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

A rough winter is likely to take a toll on the first-quarter operating metrics for both Canadian National Railway Co. (CNR-T, CNI-N) and Canadian Pacific Railway Ltd. (CP-T, CP-N), according to Desjardins securities analyst Benoit Poirier.

In a research note previewing earnings season, Mr. Poirier lowered his target price for shares of both companies, expecting to see the impact of a “challenging” quarter.

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“Overall, while both Canadian railroads have resolved some of their operating challenges since then, we expect the harsh winter conditions to negatively impact operating metrics and translate into higher expenses for both CN and CP in 1Q18,” he said. “Our numbers also take into consideration the new accounting change relating to pensions, which will increase operating ratios (ORs) although there is no impact on EPS and FCF. ORs are also expected to be negatively impacted by the recent increase in fuel prices.”

“Railroads have to reduce the length and speed of trains in order to lessen the risk of derailment and network breakage when the temperature gets below a certain level. Further, snowstorms (ie amount of snow) impact fluidity. Consequently, CN’s and CP’s operating performance has been negatively impacted since the beginning of winter. Terminal dwell (average time a freight car resides at a specified terminal location; lower is better) has increased since the beginning of the year to 24.8 and 8.5 hours, respectively, at the peak (versus 15.6 hours and 7.1 hours in 1Q17). Train velocity (train speed) was also significantly impacted during the period, reaching 20.4 miles per hour and 19.3mph at their respective peaks (versus 25.7mph and 22.3mph in 1Q17). Overall, while both Canadian railroads have resolved some of their operating challenges since then, we believe the harsh winter conditions will negatively affect their earnings. We expect costs for CN and CP to rise as they would have needed more employees to operate the additional trains on the network and to decongest rail terminals as a result of the weak operating performance.”

Mr. Poirier is projecting adjusted fully diluted earnings per share of $2.67 for CP, lower than the Street’s expectation of $2.75 and a drop of 25 cents year over year. He said the challenges faced by wintery conditions offset “solid” revenue ton mile (RTM) performance.

“Nevertheless, we are increasing our full-year forecast to include recent contract wins and now expect adjusted fully diluted EPS of $13.00 in 2018 (up from $12.76) and $14.50 in 2019 (up from $14.27),” the analyst said. “We now have more confidence in CP’s ability to meet and potentially exceed its annual EPS guidance, which calls for low-double-digit growth (we forecast 14.2 per cent).”

Expressing a preference for CP over CN, Mr. Poirier maintained a “buy” rating for its stock and lowered his target by a loonie to $254. The average target on the Street is $252.50, according to Bloomberg data.

For CN, Mr. Poirier estimates EPS of 99 cents, which is 3 cents lower than the consensus and a drop of 7 cents year over year. He lowered his full-year 2018 EPS projection to $5.15 from $5.32, and his 2019 expectation fell to $5.94 from $6.07.

“We believe it will be challenging for CN to meet its full-year 2018 guidance (C$5.25–5.40),” said Mr. Poirier.

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Keeping a “buy” rating for CN shares, his target fell to $113 from $115. The average is $103.55.

“At current levels, CN offers a more attractive potential return to our target at 21 per cent versus 13 per cent for CP although we continue to favour CP over CN,” the analyst said.


Though he’s encouraged by the potential of subsidiary Atlantic Broadband south of the border, Canaccord Genuity analyst Aravinda Galappatthige thinks Cogeco Communications Inc. (CCA-T) is losing ground with its Canadian cable segment.

After market close on Thursday, Cogeco reported second-quarter revenue of $599-million, missing both Mr. Galappatthige’s $613-million estimate and the Street’s expectation of $607-million despite representing a rise of 6.8 per cent year over year. Excluding a two-month contribution from recently acquired MetroCast, the analyst estimated revenue dropped 1.6 per cent, due largely to the Canadian dollar.

Earnings before interest, taxes, depreciation and amortization (EBITDA) of $268-million also missed expectations ($274-million and $272-million, respectively), though it was up 5.6 per cent from the previous year.

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Mr. Galappatthige emphasized Cogeco reported year-over-year Canadian cable primary service unit (PSU) net losses for the third consecutive quarter, “attributable to maturation of its TiVo product, increased competitive losses due to expanding telco fibre rollouts and increased churn from customers coming off of previous promotional offers.” The company reported a 5,800 PSU net loss, versus his estimate of a loss of 2,900 and the consensus of loss of 1,500. Segment revenue of $324-milllion also missed expectations and dropped 0.6 per cent year over year despite rate increases in Ontario and Quebec.”

