Inside the Market’s roundup of some of today’s key analyst actions
A pair of equity analysts on the Street downgraded Roots Corp. (ROOT-T) on Thursday, a day after the retailer reported “mixed” fourth-quarter 2019 results and took significant steps to react to the impact of COVID-19 on the retail industry.
Before the bell on Wednesday, Roots announced it is permanently closing its seven stores south of the border and is filing bankruptcy for its U.S. subsidiary. It also said it has repurposed its leather factory in Toronto to produce non-medical-grade face masks.
Taking a "cautious" view of the results and pointing to increased near-term uncertainty, RBC Dominion Securities analyst Sabahat Khan added a "speculative risk" qualifier to his "sector perform" rating.
“The current operating environment, which has been impacted significantly by the COVID-19 breakout, and the potential for a meaningful economic slowdown over the coming quarters could impact discretionary spending,” he said. “This could present risks for Roots given its positioning as an apparel retailer.”
Mr. Khan lowered his 2020 earnings per share estimate to a 4-cent loss from a 3-cent profit previously. His 2021 projection slid to nil from a 9-cent gain.
He maintained a $1 target for Roots shares. The average target on the Street is $1.41.
Elsewhere, Scotia Capital analyst Patricia Baker lowered Roots to “sector perform” from “sector outperform” with a $1.75 target, down from $3.50.
“ROOT’s Q4 results fell short of Company and street expectations with adj. EPS of 31 cents, down 41.5 per cent year-over-year,” she said. “The year-over-year decline reflected serious operational challenges in the business. Roots continued to experience inefficiencies related to the DC and flow of product to the stores that negatively impacted sales, gross margins and also drove higher cost as the company ramped to support holiday volumes. .... . Roots started F20 with a clear focus on generating cash flow and indicated they were off to a good start. In the wake of COVID-19 and related store closures and demand destruction, ROOT has taken significant actions to lower costs and is focused intently on managing liquidity. A bright spot in the quarter was solid eCommerce trends with penetration having hit 20 per cent.”
"Our stance in software has been that, for the time being, you want to stick with the perceived safe havens – names with the smallest chances of meaningful or rolling downward estimate revisions," he said. "These are admittedly crowded trades, but in a tape like this, valuation really only matters at extremes. Investors have lumped Shopify into this group as secular tailwinds and the potential acceleration of the move to online commerce is almost surely a safe bet. We see two issues with this trade: (1) we’re not entirely convinced that GMV, which drives 60 per cent of SHOP’s revenue, is as bulletproof as perceived as discretionary spend retreats, and (2) the stock’s valuation, at 29 times EV/R [enterprise value to revenue] on calendar 2021, is now at an extreme, which means it matters. We just can’t get there anymore on valuation, which is why we’re downgrading SHOP."
In a research note released before the bell, Mr. Hynes moved Ottawa-based company to “hold” from “buy.”
“Let’s run a thought experiment on the numbers,” he said. “To keep a Buy on this stock, we’d need to believe SHOP could see about $700 in a year from now – a roughly 10-per-cent return. And let’s say that in a year, we’d be willing to pay 20 times calendar 2022 for the stock. As an aside, 18 months ago a premium valuation would have been 12-times forward revenue, not 20 times, especially for a business with mid-50-per-cent gross margins, but I digress. If that’s the case, where do we need to see 2022 revenue to support a $700 stock? Our back of the envelope math says you’d need about $4.5-billion in 2022 revenue, which is 41-per-cent 3-year revenue CAGR [compound annual growth rate] and an estimate that’s currently about 10 per cent above a very crude consensus projection. Is it possible? Sure. But for perspective, none of the other category kings in software – Adobe, Salesforce, ServiceNow, Workday, etc. – sustained that rate of growth on the path from $1.5-4.5-billion. This is no doubt a different business; but, our point is that SHOP is already pricing in near-perfect execution, and that’s a risk that seems silly to take in this environment.”
Mr. Hynes also questioned its decision to pull its 2020 guidance in early April.
"Granted this is a near-term observation, but if things were going swimmingly for SHOP, wouldn’t they just keep their promises to the Street and steadily move numbers higher as they have every other year?," the analyst said.
