Inside the Market’s roundup of some of today’s key analyst actions
Believing “a slowdown in e-commerce, combined with the company’s massive capex cycle will limit material upside,” Jefferies’ Samad Samana downgraded Shopify Inc. (SHOP-N, SHOP-T) to “hold” from “buy” on Thursday.
“While our blue-sky view for SHOP has not changed, GMV [gross merchandise volume] growth is expected to face headwinds in 2023,” said Mr. Samana in a research report released before the bell. “Combining this with SHOP’s major ramp in capex for SFN [Shopify Fulfillment Network] will make it tough for the shares to push higher. With the stock approaching our $40 PT, we are choosing to move to the sidelines. We expect sentiment to improve in 2H23 as evidence emerges that SFN can contribute more meaningfully and growth looks to improve against easier comps in 2024.”
He thinks the Street’s forecast of GMV for 2023 of US$223-billion, implying an incremental addition of US$28-billion year-over-year, “looks difficult to achieve” given his expectation for declining sector-wide growth into next year.
“For perspective, we expect SHOP to add approximately $20-billion in 2022,” said Mr. Samana. “In a recession, we think SHOP could struggle to grow net new GMV by the 40 per cent year-over-year implied by the Street’s 2023 estimate. Notably, more than 70 per cent of SHOP’s total revenue is attributable to variable rev streams impacted by GMV.
With investors monitoring the Ottawa-based company’s free cash flow, he also warned that SBN is “becoming riskier” and sees “a long road ahead to operating profitability”
“SFN has morphed from a capital-light partnership-based model into a multibillion-dollar fulfillment buildout. Strong organic MS take rate expansion in 3Q22 implies that early adoption is ramping. However, a competitive Shopify fulfillment product (vs. 3PL or FBA) would require billions more of capex (e.g., AMZN has spent more than $100-billion building out FBA), which will weigh on free cash flow for years to come. All the while, AMZN has become more aggressive in the e-commerce/fulfillment space (e.g., Buy with Prime).”
“After investing all of its GP dollars behind growth in 2022, mgmt. has signaled a shift in priorities toward better balance in 2023. Still, we see material FCF generation as a long way off. Based on our model, a flat GM and zero opex growth in 2023 would result in non-GAAP operating margin of 6 per cent. Even with this swing in profitability, expected capex of $475-million in 2023 would result in negative FCF. We would not be surprised if SFN-related capex remains elevated in out years, presenting a headwind to a medium-term inflection.”
Believing Shopify’s valuation “appears full” despite improving profitability, Mr. Sumana maintained a US$40 target for Shopify shares. The average on the Street is US$40.84, according to Refinitiv data.
“With SHOP transitioning to a solid, but not spectacular, growth story (consensus: up 20 per cent for 2023) with limited margins (consensus: a 1-per-cent decline in operating margin for 2023), we see 2023 as a transition year for the company and the stock,” he said. “As such, we do not see significant upside from current levels, as SHOP still trades at a premium to IGV [iShares Expanded Tech-Software Sector ETF] (6 times NTM [next 12-month] revenue vs. 5 times for IGV) despite a diminished near-term fundamental outlook.”
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After it suffered through a “crisis in confidence” late in 2022, Wells Fargo’s Neil Kalton is “taking the plunge” and upgrading Algonquin Power & Utilities Corp. (AQN-N, AQN-T) to “overweight” from “equal-weight.”
“We caution that our positive rating is dependent on management and the Board taking aggressive strategic actions to put the company on firmer financial footing,” he said. “Such actions include a material dividend cut and a paring back of capital investment. AQN has scheduled a business update for Jan. 12.
“Since 11/10, AQN shares have fallen 45 per cent (vs. the S&P Utilities up 9 per cent) and shares now trade at 90 per cent of book value. In our view, the underperformance was initially driven by dividend safety concerns prompted by a negative ‘22 EPS guidance revision (down 10 per cent). We think the share price reaction caused further concerns over AQN’s balance sheet and the large (and ongoing) equity needs, which are necessary to finance planned capital investment [including its proposed acquisition of Kentucky Power] and maintain investment grade credit ratings.”
Ahead of the business update, which he expects will have “significant implications” on his investment thesis, Mr. Kalton thinks Algonquin should be focused on “balance sheet repair in a manner that eliminates or limits new equity issuances considering shares trade below book value.”
