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

ATB Capital Markets analyst Tim Monachello thinks thecurrent setup is ripe for investors to build overweight positions in the energy services sector.”

“In our view, the upside potential materially outweighs downside risks when considering tactical factors (we believe crude prices are at the bottom end of medium-term ranges), fundamental factors (supportive activity and pricing outlooks) and attractive valuations (the median 2024 estimated FCF yield across our coverage is 27 per cent),” he added.

In a research report released Monday, Mr. Monachello updated his projections for Canadian energy services providers that are exposed to U.S. drilling based on recent revisions to his rig activity forecast south of the border.

“Overall, we believe the Permian basin is likely to see the majority of activity growth over the next 6-12 months, while elevated drilled uncompleted well inventories in gas basins should limit the growth of gas drilling activity until late 2024 or 2025 ... We also provide an analysis of the role of DUC depletion on U.S. production growth that supports our view that there is limited downside to US activity levels in a scenario where US L48 crude production continues to grow modestly,” he said.

“Compared to our previous forecasts, our revised U.S. rig activity forecasts are 5 per cent lower in Q4/23, 8 per cent lower in 2024, and 10 per cent lower in 2025. Our U.S. rig count assumptions now suggest a bottoming in U.S. rig activity in Q4/23, and modest improvements throughout 2024 and 2025. On average, our revised estimates reflect a 3-per-cent year-over-year decrease in average US rig activity in 2024, with 2025 growing 5 per cent year-over-year. The impact of this revision is generally marginal across the companies highlighted ... with EBITDAS on average revised 3.4 per cent and 5.0 per cent lower in 2024 and 2025. The largest revisions are for our directional drilling coverage, PHX and CET, with EBITDAS revised 8.7 per cent and 12.9 per cent lower, respectively, across our forecast horizon.”

While he reduced his projections and target price for shares of Cathedral Energy Services Ltd. (CET-T) based on his broader sector forecast, Mr. Monachello upgraded his recommendation to “outperform” from “sector perform” previously based on recent share price depreciation.

“Despite reporting in-line Q3/23 results, and the second-strongest quarterly performance in company history, CET shares are down 10 per cent since reporting Q3/23 results, down 25 per cent since its highs in late-September, and down 53 per cent since its 52-week high in January 2023,” he said. “We believe CET’s weak performance has been largely attributable to multiple negative earnings surprises in 2023 and a downward trend in forward EBITDA expectations.

“Although we reduce our EBITDAS estimates for CET by 12 per cent in both 2024 and 2025, our reduced 2024 estimate still represents 42-per-cent year-over-year EBITDAS growth as CET progresses its strategy to in-house its MWD tools fleet in the U.S. by mid-2024 (it has been primarily renting from third parties). Although we believe CET continues to face certain risks and turbulence associated with its rapid consolidation strategy, we view these risks as more than fully reflected in its current valuation.”

His target for Calgary-based Cathedral’s shares is now $1.40, falling from $1.50 and below the $1.78 average on the Street, according to Refinitiv data.

“Our estimates suggest CET is trading at just 1.6 times 2024 EV/Adj. EBITDAS while offering a 36-per-cent FCF yield. Furthermore, we believe CET’s Q3/23 results showed a stabilization in its earnings, including a significant improvement in its margin profile, with EBITDA margins reaching nearly 22 per cent. We believe that with reduced consensus expectations for 2024, and CET showing signals of improved earnings quality, CET now offers a strong risk/return opportunity for small-cap investors.”

Mr. Monachello also highlighted a trio of “top ideas” for the sector moving forward. They are:

  • Akita Drilling Ltd. (AKT.A-T, “outperform”) with a $3.50 target, down from $3.75. The average is $3.50.
  • CES Energy Solutions Corp. (CEU-T, “outperform”) with a $4.75 target, down from $5. Average: $4.91.
  • Enerflex Ltd. (EFX-T, “outperform”) with a $11 target (unchanged). Average: $10.94.

“We highlight AKT as our top micro-cap value pick, CEU as a high-quality momentum pick for a reasonable valuation, and EFX as our top candidate for a laggard-to-leader move,” he said.

Mr. Monachello also trimmed his PHX Energy Services Corp. (PHX-T, “outperform”) target to $11.50 from $12. The average is $9.90.