“If we’re truly headed towards Great Depression-like, 20-per-cent unemployment by this summer, then demand for the nice-to-haves that are a large part of the inventory of SHOP merchants is almost surely to fall. Given that 60 per cent of revenue is directly linked to Shopify’s customers growing their sales (via monetization of payments, shipping, etc.), this could be a meaningful headwind.”
He lowered his 2020 and 2021 earnings per share expectations to 9 US cents and 72 US cents, respectively, from 37 US cents and 79 US cents.
Mr. Hynes maintained a US$600 target for Shopify shares. The average on the Street is US$512.55.
“SHOP shares aren’t likely to crater; the industry dynamics at play are too strong in their favor,” he said. “What’s more likely is that the stock could ‘go to sleep,’ grinding along sideways for a period long enough to burn off a portion of its excess valuation. Good growth businesses almost always grow into their valuation, so we fully expect there will be a time again when we have a Buy on SHOP. For now, however, we believe the correct rating is a HOLD.”
Raymond James analyst Frederic Bastien and Ben Cherniavsky are maintaining their "broadly constructive" view of the engineering and design sector amid the COVID-19 pandemic.
"All four firms under our coverage universe — WSP Global, Stantec, SNC-Lavalin and IBI Group — are harnessing recent technology investments to efficiently deliver projects remotely and support their clients’ rapidly changing needs," they said in a research note released Thursday. "They also track staff utilization and other critical KPIs in real time, which should help their executives closely align personnel requirements and cost structures with the looming downdraft in private sector demand. No engineering consultancy will exit the COVID-19 crisis unscathed, to be clear, and some will need to act more swiftly in response to the concurrent energy crisis. Others should fare better given their scale, strong balance sheet and comparatively more diversified business model.
“That said, we expect the infrastructure and transportation practices of these four companies to all play integral roles in looming government stimulus efforts. Longer term, these firms should also leave their marks on what we view as an unstoppable global trend — urbanization.”
Though he feels its engineering, design & project management (EPDM) business is likely to show “resilience” through the pandemic, Mr. Bastien expressing concern about the impact of energy sector struggles on SNC-Lavalin Group Inc. (SNC-T), leading him to downgrade his rating for its stock to “outperform” from “market perform.”
"The already struggling oil and gas business, for one, faces further challenges as the over invested industry shuts in production to adjust for structurally lower demand," he said. "This 'new normal' does not bode well for the construction-light operations SNC maintains in the Middle East as well as the three lump sum turn-key (LSTK) projects it has yet to complete in the region. We already know the company secured those at razor thin margins, leaving little to no room for performance issues, let alone disruptions from the worst pandemic of its kind.
“Closer to home, it is reasonable to expect the temporary suspension of the Montreal REM and Husky White Rose projects, combined with the various safety measures implemented at the Eglinton Crosstown and Trillium LRT sites, to cause further drains on cash. What we find more concerning are the notice of default recently issued to the SNC-led Rideau Transit Group (which puts its 30-year maintenance contract for the Ottawa LRT at risk) and the previously unthinkable — the suspension of Highway 407’s dividend last week amid cratering traffic numbers. Although we fully expect cash distributions to resume once life gets back to normal in the Greater Toronto Area, this once-in-a-lifetime event and slowing collections will likely keep SNC on the M&A sideline for that much longer.”
His target for SNC slid to $30 from $38. The average is $35.71.
"When we upgraded SNC on the back of last fall’s surprise legal settlement, we cautioned the story would not be void of setbacks," said the analyst. "Little did we know two Black Swans (coronavirus and crude) would pop up concurrently and throw a wet blanket over the firm’s strategic realignment. Against such an uncertain backdrop, we feel compelled to lower both our rating to Market Perform and our target."
At the same time, Mr. Bastien lowered IBI Group Inc. (IBG-T) to “outperform” from “strong buy.”
"Given the severity of the COVID-19 crisis on our coverage universe, we feel justified in rolling our valuation forward to 2021," the analyst said. "We balance this out with the use of a lower target EV/EBITDA of 7 times, from 8 times previously, since investors are unlikely to reward this illiquid small-cap stock with average historical valuations anytime soon. Moreover, while we remain constructive on the stock, we don't see the necessary potential catalyst(s)."
His target fell by $1 to $7.50. The average is $7.70.
