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

Following another strong quarter, Canaccord Genuity analyst Robert Young thinks Descartes Systems Group Inc. (DSGX-Q, DSG-T) “remains a logical stock to hold despite premium valuation” in “a jittery tech market that values cash flow and consistency.”

After the bell on Wednesday, the Waterloo, Ont.-based software company reported “solid” second-quarter revenue of US$123-million, up 17.6 per cent year-over-year and exceeding the expectations of both Mr. Young and the Street (US$117.4-million and US$118.4-million). Adjusted EBITDA of $54.0-million also topped estimates (US$51.5-million and US$52.4-million), while adjusted earnings per share of 27 US cents, flat year-over-year, fell in line with the consensus.

“FX was a $3.9-million impact to the top line in FQ2, a factor that will likely weigh on growth in the near term,” he said. “Demand, however, remains strong driven by continued investment, particularly in real time visibility, logistics optimization and global trade intelligence solutions. Higher energy costs, global supply chain backlog, low predictability of transit times and increasing complexity have offset recession concern. While capacity increases are driving lower freight rates, volumes have remained high.

“The company reiterated target EBITDA margins of 38-43 per cent and growth of 10-15 per cent year-over-year despite beating both in FQ2. The baseline calibration provided by management supports a modest increase to our FQ3 estimates partially offset by FX headwinds, which flows through to full-year estimates. We continue to expect low double-digit organic growth in CC terms in H2 and potential to supplement with M&A given a strong pipeline and improving valuations.”

Mr. Young thinks M&A activity is a possibility, noting it finished the quarter with US$189-million in cash as well as access to a US$350-million revolved and an unlimited shelf filing.

“Note that Descartes acquired XPS in June, which led to an outflow of $61-million,” he said. “We estimate FCF at $44.6-million or 36-per-cent FCF margin, which would be higher without a $5.2-million outflow for contingent consideration. While management remains focused on accretive and complementary M&A, it reiterated its intention to execute buybacks if needed. Descartes continues to have a strong tuck-in pipeline despite making three acquisitions in the year so far.”

Raising his financial expectations “to reflect the baseline calibration and the addition of XPS,” Mr. Young bumped his target for Descartes shares to US$77, matching the current average on the Street, from US$74 with a “buy” rating (unchanged).

Elsewhere, others making target adjustments include:

* BMO Nesbitt Burns’ Thanos Moschopoulos to US$74 from US$68 with a “market perform” rating.

“We remain Market Perform on DSGX and have raised our estimates and target price following Q2/23 results, which were a larger than typical beat on both revenue and EBITDA, relative to both consensus and management’s prior calibration. We think DSGX can continue to execute successfully on its strategy of delivering consistent EBITDA growth. However, on a relative basis, we prefer other consolidators in our coverage universe—particularly as we believe organic growth might decelerate in future quarters (potentially impacting the magnitude of its current valuation premium vs. comps),” he said.

* TD Securities’ Daniel Chan to US$85 from US$84 with a “buy” rating.

“We believe management continues to execute well on its organic growth and M&A strategy. The company enjoys solid organic growth, margins, cash flow, and is in a position of balance sheet strength,” said Mr. Chan.

* Stephens’ Justin Long to US$83 from US$80 with an “overweight” rating.


National Bank Financial analyst Vishal Shreedhar expects Empire Company Ltd.’s (EMP.A-T) business mix to “cause a drag on performance versus peers” when it reports its first-quarter 2023 results on Sept. 15.

He’s forecasting earnings per share of 72 cents for the Stellarton, N.S.-based grocery, up from 70 cents a year ago but 3 cents below the consensus estimate on the Street.

“Our expectation of 3.0-per-cent year-over-year EPS growth largely reflects slight sales growth (higher fuel prices), higher contribution from investments/other (including a higher gain on disposals at Crombie), SG&A leverage (lower COVID-19 costs) and share repurchases, partly offset by costs related to the rollout of Voila, gross margin contraction (in part due to higher supply chain costs) and higher D&A,” said Mr. Shreedhar.

“We consider FR [Food Retailing] segment results to be more meaningful than total company results for the purposes of evaluating recurring earnings power (total company results include contribution from the Investments/Other income segment).”

The analyst expects investors to remain focused on Empire’s growth trajectory, believing its business skew “may be a near-term drag.”

“Given that EMP’s exposure to the discount grocery format is lower than other grocers (about mid-teens mix by store count versus L/MRU more than 40 per cent), it’s likely sssg [same-store sales growth] performance in the near term may lag peers (on a similar month basis),” he said. “In addition, pharmacy was indicated to be a key contributor to margin performance for both Loblaw and Metro. We estimate that Empire’s pharmacy mix is low versus peers; about mid-single-digit EBITDA contribution versus 40 per cent for L and 25 per cent for MRU.”

