Inside the Market’s roundup of some of today’s key analyst actions
While Royal Bank of Canada’s (RY-T) net interest margins and expenses disappointed in its second quarter, National Bank Financial analyst Gabriel Dechaine thinks the outlook for the second half of the fiscal year is “more constructive.”
On Thursday, shares of RBC, the country’s largest bank by market capitalization, slid 1.8 per cent after it reported its profit fell 14 per cent from a year earlier to $3.6-billion, or $2.58 per share. After adjustments to exclude certain items, it said it earned $2.65 per share, missing the consensus forecast on the Street of $2.80, according to Refinitiv data.
“RY’s all-bank NIM (excl. trading) fell 7 basis points quarter-over-quarter,” said Mr. Dechaine. “The Canadian business (NIM down 8 bps Q/Q) was the primary driver of this performance and, once again, the main issue revolved around funding mix/costs. On mix, total Canadian P&C deposits were up 8 per cent year-over-year, with chequing/savings accounts falling 9 per cent and term accounts jumping 81%. On costs, the two categories have increased 100 bps and 244 bps, respectively, over the past year.
“Looking ahead, we are reasonably confident in guidance for NIM stabilization/improvement by Q4/23 given: 1) the sequential pace of term funding cost increases fell to a quarter of the pace set over the prior two quarters; 2) 14-per-cent sequential growth in GIC balances was down from 18 per cent over the prior two quarters; and 3) higher spread commercial loan growth outpaced mortgage growth for the eighth consecutive quarter. While we continue to expect some NIM pressure to arise during Q3/23, we are hopeful for a strong finish to fiscal 2023.”
The analyst also attributed the underperformance to “another quarter of (very) elevated expense growth.”
“RY’s expense growth was a negative surprise for the second consecutive quarter, with both quarters delivering expense growth around 16 per cent,” he said. “The biggest driver of this growth has been the Brewin Dolphin acquisition that, to be fair, has also contributed to revenues. Otherwise, the biggest growth driver of RY’s fixed cost base is compensation, which has risen 16 per cent this year (and is the biggest component of fixed costs). This growth represents a lagged impact of aggressive hiring over the past few years, along with base salary increases. Expense growth should moderate to the upper single digits by Q4/23 as comps become more favourable and as RY implements cost-cutting measures that have just begun to be implemented.”
Reducing his estimates to reflect lower NIM and higher expenses, Mr. Dechaine cut his target for Royal Bank shares to $136 from $142 with an “outperform” rating. The average target on the Street is $137.05.
Other analysts making target adjustments include:
* Credit Suisse’s Joo Ho Kim to $141 from $149 with an “outperform” rating.
“RY’s Q2 results were disappointing, given the wide miss on our PTPP earnings, with another quarter of elevated expenses and lower than expected NIMs impacting results,” he said. “We see near-term (Q3) pressure on expenses, as the impact of efficiency initiatives is expected to take some time to show. The bank’s guidance for low double-digit NII growth from Canadian Banking for F2023 does suggest modest NIM improvement for the remainder of the year, while we believe margins could remain under pressure at CNB given the increasing intensity in the deposit/funding market south of the border.”
* Desjardins Securities’ Doug Young to $140 from $155 with a “buy” rating.
“Adjusted pre-tax, pre-provision (PTPP) earnings were 5 per cent below our estimate,” said Mr. Young. “Clearly, the focus and pressures related to lower net interest margins (NIM) and higher non-interest expenses (NIX). While controlling NIX growth is a focus for management, scaling this back could take a few quarters. We adjusted our estimates, lowered our target price.”
* Scotia Capital’s Meny Grauman to $143 from $146 with a “sector outperform” rating.
“If the first step to change is admitting your mistakes then Royal Bank is on the road to recovery as Management openly admitted two key missteps that have weighed on results over the past few quarters,” said Mr. Grauman. “These missteps included not realizing how quickly core demand deposits would move in the search for yield, and over-hiring through the pandemic without appreciating the approaching inflationary and revenue headwinds. While Royal spoke openly about these issues, it is important to emphasize that they are not just RY specific issues but in fact sector-wide wide problems. However, the fact that Royal Bank is struggling with these challenges is significant given that investors tend to assume that it is better positioned to manage expenses and margins than many peers. So far this year that has not been the case, but the bank did commit to aggressively dealing with its expense run-rate by the end of the year, and pointed to a better outlook for both expenses and margins in 2024, when the company will also be able to begin to harvest the synergies from the acquisition of HSBC Canada.”