Though the current environment remains “challenging,” Desjardins Securities analyst Maher Yaghi sees “significant” opportunities for CGI Inc. (GIB.A-T, GIB-N) to create long-term value for shareholders as the pandemic abates.
On Wednesday before the bell, the Montreal-based technology services firm reported quarterly results that largely fell in line with Mr. Yaghi’s expectations, seeing organic revenue decline 1 per cent year-over-year due largely to the impact of COVID-19. The pandemic also result in “weak” bookings, but the analyst thinks CGI’s largest backlog could help “smooth” the decline in revenue.
"Pressure was broad-based and bookings were also affected as customers delayed IT projects," he said. "Management expects revenue to remain under pressure; however, it has acted to lessen the impact on the bottom line. Compensation expenses were significantly curtailed at the senior management level and some temporary layoffs were implemented. At this stage, management continues to target positive EPS growth in the year given the current environment."
With results and cost reductions, Mr. Yaghi lowered his revenue and earnings expectations for both the remainder of 2020 and 2021. His EPS estimates slid to $4.80 and $5.15, respectively, from $4.84 and $5.36.
“We expect the next few years to likely offer significant opportunities,” he said. “First, we expect that customers are likely to consolidate their IT service providers to generate savings. We also see consolidation within the IT service industry with increased M&A activity. GIB is well-positioned on both fronts given its healthy balance sheet and market share position in most of its operating geographies.”
Keeping a “buy” rating for CGI shares, Mr. Yaghi increased his target to $100 from $96. The average on the Street is $97.24.
“We expect GIB to implement cost-saving initiatives to squeeze out EPS growth in FY20 provided the current shutdown does not last longer than six months,” he said. “Combined with a very healthy balance sheet to undertake accretive M&A transactions and a relatively attractive valuation compared with large IT service companies, we believe the current share price still offers a good entry point.”
Elsewhere, Canaccord Genuity's Robert Young increased his target to $105 from $100 with a "buy" rating (unchanged).
Mr. Young said: “While we do expect organic growth to pause as organizations deal with firefighting, CGI sees tactical demand to serve as an advisor to large enterprise and government customers as they react to COVID-19, rebound from it and then reinvent as the need for digital transformation becomes more clear. CGI elevated the prominence of its M&A strategy to offset organic headwinds and has positioned the balance sheet to be ready for more attractive valuations. With modestly increased estimates and improved confidence, we reiterate our BUY rating."
Ahead of earnings season for Canadian forest products companies, Credit Suisse analyst Andrew Kuske said he’s shifting his bias “fairly markedly” toward Mercer International Inc. (MERC-Q), leading him to raise his rating to “outperform” from “neutral.”
His target rose to US$12 from US$10 to reflect “a view of China and European markets benefiting from an earlier recovery versus the Americas.” The average on the Street is US$9.70.
Conversely, he downgraded Norbord Inc. (OSB-T) to “underperform” from “neutral” with a $20 target, down from $28 and below the $32.21 target.
“In our view, [Norbord] is much better positioned than the last major downturn of the 2008/09 financial crisis, but the extent of restrictive orders on activities likely translates into downside risks on Oriented Strand Board (OSB) volumes and prices with sputtering construction activity,” Mr. Kuske said.
After the bell on Wednesday, the Montreal-based clothing manufacturer reported first-quarter results that fell short of Mr. Lejuez's expectations. Earnings per share of 6 US cents missed the projections of both the analyst (19 US cents) and the consensus on the Street (11 US cents).
The company also announced it has suspended its quarterly cash dividend "given the severity of the crisis and the uncertain economic outlook."
"1Q was weak, hurt by the sharp deceleration in performance in March related to COVID-19," said Mr. Lejuez. "Not surprisingly, trends in April have decelerated further and N America imprintables sales are running down 75 per cent month-to-date. Like most retailers/vendors, there is little visibility and not much good news for GIL right now. Trends have improved slightly in the last couple of days, so it seems fall of 75 per cent is as bad as its going to get (though that’s still pretty bad). On the positive side, the company seems to have ample liquidity and has cut capex and expenses to a minimum."
In response to weaker-than-anticipated sales and margins, the analyst cut his 2020 and 2021 earnings per share projections to 52 US cents and US$1.10, respectively, from US$1.58 and US$1.75.