“To that end, AQN’s dividend policy (80-90-per-cent payout) in our view has never truly squared with the company’s aggressive, capital intensive growth ambitions,” he said. “Hindsight is 20/20, and we understand how the BOD could become hostage to the policy, especially given the high retail ownership (more than 50 per cent). We fully expect mgmt. will announce a dividend cut. And we think a material reduction is already priced into the share price considering the current yield is 10.5 per cent (vs. the peer average of 3.5 per cent).”
“Other actions could depend on the outcome of KY as the credit metrics are worse with the KY utilities (absent material new equity). Assuming KY moves forward, AQN could scale back capital investment. Our preference is for mgmt. to focus growth capital on the core regulated utility operations (80 per cent of EBITDA). Separately, if possible, we think AQN should consider turning off the dilutive DRIP. The program allows for participants (20 per cent of shares) to purchase equity at a 3-per-cent discount to the market.”
Though he lowered his earnings per share forecast through 2026, Mr. Kalton maintained a US$9 target for Algonquin shares. The average on the Street is US$11.08.
“Our Overweight rating reflects our belief that the share price understates the value of AQN’s assets, which, in our view, can be unlocked via a ‘back to basics’ strategy. Such a strategy involves balance sheet repair via changing the dividend policy (lowering the targeted payout ratio) and focusing capital allocation on the core regulated operations,” he concluded.
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Problematic macroeconomic conditions are likely to pose a more significant challenge to Good Natured Products Inc.’s (GDNP-X) near-term sales than the Street current expects, according to Canaccord Genuity analyst Yuri Lynk.
He lowered his recommendation for shares of the Vancouver-based plant-based product manufacturer to “hold” from “speculative buy” on Thursday, citing several headwinds including “softening demand for industrial rollstock and excess inventory throughout the supply chain, which are leading to lower volumes, and selling prices that are dropping in sympathy with plastic resin feedstock costs.”
“While the company expects continued demand for its sustainable products, especially from food packaging customers, the industrial group’s demand is being negatively impacted by thermoforming clients’ destocking and softening end-market demand,” said Mr. Lynk in a research note. “We note that while GDNP’s focus is to continue to increase the revenue contribution from its packaging business, which was 200-per-cent higher year-over-year in Q3/2022, 72 per cent of TTM [trailing 12-month] sales were derived from its industrial group. Potential lower selling prices on the back of input pricing declines also represent a headwind for sales growth.
“Prices of major plastic commodity resins, including PET, have declined substantially since May. U.S. bottle-grade PET resin prices have declined 20 per cent since the summer and the broader U.S. producing price index for plastics materials and resins is down 10 per cent from May levels on slower consumer spending impacted by continued interest rate hikes combined with high material availability. We believe this will directly impact pricing on GDNP’s industrial business, which is 50-per-cent petroleum based. Pricing for bio-PET, which feeds GDNP’s packaging business, is less readily available, but we anticipate it will follow PET pricing downwards.”
Mr. Lynk lowered his revenue expectations for Good Natured. He now projects 2022 growth of 62 per cent year-over-year to $99.2-million (from $106.7-million previously) with gains of 14 per cent in 2023 (to $113.3-million from $125.8-million) and 10 per cent in 2024 (to $124.5-million from $138.4-million). That led to declines in his EBITDA projections to $2.5-million, $4.0-million and $6.3-million, respectively, from $4.3-million, $6.2-million and $7.2-million.
“On our lower forecasts, GDNP’s debt covenants bear watching,” he added. “The company’s covenants include a minimum liquidity requirement of $4-million (at least $2-million of which must be cash) and minimum EBITDA of at least $3.2-million in Q4/2022 (TTM) gradually increasing on a quarterly basis to $7.6-million by Q4/2024 (TTM). We believe the company can remain onside its liquidity covenant but is likely to miss the minimum EBITDA covenant in Q4/2022 or Q1/2023. The good news is that management noted on the Q3/2022 call that the lender places greater importance on the liquidity covenant than the minimum EBITDA covenant. The bad news is that GDNP will likely have to pay fees and penalties to negotiate a waiver. Furthermore, this would be the second covenant breach in a year as the company struggles with over $50 million of net debt.”
Mr. Lynk dropped his target for the company’s shares to 25 cents from 75 cents. The average target on the Street is currently 68 cents.