“Over the medium term, we believe EMP should benefit from several initiatives, including: (a) Rolling out its FreshCo conversion in Western Canada; (b) Market share gains in the GTA (Voila/Longo’s/Farm Boy); (c) Project Horizon execution; and (d) Benefits from the rollout of a new loyalty program.”

Mr. Shreedhar made “slight” increases to his revenue and earnings estimates for both fiscal 2023 and 2024, resulting in higher EPS estimates of $2.83 and $3.21, respectively (up from $2.81 and $3.18).

He maintained an “outperform” recommendation and target price of $42 for Empire shares. The average on the Street is $46.33.

“We believe Empire has established a solid foundation for growth and anticipate further benefits related to Project Horizon. In addition, we believe valuation is attractive, trading at 6.7 times NTM [next 12-month] EV/EBITDA for the Retail business (5-year average is 7.3 times),” he said.


BMO Nesbitt Burns analyst Deepak Kaushal initiated coverage of a trio of Canadian technology stocks, believing “growth-by-acquisition companies are well positioned to take advantage of falling valuations with rising interest rates to accelerate acquisitions.”

He gave Converge Technology Solutions Corp. (CTS-T) and Enghouse Systems Ltd. (ENGH-T) “outperform” recommendations and Alithya Group Inc. (ALYA-T) a “market perform” rating.

“Enghouse has been public since 1998 and is well-known to many Canadian institutional investors, while Converge and Alithya are relatively new and have been public since May and November 2018, respectively,” said Mr. Kaushal. “They are also very different companies focused on different areas of the technology industry. So what is the common thread and why should investors care? In our view each of these companies has an attractive growth-by-acquisition model that has driven growth and in most cases stock appreciation, albeit with varying degrees of value creation. Fundamentally, we believe growth-by-acquisition is an essential element to the long-term success of Canadian technology companies as it enables them to sustain a high pace of growth and innovation to keep up with better-resourced U.S. peers. As investments, we see an opportunity for these companies to accelerate growth-by-acquisition as tech valuations fall with rising interest rates. Furthermore, we believe that market corrections reveal the true value creators that earn their multiples and expose the shaky ones that need to prove themselves, and we expect our top picks to outperform.”

His targets for the stocks are:

* Enghouse at $44. The average is $37.83.

Analyst: “We believe the company’s core strength is its highly disciplined growth-by-acquisition strategy, focused on targets with low valuations and recurring revenue, and management’s uncompromising return threshold of five-year cash-on-cash payback. We believe Enghouse can take advantage of rising rates and falling target valuations to sustain its growth-by-acquisition model, and double the business over the next five years to almost $1 billion in revenue and $300 million in EBITDA, while sustaining ROIC in the mid-teens. This assumes no organic growth and Enghouse continues to deploy 50 per cent of CFO, while sustaining a 30-per-cent dividend payout ratio. Notably, our math suggests that at the current valuation, investors are not paying for organic growth and the stock is pricing in no future acquisitions, which we believe is highly unlikely. We think this offers an attractive entry point for investors.”

* Converge at $9. Average: $10.85.

Analyst: “We believe the company’s core strength lies in management’s strategic focus on rolling up sub-scale value-added resellers and boutique consultancies and upgrading their cloud capabilities and customer footprints to improve growth and margin. However, return on capital remains below cost, and acquisitions are not yet self-funded, diluting net value creation. We expect this to improve over the next two years, as management executes on its goal to reach $5 billion in revenue and $500 million in EBITDA by F2025 by acquiring $1 billion in revenue annually.”

* Alithya at $3.50. Average: $4.

Analyst: We think Alithya has done well to sustain acquisitions and growth with constrained capital. We also see a smart strategy focused on acquiring management teams and capabilities that can benefit from scale by joining Alithya’s growing platform. That said, Alithya has struggled to generate meaningful profitability and a return on invested capital, and management has had to rely on debt and stock to fund acquisitions. This has resulted in missed investor expectations and a “show-me” story for the stock. We believe management can achieve its targets of $600 million revenue and 9-13-per-cent EBITDA margin through further higher-margin acquisitions, supported by resilient underlying demand for digital transformation. That said, we expect net FCF and ROIC to remain low, diluting full value accrual to shareholders, and we prefer to see significant improvement before becoming more positive.”


