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

The current macro environment for Canadian energy services companies is negative, according to Industrial Alliance Securities analyst Elias Foscolos.

“Services stocks have historically exhibited a strong correlation with commodity prices,” said Mr. Foscolos in a research report released Monday. “The sector crashed late in 2018 with oil, which was exacerbated by the widening differential and a poor macro backdrop. Early 2019 gains were modest compared to the recovery in commodities, as the Province of Alberta mandated production curtailments limit activity upside for Services companies. As commodities have been under renewed pressure in the past couple of months, the Services Index has declined, more than losing all of its early 2019 gains. The macro backdrop is uncertain at best. On the demand side, U.S.-China tensions and concerns over a global economic slowdown are pushing prices down. On the supply side, U.S. crude stocks increased in three of the four weeks ending May 31, 2019. The most recent reported inventory surge of 6.8 mmbbls caused a 4-per-cent decline in oil prices. Over the past three weeks, WTI prices have declined 14 per cent, while the Energy Equipment Index has declined 8 per cent. The WCS differential is currently $18.50.”

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Pointing to that uncertainty, Mr. Foscolos lowered his Canadian land rig estimates for 2019 and 2020 by 4 per cent and 9 per cent, respectively, while his U.S. estimates fell by almost 5 per cent each year.

“The Canadian oil & gas sector faces even greater uncertainty, and the recent rejection of Enbridge’s L3R by a Minnesota court coupled with uncertainty regarding the TMX expansion is likely to make E&Ps even more cautious with spending moving forward,” he said. “We do not currently see any reason to believe H2/19 will improve, and we are tempering our expectations for the degree of activity growth in 2020. In the U.S., rig counts have been trending steadily downward since the start of the year, with land rigs down almost 10 per cent. Rather than low-single-digit growth, we are now expecting a slight year-over-year decline in U.S. land rigs this year, with mid-single-digit growth to occur in 2020.”

Mr. Foscolos called recently released first-quarter results “mixed.” Since then, he thinks share price performance has created “compelling” buying opportunities, despite the negative sector backdrop.

“This conclusion is supported by a relatively high dividend yield compared to the TSX and a forward EV/EBITDA multiple that is below historical average,” he said.

“Earlier in the year, it looked like Services stocks were making a comeback, returning 11 per cent in January. Since then however, the sector has more than erased all of those gains, returning negative 15 per cent since the end of January and negative 4 per cent year-to-date. In comparison, our coverage universe has returned a market cap weighted average of negative 1 per cent year-to-date. Our biggest outperformers year-to-date include Pulse Seismic (PSD), Badger Baylighting (BAD), and Strad Energy Services (SDY), while our biggest underperformers include McCoy Global (MCB), CES Energy Solutions (CEU), and Source Energy Services (SHLE).”

With the changes to his estimates, Mr. Foscolos lowered his target price for a trio of stocks. They are:

Source Energy Services Ltd. (SHLE-T, “hold”) to $1.50 from $1.80. The average target on the Street is $1.43, according to Bloomberg data.

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Analyst: “At this point, we are maintaining our Hold rating on the stock until the Company is able to demonstrate a return to full-cycle profitability.”

STEP Energy Services Ltd. (STEP-T, “buy”) to $3.75 from $4.25. The average is $4.08.

Analyst: “Current macro and industry trends have prompted us to reduce our drilling rig forecasts for Canada and the U.S. in both 2019 and 2020. This should translate into lower revenue, EBITDA, and OI in all of STEP’s operating segments. These reductions have a negative impact on STEP due to its leverage to the drill bit and leveraged capital structure.”

Tervita Corp. (TEV-T, “buy”) to $9.75 from $10.50. The average is $9.04.

Analyst: “The announcement of the sanctioning of a water disposal infrastructure project is positive in the midst of lower rig counts. The increased EBITDA contributions from the project softens the impact of reduced drilling activity. We elect to lower our target price ... on account of an overall lower 2020 outlook. We now estimate 2019 EBITDA of $235-million, and $248-million for 2020 inclusive of the impacts of the new water disposal infrastructure project. Based on Friday’s closing price, our target represents a potential 48-per-cent one-year upside justifying our Buy rating.”

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AltaGas Canada Inc. (ACI-T) possesses “intriguing growth upside with a green energy twist,” said Beacon Securities analyst Lyndon Dunkley.

Calling it “not your grandparents’ utility,” he initiated coverage of the stock with a “buy” rating.