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It is time for investors to “back up the truck for the seasonal trade” in lumber and building materials stocks, according to Raymond James analyst Daryl Swetlishoff, who sees “valuation sensitivities backstop material upside.”

“Over the 2004-19 (15 year) time period, lumber prices saw an average 15-20-per-cent increase between the October low and March peak,” he said. “Building materials share prices are highly correlated to spot WSPF prices with an index of lumber leveraged company share prices exhibiting an 92-per-cent R² to the commodity moves through this time frame. While lumber production is similar each month, demand is seasonal with consumption lowest during the 4Q & highest in early Spring. Hence the supply chain manages inventory by ‘getting lean by Halloween’ and pricing typically bottoms.

“Once again, the trade theme has proven to be a good entry point for investors with stocks staging a nice seasonal rally as end users have begun to replenish depleted inventories. Importantly, however, with building materials shares still trading near the lowest levels observed year-to-date, we highlight current valuations continue to showcase compelling upside. We expect the relationship to continue to push closer to historical levels and reiterate our conviction investors should be adding to positions as the trade theme has generated positive returns in 8 out of 11 years observed prior to Covid. With Western Canadian rail shipments often disrupted by reduced railcar availability into the winter, we highlight the supply chain (Pro Dealers and wholesalers) typically builds inventory between Nov-Feb in anticipation of the Spring building season – supporting additional momentum for the commodity and trading levels alike.”

Mr. Swetlishoff emphasized both cash spruce, pine, and fir (SPF) limber and oriented strand board (OSB) have risen by almost 11 per cent since hitting a seasonal bottom at the end of October.

“Despite Tree Stock shares responding well (up 25 per cent vs. the TSX up 7 per cent), we highlight the seasonal lumber trade is far from over with our top picks still offering attractive value trading at just 0.6 times Price to Book Value P/BV) and 3.0x 2025 EV/EBITDA,” he said. “Given investor inquiries on Bull/Bear narratives, we present sensitivities based on US$400, US$450 and US$500 lumber prices for several valuation metrics as well as Free Cash Flow (FCF) generation. Our analysis puts FCF yields of Doman, Interfor and West Fraser at the top of the sector in each of the observed scenarios. Results underscore the fundamental value inherent in the space with even the Bear Case assumptions supporting more than 60-per-cent upside in theoretical equity values on a P/BV and EV/mfbm basis.

“We also update our 2023 and 2024 commodity price forecasts and introduce financial estimates for 2025. Despite the recent rally, investors continue to discount improved building materials fundamentals, with stocks currently pricing in US$150-350/mfbm [thousand board feet] lumber prices – well below current WSPF spot of US$408. Our valuation assumes conservative 2024 commodity pricing (in line with BC cash costs of production) however, we expect the seasonal rally to continue, as 1) Near record low BC interior harvests (running 40 per cent below the 5-yr average), 2) BC producers operating well below marginal costs of production of ~US$475-500/mfbm, and 3) extremely lean supply chain inventories at all levels backstops tight fundamentals into seasonally stronger markets.”

Given that view, the analyst said his current price targets for companies in his coverage universe point to 30-50-per-cent upside from current levels.

“We highlight shifting our valuation base to what we expect to be a stronger 2025 drives 75-per-cent returns on average,” he said. Declining net debt levels are also poised to backstop positive balance sheet and valuation implications, augmenting ample financial flexibility particularly for lumber bellwether West Fraser. In accordance with our analysis, we highlight Doman, Interfor and West Fraser as preferred stocks to play our constructive thesis, with Strong Buy addition Canfor (vs. Outperform prior) also offering compelling value in light of historically cheap valuation dynamics.”

Mr. Swetlishoff upgraded Canfor Corp. (CFP-T) to “strong buy” from “outperform” and increased his target for its shares to $25 from $23. The average on the Street is $24.

He also made these other target adjustments:

  • Canfor Pulp Products Inc. (CFX-T, “outperform”) to $2.40 from $2.60. Average: $2.28.
  • West Fraser Timber Co. Ltd. (WFG-N/WFG-T, “strong buy”) to US$100 from US$110. Average: US$110.
  • Western Forest Products Inc. (WEF-T, “market perform”) to 60 cents from 75 cents. Average: 85 cents.