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Despite lowering his fourth-quarter 2022 estimates for both Canadian National Railway Co. (CNI-N, CNR-T) and Canadian Pacific Railway Ltd. (CP-N, CP-T) and warning of further risks to their near-term estimates, Citi analyst Christian Wetherbee maintained his preference for both companies over their peers south of the border and raised his target prices for their shares.
“We remain defensively positioned, favoring Canadian rails for relative volume outperformance over U.S. rails, which enter 2023 with resources out of sync with the broader volume cycle,” he said. “As we previously noted, we don’t expect a meaningful catch-up opportunity for the U.S. carriers until Canadian volume and U.S. service normalizes near mid-year. However, for 4Q results, we see more risk to Canadian and Union Pacific estimates in the near-term, vs. the eastern rails, but we are lower than consensus for each name in our coverage. Tactically, we’d be most constructive on Norfolk and CSX into results, as we’re closest to street estimates and both posted volume that held up better in late December. Both also provide some optionality extending into early 2023 on stability in coal yields.”
Mr. Wetherbee trimmed his fourth-quarter estimates for both CN and CP, citing port delays in Vancouver as well as the impact of severe weather late in December, which affected the entire North American rail network.
“By month total rail volume was up 2.0 per cent in October, up 2.7 per cent in November and down 1.8 per centin December, highlighting the sharp fall off,” he said. “As such, we are lowering our volume estimates for all of our coverage, but our EPS estimates fall for CN, CP and UP, while a degree of coal yield stability likely offsets for CSX and Norfolk Southern. On average our 4Q EPS estimates fall 3 per cent for the rails and we are now 4 per cent below consensus, with our Canadian estimates falling 7 per cent on average and we’re now 6 per cent below consensus.”
“We left our 2023 estimates little changed (small tweak higher for CN and lower for UP), but we continue to see estimate risk and are 3 per cent below consensus on average. For the U.S. rails this risk seems more weighted toward 1H23 when year-over-year head count growth is the most out of sync with volume growth expectations and when service is still recovering. We see particular EPS risk in 1Q, consistent with our air pocket thesis, and are 7 per cent below consensus for the group and 8 per cent below consensus for the U.S. rails. Overall for 2023 we think outlooks are likely to be conservative, particularly for ORs [operating ratios] which will be difficult for U.S. carriers to improve.”
For the fourth quarter, he’s now projecting earnings per share for CN of US$2.02, down 5.4 per cent from US$2.13 previously and below the consensus estimate of US$2.11. His CP forecast fell 9.4 per cent to US$1.05 from US$16, also under the Street’s expectation (US$1.13).
Despite those reductions, Mr. Wetherbee raised his target for CN shares to US$139 from US$128 and CP to US$89 from US$79, keeping “buy” ratings for both companies. The averages on the Street are US$130.27 and US$84.95, respectively.
“We continue to prefer CN and CP relative to the U.S. rails,” he concluded. “That said, we expect the largest 4Q EPS misses for the Canadians. On the other hand we see estimates closest to consensus for Norfolk Southern and CSX. Given our sense that investors are the most skeptical of Norfolk, and coupled with the recent rally in Met coal prices (which could sustain coal yield strength in 4Q and 1Q), we believe the set up might be best for NS followed by CSX. We think late quarter weather impacts increase the tactical risk for UP and the Canadians.”
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Following a “disappointing” share price performance in 2022, Canaccord Genuity analyst T. Michael Walkley thinks there are several “attractive” investment opportunities in software security stocks entering the new year.
“Valuations across software materially contracted during 2022, with the average stock in our Software Security group down 37 per cent,” he said. “With group multiples now under 5.0 times calendar 2024 estimated EV/Sales, we believe investors should revisit high-quality companies well-positioned for long-term success and profitable growth. We believe investors are likely to home in on high-quality growth names with durable competitive moats and ability to balance strong top-line growth and profitability. Given the slate of upcoming reports by Security Software vendors amidst ongoing volatility, we highlight several stocks in our coverage universe best positioned to sustain long-term competitive differentiations and profitable growth trends ... We lower price targets for several of our software security coverage companies due to software multiples contracting. However, we remain bullish on fundaments, especially for companies benefitting from zero trust security trends, taking advantage of competitors struggling to integrate acquisitions, and driving sustained market share gains with profitable growth. Five stocks we believe investors should focus on as ideas for 2023 are CrowdStrike, Zscaler, CyberArk, Tenable, and Absolute Software.”
Waterloo, Ont.-based BlackBerry Ltd. (BB-N, BB-T) was one of several companies with a reduced target price from Mr. Walkley, who said he’s “awaiting Cybersecurity division improved execution and return to growth.”