“We expect consistent, sustainable, minimum 5-per-cent annual EPS, EBITDA and dividend growth driven by the expected rate base growth from the regulated utilities and the inflation related growth component of the long term renewable power contracts – ACI has set a five-year capital plan of $330-million for its regulated utility assets, the majority of which has already been approved by jurisdictional regulators,” he said. “The capital outlay is expected to be funded through free cashflow and a small increase in debt, making ACI one of the rare self-funding utilities.”

“Potential upside to our forecasts from increased industrial activity in northwestern B.C. and greater market penetration in Nova Scotia – ACI is uniquely positioned in B.C. with Pacific Northern Gas (PNG) as the owner of the only natural gas pipeline that connects the high activity Montney resource play to Canada’s West Coast. In Nova Scotia, and at Halifax in particular, the province’s slow adaptation of natural gas as a fuel source has highlighted over 20,000 customers for ACI to pursue through Heritage Gas.”

Mr. Dunkley set a $27 target. The average target on the Street is $22.08.

“Even with recent price appreciation, ACI generates a higher yield and trades at a discount to its (albeit larger enterprise value) peer group," the analyst said. " At current price levels, ACI is yielding 4.0 per cent (peer group 3.9 per cent) and trades at a 15.1 times 2020 estimated P/E multiple (peer group 17.5 times) based on our estimates.”

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"Now is the time for [Aecon Group Inc.] to shine,” said Raymond James analyst Frederic Bastien.

"The past years have seen Aecon Group take giant steps in diversifying its business, bidding with increased discipline and executing jobs more efficiently," he said. "These efforts are enabling the contractor to capitalize on opportunities of all sizes across Canada and outperform its peers with consistently solid operating results. What’s more, with competition for mega integrated projects less intense than in recent memory and CEO Jean-Louis Servranckx’s plans for the next several years coming into focus, we have every reason to stay bullish on the stock."

Mr. Bastien emphasized Mr. Servranckx’s top priority is “to see through Aecon’s record-high backlog safely and profitably.”

He added: "He knows all too well that to achieve this management must balance the entrepreneurial spirit of its staff with sufficiently adequate processes. These will not only help ensure successful practices are replicated across a dynamic scope of jobs ranging from large-scale P3 projects to local work, but also limit (if not stop) bad ones from repeating. We also take some comfort in knowing Mr. Servranckx is not racing like mad to grow the backlog to $10-billion. At its current level of $7-billion, Aecon can be very strict about the margins it is bidding new projects for.

“Few contractors come close to Aecon when it comes to diversity of project work. We believe this is also emblematic of the firm’s status as construction partner of choice across the country. CEO Servranckx appreciates that in order to keep this going, Aecon must further invest in its people. Integral to a 4-year strategic plan he is to launch soon is a comprehensive program that will facilitate the development of top-notch project managers and drive employee engagement. Along these lines each salaried, full-time ARE employee was recently granted restricted stock units (RSUs) and given a window of opportunity to buy additional units at a discount (an offer taken up by over 70% of staff). Lastly, we expect Mr. Servranckx to leverage his extensive connections to recruit talented individuals. In fact he has already signed on a major projects expert from Europe to help lead the REM project in Montreal. To us, these nominal investments will help the contractor lay a solid foundation for long-term growth.”

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Maintaining a “strong buy” rating for the stock, Mr. Bastien hiked his target to $26 from $23. The average on the Street is currently $23.70.

“We recognize there is no love lost for construction stocks in the wake of a few spectacular E&C blowups,” he said. “But unlike its closest peers Aecon is riding strong sectorial trends, keeping its eyes on the ball and banking on a healthy balance sheet. Since we believe these truths should yield ARE at the very last a premium valuation, we reaffirm our Strong Buy rating on the stock. Our valuation moves out to 2020, which increases our target for ARE’s construction business to $23.01 from $20.16 (this remains based on an EV/EBITDA multiple of 6.5 times that approximates the contractor’s 10-year forward average multiple of 6.4 times). We then add our net asset value estimate of $3.41 for the Bermuda Airport concession. This results in a new target price.”

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Canaccord Genuity analyst Yuri Lynk thinks Badger Daylighting Ltd.'s (BAD-T) second-quarter results could be hurt by a slow start to the construction season and elevated expense costs stemming from the roll-out of its Common Business Platform (CBP).