* Barclays’ John Aiken to $122 from $142 with an “underweight” rating.
“Higher than expected costs, the recurring theme in the second quarter, was behind RY missing expectations. Management has put actions in place to address the issue, however immediate benefits may not be apparent in the third quarter,” said Mr. Aiken.
* CIBC’s Paul Holden to $139 from $142 with a “neutral” rating.
* Canaccord Genuity’s Scott Chan to $128.50 from $133.50 with a “hold” rating.
In contrast to RBC and the rest of the sector, Canadian Imperial Bank of Commerce (CM-T) is “coming through on expenses as others struggle,” according to RBC Dominion Securities analyst Darko Mihelic.
“Better than expected results in Q2/23 were mainly due to a performing reserve release in Canada,” he said. “CM has been focusing on controlling expenses over the last couple quarters, and it finally became a relative differentiator in Q2/23. CM had the highest CRE and gross impaired CRE exposure among the group this quarter, though its office exposure was more moderate (quality is difficult to judge). We see Q2/23 as indicative of CM’s ability to come through on expense control, but we dislike the reserve release and see Corporate as an unlikely longer-term area of strength.”
On Thursday, the bank’s shares rose 2.1 per cent following its premarket earnings release that included a 1-per-cent quarter-over-quarter decline in expenses to $3.227-billion. Mr. Mihelic emphasized its the only bank that had decreased expenses sequentially.
Overall, it reported adjusted earnings per share of $1.70, exceeding both the analyst’s forecast of $1.65 and the Street’s estimate of $1.61.
“Better than expected results were mainly because of stronger than expected earnings in Canadian Personal and Business Banking and Corporate,” he said. “There was a release in performing provisions for credit losses (PCLs) in Canadian Personal and Business Banking, as CM had forecast less pessimistic forward-looking indicators than before, and we view this source of ‘strength’ in the quarter relative to our estimate as low quality. We also view earnings from the Corporate segment as volatile and difficult to forecast. Despite our view that earnings over and above our expectations were on the lower-quality side, we saw some places for improvements to our models. We increased our NIM assumptions in Canadian Personal and Commercial Banking, and after looking at PCL trends, we also lowered our stage 3 PCL estimate in Capital Markets in 2024 (they just seemed too high).
“Overall, our core EPS estimates increase to $7.29 (from $7.15) in 2023 and to $7.25 (from $6.93) in 2024.”
With those increases, Mr. Mihelic raised his target for CIBC shares to $72 from $69 with a “sector perform” recommendation (unchanged). The average target is $63.76.
“CM is trading at a P/E [price-to-earnings] multiple of 7.8 times, below its historical average of 9.8 times but below the peer average of 8.6 times,” he said. “On a P/B [price-to-book] basis, CM is trading at 1.12 times, also below its historical average of 1.86 times and the peer average of 1.42 times. CM’s valuation is becoming attractive, in our view, especially if we conclude that a recession in North America will not be severe and the banking malaise in the U.S. is nearing an end.”
Other changes include:
* National Bank’s Gabriel Dechaine to $64 from $62 with a “sector perform” rating.
“CM’s all-bank NIM (excl. trading) was flat sequentially, with NIM expansion in Canada (up 9 basis points quarter-over-quarter), offset by NIM compression in the U.S. (down 13 bps Q/Q),” said Mr. Dechaine. “This performance, especially in Canadian P&C banking, is in stark contrast to what peers have reported this quarter (e.g., steeper than expected NIM compression). The bank’s guidance is for stronger NIM performance in the second half, driven by wider loan spreads and normalization of funding spreads and mix shift (i.e., slower pace of shift to term funding & out of non-interest bearing).”
* Canaccord Genuity’s Scott Chan to $62 from $61.50 with a “buy” rating.
“Overall, we believe CM delivered resilient FQ2 results in a tough macro environment (and only bank thus far to report a headline adj. EPS beat),” he said.
* Barclays’ John Aiken to $58 from $56 with an “equalweight” rating.
“We were impressed with CM’s ability to earn past the allowances it put up against its U.S. office exposures. Further, management was saying all the right things particularly in regard to cost management. However, as we are heading into a potential economic slowdown, we are not sure that it will get full valuation credit,” said Mr. Aiken.
* TD Securities’ Mario Mendonca to $59 from $58 with a “hold” rating.
In a separate note, Mr. Mihelic said the second quarter from Toronto-Dominion Bank (TD-T) was “okay and the stock is undervalued” following “all of this turbulence.”
