Inside the Market’s roundup of some of today’s key analyst actions
Industrial Alliance Securities analyst Michael Charlton thinks Canada's two publicly listed Energy Royalty companies offer investors "relative stability while maintaining energy exposure."
“Investors looking to either maintain or increase exposure to the oil and gas sector, but may be intimidated by the volatility seen in commodity markets over the past several years, should consider investing in a royalty company that offers dividends and exposure to multiple E&P companies and their various plays at relatively low risk compared to investing in a single player,” he said. “Traditional E&P share prices can fluctuate wildly on any given day in response to commodity price movements that are anticipated to have a meaningful near-term impact to revenue, cash flows, and earnings. Since the Royalty Company has a structural FCF [free cash flow] advantage with no operating costs to cover, the Royalty Company will remain profitable at WTI prices far lower than an E&P could possibly withstand. With virtually no chance of the Royalty Co encountering a negative cash flow type situation based on commodity prices alone and a dividend paid to investors, we believe that Royalty Co share prices will remain less volatile than an individual E&P.”
Mr. Charlton said concerns about royalty companies' ability to grow, given they rely on the on a third party’s exploration and development plans, is "somewhat unjustified."
"For starters, we believe that at a bare minimum E&Ps have a desire to keep production levels flat and given the declining nature of oil (and gas) wells, continued drilling is required, even if only to keep production flat and Royalty Companies often use incentives to spur drilling activity," he said.
"Technological advancements keep enhancing play economics, and pushing marginal plays into profitability, which also spurs drilling activity and will likely continue to do so until fossil fuels are entirely replaced. In the near term we see emerging plays like the Clearwater and a desire to maintain production levels or post moderate sustainable growth from E&Ps as the logical near-term revenue drivers for Royalty Co’s until sentiment changes and we see a meaningful ramp up in capital programs if/when investors start to demand production growth over FCF once again, a shift that we believe is only a matter of time as business cycles repeat over the long term."
Mr. Charlton said the companies’ business model is “meant for dividends,” noting they have minimal capital requirements and rely “on production royalties from third-party (the lessee) exploration and drilling activities to derive the bulk of its revenue.”
For PrairieSky, he set a target price of $17.50 per share. The average on the Street is $17.77.
“The Company looks to be well positioned to continue delivering dividends to its shareholders through the continued leasing and development of its royalty holdings in highly active parts of the WCSB,” he said. “For investors seeking income in a company that pays a stable, sustainable monthly dividend while waiting for a broader recovery in investor sentiment towards the Canadian E&P space, we believe those investors need look no further. In our view, PrairieSky offers exactly that — balanced exposure to multiple plays and formations in all stages of development. As we have said, holding PrairieSky is like holding 5 per cent of future drilling and development activity across the entire WCSB, with optionality on technology!”
Mr. Charlton set a $10.50 target for Freehold, which exceeds the consensus by 12 cents.
“The Company is well positioned to continue to grow production and FCF through continued leasing and then drilling activity on its six core assets, leveraging the relatively stable cash flows from its active plays across the WCSB,” the analyst said. “We believe Freehold has achieved critical mass whereby its clients’ drilling and development operations are capable of driving Freehold’s production growth such that it is able to offset natural production declines of approximately 18 per cent and maintain the Company’s monthly dividend. For investors seeking sustainable dividend income while they wait for a broader recovery in the E&P space to potentially fuel capital appreciation, Freehold offers balanced exposure to multiple plays and formations in all stages of development that have the potential for increased liquids weighting and is run by a highly experienced management team. Further sweetening the value proposition offered by the Company is the fact that all of this is available at a discount when compared to historical share prices."
Meanwhile, after its fourth-quarter results and reserves exceeded his expectations, Raymond James analyst Jeremy McCrea raised his rating for Freehold Royalties Ltd. (FRU-T) to “outperform” from “market perform,” keeping an $8.50 target.
“As investors place ever greater emphasis on profitability and return metrics, we believe Freehold’s royalty business remains superior over many traditional E&P operators (that for the most part, have mixed track records on return on capital metrics),” he said. “Although we likely see a reduction in capex spending this year by the sector, as the reserve report shows today, royalty companies can continue to see ‘value creation’ over their land base. Obviously, some years will see less value created (i.e., likely 2020), while other years will potentially see more. Today, the current valuation doesn’t reflect the potential for these stronger years. With among the lowest leverage metrics of E&P names, and the ability to provide a 9.6-per-cent dividend yield (86-per-cent payout at strip), there are few business plans like FRU.”