However, he thinks any share price underperformance stemming from these results would “represent an excellent opportunity for long-term investors to add to positions, in our view, as we anticipate seeing delayed work show-up in Q3 and Q4.”

“It’s no secret the U.S. Midwest and parts of Canada have experienced extremely wet weather that could weigh on this quarter’s results,” said Mr. Lynk. “Also, the CBP spend is peaking with the ERP going live in H2/2019 so SG&A as a proportion of sales is likely to be well above management’s 4-per-cent target.”

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In a research note on the heels of Canaccord sponsoring a non-deal roadshow with Badger in New York City and Boston, Mr. Lynk said: "Investors spent a good deal of time in the meetings on just how big Badger’s U.S. business could be. Recall, one of Badger’s strategic milestones is to double its U.S. business from 2016 levels between 2019 and 2021. Impressively, the company is already 75 per cent of the way toward this goal and once it’s achieved, we believe management will set out to double it again. Management stressed the U.S. is still a significantly untapped market noting Badger is in less than 25 per cent of the lower 48 states’ 350 Metropolitan Statistical Areas, which are geographic regions with a population of over 100,000 people. Furthermore, Badger has room to increase penetration in the MSAs it is already in with management noting there are several major U.S. cities where Badger has significantly fewer trucks similarly sized Canadian cities.

“Management was extremely enthusiastic on the potential margin impact of its strategic initiatives. These efforts played a big role in driving gross margin 60 bps higher year-over-year in 2018 to 31.1 per cent but we believe there is more to come. Last year, management was successful with strategic pricing initiatives (read: fuel surcharges), which have still not been roll-out across all branches, and this year we believe better tracking of over-time charges can be an incremental boost. In this vein, management noted customers often agree to pay overtime in the initial quote but Badger doesn’t always charge it because of human error. Right now, quoting, hour tracking, and invoicing are all done via disparate systems that don’t communicate with each other. The Common Business Platform (CBP), which includes an Oracle Cloud ERP implementation, is aimed at addressing revenue leakage such as this.”

Mr. Lynk maintained a “buy” rating and $53 target for Badger shares, which falls a loonie short of the consensus.

“We see great value in Badger shares at 16 times 2020 estimated EPS,” he said. “After all, this is a company with excellent financial flexibility that should generate 24-per-cent EPS growth next year and pre-tax ROIC [return on invested capital] of more than 20 per cent.”

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Seeing upside to the Street’s expectations and an “attractive” entry point for investors, Credit Suisse analyst Brian Russo raised his rating for Sirius XM Holdings Inc. (SIRI-Q) to “outperform” from “neutral.”

“With the Pandora acquisition behind it, solid operating trends (‘19 estimates: 1 million net adds despite SAAR down 3 per cent year-over-year, stable 1.8-per-cen churn despite continued 2-per-cent ARPU growth, EBITDA growth to accelerate), and a powerful buyback (Credit Suisse estimates $2-billion, 28 per cent of float), SIRI’s price has fallen to the point where the risk/reward opportunity is attractive in our view,” he said.

“2019 consensus EBITDA has fallen 5 per cent and FCF 8 per cent since October, driven in part by a new agreement to expand SiriusXM radios across all Toyota light vehicles (a longer-term positive despite upfront expenses) and a capex pull-forward that lowered ’19 FCF but will contribute to a significant capex step down in ‘20 (CS estimates a drop of $177-million year-over-year). This brings consensus roughly in-line with ‘19 guidance, which is rare given mgmt.’s long track record of beating guidance and the street’s tendency to anticipate this in its forecast.”

Though he raised his 2019 and 2020 revenue and EBITDA estimates, Mr. Russo maintained a US$7 target for Sirius shares. The average on the Street is US$6.66.

“Since announcing the Pandora acquisition in Sept., SIRI shares have fallen 15 per cent versus the S&P500 down 2 per cent,” he said. “At current prices, SIRI trades at 15 times ’19 estimated FCF/shr, its lowest valuation on this metric over the past 2 years (and vs. 17 times 2-year average).”

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“Return-focused” investors might want to start looking at Whitecap Resources Inc. (WCP-T), according to Raymond James analyst Jeremy McCrea.

“Given its strong rates of return and also larger relevance for investors, it’s a company that likely sees a sustainable bid before smaller cap peers,” he said. “Assuming little acquisitions for the foreseeable future (given WCP’s share price), investors will finally get a ‘clean look’ at the strength and top quartile half and full cycle economics with WCP’s portfolio. With PDP NAV/sh growth of 8-13 per cent this year as well and dividend yield of 7.7 per cent, Even without a multiple re-rating, in our view, WCP should provide reassuring returns to investors for years to comes.”

