Inside the Market’s roundup of some of today’s key analyst actions
IA Capital Markets analyst Johann Rodrigues expects the next 12 months to be “choppy” for retail real estate investment trusts as they adjust to a “new normal.”
However, he thinks the long-term upside for the sector could be “substantial.”
“The next few years will be a period of transition for retailers, consumers, and landlords alike,” said Mr. Rodrigues in a research report released Monday. “An immediate return to ‘the way things were’ is likely but is it transitory? Grocery stores, pharmacies, and other necessity-based retailers weathered the storm well and are viewed as some of the most valuable tenants today, however, even they are at risk of online shopping cannibalization in the years to come. The fact that almost every retail REIT is diversifying with other property types is telling; Retail REITs are working hard to become Retail+, and that alone offers a cautious prognosis of the property type’s future. Certainly, retail GLA is shrinking and the value of the best square footage is held in what it could be, not necessarily what it is.”
“Choice, First Capital, and SmartCentres all have tremendous density pipelines, the majority of which are future residential development, that would allow them to grow their NAVs by 50-per-cent-plus. While Automotive Properties doesn’t have a defined long-term development plan, a third of its properties have excess land for intensification and another third are candidates for a higher/better use that isn’t an auto dealership (though the buildout is much more long term). All situations are capital-intensive and require stellar execution by management and considerable patience by investors (though most of the REITs offer hefty yields) but the payoffs could be abundant.”
Mr. Rodigues acknowledged investors may be tempted to “push all the chips towards multi-family and industrial,” but he thinks “necessity-based retail offers above-average organic growth and stable yet growing distributions in the near term with enticing density pipelines to augment said growth long term.”
“If those REITs can be bought at NAV discounts, such as Choice Properties and First Capital today, investors have the chance to earn double-digit total returns that could outperform the broader average, regardless of economic condition,” he added.
Mr. Rodrigues initiated coverage of four REITs on Monday. They are:
* Automotive Properties Real Estate Investment Trust (APR.UN-T) with a “hold” recommendation and $14 target. The average on the Street is $13.89.
Analyst: “Auto Properties provides investors access to one of the most stable cash flow streams in Canadian real estate, a strong management team, and leading yield. However, with investors in search of growth to offset cap rate expansion and a wide selection of REITs trading at huge NAV discounts, it’s difficult to envision near-term outperformance from one with capped organic growth trading near its all-time largest NAV premium. Purely for valuation reasons, we will sit on the sidelines awaiting a better entry point.”
* Choice Properties Real Estate Investment Trust (CHP.UN-T) with a “buy” rating and $16.50 target. Average: $14.94.
Analyst: “We are initiating coverage on Choice Properties with a Buy rating for the following reasons: 1) Choice has the highest-quality public industrial portfolio, the lone retail REIT with that asset class. Both the size and rents are growing rapidly, which should help push organic growth more than 2.5 per cent. 2) Given the portfolio’s density potential, it will likely end up with the sector’s largest new purpose-built rental portfolio, 3) While these two make for a tantalizing long-term opportunity, in the short term, we prioritize portfolios set up to withstand an oncoming recession. Choice has the industry’s largest retail portfolio but with 84 per cent of rent generated by necessity/value-based tenants, it’s also the most stable and recession-insulated. 4) Investors can acquire units at a NAV discount (2 per cent vs its long-term average 3-per-cent premium).”
* First Capital Real Estate Investment Trust (FCR.UN-T) with a “buy” rating and $19 target. Average: $19.
Analyst: “We are initiating coverage on First Capital with a Buy rating for the following reasons:1) Between its multi-visit drivers, high-income demographics and leading exposure to necessity/value-based tenants, the REIT is well insulated against a recession, 2) First Capital led our coverage’s retail REITs in 10-year SPNOI (2.1 per cent vs. 1.1-per-cent peer avg.) and NAV/unit (3.5 per cent vs. 2.8 per cent) growth. We forecast leading FFO/NAV growth going forward. 3) Having reinstated its pre-pandemic distribution, its yield is back in line with peers and not a strike against anymore, 4) Despite all this, the REIT trades at a massive 22-per-cent NAV discount, over 2 times its 10-year average (negative 10 per cent) and 4x its pre-pandemic 8-year average (negative 5 per cent). First Capital offers investors superior growth at a once-in-a-decade discount, at a time when growth is crucial to offset cap rate expansion.”
