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

Following Thursday’s pre-release of weaker-than-anticipated third-quarter results, Desjardins Securities analyst Keith Howlett lowered his rating for Gildan Activewear Inc. (GIL-T, GIL-N) by two levels to “sell” from “buy,” pointing to the “surprise meltdown of the printwear cash machine.”

With that announcement, Gildan shares plummeted by over 25 per cent in Friday trading, leading Mr. Howlett to reverse course on his view of the stock.

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On Monday, he raised his rating for the Montreal-based clothing manufacturer to “hold," despite expressing concern about the deteriorating state of the U.S. printwear market.

“We have yet to reconcile the reported 4.3-per-cent growth of the promotional products industry in the U.S. in 3Q with the high-single-digit decline of Gildan’s U.S. printwear sales,” he said.

“The Advertising Specialty Institute, which tracks the promotional products industry in the U.S., reported that the industry grew 4.3 per cent in 3Q19. The leading product in the industry is T-shirts, and the three largest suppliers to the industry are the three major printwear distributors. The promotional products channel represents about 30–40 per cent of printwear demand and is the channel most sensitive to the outlook for the economy, in our view. Free products supplied to participants at corporate and other events are likely to be cut from the budget when belts are tightened. That said, we find it surprising that the belt tightening has already commenced in the U.S., given the economy is still growing. It is possible that the decline Gildan experienced is not representative of its competitors. Given Gildan’s scale within the industry and its market intelligence, it seems unlikely, however, that the decline is a Gildan-only issue. We also are unable to locate any evidence that T-shirts are being displaced by another promotional product. Assuming it is simply a drop in demand for all promotional products, it is unclear how long that situation will persist, given that, to our knowledge, a recession has not yet even begun.”

He maintained a target price of $40 per share, which exceeds the consensus target on the Street of $39.15, according to Bloomberg data.

“We have confidence that management will successfully execute on its long-term growth plan, and in particular on its objective to increase gross margin rate to 30 per cent," he said. “Given the rapid and unexpected decline in U.S. printwear sales, it is now unlikely that result will be achieved by FY21. The surprise downturn in printwear demand seems likely to last at least through 1Q20.”

Conversely, Edward Jones analyst Brian Yarbrough cut Gildan to “hold” from “buy” without a specified target.

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Calling it a “free cash growth machine,” Raymond James analyst Michael Glen initiated coverage of MTY Food Group Inc. (MTY-T) with an “outperform” rating on Monday, despite acknowledging its stock can be “quite controversial at times” given an ongoing debate among investors about both “the sustainability and ultimate benefits” of its aggressive M&A strategy.

“Our constructive view is driven by a combination of factors, including: (1) A strong and tangible history of deploying capital towards cash flow accretive M&A; (2) A management team that has a tremendous amount of experience acquiring and integrating restaurant franchise businesses that require some attention; (3) A very active pipeline of increasingly larger transactions which offer upside to our current forecast; and (4) A heavily discounted valuation which is driven predominantly by investor focus on a singular metric: same-store-sales-growth,” he said.

The analyst added: “MTY has a strong history of deploying capital to in order to make cash flow accretive transactions, and we believe M&A is the core growth strategy that the company will keep pursuing. As such, for investors looking for a stock that will trade aggressively off of same-store-sales prints, this is not going to be a name. However, for investors looking for a demonstrated track record of growth in free cash per share, we would view this as a core holding.”

Mr. Glen noted MTY stock has corrected “quite significantly” since the company released its third-quarter results on Oct. 10. However, he emphasized it was the first full quarter of since the acquisition of the Papa Murphy’s pizza chain.

“It appears this was not adequately reflected in some estimates,” he said. “As management indicated on the Q3 conference call, Papa Murphy’s should generate 3 times the EBITDA in Q4 versus Q3 (which we believe represents a lift to $10-12-million from $3-4-million sequentially).”

Mr. Glen set a target of $65 per share, which tops the consensus of $63.43.

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“We often hear pushback from investors that MTY stock, which is currently trading at a multiple of 11 times fiscal 2020 and 2021 estimated EBITDA, is ‘expensive,’" he said. “We disagree with this sentiment. As a starting point, franchising restaurant stocks in general trade at fairly elevated multiples, with the U.S. quick-service peers trading at an average multiple of 15.2 times 2020 estimated EBITDA and 15.0 times 2021 estimated EBITDA. This implies a relative trading discount of 4 times for MTY stock, which is one of the wider valuation discrepancies in the space. This discount is despite a free-cash-flow yield of 7 per cent and a 5-year free-cash per share CAGR of 19 per cent.”

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With lingering economic uncertainty hanging over the industry, Desjardins Securities analyst Benoit Poirier said he’s “awaiting further signs of improvement” for Canadian railways, leading him to lower his target price for both Canadian National Railway Co. (CNR-T, CNI-N) and Canadian Pacific Railway Ltd. (CP-T, CP-N) ahead of the release of their third-quarter results.

“The various economic indicators we monitor have continued to show softness in 3Q19,” he said. “While expectations in terms of industrial production remain positive, they have been revised downward during 3Q19, driven by uncertainty related to the U.S.–China trade dispute.”

“Both CN and CP reported weaker-than-expected RTM in 3Q, mainly due to (1) wet weather conditions which negatively impacted the harvest, (2) an unfavourable crude oil differential, (3) the structural decline of the lumber industry in B.C., and (4) softer potash volumes due to longer-than-expected negotiations between potash producers and China/India. Moving forward, we believe the uncertain economic environment could negatively impact intermodal volumes. In the past, CN and CP have demonstrated their ability to quickly adjust costs. We expect both railroads will be able to return unnecessary leased cars while also adjusting their workforce. In addition, fuel and FX variations should favour OR improvement in 3Q.”