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Touting its “40 years of high quality, low emissions drilling inventory,” Stifel analyst Michael Dunn raised his recommendation for Arc Resources Ltd. (ARX-T) to “buy” from “hold” on Monday.

“We continue to be of the view that ARX boasts an asset base that is the envy of many large companies, given its relatively deep inventory of large scale, high quality condensate-rich well locations at Kakwa and Attachie, and its deep inventory of high quality natural gas drilling locations in NEBC,” he said.

Mr. Dunn said his rationale for his previous downgrade to the Calgary-based company “did not play out.” On Oct. 15, he moved its shares to “hold” after cutting his 2024 adjusted funds from operations per share estimate by 7 per cent following revisions to his natural gas price forecast.

“We had anticipated the Street would similarly be moving its 2024 AFFOPS estimates lower when ARX rolled out its 2024 guidance with its 3Q results,” he said “That did not happen. Instead, following its 3Q results we raised our 2024 AFFO estimate by 5 per cent after tuning our model for the 2024 AFFO scenarios ARX provided. At the time, the stock was near our target price, which was set based on 10 times 2024 estimated EV/unhedged FCFF. With Attachie expected to contribute to growth in 2025 ...we are now using a target multiple of 10 times 2025 EV/unhedged FCFF, which yields a target price of $26.25 per share.”

His target rose to $26.25 from $24.25. The current average is $27.45.

“ARX provides attractive exposure to decades of high quality Montney inventory and Canadian condensate prices, as well as LNG prices in the medium term. FCF should see a significant step up in 2025 and beyond when Attachie Phase I starts up,” said Mr. Monachello.

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Tecsys Inc.’s (TCS-T) sales and earnings momentum is “underappreciated” by investors, according to Echelon Partners analyst Amr Ezzat.

Touting it as a “story of transformation,” he initiated coverage of the Montreal-based supply chain technology firm with a “buy” recommendation, seeing it “undergoing a significant change as it continues to shift away from an on-premise model to a SaaS [software as a service] model.”

“Revenues have seen consistent annual double-digit growth since F2020, up from the previous anemic organic growth profile, highlighting the Company’s ability to capture market share and continue to expand its customer base,” said Mr. Ezzat. “The surge in sales velocity can be attributed to the vulnerabilities in global supply chains that were exacerbated by the COVID-19 pandemic. This has heightened the demand for comprehensive, end-to-end integrated SaaS supply chain solutions. All fundamentals point to sustained momentum going forward.

“The Company’s SaaS bookings (SaaS Remaining Performance Obligation – RPO) were up 36 per cent year-over-year to $139.4-million in FQ124. RPO serves as a leading indicator of future revenues by representing contracted, yet-to-be-recognized revenues, signalling a strong revenue pipeline and customer commitments. Over the past three years, RPO has experienced a remarkable CAGR [compound annual growth rate] of 34.7 per cent. While SaaS typically generates lower initial revenue, the silver lining in the strategic shift lies in the creation of a stable, visible, growing recurring revenue stream. We forecast sales to grow 13 per cent on average over the next two years and anticipate an acceleration thereafter.”

Following a “distinct recalibration” of its business model to Saas, Mr. Ezzat predicted Tecsys’ operating leverage will drive “explosive” earnings growth, which he called “an overlooked and misunderstood evolving dynamic.”

“The transition has curtailed the larger (but lumpier) on-premise license revenue side of the business, which has historically delivered between 2-3 times the upfront revenues of the SaaS model, considerably understating the recent underlying revival in revenue growth,” the analyst said. “Coupled with a model that remains too reliant on in-house implementation and investments to support the revival in growth, the transition to SaaS has put a strain on margins. The cornerstone of our investment thesis lies in the fact that the revenue stream experiencing the fastest growth (SaaS) also boasts the highest margins (approximately 50 per cent), ultimately paving the way for aggressive earnings growth.