* SmartCentres Real Estate Investment Trust (SRU.UN-T) with a “hold” rating and $30 target. Average: $31.18.
Analyst: “Perhaps more than any other retail peer, SmartCentres’ portfolio provides investors with a two-pronged approach to total return. The Walmart-backed retail portfolio generate super-stable cash flow growth (albeit generally at the lower end of the range) that then supports its sector-leading distribution. In the near future, its sizeable development pipeline will begin to deliver at an annual quantum large enough to augment those growth prospects, taking NAV growth up from what has traditionally been middle-of-the-pack. That said, given the lack of growth today as well as only a slight discount to NAV, we await a better entry point.”
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In a research report titled Dear Mr. Fantasy – Citi’s 12th Annual Fantasy REIT Draft, analyst Michael Bilerman raised his recommendation for Tricon Residential Inc. (TCN-N, TCN-T) to “buy” from “neutral,” seeing shares of the Toronto-based single family rental-focused company as “relatively attractive.”
“We see three potential catalysts for TCN: (1) solid internal growth driven by a sector leading loss-to-lease (20 per cent) and reliance on renewals which are more resilient vs. new lease rate growth, (2) external growth primarily through JVs, and (3) simplification through monetizing/exiting ancillary businesses,” he said. “In addition, we have a favorable view of TCN’s technology platform, which should help both internal and external growth. These are balanced by risks including higher leverage vs. peers in a higher interest rate environment, higher fee income/complexity associated with the fund business model which results in a lower multiple vs. peers, regulatory risks, macroeconomic uncertainty, a slowing transaction and housing market, and the fact that Tricon is not a REIT / RMZ index eligible.”
In the fantasy football themed report, Mr. Bilerman placed Tricon in the “waiver wire” section of his picks, noting: “Claiming the right players off waivers, however, could be the difference between a winning season and a losing season. That said, while these players do not come cheap and may not necessarily be in a prime position to work in all environments, moving forward these players should continue to fight for every yard and find new opportunities to grow and add depth.”
He maintained a US$12.50 target for its shares. The average on the Street is US$14.64.
“We are positive on the SFR sector and favor TCN’s exposure to high growth Sunbelt markets. In addition, we believe that TCN benefits from a strong technology platform that will help drive internal and external growth,” said Mr. Bilerman.
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While natural gas prices remain volatile, equity valuations for producers remain low, according to Scotia Capital analyst Cameron Bean.
“North American natural gas prices continued to move over the summer, with the 120-month Henry Hub strip gaining more than 23 per cent since late April 2022,” he said. “While natural gas prices have been volatile in the face of several recent market events (e.g., Freeport LNG shutdown, EPA turbine ruling, Nordstream pipeline shutdown, and speculation over a U.S. rail strike), they remain elevated and materially above the prices implied in the natural gas equity valuations. With the continued strength in long-term natural gas prices we have updated our net asset value (NAV) assumptions and commodity price scenarios, resulting in a moderate increase to our average valuation price to US$3.80/mmBtu (from US$3.50/mmBtu previously) and several target price increases. We have also made tweaks to some of our other modeling and type curve assumptions.”
With those changes, Mr. Bean raised his rating for Crew Energy Inc. (CR-T) to “sector outperform” from “sector perform” on Monday.
“We have also removed the speculative risk ranking from the stock due to the company’s much improved financial outlook,” he added. “While we are somewhat late on this call, we believe the stock remains undervalued and see a good risk/return proposition in the name following the company’s recent non-core asset sale and partial note repurchase. Looking ahead, we see (1) results from the next five Groundbirch wells, (2) results from the 11-27 UCR pad, and (3) further reduction or refinancing of the 2024 senior notes as catalysts for the stock.”
Believing its operational success “looks sustainable” and calling its deleveraging efforts “impressive,” the analyst raised his target for its shares by $1 to $9. The average on the Street is $8.57.
“The Canadian upstream M&A market has shifted over the last several months, with the most recent deals executed at much higher valuations versus those realized in 2020 and 2021,” said Mr. Bean. “We believe this trend will continue as several industry participants seek to bolster their inventories, and we expect the evolving M&A market to drive valuation improvements for public market companies with desirable asset bases and deep drilling inventories. In our view, CR should benefit from this market environment, given its large Montney land position. The company owns more than 340 sections of Northeast BC Montney rights holding more than 2,500 drilling locations (including more than 700 at Groundbirch) in lean, liquids-rich, and condensate-rich natural gas plays. Notably, CR’s Groundbirch asset is proximal to the inlet for the Coastal GasLink pipeline (and largely outside the Blueberry River First Nation claim area). We believe that both the asset quality and proximity could make CR a consolidation target for future LNG supply.”