Mr. Poirier also emphasized both companies are struggling to adapt to a “challenging” volume environment and greater competition from other modes of transportation, which is leading to pricing pressures.

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“While both railroads should be able to offset some of these challenges through cost-cutting initiatives, we believe CN will revise its 2019 outlook downward to reflect the current uncertainty," he said. "We believe CP will be able to meet its guidance, although we have reduced our forecast to reflect the current market environment. Bottom line, we are maintaining our Hold rating on both stocks as we believe they are fairly valued at current levels.”

Mr. Poirier lowered his target for CN to $126 from $129. The average on the Street is $126.59.

“We expect CN to reduce its 2019 guidance with 3Q19 results to reflect the challenging volume environment across the board,” he said. “Bottom line, while we continue to like CN in the long term, we are maintaining our Hold rating given the limited upside vs our current target (11-per-cent potential return), rich valuation and uncertain macro environment.”

His target for CP fell to $324 from $330. The average is $331.57.

“We remain confident in management’s ability to meet its 2019 guidance (low-single-digit growth in RTM [revenue ton miles] with low-double-digit growth in adjusted fully diluted EPS; we expect 1 per cent and 12 per cent, respectively)," said Mr. Poirier. "Considering its rich valuation, limited upside to our current target and softer macro environment, we are maintaining our Hold rating.”

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Questor Technology Inc. (QST-X) is a “genuine oilfield unicorn,” according to Raymond James analyst Michael Shaw.

Though he said Canada’s oilfield services industry is currently “a serious grind” for investors, pointing to a rig count “stuck" at 130 while activity declines south of the border, Mr. Shaw initiated coverage of the Calgary-based waste gas combustion company with an “outperform” rating.

“It’s within this challenging environment that QST has authored a rare fact pattern for small cap energy investors: it generates free-cash flow in today’s macro environment and can deploy investment capital to grow that cash flow without requiring significant macro improvements,” he said. "It’s not uncommon to find OFS companies generating free-cash flow, in some cases with fairly high yields, but very few can redeploy the cash into their core businesses and generate acceptable returns, which is why most are focused on some combination of debt reduction and share buybacks. But unlike its conventional OFS cousins, QST has been generating noteworthy EBITDA growth, doubling in the last two years, while preserving 40 per cent or more returns on invested capital.

“Questor rents and sells ultra-high efficiency ‘thermal oxidizers’ (enclosed flares). This has worked well where tough environmental regulations, public concerns for the local impacts of oil and gas development, and investor pressure on E&Ps to adopt more rigorous environmental standards has motivated E&P, mid, and downstream customers.”

He set a target price of $5.50 per share, which falls short of the $6.31 consensus.

“The investable Canadian oilfield industry has become a battle of attrition,” said Mr. Shaw. “With the Canadian rig count stuck around 130 and the US onshore rig count moving lower weekly, we believe investors’ focus should be on those companies generating free-cash flow in today’s market and then, where possible, investors should narrow the field further to those few with high-return reinvestment opportunities. Questor’s results over the last several quarters have shown this is possible. Questor has been generating free cash flow and year-over-year growth notwithstanding flat to negative rig count trajectories in both Canada and the US since mid-2018, though we’d be remiss to exclude 4Q18, in which EBITDA was lower year-over-year against a challengingly strong 4Q17 comp.”

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Awaiting signs of improvement in Canadian completions activity before he becomes more bullish on its stock, RBC Dominion Securities analyst Keith Mackey lowered his financial projections and target price for shares of Calfrac Well Services Ltd. (CFW-T) on Monday.

“We expect Canadian E&P drilling and completion capex to remain below historical levels,” he said. "We forecast average horsepower demand of 0.9 million in 2020, equating to total utilization of sub-50 per cent. While actively staffed equipment utilization is higher, we expect low overall utilization to drive increased competition and pricing pressure until activity improves. Historically utilization of 70 per cent or higher has been the threshold for frac services pricing power in Canada.

“As the only publicly traded Canadian frac pure-play company, Trican offers leverage to potential increases in Canadian industry activity. We estimate a recovery in Montney completions to 2018 levels could drive a 36-per-cent improvement in Trican’s EBITDA, assuming it holds its historical market share. We believe the consolidated nature of the Canadian frac services market also creates a potential advantage relative to the fragmented U.S. market. The top four companies complete over 90 per cent of Montney stages, and Trican is generally a top-2 Montney contractor by completion stage count.”

With a “sector perform” rating, Mr. Mackey reduced his target to $1.25 from $2. The average is $2.48.

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In reaction to its “significant” guidance cut last week, CIBC World Markets analyst John Zamparo cut his estimates for both Hexo Corp.'s (HEXO-T) fourth quarter results, which are scheduled to be released on Thursday, as well as fiscal 2020.

“While we have previously published that we believed the F2020 revenue guidance was in doubt (and consensus reflected this), last week’s change reduces management credibility at a time when cannabis valuations across the sector are reeling,” he said.

Keeping a “neutral” rating, his target fell to $4 from $7.50. The average is currently $5.25.

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In other analyst actions:

TD Securities analyst Vince Valentini raised Rogers Communications Inc. (RCI.B-T) to “action list buy” from “buy” with a target of $89. The average on the Street is $73.94.

Mr. Valentini cut Shaw Communications Inc. (SJR.B-T) to “buy” from “action list buy,” keeping a $32 target. The average is $29.15.

GMP analyst Steven Butler raised Eldorado Gold Corp. (ELD-T) to “buy” from “hold” with a $12.50 target. The average is $12.65.

Fearnley Securities initiated coverage of Africa Energy Corp. (AFE-X) with a “buy” rating and 40-cent target. The average is 37 cents.

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