Keeping a "neutral" rating, Mr. Lejuez lowered his target to US$16 from US$18. The average on the Street is US$18.26.
Elsewhere, RBC Dominon Securities analyst Sabahat Khan moved his target to US$15 from US$17 with a "sector perform" rating (unchanged).
Mr. Khan said: “Q1 results reflected the initial impact of COVID-19 and we expect continued weakness through 2020 (with Q2 likely reflecting a ‘bottom’). Given that management (and the broader imprintables industry, for that matter) has limited visibility to how a recovery could play out, we believe that the company is taking the necessary steps to ensure that it has ample liquidity as it navigates this challenging backdrop. The investment community had largely assumed that the NCIB was on hold until things ‘normalized’; however, the suspension of the dividend was announced somewhat ahead of our expectation. We view the dividend suspension as a proactive and prudent measure that will result in the conservation of $120-million of cash flow. Looking ahead, we reduce our forecasts to reflect weaker 2020 sales/earnings and a more subdued recovery in 2021 relative to our prior expectations. Although we view Gildan as being better positioned amidst the current backdrop than many of its peers and think that it stands to gain market share once the ‘dust settles,’ we remain on the sidelines until we gain increased visibility to improving demand trends.”
On Wednesday, the Toronto-based electronics manufacturing services company reported first-quarter results that exceeded expectations on the Street. Revenue of US$1.32-billion and adjusted earnings per share of 16 US cents both topped the consensus expectation on the Street (US$1.23-billion and 10 US cents).
"The company has nearly all of its manufacturing sites back in operation and has adapted to new post COVID-19 health and government guidelines, such as worker spacing, temperature checks, shifting of work shifts, protective and cleaning equipment, etc," said Mr Suva. "While Celestica did not provide detailed Q2’20 guidance, the company did state they expect Q2’20 to be similar to Q1’20, which is materially better than other companies as COVID-19 impacts are worsening in Q2’20 compared to Q1’20."
Mr. Suva did lower his 2020, 2021 and 2022 earnings per share projections to 60 US cents, 66 US cents and 72 US cents, respectively, from 68 US cents, 77 US cents and 81 US cents.
However, keeping a "sell" rating, he increased his target for Celestica shares to US$5 from US$4. The average on the Street is US$6.17.
“While we are very impressed, we note the stock increased 19 per cent [Wednesday] compared to the 3.6-per-cent NASDAQ gain," he said.
“We rate CLS Sell as we see downside risks to consensus CY20 sales forecast given Celestica’s disproportionately high exposure to networking (42 per cent of revenue) and enterprise (21 per cent of revenue) end markets. We acknowledge the 2019 stock underperformance has set a low bar and the company is trading at 20-per-cent FCF [free cash flow] yield and 1.3 times price to tangible book value. However, our experience shows disengagement and program exit with top customers typically cause stock turbulence for several quarters.”
Elsewhere, RBC Dominion Securities analyst Paul Treiber raised his target to US$6.50 from US$5, maintaining a “sector perform” rating.
Mr. Treiber said: “Celestica reported better-than-expected Q1 results and provided an outlook for Q2 that suggests better visibility and less headwinds than we previously expected. While Celestica saw a slowdown in aerospace and industrial, demand from hyperscalers was higher than expected. As such, we believe Celestica’s valuation multiples would begin to normalize from prior trough levels.”
Desjardins Securities analysts Michael Markidis and Kyle Stanley feel the impact of COVID-19 on multi-family real estate investment trusts will not be seen in first-quarter 2020 financial results.
However, in a research report previewing the upcoming earnings season, the analysts say they are placing a greater emphasis on the supply curve, expressing concerns about the risks to demand drivers, like population and employment growth.
"Given the circumstances, we are encouraged by April rent collection figures (92–97 per cent of revenue) which have been disclosed by BEI, HOM, KMP, MI and NVU over the past several weeks," they said. "The temporary waiver/suspension of renewal increases, combined with the prospect of some occupancy leakage, will likely temper sequential same-property revenue growth over the next quarter or two. More important, in our view, is the effect that COVID-19 may have on fundamentals and asset values through 2021."
