Inside the Market’s roundup of some of today’s key analyst actions
Heading into first-quarter earnings season, Desjardins Securities analyst Benoit Poirier is now “more confident” both Canadian National Railway Co. (CNR-T) and Canadian Pacific Kansas City Ltd. (CP-T) will “benefit from significant operating leverage and achieve their respective annual guidance,” pointing to “volumes coming in stronger than initial expectations, issues related to the weather and stock-based comp being one-time in nature, and both rails facing much easier year-over-year comps in the rest of the year (1Q was the toughest test by far).”
“That said, we do not expect either railroad to increase guidance with 1Q results given the potential labour issues on the horizon,” he added. “While we are neutral between the two rails longer-term, we prefer CN’s setup over the coming quarters.”
In a research report titled Rails are rockin’ when intermodal’s back poppin’, Mr. Poirier reduced his profitability estimates for both companies despite a “stronger-than-expected” volume performance. His projected operating ratio, a closely watched measure of costs versus sales, for CN was reduced to 64.1 per cent from 62.3 per cent and to 64.7 per cent from 61.4 per cent for CP. His earnings per share projections slid to $1.70 and 93 cents, respectively, from $1.77 from $1.01.
“The main driver of the reduction in our estimates is pressure on OR attributed to the cold weather in January and March (increased our purchased services cost forecasts for both rails), the lack of a fuel tailwind and higher stock-based comp for CP,” said Mr. Poirier. “However, with volumes coming in stronger than initial expectations, issues related to the weather and stock-based compensation being one-time in nature, and with both rails facing much easier year-over-year comps in the rest of the year (1Q was the toughest test by far), we are now more confident that CN and CP will benefit from significant operating leverage and achieve their respective annual guidance. That said, we do not expect either railroad to increase guidance with 1Q results given the potential labour issues on the horizon — ongoing negotiations with the longshoremen’s union at the Port of Montréal and the possible TCRC conductors/engineers strike, which could be as soon as May 22 (6,000 workers at CN and 3,200 at CP — separate negotiations are ongoing). This is a unique situation as it is the first time in more than a decade that both CN’s and CP’s conductor union contracts are up for renewal at the same time. We believe the respective management teams will take a cautious approach and likely wait until 2Q results to increase guidance after the labour situation is resolved and volume data is more robust.”
Despite the first-quarter reductions, Mr. Poirier raised his targets for both companies’ shares, maintaining “buy” recommendations. His CN target increased to $195 from $189 and CP to $130 from $118. The averages on the Street are $180.15 and $123.89, respectively, according to LSEG data.
“Given CN’s year-to-date performance lags CP’s, its more reasonable valuation and greater exposure to the upswing in intermodal, we prefer CN over CP in the short term. CN’s shares are up only 7.8 per cent year-to-date vs up 14.9 per cent for CP,” he said. “We believe CN’s shares are poised for some catch-up as market fundamentals improve and 1Q estimates continue to be adjusted. We derive a potential return of 10.2 per cent for CN vs 8.5 per cent for CP based on our updated target prices. From a mix perspective, 23 per cent of CN’s 2023 revenue came from intermodal (but this has been as high as 29 per cent in the past) vs only 20 per cent for CP — if intermodal continues to outperform expectations as we exit the freight recession, we believe investors are better positioned for exposure to the cyclical upswing in volumes with CN in the short term (not to mention its greater exposure to the West Coast, with plenty of untapped capacity at Prince Rupert).”
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Dye & Durham Ltd.’s (DND-T) recent US$905-million refinancing transactions provide balance sheet flexibility, according to Scotia Capital analyst Kevin Krishnaratne, who also thinks its free cash flow profile is “poised to benefit.”
“We view DND’s recently closed refinancing transactions (8.625-per-cent US$555-million senior secured notes due 2029, US$350-million term loan maturing 2031, CAD$105-million revolver maturing 2029), in addition to the repayment of prior existing facilities with Ares as continued steps in the right direction to enhance the company’s balance sheet flexibility,” he said. “Although leverage remains elevated at 4.78 times net debt to LTM [last 12-month] Further Adj. EBITDA as at Dec. 31 per company calculations, the refinancing moves eliminate prior risks related to the Ares facility maturity date being accelerated (to 2025 from 2026) if DND’s 2026 debentures were to remain outstanding. Furthermore, given how DND now intends to repurchase the remaining $185-million 2026 debentures, there is a long window until the company’s next debt related maturities, those being the 6.50-per-cent 2028 debentures. We note that there is a new springing maturity in place for the new revolver (2029) and term loan (2031), which may both see an acceleration in their maturity within 91 days of the US$555-million senior secured notes, if the latter are not repaid, extended, refinanced, or replaced prior to their due date.
