 from US$45). The average is US$52.86.

"We have had a Sell on Altria since December, but we are upgrading it to Neutral now because we believe that cigarette volumes will probably get a bit less bad next year (as we expect e-vapor volumes to decline) and because it has fallen below our price target. Relative to its international peers we now think it looks roughly fairly valued, whereas before we thought it looked expensive.

“We expect the next items of news flow – the 3Q earnings and the FDA’s flavor ban – to be quite difficult for Altria, but it’s possible to argue that they are already in the price.”


Raymond James analyst Brian MacArthur initiated coverage of Trilogy Metals Inc. (TMQ-T) with an “outperform” rating and $3.75 target. The average is $3.94.

Mr. MacArthur said: “While not a producer, we believe Trilogy is an attractive base metals development opportunity that offers investors exposure to copper, through its flagship Arctic project. Arctic is a high-grade copper development project located in a low-risk jurisdiction (Alaska) with the support of the Alaskan government and Native stakeholders. Trilogy also has has an option agreement with South32 whereby South32 can pay $150-million by January 2020 for 50 per cent of Trilogy’s assets in Alaska. These funds could reduce Trilogy’s capital requirements and improve its economics. Trilogy also owns the Bornite project, which has had encouraging drilling results and offers exploration upside, as well as optionality to prices. Given Trilogy offers investors exposure to copper through a quality asset base with growth potential, lower jurisdictional and financing risk (through its agreement with South32) and exploration potential, we rate the shares Outperform.”


In other analyst actions:

Desjardins Securities analyst Michael Markidis resumed coverage of Summit Industrial Income REIT (SMU.UN-T) with a “buy” rating and $14 target. The average is currently $13.54.

Mr. Markidis said: “Through completed/pending acquisitions and dispositions, SMU has significantly altered the pro forma composition of its portfolio. Most significant are (1) the virtual elimination of its data-centre holdings, and (2) the substantial increase in the geographic weighting to Alberta. The asset base is now bigger and the expected earnings impact is material. On the other hand, we believe the underlying organic growth profile of the overall portfolio may now be somewhat lower.”

In a note titled Crowning a New King in the North, Stifel analyst W. Andrew Carter raised Cronos Group Inc. (CRON-T) to “buy” from “hold” with a $14 target, down from $16.50. The average on the Street is $16.24.

RBC Dominion Securities lowered Athabasca Oil Corp. (ATH-T) to “underperform” from “sector perform” with a 60-cent target, down from 90 cents and below the $1.13 consensus.

KeyBanc upgraded Waste Connections Inc. (WCN-T) to “overweight” from “sector weight”

Editor’s note: An earlier version of this article incorrectly identified Michael Markidis's firm. He is an analyst with Desjardins Securities. This has been updated.

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