“In terms of sub loading, the softness that we first saw in Q4/17 appears to have sustained,” he said. “This is generally in line with the swing in momentum we are seeing towards the Telcos quite recently. Thus, Cogeco’s cableco peers have also seen this loss of net add share in recent quarters. We, however, did expect Cogeco to be a little less impacted due to the relatively lower penetration of Telco FTTH in their footprint. Against that backdrop, the subscriber numbers in Q2 are a little disappointing. Furthermore, the Q2 Canadian cable EBITDA decline was also somewhat unusual, although management continues to guide towards low single-digit growth in F2018.”

Mr. Galappatthige does feel the Montreal-based company’s U.S. segment is “well positioned” for the long term, and he expects to see sequential improvements.

“We continue to believe that ABB remains very well positioned to deliver strong results in the longer term, particularly as the company focuses on capitalizing on low video penetration, B2B opportunities in the new MetroCast territories, and exploiting the attractive Florida market. However, opex and capex investments around Florida and other opportunities within MetroCast are driving flatter EBITDA and lower FCF in the near term. Nonetheless Q2 was encouraging in that it reflected a meaningful improvement in subtrends and sequential improvement in EBITDA. A key goal, is to return ABB to mid-single-digit EBITDA growth (Q2 organic was 1.9 per cent).”

Based on the results, he lowered his 2018 and 2019 financial projections for Cogeco, leading him to drop his target price for its shares to $73 from $85 with an unchanged “hold” rating. The average target is $84.50

“With the stock down 23 per cent year-to-day and ABB starting to reflect some improvement in profitability, as well as better sub trends, one can certainly make a case to upgrade Cogeco. However, the softness in the Canadian results give us pause,” he said. “While other Canadian cablecos have also recently experienced subscriber pressure, these peers are starting to focus on profitability and are expected to see 3-5-per-cent EBITDA growth. When we consider this alongside the likelihood of some FTTH [fiber to the home] activity in Cogeco’s footprint (especially as Bell’s GTA rollout draws toward completion), we are forced to take a more cautious view on Cogeco Connexion. Thus, we have reduced our blended target multiple from 6.4 times to 5.9 times 2019E EV/EBITDA. We advise investors to look for an attractive entry point in the event of a further downtick in the stock or alternatively alongside improved returns from the Canadian business.”

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Elsewhere, Desjardins Securities’ Maher Yaghi lowered his target to $87 from $92 with a “hold” rating.

Mr. Yaghi said: ”While the stock’s valuation is beginning to be more attractive, we still need to see improved results in the Canadian segment before becoming bullish. Management is hopeful this might occur as soon as next quarter. We believe investors would need to monitor this as without growth in Canadian cable, overall growth becomes muted even with a strong performance in U.S. cable.”


CannaRoyalty Corp.’s (CRZ-CN) acquisition of River Distribution provides “transformational” exposure to the California market, said Canaccord Genuity analyst Matt Bottomley.

The Ottawa-based company announced the deal for River Distribution, a distributor of several brands in the state’s recently legalized recreational market, on March 27.

“With a strategic partnership previously in place, including a revenue royalty stream and minimum CR brand purchase commitments, CannaRoyalty has now acquired 100 per cent of River in exchange for 5 million CRZ shares (and up two 2M shares in future milestones). At the time of announcement, this implies a total purchase price of $19million to $27-million,” said Mr. Bottomley.

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“Combined with its previous acquisition of Alta Supply (Expanding its California Reach), we believe CannaRoyalty has secured a strong position in California’s wholesale cannabis market with a current reach into hundreds of dispensaries throughout the state. As the state’s recently introduced rec regulations require dispensaries to source products through licensed distributors (like River), this segment of the value chain is set to become increasingly meaningful. We believe California could eventually ramp to upwards of 5,000 dispensaries (spread among hundreds of operators) and exposure to regulated retail locations will be critical to carving out meaningful market share in the state. By increasing its investment in River from a strategic partner to a wholly owned operation, CannaRoyalty will also have increased control over the products and SKUs (including CR brands) it brings to market.”

Based on River’s trailing sales of US$25-million, Mr. Bottomley believes the deal is “highly” accretive to CRZ with an “attractive” purchase price multiple of less-than 1.0 times trailing revenues and 3-4 times trailing EBITDA. He added that comes “even before considering the expected steep growth profile that legalized rec sales in California will provide.”

Maintaining a “speculative buy” rating for CannaRoyalty shares, he hiked his target price to $7.50 from $5.50. The average is $6.33.


With a “growing market share in a growth market,” Industrial Alliance Securities analyst Elias Foscolos initiated coverage of Source Energy Services Ltd. (SHLE-T) with a “buy” rating.

“The demand for proppants is largely driven by drilling activities and E&P capital spending budgets,” he said. “In Canada, rig counts increased 55 per cent year over year to an average of 188 rigs in 2017, which we expect to have a modest uptick in 2018 and 2019. Also, our analysis shows that capital spending for Canadian E&P companies should be at least as strong as in 2017. This sets up Source to continue to experience upward momentum in 2018.