“While we’ve not yet updated our model for the above transactions, management has indicated that it expects to achieve $20-million in annualized interest savings as a result of its moves. Recall how we have already been modeling a sharp rebound in FCF (including acquisition + restructuring expenses) in the back half of DND’s FY24 (June) moving from negative $1.3-million in 1H to $56.7-million in 2H on stronger RE seasonality, working capital normalization, and the successful execution of several cash flow enhancement initiatives vs. Q1 (pricing optimizations, reductions in capex, restructuring, and other costs). While there’ll be just incremental benefit to FY24 FCF results (less than $5-million), there is nice upside to our current FY25 FCF estimate of $112.0-million, before considering further interest savings/debt reduction via potential asset sales and natural deleveraging.”
Coming off a research restriction following the deals, the analyst acknowledged the legal software vendor continues to be exposed to real estate transaction volumes, but he said he’s “encouraged by management’s ability to advance more of its revenue to a recurring model via minimum volume pricing and upsell/cross-sell of more subscription practice management solutions, a strategy that should benefit from the rollout of its global Unity platform.”
“RE transaction-based revenue was 44 per cent in Q2 (Canadian RE transaction-based revenue was 19 per cent or even lower ex-refinancing activity),” said Mr. Krishnaratne. “Recent RE trends still point to being a bit mixed. In Canada, CREA data suggests RE volumes up 3.7 per cent month-over-month in January ahead of a 3.1-per-cent m/m decline in February, though trends have improved against a quieter fall. In the UK, Gov.uk provisional data shows seasonally adjusted transactions up 1.5 per cent m/m in January and up 1.2 per cent m/m in February. Meanwhile, Zoopla data indicated positive trends, reporting 9-per-cent y/y property sales over the one-month period through mid-March, along with ‘improving sentiment’. In Australia, new home sales were approximately flat m/m in January, followed by a strong 5.3-per-cent m/m increase in February, with volumes modestly higher y/y.”
The analyst reaffirmed a “sector outperform” recommendation and $24 target for Dye & Durham shares. The average on the Street is $21.17.
“Shares have performed well post Q2 results mid-Feb (up 30 per cent), but we continue to see further upside with the stock trading at 7.6 times calendar 2024 estimated Adj. EBITDA and 11.8-per-cent CY24 FCF yield (13.7-per-cent PF interest cost savings via recent debt refinancing),” he concluded. “Additionally, we still see opportunities for even further balance sheet optimizations via the sale of non-core assets and other initiatives to deleverage and drive FCF upside.”
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Jefferies analyst Lloyd Byrne raised his target prices for a group of Canadian energy stocks on Friday. His changes include:
- ARC Resources Ltd. (ARX-T, “buy”) to $30 from $28. The average on the Street is $27.38.
- Canadian Natural Resources Ltd. (CNQ-T, “hold”) to $110 from $86. Average: $106.97.
- Cenovus Energy Inc. (CVE-T, “buy”) to $36 from $28. Average: $31.86.
- MEG Energy Corp. (MEG-T, “hold”) to $35 from $28. Average: $32.77.
- Strathcona Resources Ltd. (SCR-T, “hold”) to $36 from $26. Average: $34.50.
- Suncor Energy Inc. (SU-T, “hold”) to $53 from $50. Average: $52.69.
- Tourmaline Oil Corp. (TOU-T, “buy”) to $75 from $70. Average: $76.63.
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In a research report titled Building A Better Foundation, CIBC World Markers analyst Mark Petrie said the fourth-quarter 2024 results from North West Company Inc. (NWC-T) “reflect improving execution and operational excellence.”
“GM% [gross margins] continues to benefit from supply chain and in-stock work, while cost control is solid,” he said. “We expect same-store sales (SSS) growth skewed toward merchandise will be a key earnings driver underpinning F2024 as the company benefits from First Nations drinking water settlement payments in Canada and stronger SNAP and PFD payments in International.”
Mr. Petrie thinks the Winnipeg-based grocery and retail company is poised to benefit from improving discretionary spending driven by government assistance and sees its margin outlook as “steady.”
“Better in-stock inventory positions remain an important contributor and led to an improved GM% in Q4,” he said. “Ramping up general merchandise inventory (particularly big-ticket, i.e., motorsports) allowed NWC to take advantage of lower freight costs and sets the company up with a strong in-stock position for F2024 in anticipation of spending driven by increased government support payments that will accelerate in 2024 and beyond. Though forecasting the impact of these support payments is difficult, we note that inventory dollars were up $20MM in Q4 vs. last year. We expect inventories to remain elevated to take advantage of logistical efficiencies and to support merchandise sales from higher demand.”
