Inside the Market’s roundup of some of today’s key analyst actions
A strong start to the year for North American lumber producers has been “thwarted” by COVID-19, according to RBC Dominion Securities analyst Paul Quinn.
In a research report previewing earnings season in the sector released Thursday, Mr. Quinn slashed his first-quarter EBITDA projections by 58 per cent and his 2020 expectations by 92 per cent in order to reflect a drop in demand across commodity markets. The reductions came alongside declines to his price deck for lumber, panels, pulp and packaging.
“In response to the COVID-19 pandemic, several lumber producers have announced and implemented reduced production schedules to align supplies with a weaker demand environment,” he said. “Curtailments have been announced by several major North American lumber producers, including Canfor, Interfor, West Fraser, Western Forest Products, and Weyerhaeuser. We estimate that approximately 26.2 per cent of North American capacity has been curtailed as a result of the virus. We expect supplies to more closely align with the lower demand, with the downtime in effect during Q2, and a gradual ramp-up in production as builders return to worksites.”
With the updated outlook, Mr. Quinn made a trio of ratings changes to stocks in his coverage universe. He lowered these stocks to “sector perform” from “outperform” previously.
Conifex Timber Inc. (CFF-T) with a 50-cent target, falling from $1. The average target on the Street is 58 cents.
“While Conifex remains 'undervalued on some traditional metrics, we are often reminded that value is only what someone is willing to pay for it,” he said. “In this case, we do not see a natural buyer for the Mackenzie sawmill/biomass asset well above current levels (and we expect that the company has tried).”
Cascades Inc. (CAS-T) with a $15 target (unchanged). Average: $13.83.
“Year-to-date, Cascades has outperformed the TSX by 40 per cent, driven by the company’s higher exposure to stable end-markets and what we view as thematic buying from investors looking to add tissue exposure,” the analyst said. “However, we believe that investors have not yet priced in the 223-per-cent year-to-date increase in OCC prices, which will erode margins. In addition, we see higher relative returns elsewhere; therefore, we are moving to Sector Perform.”
CanWel Building Materials Group Ltd. (CWX-T) with a $4 target, down from $5. Average: $4.53.
Mr. Quinn also made the following target price adjustments to Canadian companies he covers:
- Canfor Pulp Products Inc. (CFX-T, "outperform) to $7 from $6. Average: $7.77.
- Acadian Timber Corp. (ADN-T, “sector perform”) to $15 from $16. Average: $16.
- Norbord Inc. (OSB-T, “outperform”) to $32 from $44. Average: $32.70.
- Western Forest Products Inc. (WEF-T, “outperform”) to $1.00 from $1.25. Average: $1.
“In Canada, our top ideas are Canfor Corporation, Canfor Pulp, Interfor, KP Tissue, Norbord, West Fraser, and Western Forest Products,” he said.
Seeing its risk/reward coming “into balance,” BMO Nesbitt Burns analyst Devin Dodge lowered Stantec Inc. (STN-T) to “market perform” from “outperform."
“Stantec has been the best-performing Industrials stock in Canada in 2020 and it has also outpaced all of its global engineering & design peers,” he said. "However, we believe the risk of a sluggish demand recovery has been rising due to fears of deteriorating financial health across its customer base, particularly among its private clients.
His target fell to $41 from $46. The average is $44.75.
Citing its “blue-chip” balance sheet and “attractive e-commerce related industrial real estate exposure that may be well positioned for long-term growth,” Industrial Alliance Securities analyst Brad Sturges raised his rating for Granite Real Estate Investment Trust (GRT-UN-T) on Thursday.
Moving the Toronto-based REIT to "strong buy" from "buy," Mr. Sturges said Granite has outperformed its TSX-listed peers thus far in 2020, due largely to its defensive "posturing," which he anticipates will continue for the next 12 months.
"Granite may shift to some offense on an opportunistic basis as the global economy starts to reopen and returns to more normalized levels," he said. "The global industrial real estate sector could relatively recover faster than other property sectors due to accelerating e-commerce retail sales penetration, including food and pharma, and the potential for global supply chains to be reimagined given recent disruptions experienced during the global pandemic."
"Granite also benefits from senior management’s historical track record of generating above-average total returns, above-average AFFO [adjusted funds from operations] per unit and NAV [net asset value] per unit growth prospects based on internal and external growth initiatives, the potential for P/AFFO multiple expansion as the REIT’s Magna tenant concentration is further reduced, and potential for future distribution increases," said Mr. Sturges. "Granite’s investment risks include above-average tenant concentration, above-average re-leasing risks for special purpose properties (SPPs), development risks, and foreign currency exposure.
Mr. Sturges maintained a target price of $77 per share. The average on the Street is $73.
Admitting he underestimate the impact of COVID-19 on the Canadian Big 3 grocers' sales, Desjardins Securities analyst Chris Li sees them continue to outperform in the near term as investors maintain their defensive stance.