“TD’s adjusted EPS was close to our expectation as lower than expected PCLs [provisions for credit losses] offset weaker than anticipated PPPT [pre-provision, pre-tax earnings],” he said in a note titled A good but not great quarter. ”Results in capital markets were particularly light despite the addition of Cowen, but this should improve from here. NIM expansion is seemingly coming to an end and without FHN, TD is looking at more de-novo branch growth in the U.S. and a 30 million share buyback to be completed quickly (another NCIB is likely, though not assumed). We continue to see upside to earnings as TD deploys excess capital and we see the shares as undervalued.”
For the quarter, TD reported adjusted earnings per share of $1.94, a penny below Mr. Mihelic’s estimate and 12 cents below the consensus projection on the Street due largely to PCL weakness.
“TD no longer expects to meet its medium-term adjusted EPS growth target of 7-10 per cent, following the termination of the First Horizon (FHN) deal,” the analyst said. “TD will hold an investor day on June 8th focused on the Canadian retail business, and a subsequent investor day focused on its U.S. and wholesale businesses.
“We update our model to reflect Q2/23 actual results, lower Canada P&C and capital markets assumptions, and higher wealth earnings. In Canada P&C, we assume lower NIMs and non-interest income throughout our forecast period and reflect slower loan growth and higher impaired PCLs in 2024. We lower our non-interest revenue assumptions and reflect lower costs in capital markets throughout our forecasting period. We also assume that TD will repurchase 30 million shares in Q3/23, and this has a positive impact on our core EPS estimate. Overall, our core EPS estimate moves to $8.41 (was $8.40) in 2023 and $9.10 (was $8.84) in 2024.”
Maintaining an “outperform” recommendation for TD shares, Mr. Mihelic raised his target by $1 to $96. The average is $93.31.
Others making changes include:
* National Bank’s Gabriel Dechaine to $90 from $94 with a “sector perform” rating.
“All-bank NIM compressed on a sequential basis, reflecting NIM declines in both the Canadian (down 6 basis points quarter-over-quarter) and U.S. (down 4 bps) P&C operations,” said Mr. Dechaine. “Otherwise, performance in both businesses was strong, with Canada delivering double-digit PTPP growth, the U.S. double-digit earnings growth, and both positive operating leverage. As it relates to NIM performance, management expects a return to moderate expansion by the end of the year.”
* Desjardins Securities’ Doug Young to $98 from $104 with a “buy” rating.
“Adjusted pre-tax, pre-provision (PTPP) earnings were 3 per cent below our forecast and increased 10 per cent year-over-year,” said Mr. Young. “There was nothing new on what prevented the First Horizon acquisition. While net interest margins (NIMs) fell short of our forecast, management sees a path to moderate expansion starting in 4Q FY23 for its Canadian and US P&C banking operations.”
* Credit Suisse’s Joo Ho Kim to $85 from $88 with a “neutral” rating.
“·After serially beating (our) PTPP forecasts over the past 3 quarters, TD reported a rare miss on our estimates in Q2,” said Mr. Kim. “The biggest driver of the miss was on NIMs, as both P&C (and all-bank) reported sequential declines (along with the bank’s guidance for some moderation in Q3 before improving in Q4). Wholesale Banking results also surprised to the downside, as earnings stepped down meaningfully, and we believe some pressure could remain for the remainder of the year as the bank further integrates its Cowen acquisition. Last but not least, while TD expects to complete its near 2-per-cent buyback by the end of this summer (and perhaps launch another one thereafter), we believe the timing of further deploying its excess capital is still uncertain. Yes, the bank will deploy some of that through building out its branch presence in certain MSAs (150 branches by 2027) and while we agree that having a cushion on capital in uncertain times makes sense, we also believe continued clarity on how the bank plans to expand can ultimately be a win for the shares’ revaluation (especially at times when growth remains scarce).”
* Canaccord Genuity’s Scott Chan to $86 from $89 with a “buy” rating.
“Overall, TD’s FQ2 results were lighter with NII and expenses coming in below expectations (but credit better) leading to an adj. EPS miss. As a result, we made net negative changes to our forecasts,” said Mr. Chan.
* Scotia’s Meny Grauman to $103 from $104 with a “sector outperform” rating.