“Cost pressures were more than offset in F2023 through prudent pricing strategy, shifts in sales blend (airline revenue favoured over warehouse), and decreases in markdowns and shrink. As supplier and freight costs normalize, we expect less of an outsized positive impact in gross margin rate attributable to cost pass-throughs in F2024. On the flipside, we expect airline margins to peter out as a tailwind. To reflect management’s reiterated focus on productivity and efficiency gains in merchandising and supply chain networks, we forecast a flat SG&A rate this year and modest leverage next year.”
Keeping a “neutral” recommendation for its shares, Mr. Petrie increased his target to $43, above the $42.25 average, from $41.
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Stifel analyst Martin Landry came away from recent investor meetings with Kits Eyecare Ltd. (KITS-T) with “increased confidence” in its momentum and ability to continue to gain market share.
“Recall that KITS pre-released its Q1/24 results showing revenue growth of 23 per cent year-over-year, in line with expectations,” he said. “This is a growth pace that is much faster than the growth of the online eyewear industry, suggesting that KITS continues to gain market share. Repeat customers continue to be the key for KITS to gain market share and improve profitability. Management reiterated its goal of growing revenues above $200 million within the next two years and also discussed the expected gross margin uplift to 40 per cent, which could be reached with revenues above $200 million. Our forecasts are lower than these aspirational goals providing potential for upward revision over time as the company executes.”
On April 4, the Vancouver-based company pre-reported revenue grew to over $34-million, in line with Mr. Landry’s $34.3-million estimate and the consensus of $34-million.
“This marks the sixth consecutive quarter where revenues have grown at a pace of 20-per-cent-plus year-over-year, an impressive performance, in our view. Q1/24 cash balance reached $18-million, up from $16-million sequentially,” he noted.
While he does not see imminent acquisitions, Mr. Landry thinks a deal for a large customer list could be “appealing for the company especially if the cost per customer is below the company’s current customer acquisition costs and under a scenario where cost synergies could be realized shortly after the acquisition.”
“In addition, management discussed the potential to expand into other geographies than the United States and Canada, a similar strategy to Coastal Contacts, which was present in Europe, Australia and Japan at the time of acquisition by EssilorLuxottica,” he added.
“Management reiterated that the company’s optical lab located in Vancouver could support twice as much revenue as currently with no further CAPEX spending. This suggests that the company could continue to generate positive free cash flows in the coming year under a scenario where profitability does not deteriorate. Management still sees the potential to increase revenues above $200-million in the next 24 months and for gross margins to exceed 40 per cent when the $200-million revenue threshold is reached. We believe that improving profitability could draw additional shareholders for which sustained net earnings is an investment criteria.”
Also expecting increased usage of influencers on social media, Mr. Landry reiterated his “buy” recommendation and $8.25 target for Kits shares. The average on the Street is $9.29.
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In other analyst actions:
* CIBC’s Kevin Chiang raised his Bombardier Inc. (BBD.B-T) target to $61 from $60, keeping a “neutral” rating. The average on the Street is $75.47.
“We expect BBD to holds its 2024 guidance and reiterate that revenue visibility remains strong given the current backlog. With the free cash flow (FCF) cadence well understood for 2024 and BBD hosting an Investor Day on May 1, we don’t expect any major surprises from the company,” he said.
* TD Cowen’s Mario Mendonca increased his targets for Great-West Lifeco Inc. (GWO-T) to $45 from $44 and Sun Life Financial Inc. (SLF-T) to $75 from $73 with a “hold” rating for both. The averages are $44 and $76.23, respectively.
* Jefferies’ Chris LaFemina moved his targets for Lundin Mining Corp. (LUN-T) to $20 from $18 and Teck Resources Ltd. (TECK.B-T) to $80 from $75 with a “buy” rating for both. The averages are $14.26 and $66.95, respectively.
* JP Morgan’s Jeremy Tonet bumped his Pembina Pipeline Corp. (PPL-T) target to $52 from $51 with a “neutral” rating. The average is $53.33.
* TD Cowen’s Andrew Charles cut his Restaurant Brands International Inc. (QSR-N, QSR-T) target to US$84, below the US$85.16 average, from US$90 with a “buy” recommendation.
* CIBC’s Hamir Patel cut his Richelieu Hardware Ltd. (RCH-T) target to $45 from $46 with a “neutral” rating, citing reduced near-term free cash flow expectations. The average is $45.75.
“Although the ongoing sale of inventories purchased at higher than current costs and start-up costs associated with the modernized centres are likely to weigh on margins into H2, we believe RCH is well positioned to execute on an attractive M&A pipeline and deliver continued market share gains (supported by recently completed site modernization investments),” he said.
David Leeder