“But wait, there’s more! SaaS margins are projected to improve further, growing from 50 per cent in F2023 to 70 times by F2028. This drives TCS’ consolidated gross margins from the current 44 per cent to 55 per cent by F2028. We then see EBITDA margins (conservatively) normalize at 17.5 per cent in F2028 from F2023′s 6.2 per cent, leading to a quintupling of run-rate EBITDA. As such, we encourage investors to adopt a longer-term view when evaluating the merits of investing in Tecsys.”

Mr. Ezzat believes there now exists an “evident long-term valuation discount,” which he thinks is “too wide to ignore.”

“We believe using an EBITDA/earnings multiple on short-term earnings estimates significantly (and incorrectly) undervalues Tecsys’ shares as it gives no recognition to the Company’s expanding EBITDA margin profile, which we expect to normalize at 17.5 per cent in F2028. On a long-term normalized EBITDA multiple basis, the valuation disconnect becomes too wide to ignore; we urge investors to adopt a longer-term view when evaluating the merits of investing in Tecsys,” he said.

“We benchmark Tecsys to two sets of peers: supply chain/logistics enterprise software and SaaS players as well as Canadian software and high-visibility players. Tecsys looks attractive on a sales and gross profit multiples basis. An interesting metric we highlight in our comparables benchmarking analysis is EV/LTM gross profit; Tecsys trades at 5.8 times versus the peer median of 10.6 times, a steep 45-per-cent discount. In our opinion, any potential acquirer of Tecsys will evaluate the Company’s takeout merits on this basis due to the expected significant opex synergies. The valuation disconnect would make Tecsys accretive to a lot of players in our comparables set. The valuation disconnect between the gross profit and EBITDA multiples underscores the point ... the Company sacrificed short-term profitability in favour of consolidating a dominant position within the healthcare vertical as well as its SaaS offering, however, with management geared towards focusing on margin expansion, we believe its valuation still remains inexpensive on a long-term EBITDA multiple basis.”

The analyst set a target for Tecsys shares of $45, equating to a 46.9-per-cent total return. The average target on the Street is $46.40.

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Following better-than-expected third-quarter results, an operational rebound is “on deck” for K92 Mining Inc. (KNT-T) to finish the fiscal year, according to National Bank analyst Don DeMarco.

On Nov. 14, the Vancouver-based company, which owns and operates the Kainantu Gold Mine in Papua New Guinea, reported adjusted earnings per share of 1 cents, a penny above the Street’s expectation and matching Mr. DeMarco’s estimate. Cash flow per share, before currency adjustments, of 5 cents was also 1 cent above the consensus and in line with the analyst’s view.

“Financials topped the Street by a penny (in line vs NBF), AISC [all-in sustaining costs] better-than-expected and expectations for a strong Q4/23 reiterated with plant throughput setting new records in Oct,” said Mr. DeMarco at the time. “Overall, we ascribe a positive bias and look for upcoming catalysts/de-risking events with the MRE update (Q4/23), paste fill plant pricing and capex guidance (Q1/24) and setting up for operational momentum to continue into 2024.”

After updating his model based on the release, the analyst now expects full-year production of 111,000 gold equivalent ounces, landing at the low end of the company’s guidance range (111,000 to 116,000 ounces) “buoyed by expectations for a strong finish with Q4/23 of 32k ounces (Q3/23 was 26k ounces) a high 2023 quarterly watermark.” While also expecting lower costs, Mr. DeMarco projects an increased in sustaining capital expenditures in the quarter.

Maintaining an “outperform” recommendation for K92 shares, he trimmed his target to $9.75 from $10 based on a narrowly lower net asset value estimate. The average is $10.39.

“Our thesis is supported by the exploration upside and production growth, both of which heighten M&A appeal, also noting it is one of the few remaining single-asset companies and with visibility for production over 400k oz, a wheelhouse of interest to seniors,” he said.

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Ahead of the Tuesday’s premarket release of Alimentation Couche-Tard Inc.’s (ATD-T) second-quarter 2024 earnings report, Desjardins Securities analyst Chris Li expects the results to exhibit “softening” U.S. consumer trends and tobacco headwinds, “offset by continuing solid fuel margins supported by favourable industry fundamentals and company initiatives.”

“While we do not expect the results to be a catalyst, we remain positive on ATD’s long-term organic growth initiatives and M&A opportunities discussed at its recent investor day,” he said. “Our organic EBITDA CAGR [compound annual growth rate] of 4–5 per cent (FY23–28) is conservative vs management’s 7 per cent, with upside from M&A.”