“While we certainly would not argue that TD delivered a good result in Q2, we do believe that the sell off on earnings day was overdone,” said Mr. Grauman. “First off, while the margin expansion story at TD is largely over, that was already abundantly clear in Q1 and should not come as a surprise. Secondly and more importantly, although TD’s buyback program may have underwhelmed the market it remains the Canadian bank with the most excess capital, and that is unlikely to change anytime soon. True, TD has yet to answer some key strategic questions in light of the FHN deal termination, but in our view that discussion is less pressing in the current environment. The market appears to be ever so subtly pivoting away from defensive bank stocks right now, but we believe that this move is premature given the ongoing uncertainty about the economic cycle and the potential for further surprises in the U.S. regional banking sector. With inflation still high and rate hike expectations rising again on both sides of the border a soft-landing is still not a forgone conclusion, even if credit performance was not a central issue this earnings season.”
* Barclays’ John Aiken to $81 from $83 with an “equalweight” rating.
“TD surprised with its miss predicated on lower-than-forecast revenues as opposed to higher expenses. While we believe that TD should be able to recover its lost profitability in short order, the scale of the miss puts the time required in question,” said Mr. Aiken.
* BMO’s Sohrab Movahedi to $83 from $85 with a “market perform” rating.
* Bank of America Merrill Lynch’s Ebrahim Poonawala to $90 from $99 with a “buy” rating.
* CIBC’s Paul Holden to $94 from $97 with an “outperformer” rating.
While acknowledging “negative sentiment rules,” National Bank Financial analyst Rupert Merer thinks valuations for Canadian renewable power infrastructure companies are now “compelling” with public markets at a discount to private markets and feels inflation won’t have as significant an impact as previously feared.
“Lower valuations across the sector have created a difficult equity financing environment, encouraging non-dilutive sources of financing to fund growth (including debt, asset recycling and sell-downs),” he said. “Results have generally been soft on abnormal weather conditions, also dampening enthusiasm for IPP [independent power producer] stocks. A change in weather could help, but the impact of inflation on the cost of new projects could be a more persistent concern. That said, we believe inflation is a positive for the sector, given the benefit of rising power prices on the value of existing assets. Typically, less than 10 per cent of the value of these companies is attributable to growth, so inflation just can’t hurt that much.”
In a research report released Friday, Mr. Merer said both geopolitical turbulence and bond volatility has caused further uncertainty in the sector, noting yields on both the Canada and U.S. 10-year government bonds have “resulted in choppy action” for IPP.
“The Canada 10-year yield is now at 3.2 per cent, up from lows of 2.8 per cent in early May,” he said. “This has put some pressure on the sector, which has been trying to rebound following a tough 2022. With NBF’s 12-month forecast at 2.7 per cent, we could see relief throughout the year on this front. Additionally, elevated geopolitical concerns have been top of mind, and in conjunction with a volatile bond market, are weighing on market sentiment.”
For investors, Mr. Merer thinks valuations have been “sentiment driven,” however value “should surface” over the long term.
“With negative sentiment weighing on the sector, the implied discount rate on cashflow across the larger IPPs has risen to 8.1 per cent and the beta for the group is 0.9 times (we believe that utility stocks typically trade with a beta less than 0.8 times),” he said. “We calculate an average forward EV/EBITDA multiple of 10 times across our coverage, below private market valuations on recent deals that we have seen at 13 times (range of 11-16 times). With market sentiment outweighing the long-term fundamentals, we believe there are some compelling investment opportunities in the sector. With potential upcoming catalysts from improving weather conditions and progress on investment, we could see the narrative change and the public/private valuation gap narrowing towards normalized levels.”
Pointing to “a slightly higher market risk premium and some changes to beta assumptions following Q1,” Mr. Merer made a pair of target change reductions:
- Innergex Renewable Energy Inc. (INE-T, “outperform”) to $20 from $21. The average on the Street is $18.23.
- Northland Power Inc. (NPI-T, “outperform”) to $40 from $42. Average: $41.70.
His other stocks with “outperform” recommendations are: Atlantica Sustainable Infrastructure PLC (AY-Q), Altius Renewable Royalties Corp. (ARR-T), Boralex Inc. (BLX-T), Brookfield Renewable Partners LP (BEP.UN-T) and Polaris Renewable Energy Inc. (PIF-T).
Displaying “stable recurring revenue growth” in “another steady” quarter, Eight Capital analyst Christian Sgro upgraded Wishpond Technologies Ltd. (WISH-X) to “buy” from “neutral” previously, touting a “favourable fundamental and stock dynamics in combination with an attractive valuation profile.”
Before the bell on Thursday, the Vancouver-based reported first-quarter revenue of $5.6-million, up 38 per cent year-over-year and above both Mr. Sgro’s $5.4-million estimate and the consensus forecast of $5.5-million. Adjusted EBITDA grew 0.6 per cent to $0.2-million, also topping expectations (nil and $0.1-million, respectively).