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“Despite weaker-than-consensus Q4 performance, we believe SHLE will continue to have potential upside. In Q4/17, SHLE posted revenue of $75-million, which was 7 per cent lower than the record performance of $81-million in Q3/17. This was largely due to weather driven disruptions in rail services. Although there were some similar circumstances at the beginning of this year, we believe that this is temporary.”

Mr. Foscolos set a target price of $7 per share, which is below the consensus of $9.75.

“2017 has been a year of big changes for Source,” he said. “Post an IPO and two transformational acquisitions, Source’s performance showed constant strength and has set the stage for a strong year.”


Believing recent mid-single digit comparable-same store sales sales growth “should not be considered the norm,” Stephens analyst Will Slabaugh downgraded McDonald’s Corp. (MCD-N) to “equalweight” from “overweight.”

Mr. Slabaugh said the U.S. fast food giant’s results “resulted only from successful initiatives coming together.”

He lowered his target to US$170 from US$185. The average target is US$187.81.


Credit Suisse analyst Robert Moskow downgraded The Kraft Heinz Co. (KHC-N) by two levels to “underperform” from “outperform,” expressing concern over its growth potential.

“We harbor serious doubts about the management team’s ability to generate sufficient product innovation to grow its collection of ‘retro’ brands in highly commoditized categories,” he said. “The company’s expertise in cost-cutting and price realization worked well at a time when all of its peers were forced to run the same playbook. But now, with retailers like Walmart and Kroger demanding more from the vendors to drive growth, the playing field has become more competitive.”

“With margins looking very much at their peak, sales growth stagnating, and the company talking more about reinvestment, it becomes very difficult to believe in the company’s ability to create value as a stand-alone entity. The 3G business model is very good at cutting non-essential overhead, focusing on price realization, and running an efficient plant and distribution network. However, its ability to drive sales growth through marketing, new products, and strategic investment has yet to be proven.

Mr. Moskow lowered his 2018 and 2019 earnings per share projections to US$3.70 and US$3.75, respectively, from US$3.88 and US$4.15. Both sit below the consensus (US$3.80 and US$4.05).

He dropped his target for Kraft Heinz shares to US$55 from US$70, which is well below the average on the street of US$75.61.

“While KHC stock has devalued considerably since the start of the year, we believe it will head lower still as consensus sales and EBITDA estimates revise down,” he said.


Believing it’s emphasizing the right categories but wrong brands, Mr. Moskow also downgraded J.M. Smucker Co. (SJM-N) to “underperform” from “neutral.”

“While the company has leading brands in two big, growing categories (coffee and pet food), the dynamic changes in consumer preferences have significantly devalued or commoditized its legacy brands and impaired its competitiveness,” he said. “We expect margins to head lower as these pressures necessitate more reinvestment and promotional spending. For example, while some investors believe that Smucker stands to benefit from falling coffee commodity input costs, we believe that its Folgers brand (about 25 per cent of profits) will need to lower its prices and its margin structure to defend its market share from private label incursion.”

Mr. Moskow expressed concern over the possibility of earnings dilution from the sale of its Pillsbury baking business.

“This brand has lost significant market share to the market leader Pinnacle’s Duncan Hines and the management team has not expressed an interest in putting more capital behind it to keep pace with Pinnacle’s extensive innovation,” he said. “Retailers focusing on simplifying their shelves have been discontinuing third tier brands like these to make room for private label. By our math, a divestiture would create significant earnings dilution of perhaps $0.25, even if the business fetched an 8 times EBITDA multiple. With the brand now declining at a double-digit pace, we doubt that a buyer would pay much more than that.”

The analyst lowered his 2019 and 2020 EPS projections to US$8.89 and US$8.81, respectively. Both sit below the average on the Street (US$9.19 and US$9.69)

His target is now US$115, down from US$120 and below the consensus of US$130.14.

“Our target price of $115 assumes a forward P/E [price-to-earnings] of 13 times against our FY 20 EPS estimate of $8.81,” said Mr. Moskow. “This assumes a discount of 16 per cent to packaged food peers, below its historical discount of 13 per cent. We think the discount is justified because Smucker’s brands have become increasingly commoditized. A rebound in Coffee division margins from lower commodity costs represents the largest upside risk to our thesis.”


BMO Nesbitt Burns analyst Andrew Breichmanas upgraded Golden Star Resources Ltd. (GSC-T) to “outperform” from “market perform” and raised his target to $1.50 from $1.25. The average target is $1.59.

“Our view on the stock had been that performance of the underground mines at Wassa and Prestea needed to be better demonstrated before shifting attention to longer-term growth prospects,” said Mr. Breichmanas.

“However, following further drill results and the addition of inferred resources, we consider the depth potential at Wassa difficult to ignore and see value in the stock even with a conservative view of Prestea performance going forward.”

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