Mr. Bean also made these other target adjustments for TSX-listed stocks:
- Advantage Energy Ltd. (AAV-T, “sector outperform”) to $16.50 from $15. Average: $14.69.
- ARC Resources Ltd. (ARX-T, “sector outperform”) to $29 from $27. Average: $24.65.
- Birchcliff Energy Ltd. (BIR-T, “sector outperform”) to $16 from $14. Average: $13.81.
- NuVista Energy Ltd. (NVA-T, “sector perform”) to $16 from $15.50. Average: $16.40.
- Peyto Exploration & Development Corp. (PEY-T, “sector outperform”) to $25 from $24. Average: $18.22.
- Paramount Resources Ltd. (POU-T, “sector perform”) to $37 from $34. Average: $42.50.
- Tourmaline Oil Corp. (TOU-T, “sector outperform”) to $116 from $106. Average: $94.58.
- Topaz Energy Corp. (TPZ-T, “sector outperform”) to $33 from $32. Average: $29.77.
“Overall, we see PEY and CR representing the deepest value in the Canadian group, with SWN offering the deepest value in the U.S. group,” said Mr. Bean.
“TOU, PEY, and SDE are our top picks in the Canadian group, with SWN and EQT as our top picks in the U.S. group.”
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Desjardins Securities analyst Chris MacCulloch reaffirmed his view of NuVista Energy Ltd. (NVA-T) as “one of the best-positioned growth and capital return stories in the Canadian energy sector” after hosting investor meetings in Montreal with chief operating officer Mike Lawford and incoming chief financial officer Ivan Condic last week.
“From growing pains to capital gains, NVA is delivering shareholder value through the drill bit,” he said. “One of the key differentiating factors for NVA in recent years has been top-decline organic production growth rates. Recall that the company was one of the fastest-growing Montney producers prior to the pandemic when it was actively drilling to fill minimum volume commitments (MVCs) with third-party infrastructure providers, some of which were executed in the wake of its transformative acquisition of the Pipestone North asset from Cenovus Energy in 2018. Following the commodity price crash, NVA effectively ceased drilling and completion activity through the remainder of 2020, stockpiling DUC locations while also successfully renegotiating the terms of its MVCs. These decisions ultimately helped the company ride out the storm before the commodity price recovery started taking hold in 2021, upon which it resumed its three-rig program at Pipestone and Wapiti
“Since then, the company has quickly regained operational momentum and is now on pace to deliver 32-per-cent annualized production growth in 2022 and 22 per cent in 2023 based on our forecast for average output of 69,000 boe/d and 84,000 boe/d, respectively. When also considering the impact of share buybacks given that we are currently modelling 50 per cent of FCF toward the NCIB (and a future SIB), NVA’s 2023 PPS growth metric improves to 30 per cent based on strip prices, conservatively assuming our $18 per share target price as the cost basis for buybacks.”
Barring a significant drop in commodity prices, he thinks NuVista will likely “exhaust” its normal course issuer bid by the end of the year and and “accelerate” shareholder returns through significant issuer bid in 2023.
“Our working assumption is that the company will pursue a SIB next year, and it could be material given we are now forecasting a $130-million working capital surplus exiting 2023 at strip prices, even after allocating 50 per cent of FCF to share buybacks,” said Mr. MacCulloch.
He maintained a “buy” rating and $18 target for the company’s shares. The average on the Street is $16.40.
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Citing “rapid deleveraging assisted by the recent strength in commodity prices,” BMO Nesbitt Burns’ Ray Kwan no longer sees Obsidian Energy Ltd.’s (OBE-T) balance sheet as “an area of concern”, leading him to raise his rating for its shares to “market perform” from “underperform.”
“Forecasted future leverage improvements have given way to firm net debt reductions over the past two years, and we now consider the balance sheet to be on solid footing,” he said. “We are forecasting the company to have leverage of 0.5 times D/CF [debt-to-cash flow] by the end of 2022 versus peers at 0.1 times. Additionally, we see the company being in a net cash position by Q4/23. Obsidian’s debt profile consists of a $175 million credit facility with a term-out period of July ‘24 and $126 million of senior unsecured notes maturing in 2027.”