Mr. Li is now expecting earnings per share of 77 US cents, down from 72 US cents during the same period a year ago and a penny below the 78-US-cent consensus forecast. His revenue estimate of US$16.357-billion is narrowly higher than Street’s projection of US$16.254-billion, but it’s also a decline from a fiscal 2023 (US$16.88-billion).

“In line with peers, we expect U.S. merch SSSG [same-store sales growth] of 1.3 per cent vs 2.1 per cent in 1Q FY24, driven by slower tobacco sales and a cautious U.S. consumer, offset by growth from packaged beverages, Fresh Food, Fast and private brands,” he said. “ATD is also up against a tough year-ago comp of 5.6 per cent. We believe consensus of 2.6 per cent is likely high. We forecast merch SSSG of 2.0 per cent in Europe (2.5-per-cent consensus) and 4.5 per cent in Canada (4.3-per-cent consensus), and 50 basis points year-over-year yoy globally due to a favourable product mix.

“SS fuel volume in the US (0 per cent vs 0.6-per-cent consensus) and Europe (down 0.5 per cent vs up 0.1-per-cent consensus) is expected to be impacted by weaker demand, while Canada (4.5 per cent vs 5.1-per-cent consensus) should benefit from promotional activities to win back market share.”

While he made modest increases to his 2024 revenue and earnings expectations, Mr. Li maintained a $82 target for Couche-Tard shares, reiterating a “buy” recommendation. The average on the Street is $86.60.

“While the potential return is extremely limited for a Buy rating, our positive view is based on attractive long-term growth, supported by ATD’s strong financial position. We plan to revisit our estimates and valuation following the results,” he said.

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In other analyst actions:

* Deutsche Bank’s Amit Mehrotra downgraded both Canadian Pacific Kansas City Ltd. (CP-N, CP-T) and Canadian National Railway Co. (CNI-N, CNR-T) to “hold” from “buy” on Monday. The analyst’s targets fell to US$77 and US$121, respectively from US$85 and US$125. The averages are US$87.08 and US$123.39.

* Paradigm Capital’s J. Marvin Wolff reduced his target for shares of Martinrea International Inc. (MRE-T) to $21.50 from $24, keeping a “buy” recommendation, after a recent update to his target for NanoXplore Inc. (GRA-T). Martinrea holds a 22.7-per-cent stake in the Montreal-based carbon and graphite product manufacturing company, which recently unveiled a large-scale dry process for manufacturing graphene.

“Martinrea provides an earnings growth play in the auto parts sector with growth on several fronts: new mandate wins; margin expansion from both higher margins on light-weighting solutions; and operating cost efficiencies,” said Mr. Wolff. “We see Martinrea being able to increase profits substantially over the next two years, plus any share price contribution from NanoXplore. We expect VoltaXplore, will announce plans to build a 2 GW battery plant in the next few week.”

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Tickers mentioned in this story

Study and track financial data on any traded entity: click to open the full quote page. Data updated as of 20/02/24 3:16pm EST.

SymbolName% changeLast
AKT-A-T
Akita Drilling Ltd Cl A NV
0%1.5
ATD-T
Alimentation Couche-Tard Inc.
+0.13%85.18
ARX-T
Arc Resources Ltd
+2.73%22.59
CNR-T
Canadian National Railway Co.
+0.27%173.59
CP-T
Canadian Pacific Kansas City Ltd
+0.35%115.19
CFP-T
Canfor Corp
+2.44%16.81
CFX-T
Canfor Pulp Products Inc
-1.26%1.57
CET-T
Cathedral Energy Services Ltd
-1.12%0.88
CEU-T
Ces Energy Solutions Corp
+0.24%4.17
KNT-T
K92 Mining Inc
-1.54%6.39
MRE-T
Martinrea International Inc
+0.5%14.03
PHX-T
Phx Energy Services Corp
+1.22%9.15
TCS-T
Tecsys Inc J
0%34.36
WFG-T
West Fraser Timber CO Ltd
+1.72%108.2
WEF-T
Western Forest Products Inc
0%0.66

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