RBC Dominion Securities analyst Greg Pardy reiterated his bullish stance on Canadian Natural Resources Ltd. (CNQ-T) following a recent discussion with chief financial officer Mark Stainthorpe, calling the meeting “instructional” and reinforced his confidence in its operating momentum, capital discipline and free cash flow generation.”

The Calgary-based energy company is currently his favourite senior producer and is on the firm’s “Global Energy Best Ideas” and “Top 30 Global Ideas” list.

“From where we sit, CNQ affords energy investors with one-stop upstream shopping when it comes to the scale, depth and breadth of its resource inventory in western Canada,” said Mr. Pardy. “The company’s 2022 production is 73-per-cent oil & ngl weighted with diversified asset exposure ranging from upgraded mining/non-upgraded in-situ oil sands to the Montney and even the emerging Clearwater oil play in western Canada. CNQ’s proven North American gas reserves stood at 12.1 TCF as of year-end 2021, which equates to a reserve life index (RLI) of 19.8 years. The company’s proven synthetic crude oil (SCO) reserves stood at circa 7.0 billion barrels as of yearend 2021, equating to an RLI of 43 years.

“With its planned turnaround activity now complete—and loaded with $375 million of additional growth capital — CNQ is poised to deliver increasing production in the second half of 2022. Incremental production will be supported by increasing volumes from its conventional oil and natural gas operations, including heavy oil in the emerging Clearwater. Within the Clearwater play at Smith, CNQ is producing in excess of 10,000 bbl/d of heavy oil with an undeveloped acreage position of about 940,000 net acres. Additionally, growth in CNQ’s Jackfish and Primrose thermal operations are expected to add incremental production in 2023 and more notably in 2024-25 once new pads are fully ramped up. Our 2022 average production outlook for CNQ of 1.32 million boe/d factors in production of 1.37 million boe/d in the third quarter and 1.39 million boe/d in the fourth quarter.”

Mr. Pardy thinks investor sentiment toward Canadian Natural has unfairly “languished somewhat in recent months partly due to wider WTI-WCS spreads — while the premium at which SCO has been trading vs. WTI has been somewhat overlooked.”

“A US$5 change in WCS prices would impact our 2022 cash flow estimate by approximately $581 million (2.5 per cent), while a US$5 change in SCO prices at Horizon/AOSP impacts our 2022 cash flow estimates by $655 million (2.8 per cent),” he noted.

Saying his optimism toward the company reflects “its strong leadership team, shareholder alignment, long life-low decline portfolio, abundant free cash flow generation, robust balance sheet and best-in-class operating performance,” Mr. Pardy thinks it should command a premium relative, reiterating an “outperform” rating and $90 target. The average is currently $96.60.


Killam Apartment REIT’s (KMP.UN-T) assets in the Kitchener-Waterloo-Cambridge region of Ontario possess “significant repositioning potential” in a “development hot spot,” said iA Capital Markets analyst Johann Rodrigues.

He recently toured the four assets, consisting of 785 suits purchased for approximately $191-million from a church group “that had neglected to invest any in-suite capital, making them ideal candidates for repositioning.”

“Work has kicked off recently, as the REIT has thus far completed 16 suites, and the early results are outstanding,” said Mr. Rodrigues. “We toured two of them: 1) $46K invested with rents moving from $1,185 to $1,900 (60-per-cent lift; 19-per-cent ROC), and 2) $60K invested, $1,200 to $2,375 (98-per-cent lift: 24-per-cent ROC).

“With a current turnover rate of 26 per cent, it will likely take four to five years for the entire portfolio to be repositioned, however, management believes they can achieve 15-per-cent-plus returns on capital investments of $40-60K per suite. At the mid-point, this equates to $6-million in incremental NOI on $40-million of invested capital, or +$0.75/unit to NAV (4 per cent). As a bonus, one of the assets has excess land for a 240-suite development. When underwriting the asset, management believed they could turn the 3.6-per-cent purchase cap rate to 4.5-5.0 per cent in five years but recent projections could take it to 6.0-6.5 per cent.”

The analyst also called recent political concerns swirling around the sector as “much ado about nothing,” noting: “With most REITs these days, management has spent quite a bit of time dealing with political jockeying in advance of Trudeau’s report on the ‘financialization of the housing market.’ While some investors fear the removal of the group’s REIT tax status, Killam does not believe they will go this route as it does nothing to improve affordability. Management agrees with our view that the likely outcome is smaller policy moves that can be held up as proof they’re aiding renters without drastically punishing corporate cash flows, such as incentives for affordable suites and new supply.”