“With legacy acreage in the Peace River region combined with recent crown land purchases, we see Obsidian as having a meaningful position in an emerging area of the Clearwater/Spirit river heavy oil play. Two wells (1.5 net) are planned to be drilled near the end of Q4/22, with 3-4 additional appraisal/exploration wells expected in Q1/23. We see potential to de-risk significant inventory for a future Clearwater development program if appraisal is successful.”
Expecting near-term production growth from an expanded capital program, Mr. Kwan raised his target for Obsidian shares to $14 from $10. The average on the Street is $15.88.
“Although we consider overall asset quality to be below average given relatively high asset retirement obligations, our outlook has improved considerably given the strengthening of the company’s balance sheet,” he concluded. “OBE trades a 2023 estimated FCF yield of 37 per cent (BMO Deck) relative to peers at 26 per cent.”
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Calling its Oko West asset in northwest Guyana “one of the most exciting discoveries of recent years,” BMO Nesbitt Burns analyst Brian Quast initiated coverage of Reunion Gold Corp. (RGD-X) with an “outperform” recommendation.
“While the company has been active for quite some time, it is really the newly discovered Oko West that has brought the company to investor attention,” he said. “Located in Guyana, a mining friendly, yet less well known, jurisdiction, high grades near the surface combined with excellent widths make Oko West, and specifically Block 4 of the Kairuni zone, an exciting development asset. With excellent infrastructure that is expected to improve in coming years, along with experienced management, it seems as though the company is poised to take this asset through to production, assuming that another company doesn’t take on that responsibility.”
Mr. Quast did not specify a target for Reunion shares. The current average on the Street is 70 cents.
“With the foundation of a maiden resource and step out drilling results to accelerate, we expect momentum to increase the stock in the coming 12 months,” he added.
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In other analyst actions:
* CIBC World Markets’ John Zamparo cut his Aurora Cannabis Inc. (ACB-T) target to $2.50 from $3.75 with a “neutral” rating. The average on the Street is $3.25.
* DA Davidson’s Brandon Rolle bumped his BRP Inc. (DOO-T) target to $123 from $122 with a “buy” rating. The average is $131.06.
* RBC Dominion Securities’ Keith Mackey raised his target for Enerflex Ltd. (EFX-T) by $1 to $12 with a “sector perform” rating. The average is $11.58.
* With the close of its $68-million equity financing, Stifel analyst Ian Gillies cut is target for Neo Performance Materials Inc. (NEO-T) to $17 from $19.75 with a “buy” rating, while Raymond James’ Frederic Bastien lowered his target to $23 from $25 with an “outperform” rating. The average is $24.17.
“We reaffirm our Outperform recommendation on the shares of Neo Performance Materials after the completion of a bought deal treasury offering capped an eventful few weeks for the company. NEO notably agreed to acquire the rights to a rare earth rich project in a bid to advance its Magnets-to-Mine vertical integration strategy, secured a loan to relocate and expand one of its catalyst manufacturing plants, and saw Oaktree sell substantially all its remaining ownership stake in the company to a strategic buyer. While the dilutive equity offering prompts a reduction to our target price, we expect these developments will ultimately surface value for shareholders,” Mr. Bastien said.
* KBW’s Sanjay Sakhrani lowered his Nuvei Corp. (NVEI-Q, NVEI-T) target to US$52 from US$55 with an “outperform” rating. The average is US$59.86.
* RBC’s Greg Pardy raised his Ovintiv Inc. (OVV-N, OVV-T) target to US$56 from US$51, keeping an “outperform” rating. The average is US$69.96.
“Our recent discussion with Ovintiv’s IR Senior Advisors, Michael Schmidt, Michael Pomorski and Patti Posadowski delved into the company’s operations and touched on its natural gas marketing portfolio. With its formula driven shareholder returns model in motion, Ovintiv’s buybacks should move appreciably higher in the quarters to come,” he said.
* In response to Friday’s announcement with Agnico Eagle Mines Ltd. (AEM-T) for a 50-per-cent interest on the San Nicolás Copper-Zinc Project, Raymond James analyst Brian MacArthur raised his Teck Resources Ltd. (TECK.B-T) target by $1 to $57 with an “outperform” rating. The average is $54.98.
“We view this transaction as positive for Teck as it has surfaced value from one of its Project Satellite assets with a well capitalized partner that has Mexican operations. We have updated our forecasts to reflect this transaction,” he said.
David Leeder