“We like that revenues were stable sequentially (despite advertising seasonality), highlighting a shift to a greater proportion of recurring contracted revenues,” said Mr. Sgro.
“We decompose Q1/23 year-over-year revenue growth as 31 per cent organic compared to a total of 38 per cent. After a busy year of M&A in 2021, we like that Wishpond’s go-forward growth is nearly all organic with an unchanged target of 30-per-cent-plus growth. Wishpond’s broad product suite underscores the success of the M&A strategy, with most acquisitions now integrated within the comprehensive Propel IQ offering. The company continues to add headcount and drive product innovation, supporting new business and retention. The company has a roadmap of several AI-powered solutions that it expects to release in the coming quarters, with an AI-powered Website Builder already live in the market.”
Mr. Sgro called Wishpond’s financial profile “attractive,” pointing to its targets of 30-per-cent organic growth, 65-70 per cent gross margins and breakeven cash flow.
Believing “continued execution will potentially drive valuation upside as Wishpond scales,” he bumped his target to $1.30 from $1.10. The average is $1.88.
“We think it is too soon to value Wishpond on a profitability multiple, although we see a clear path to 15-per-cent-plus adj. EBITDA margins with scale. For reference, Wishpond currently trades at 11.5 times 2024 estimated EV/adj. EBITDA which we see as valuation support,” he said.
In other analyst actions:
* Canaccord Genuity’s Mark Rothschild downgraded Canadian Net RET (NET.UN-X) to “hold” from “buy” with a $5.50 target, down from $6.50 and below the $6.79 average.
“While operations remain stable and the REIT can achieve steady organic growth, we expect that the REIT’s units will continue to trade at a material discount to NAV as external growth is likely to remain modest and investors gain comfort with the new CEO. In addition, leverage remains relatively high,” he said.
* Scotia Capital’s Justin Strong lowered his Anaergia Inc. (ANRG-T) target to $2 from $4.75 with a “sector perform” rating, while TD Securities’ Aaron MacNeil cut his target to $1.50 from $1.80 with a “speculative buy” rating. The average is $2.81.
“ANRG’s subsidiary that owns 51 per cent of the company’s flagship Rialto Bioenergy Facility (RBF) project has voluntarily begun restructuring proceedings,” said Mr. Strong. “The project has been plagued by delays in ramping to full commercial operation due to delayed implementation of laws requiring organic waste diversion from landfills by the city of Los Angeles.
“Management remains constructive on the project. Anaergia estimates that with appropriate feedstock for the RBF facility, made feasible by debt service and other payment relief offered under a Chapter 11 reorganization to allow ramp up, the asset will preserve long-term value. While the project’s long-term prospects for ANRG remain strong and 2023 guidance is unchanged we have taken the opportunity to further risk the multiple by which we value the company’s Build-Own-Operate segment.”
* Eight Capital initiated coverage of Ivanhoe Mines Ltd. (IVN-T) with a “buy” rating and $18.50 target, exceeding the $15.78 average on the Street.
* Believing the sale of its 49-per-cent stake in the Nordseecluster offshore wind portfolio to partner RWE Offshore Wind GmbH for €35-million “leaves something to be desired,” iA Capital Markets’ Naji Baydoun reduced his Northland Power Inc. (NPI-T) target to $42 from $44, keeping a “buy” rating. The average is $41.57.
“We believe that NPI’s strategic positioning and market leadership in the offshore wind space should continue to drive significant growth at attractive risk-adjusted returns over the longer term,” said Mr. Baydoun.”However, the sale of the Nordsee projects for a relatively minor amount (compared to NPI’s large funding needs) and the removal of a potentially large-scale investment opportunity is a net negative, in our view. This is somewhat offset by a partial reduction in equity financing requirements (estimated at $300-million-plus) and the discipline shown in divesting a project that no longer meets the Company’s investment return hurdles.”
* Following its Investor Day event, RBC’s Walter Spracklin raised his Stella-Jones Inc. (SJ-T) target to $69 from $67 with an “outperform” rating. The average is $69.86.
“Management outlined a growth plan that demonstrated to us a very convincing opportunity set that should enable SJ to drive attractive growth out to 2025,” he said. “Importantly, we believe the 2025 targets provided at the Investor Day incorporate conservatism, especially as it relates to U.S. infrastructure related spending. We also point to what we view as upside to margin targets on the back of increasing pole mix, tie pricing, and economies of scale. We see solid opportunity in the shares.”