Granite Real Estate Investment Trust (GRT.UN-T) is “executing well with the benefit of a favourable backdrop,” said RBC Dominion Securities analyst Neil Downey in the wake of the release of “solid” fourth-quarter results after the bell on Wednesday.
“We continue to like Granite REIT’s units based upon: 1) exposure to a sector (warehouse, distribution and logistics) with strong fundamentals; 2) improving portfolio quality; 3) low financial leverage (21-per-cent net debt); 4) currency diversification (Canada is a small economy with a ‘commodity currency’); 5) building ‘platform value’ and fully internalized management structure; 6) increasing value-add opportunities across the business; 7) expected annual distribution growth (the record is now at eight consecutive years of growth, and this year’s AFFO [adjusted funds from operations] payout ratio appears to be just under 80 per cent); and, 8) reasonable (but in noway ‘cheap’) valuation, within the context of a property sector that has become quite well ‘bid.’”
With the results, Mr. Downey raised his 2020 and 2021 funds from operations per unit estimates by 6 cents and 2 cents, respectively, to $3.96 and $4.15.
Maintaining an “outperform” rating, he raised his target for Granite to $75 from $70. The average is currently $73.18.
“Modern warehouse, logistics and distribution space remains a highly sought after property class,” he said. "The fundamentals are strong and Granite REIT is performing very well. Across the sector, Granite’s Canadian and U.S. peers trade at an average premium to NAV of 15 per cent and several entities have share prices that are more than 20 per cent over NAV.
“In light of the sector’s strength and Granite’s solid execution, we believe our revised target valuation metrics are reasonable and reflective of factors such as Granite’s property portfolio mix (special purpose properties, multi-purpose properties, and, modern logistics and warehouse/distribution properties), geographically diversified footprint, tenant concentration, tax efficiency, low financial leverage, and overall franchise value.”
Meanwhile, Industrial Alliance Securities analyst Brad Sturges raised his target to $77 from $75, keeping a "buy" rating.
Mr. Sturges said: “Granite has undergone a significant transformation in recent years, including major changes such as: 1) achieving a sizeable reduction in its Magna International Inc. (Magna, MG-T, Not Rated) tenant concentration partly due to certain non-core asset sales of Magna-tenanted special purpose properties (SPPs); and 2) increasing its portfolio exposure to modern distribution facilities. Further transformation of Granite’s global industrial facility portfolio may result in additional P/AFFO multiple expansion in the next 12 months, and beyond.”
Desjardins Securities’ Michael Markidis increased his target to $73 from $68 with a “hold” rating (unchanged).
Mr. Markidis said: “Since taking the reins in mid-2018, CEO Kevan Gorrie has (1) reinvigorated investor interest, and (2) spearheaded a significant transformation of the business, through both asset acquisition and the addition of key personnel. However, these positive attributes are currently priced into the stock, in our view.”
Industrial Alliance Securities analyst George Topping expects gold prices to push past their 2011 peak “as generalists flock to [a] relatively tiny market.”
In a research note released Friday morning, the analyst updated his near- and long-term precious and base metals price forecasts, raising his expectations for gold while lowering his copper, zinc and nickel projections. His silver price estimate remained the same for 2020 (at US$18.40 per ounce) before declining in 2021 through 2025.
"Gold is up 10 per cent year-to-date, while the S&P 500 and TSX are down 6 per cent and 3 per cent, respectively, as the Coronavirus spreads globally," he said. "We had previously built in a full gold cycle into our price deck but have now revised to a higher cyclical top, with our annualised gold prices averaging US$1,600/oz this year and then rising to average US$1,900/oz in 2023. Gold is the best way to protect purchasing power as central bankers print money to prop up their economies but devalue currencies relative to hard assets in the process. M&A transactions should build on 2019 as Seniors look for future growth. Wesdome, Rubicon, Sabina, and Probe are likely takeout candidates. Osisko Mining is either a build or mid-term takeout."
For gold, Mr. Topping increased his 2020 price forecast to US$1,600 per ounce from US$1,525. His 2021, 2022 and 2023 estimates rose to US$1,650, US$1,750 and US$1,900, respectively, from US$1,600, US$1,650 and US$1,750.
With those changes, the analyst made several target price changes to stocks in the sector, including:
Franco-Nevada Corp. (FNV-T, “buy”) to $180 from $159. The average on the Street is $147.83.
Osisko Gold Royalties Ltd. (OR-T, “buy”) to $20 from $18. Average: $16.56.