“On Tesco’s recent earnings call, management humbly acknowledged that its forecasts are ‘precisely wrong’,” said Mr Li. "We feel the same way about ours but we must try. Following L’s withdrawal of guidance last week, EMP’s COVID-19 update [Wednesday] and ahead of MRU’s 2Q results next week, we have made our best attempt to estimate the impact of COVID-19 on sales and costs.
"Our earnings estimates are generally revised up as we expect higher sales growth to more than offset incremental costs related to the pandemic. The key unknown is how long these costs last and how much will recur next year. This will have implications for earnings growth next year once market conditions normalize."
Citing Statistics Canada data, Mr. Li said hes estimate the average annual household spending on food purchased from restaurants is aprroximately $2,600. Working under the assumption spending on restaurants will decline by 60–70 per cent for six months, he thinks it will lead to $3.3–3.8-billion in incremental grocery sales, which will lead to 500–600 basis points of tonnage growth for the grocers.
"While EMP’s COVID-19 update provided one useful data point on costs, our best guess is that the incremental costs will account for about 1 per cent of the food retailers’ sales," he said. "This percentage is largely in line with Tesco’s estimate for its UK business. Our base case assumes 10 per cent of the costs are recurring. Our downside scenario assumes 30 per cent of the COVID-19 costs are recurring."
Expecting incremental costs to be more than offset by increased sales over the next four quarters, Mr. Li raised his sales and earnings expectations for the sector.
That led to changes to his target prices for the companies' stocks. They were:
Empire Co. Ltd. (EMP-A-T, “buy”) to $34 from $30. The average on the Street is $34.50.
“Year-to-date, EMP is up 1 per cent and trails L (9 per cent) and MRU (11 per cent),” he said. “We attribute the underperformance to weaker same-store tonnage results (partly due to lapping strong year-ago comps and regional economic softness), investors’ concerns about the company’s limited discount presence (trade-down in a recession), relatively high exposure to western Canada, higher execution risks and significant costs related to various initiatives (eg Ocado, FreshCo western Canada expansion, etc). While these are all fair concerns, we believe they are partly reflected in the share price, with the stock trading at 15 times 12-month forward P/E [price-to-earnings], a discount to Loblaw at 16 times and 19 times for MRU.”
Loblaw Companies Ltd. (L-T, “hold”) to $76 from $73. Average: $78.10.
"Looking past the near-term uncertainty, we believe L’s leading market share and scale, strong pipeline of P&E improvement initiatives, rich data-driven insights, and solid FCF and balance sheet will enable the company to create long-term shareholder value by consistently growing earnings (8–10-per-cent EPS growth target) and returning capital," he said."
Metro Inc. (MRU-T, “hold”) to $60 from $57. Average: $58.20.
“While MRU is certainly a high-quality company with a strong management team and ticks all the boxes for its defensive nature, unless fundamentals get worse from here, we do not see much room for further multiple expansion. With only low-single-digit potential total return, we prefer to wait for a more attractive entry point closer to our downside valuation in the low C$50 level,” he said.
On the sector as a whole, Mr. Li concluded: “Continued outperformance will likely become more challenging in 2H and early 2021 as the COVID-19 impact eases, the industry laps very strong comps, competition intensifies, spurred by the launch of potentially disruptive online services (eg Ocado by EMP, Delivery Unlimited by Walmart, etc) as well as lingering costs from COVID-19. Within the staples space, as market conditions begin to stabilize in the back half of the year, we could see a rotation out of the grocers into stocks with more torque such as Couche-Tard.”
AltaGas Ltd. (ALA-T) “is uniquely positioned with midstream assets in core parts of the Western Canadian Sedimentary Basin along with a series of U.S.-based utility assets,” said Credit Suisse analyst Andrew Kuske
Seeing it provide “interesting exposure to frac spreads and selected export movements along with an ability to eventually drive greater returns from the core utility business,” Mr. Kuske initiated coverage with a “neutral” rating.
“In our coverage universe, AltaGas Ltd. is somewhat uniquely positioned with a $4-billion (albeit from COVID-19 impacted market volatility) market cap with a degree of balance coming from a core utility business and midstream assets,” he said. "We believe the midstream business casted a bit of an overhang on the stock in the near term, however, it should provide upside. Moreover, the core utility business is under-earning which gives another lever for potential upside.
“Clearly, ALA underwent a significant transformation over the last 12-18 months by executing a series of divestitures that helped to de-lever the balance sheet following the close of the WGL Holdings acquisition in the summer of 2018. Putting the near-term COVID-19 issues aside, for the most part, the ALA story now shifts to operational execution in all businesses. From our perspective, opportunities exist for ALA to de-risk cash flows and drive greater returns. We view the Ridley Island Propane Terminal (RIPET) and Petrogas as potentially significant value drivers. Yet, we believe near-term risks exist in current market conditions and, as a result, find better relative value exists elsewhere.”