Though the analysts did not adjust their first-quarter estimates in response to the pandemic, Mr. Markidis made a pair of rating changes.
He raised Canadian Apartment Properties Real Estate Investment Trust (CAR-UN-T) to “buy” from “hold” with a $57 target, down from $61. The average on the Street is $58.22.
"Given its $8-billion market cap, CAR is perhaps the most convenient way for some investors to play the Canadian multifamily sector," he said. "More than 50 per cent of consolidated NOI [net operating income] is derived from apartment properties in Toronto, Montréal and Vancouver. Exposure to Alberta and Saskatchewan (6 per cent) is comparatively limited. CAR has historically prioritized occupancy vs rent growth in managing its portfolio. This approach may arguably be better suited to protecting the top line in the near term.
“The balance sheet is strong — pro forma D/EBITDA of 9.2 times is the lowest within the multifamily peer group. We estimate corporate liquidity exceeds $300-million (6 per cent of total debt) and we believe the asset base could support significant incremental debt financing should the need arise.”
At the same time, he lowered Killam Apartment Real Estate Investment Trust (KMP.UN-T) to “hold” from “buy” with a $19.50 target, down from $22. The average is $20.81.
“KMP’s portfolio primarily comprises apartments; however, it also derives income from its MHC and commercial segments (7 per cent and 5 per cent of NOI in 2019, respectively),” the analyst said. “Halifax represents 40 per cent of apartment NOI. This market tightened considerably in 2018 and 2019; however, as noted earlier, purpose-built supply risk is elevated. We are also concerned that the performance of the commercial segment, which includes some retail space, could be a drag on NOI into next year. If our forecast proves correct, KMP’s 2021 earnings and NAV growth will lag the peer group.”
The analysts added: “Our multifamily pecking order heading into 1Q20 reporting, which will ramp early next week, is as follows: IIP, MI, CAR, HOM, BEI, KMP and NVU.”
Following the release of “mixed” quarterly results on Tuesday after the bell, CIBC World Markets analyst David Popowich upgraded Vermilion Energy Inc. (VET-T) to “neutral” from “underperformer” with a $6 target, rising from $5. The average is $6.92.
“The cash flow beat is a positive headline, and the company’s cash preservation initiatives have improved the margin of safety on our payout ratio estimates for the remainder of the year,” he said. "On the other hand, a large impairment charge is out of character for Vermilion, and we believe debt management will remain an overhang for the remainder of the year. We believe the lows have been put in this stock for the time being, and are upgrading Vermilion from Underperformer to Neutral.
“However, we believe much higher oil prices (at least US$50.00/Bbl WTI) are required to support a compelling investment thesis, which would include some combination of production growth, a sustainable dividend, and/or meaningful debt reduction.”
Seeing it “back on strong footing” and a leader in a secular growth sector, Cormark Securities analyst Kyle McPhee initiated coverage of Toronto-based Centric Health Corp. (CHH-T) with a “buy” rating and 35-cent target, matching the consensus on the Street.
"CHH is sitting in a good spot," he said. "The company is facing a sustained path of organic growth and consolidation as the leader in a secular growth sector (institutional pharmacy services to senior living facilities in Canada). Additionally, for the first time in a long time, CHH faces this path without the shackles of debt overload and bloated opex. The revitalized company profile exists on the back of a turnaround plan delivered by President/CEO David Murphy who joined in May 2018 followed by a series of moves that included segment divestment, cost cutting, capital raises and debt reduction.
“The market is starting to take notice with the stock rallying over the last month. Despite the move, we think the stock still fails to reflect all value for the extent of the opportunity, notably the abundance of organic bed addition opportunities, sizable synergies linked to the first major consolidation transaction announced in March 2020 (Remedy’sRx), and FCF leverage as EBITDA expands.”
In other analyst actions:
* Raymond James analyst Steven Li initiated coverage of Toronto-based Converge Technology Solutions Corp. (CTS-X) with an “outperform” rating and $2.35 target. The average is $2.50.
“CTS is building a leading North American hybrid IT solution provider reselling not just products, but also a full suite of infrastructure, software, and managed services solutions (cloud, cyber security, analytics),” he said. “We believe these solutions leave CTS poised to benefit from strong secular trends while their deep technical/domain expertise allows a solutions approach (higher margins).”
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