Osisko Mining Inc. (OSK-T, “buy”) to $5.05 from $4.70. Average: $5.09.
Wheaton Precious Metals Corp. (WPM-T, “buy”) to $55 from $51. Average: $47.04.
Wesdome Gold Mines Ltd. (WDO-T, “buy”) to $13.40 from $10.75. Average: $10.27.
“Gold equity NAVs fluctuate as a sinusoidal wave where 0.5 times NAV is common for producers in a bear market versus 1.5 times NAV (up to 2.0 times for royalty equities) in a bull market as determined using most analysts’ low discount rates and conservative gold prices,” he said. “We have resisted using NAV multiples, preferring instead higher (realistic) forecasted gold prices and discount rates. However, the top 10 gold equities by market cap total just US$150-billion or 10 per cent of Apple’s (AAPL-Q, Not Rated) market cap and even the annual physical gold market is just US$260-billion. With so much money chasing so few shares, certain stocks, such asthe go-to name for generalists, Franco-Nevada, will receive a premium (we now use a 1.2 times NAV multiple vs. 1.0 times NAV previously). Others will no doubt join as the bull market develops further. Wheaton, just as large but less diversified (more than 40 per cent revenue from silver), is relatively and undeservedly cheap given the funds flow that’s coming.”
Martinea International Inc. (MRE-T) stock “deserves to trade much higher,” said Raymond James analyst Michael Glen following the release of fourth-quarter results that included “significantly” higher-than-anticipated free cash flow generation.
“We believe Martinrea is under-owned, undervalued, and underappreciated," he said. "We use an extremely conservative target EBITDA multiple of 3.75 times, which remains well-below the 5 and 10-year average forward multiples of 4.8 times and 4.4 times, respectively. The biggest investor pushback regarding MRE stock has been free-cash generation, and we viewed this as the primary factor influencing the heavily discounted valuation. This situation has now changed quite substantially, and we believe the stock deserves to move higher and significantly narrow the valuation gap between itself and its North American peers. We see tremendous value in the stock at current levels and reiterate our Outperform rating.”
Mr. Glen also kept a $16 target for Martinrea shares, which sits below the consensus of $17.75.
“This is a very significant improvement in the free-cash profile for the company, and absent the current market environment marred with concerns surrounding the coronavirus,we would anticipate a very favourable move in the stock price off the back of these results,” the analyst said. “At a forward P/E of 4.6 times, Martinrea remains one of the single cheapest auto parts stocks in NorthAmerica, and given the progress management has made in terms of improving the operating profile of the company, it simply does not deserve to trade at these levels.”
Shares of Toronto-based toy maker plunged almost 40 per cent in response to the news.
On Friday, BMO Nesbitt Burns’ Gerrick Johnson downgraded Spin Master to to “market perform” from “outperform,” calling its most recent product development and recent entertainment initiatives “lackluster” and calling its execution “poor.”
Though he sees its current valuation as fair despite seeing downside risk, his target slid to $20 from $35.
RBC Dominion Securities lowered Spin Master to “sector perform” from “outperform” with a target to $23 from $47.
The average target on the Street is $26.44.
Elsewhere, CIBC World Markets' Robert Bek dropped his target to $27 from $36 with a "neutral" rating (unchanged).
Mr. Bek said: “The change in our target reflects substantially lower FY20 guidance versus expectations, given continued operational challenges with its distribution network, coupled with the massive negative (and extreme uncertainty) of COVID-19 disruptions. While our $27 target price still implies a hefty upside from the current price, the material risks and uncertainties to assumptions and estimates continues to argue for conservatism at these levels. We remain positive on the longerterm, however we prefer to wait on the sidelines until visibility into 2021 improves, and advise only those with the highest risk appetite to consider the name at this time.”
“With the company already pursuing what amounts to a maintenance level budget, and with an impressive hedging position covering 50 per cent of 2020 estimated production, we believe Crescent Point is well positioned to weather the current storm facing oil prices (at least relative to peers and while these hedges remain in place),” he said. “This should allow the company to remain active with the share buyback program, which should differentiate the story over the near-term.”
Maintaining a "market perform" rating, Mr. Cox trimmed his target to $6 from $6.50. The average is $8.04.
In other analyst actions:
BMO Nesbitt Burns analyst John Gibson lowered Calfrac Well Services Ltd. (CFW-T) to “market perform” from “outperform” with a $1 target, down from $1.50. The average target is $1.20.
RBC Dominion Securities raised Tamarack Valley Energy Ltd. (TVE-T) to “outperform” from “sector perform"