He set a target of $17. The average on the Street is $18.36.
Seeing it poised to benefit from the increasing popularity of plant-based protein, Canaccord Genuity analyst Tania Gonsalves initiated coverage of Vancouver-based Burcon NutraScience Corp. (BU-T) with a “buy” rating.
“Burcon has spent two decades and close to $100.0-million perfecting its plant protein extraction technology and building out its IP portfolio,” she said. "The market wasn’t ready until now. Last year, Burcon licensed its pea and canola proteins to Merit Functional Foods. Merit is jointly owned and operated by Burcon (40 per cent), the former COO and VP of innovation of Manitoba Harvest (40 per cent), and founder of Hemp Oil Canada Inc (20 per cent).
“In January, Merit and Burcon announced the most transformative deal in their history. The companies partnered with Nestlé, the world’s largest food and beverage company, to supply protein for its plant-based meat and dairy alternative products. With a brand-new production facility slated to come online this December, we expect Burcon and Merit to begin generating revenue this year. We forecast Merit growing protein sales to $212.5-million by fiscal 2025, on which Burcon will generate an estimated $11.7-million in royalty income.”
Ms. Gonsalves said Burcon is likely to gain market share from the jump in retail sales for plant-based foods moving forward, noting a backlash against soy products over their allergenicity and phytoestrogen content. She thinks pea protein will be the biggest benefactor.
"It is non-GMO, easily digestible and nonallergenic. The global pea protein market is estimated to be worth over US$200.0-million. Consumption is forecast to grow from 275,000 MT in 2019 to 580,000 by 2025, fueled by use in well-established brands like Beyond Meat. Sales and consumption have been capped by production capacity. Actual demand is likely much higher," the analyst said.
“Burcon’s pea protein is differentiated based on its superior flavor, colour, solubility, nutrition profile and 90 per cent-plus purity. We expect it to fetch a long line of buyers and premium price. Still, with global pea protein production likely to double over the next couple of years, Burcon has sought to diversify its offering with canola protein. As the world’s second largest oilseed crop, canola meal is cheap and abundant. It contains 35-per-cent protein but is difficult to extract and purify. Burcon has developed a patented solution that produces a canola protein with similar favourable characteristics to its pea protein. We expect Merit to be one of the first producers of canola protein in the world. Canola protein is rich in the amino acids that pea protein lacks. By blending the two, Burcon has created a ‘perfect protein’, with all the essential amino acids and digestibility equivalent or superior to eggs and cow’s milk.”
Ms. Gonsalves set a $1.75 target for Burcon shares. The average is $2.88.
Expecting coffee and peanut butter demand to “remain stronger for longer,” Credit Suisse analyst Robert Moskow raised his rating for J.M. Smucker Co. (SJM-N) to “neutral” from “underperform.”
"Smucker’s portfolio is well-positioned for stay-at-home food consumption. Smucker’s retail sales grew 39% in the 4-weeks ending April 4 due to strong consumer demand for its trusted market leaders, especially Folgers and Dunkin’ coffee, Jif peanut butter, and Uncrustables frozen sandwiches. In its March 23 COVID-19 announcement, management said that its Coffee and Consumer Foods manufacturing facilities are operating at or near full capacity to meet increased demand and are focusing on top-selling SKUs to maximize throughput. Even after stay-at-home mandates phase out, we expect sales to remain at an elevated level as many consumers continue eating at home to save money and maintain some degree of social distancing. Peanut butter profit margins will move higher now that Smucker has terminated price promotions through November. For context, Smucker’s portfolio proved highly recession-resistant in 2009."
After raising his earnings expectations for 2020 and 2021, Mr. Moskow kept a US$115 target for Smucker shares. The average is US$108.85.
“We believe that most of the incremental sales growth over the next three quarters will translate into EBIT growth assuming that the benefits from operating leverage and terminating promotional discounts on peanut butter will offset higher labor and logistics costs,” he said.
In other analyst actions:
Scotia’s Trevor Turnbull upgraded Osisko Gold Royalties Ltd. (OR-T) to “sector outperform” from “sector perform”
Scotia’s Ovais Habib raised Alacer Gold Corp. (ASR-T) to “sector outperform” from “sector perform”
National Bank Financial analyst Adam Shine lowered Thomson Reuters Corp. (TRI-T) to “sector perform” from “outperform” with a $96 target, rising from $93. The average is $106.30.
BMO Nesbitt Burns cut Stantec Inc. (STN-T) to “market perform” from “outperform” with a $41 target, down from $46 and below the $44.95 target.
Eight Capital downgraded Aphria Inc. (APHA-T) to “buy” from “neutral” with an $8 target, down from $9. The average is $9.42.
JPMorgan analyst Doug Anmuth downgraded Twitter Inc. (TWTR-N) to “neutral” from “overweight” with a US$29 target. The average is US$30.67.