Mr. McCrea did emphasize, however, that both commodity and differential volatilty are likely to weigh on investor sentiment toward mid-cap E&P’s in the near term.

“Unfortunately, there is also a growing chorus with investors that even if one or two more pipelines are built, growth in the sector is likely capped,” he said. “The reaction to this has been a collapse in sentiment as investors seek ‘growth’ elsewhere. While some management teams still propagate this old business strategy around ‘growth’, we have noticed that over the past year that many CEO’s have quietly said they would run their businesses differently if it were private (and give up investor’s demand for growth in lieu for better returns). With production curtailments throughout AB, we find many operators are more-so replicating such private models nowadays, paying down debt, increasing dividends, and implementing share buybacks. Although growth is not readily seen with production growth, we believe that shareholders are probably being more rewarded today than many periods historically. The timing on when ‘return focused’ investors become convinced of this new change is hard to determine. As a result, during this sector transition period, clearly both growth and return based investors have left the sector on the believe that each of their core metric is negative, and thus making valuations still relatively expensive from each of their perspective. Overall, its difficult to see how growth investors might ever come back to CDN energy however we do believe ‘rate of return’ type investors are likely to find the sector increasingly attractive. Convincing them will take time however.”

With a “strong buy” rating, Mr. McCrea moved his target to $8.75 from $8.50. The average is now $8.49.

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"Powerful, long-term trends" point to a shrinking U.S. beer industry, according to Credit Suisse analyst Kaumil Gajrawala.

“A generational demographic shift leaves no question U.S. beer market trends are unlikely to change in the medium term,” he said in a research report released Monday. “Mainstream brands make up 40 per cent of industry volume and are declining 5 per cent annually (called ‘Premium’ in the U.S.). This is unlikely to change. We examine additional secular headwinds: 1) Consumers drinking less; 2) A generation of share losses to wine & spirits; 3) Biggest brewers with the highest exposure to the segments declining the fastest; 4) Young drinkers preference for newer AlcBev options; 5) Rise of alternative away-from-home drinking (taprooms); 6) Cannabis substitution risk; and 7) Debt levels stifling investment.”

He initiated coverage of Boston Beer Co. (SAM-N) with a “neutral” rating and US$320 target, which exceeds the US$292.25 consensus.

“Rather than cushion earnings from weak top line through cost savings in 2017 The Boston Beer Co (BBC) stepped up investments in ad spend, marketing and innovation — guiding at that time to EPS decline of as much as 38 per cent at the low-end," the analyst said. "Today, the benefits are flowing through with new, meaningful innovations creating growth to likely lead to record EPS in 2019, followed by 14-per-cent 3-year EPS CAGR to 2022.”

Believing “recent trends and a challenging portfolio reality are unlikely to improve,” Mr. Gajrawala gave Molson Coors Brewing Co. (TAP-N) an “underperform” rating and US$50 target. The average is US$66.56.

“Due to the $12-billion consolidation of the U.S. business in 2016, short, medium and long-term shareholder value creation will be determined by the success or failure of the U.S. operation (MillerCoors (MC)),” he said. “This business comprises 75 per cent of EBIT and we are skeptical it will improve. The issue is the portfolio, not marketing or management. Both MC and ABI heavily invested over two decades to stabilize a mainstream category (‘Premium’), which is in its 14th consecutive year of declines. This category represents 70 per cent of MC’s volume, and thus presents 340 basis points of volume headwind, with a higher impact on profit from deleveraging. At 4 times leverage, strategic options are limited. We model a 1-per-cent EPS CAGR (’19-’22).”

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Believing demand in China demand will “likely be stronger than most anticipate,” Roth Capital Partners analyst Craig Irwin upgraded Tesla Inc. (TSLA-Q) to “buy” from “neutral.”

“Depending on the health of the Chinese auto market, monthly deliveries by year-end 2019 could easily be tracking at double this rate or better,” he said.

Mr. Irwin set a US$238 target, which falls short of the US$272.52 consensus.

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In other analyst actions:

Eight Capital analyst Ian MacQueen reinstated coverage of Vermilion Energy Inc. (VET-T) with a “buy” rating and $42 target. The average is $41.83.

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