He reiterated a “buy” rating and $21 target. The average is $21.89.


Touting it as a “profitable MSO trading at discounted valuations,” PI Financial analyst Jason Zandberg initiated coverage of Verano Holdings Corp. (VRNO-CN) with a “buy” recommendation.

“Verano has consistently demonstrated year-over-year growth in key operating metrics, and is among the industry’s leading companies for revenue, EBITDA, and gross margins,” he said. “To date, Verano has achieved strong-market share across its core markets and demonstrated exceptional EBITDA margins compared to all of its MSO peers. With the acquisition of Goodness Growth Holdings scheduled to close in Q4/22, the Company is set to solidify its position as a leading player in the large-cap MSO peer group.”

Mr. Zandberg predicts a re-rating is ahead for the cannabis sector, which now trades at all-time lows.

“We expect the industry to experience margin expansion and approach more balanced cannabis valuations,” he said. “Consequently, a re-rating of the sector will result in multiple expansion across the sector which, we believe, will add additional upside to Verano’s stock price.”

Also emphasizing Chicago-based Verano’s “successful” M&A track record and “compelling growth strategy through capital expenditures,” he set a target of $22 per share. The average on the Street is $23.44.

“The valuation multiples amongst US MSOs have gradually fallen from the highs of Q1/21 (this includes Verano),” he said. “These highs in valuation were initially driven by Democrats taking both seats in the senate runoffs in Georgia during January 2021. This result spurred popular belief that a legalization event was imminent in the cannabis sector. Belief in this possibility has since dissipated significantly due to Democratic senators vetoing a filibuster in the senate. This does not indicate a gradual deterioration in the core business model or a key flaw in the Company, rather, it signals the dampening of positive investor sentiment in the space due to oversupply constraints in addition the slow and uncertain paceof federal reforms in the US toward legalization of cannabis.

“We believe that while early Q1/21 valuations represented a rush to the markets, creating a situation where stocks were overbought, the current valuation multiples indicate that most names in the industry are oversold. We see the selected multiple of 4.8x multiple as being a fair representation of the true value of the industry, taking into account the slow rate of federal activity and lower valuations in recent quarters. 4.8 times is slightly under a 2-times lift to current valuations and slightly below the mean of the lowest and highest multiples recorded between January 20, 2021 to August 26, 2022.”


The “positive” pre-feasibility study for Osino Resources Corp.’s (OSI-X) Twin Hills gold project in Namibia “demonstrates meaningful low-cost production potential,” according to Echelon Capital Markets analyst Ryan Walker.

However, he did emphasize a capital cost increase in the project to US$375-million, up from US$202-million preliminary economic assessment in 2022 and previous US$300-million guidance.

“As expected, the increase partially reflects scope changes to the project highlighted by a 43-per-cent increase in plant throughput to 5.0Mtpa from 3.5Mtpa,” said Mr. Walker. “It also reflects current consumer prices and recently escalated commodity prices, especially steel, reagents, diesel, and transport costs. We note here that commodity prices have been showing signs of easing more recently and may represent potential cost saving in the Definitive Feasibility Study in H123. That said, the project is least sensitive to capex.”

“Importantly, the bigger price tag also delivers the potential for an increased production profile, with the operation forecast to average 200koz/yr at AISC of US$890/oz in the first four years, 169koz/yr at US$930/oz in the first 10 years, and 152koz/yr at US$939/oz over the 13-year mine life.”

Maintaining a “speculative buy” rating for the Vancouver-based company’s shares, Mr. Walker trimmed his target to $1.85 from $2.20 due to first gold production taking longer than previously anticipated. The average on the Street is $2.42.

“Our continued positive view reflects Twin Hills’ positive PFS economics, significant (3.1Moz) resource bolstered by substantial exploration potential on a district-scale land package in an established Namibian mining region,” he said.


In other analyst actions:

* JP Morgan’s Ryan Brinkman trimmed his ABC Technologies Holdings Inc. (ABCT-T) target to $6 from $7 with a “neutral” rating. The average on the Street is

* Credit Suisse’s Fahad Tariq lowered his target for Hudbay Minerals Inc. (HBM-T, “outperform”) to $7 from $7.50 and Lundin Mining Corp. (LUN-T, “neutral”) to $7.75 from $8.50. The averages on the Street are $9.41 and $9.87, respectively.

* TD Securities’ Daryl Young cut his Major Drilling Group International Inc. (MDI-T) target to $14.50 from $16, maintaining a “buy” recommendation. The average is $17.

Follow David Leeder on Twitter: @daveleederOpens in a new window

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