“Similar to CrowdStrike, we believe BlackBerry’s security business looks well positioned to benefit from an increase in cybersecurity investments to modernize legacy protocols toward Zero Trust architectures,” he said. “In recent periods, BlackBerry has focused on enhancing its Endpoint Security portfolio with the acquired Cylance AI technology after years of lagging behind next-gen competitors CrowdStrike and SentinelOne due to the lack of a competitive EDR offering. While we believe Blackberry has a more competitive product portfolio and improving long-term growth potential, we are maintaining our HOLD rating based on further evidence the company can execute and post sustained growth trends with improving ARR levels.
“We await more proof in execution on the new product roadmap, evidence of crossselling opportunities emerging, growing overall software and services revenue, and the potential for upside to our estimates before becoming more constructive on the shares.”
With his “hold” recommendation, Mr. Walkley trimmed his target for BlackBerry shares to US$4 from US$4.50. The average target is US$5.02.
“Given Blackberry’s much slower growth and lack of profitability versus the Security Software comparable group average, we believe it will trade at a discount until sustained growth is maintained and potentially accelerated to double-digit levels,” he concluded. “Further, we believe in this tough macro environment, investors will also wait for BlackBerry to show a clear path towards sustained profits. We do view the potential sale of its licensing business as a potential near-term catalyst given the cash infusion should more than sustain the company’s investment plans to drive growth and then eventually leverage to sustained profits and positive FCF.”
For his preferred picks, he has these targets and recommendations:
- Crowdstrike Holdings Inc. (CWRD-Q) with a “buy” rating and US$175 target. Average: US$179.32.
- Zscaler Inc. (ZS-Q) with a “buy” rating and US$165 target, down from US$220. Average: US$181.93.
- CyberArk Software Inc. (CYBR-Q) with a “buy” raitng and US$165 target, down from US$187. Average: US$177.
- Tenable Holdings Inc. (TENB-Q) with a “buy” rating and US$56 target. Average: US$48.
- Absolute Software Inc. (ABST-Q) with a “buy” rating and US$17 target. Average: US$13.52.
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Meanwhile, Wedbush analyst Dan Ives thinks the broader technology sector is being “overlooked” in the current “uncertain” macroeconomic environment.
In a research note released Thursday, he said investing opportunities “abound” and a rebound is approaching.
“Right now the easiest thing to do on Wall Street is be negative on tech stocks given darker macro storm clouds into 2023, multiple compression, stocks breaking technical levels, and worries about what initial 2023 guidance will look like over the next month when the 4Q conference calls begin,” said Mr. Ives. “Tech is all being painted with the same doomsday brush coming off a horror show year in 2022 for the broader sector and risk assets. We get it loud and clear as the bears and tech naysayers finally nailed it in 2022 for the negative tech trade after being wrong for 12 years coming out of the 2008/2009 abyss in a historical bull run and now are doubling down at the poker table on the same negative tech bet for 2023. However, our approach into 2023 is a much more opportunistic one for the tech sector as this near-term macro climate uncertainty will lead to the next growth cycle over the coming years that begin now in our opinion.
“The stage is being set: tech names across the board are cutting costs to preserve margins and get leaner in this macro, guidance will be more conservative coming out of the gates with hittable/beatable numbers, multiples are already below their five-year mean in the tech sector, and finally this is the most under-owned tech sector we have seen since 2009. In 2001 and 2009 just like today coming out of a dismal 2022 the overriding sentiment is that tech stocks run is over and its a new era ... we could not disagree more.”
A day after Amazon.com Inc. (AMZN-Q, “outperform” rating, US$140 target) confirmed a plan to cut its workforce by 18,000, or approximately 6 per cent, Mr. Ives said headcount reductions are “the first major step towards stabilizing these stocks in our opinion.”
“Look at Meta’s stock since Zuckerberg announced the layoffs and pulling back from the metaverse spending spree,” he said. “Over the last 24 hours we have seen significant headcount cut reduction from stalwarts Salesforce and Amazon which we view as a positive for the Street as investors want these management teams to get ahead of the storm and preserve margins and the bottom-line in this uncertain macro. We are seeing 5-10-per-cent headcount cuts across the tech sector as many of these companies (both big and small) were spending money like 1980′s Rock Stars and now need to reign in the expense controls ahead of a softer macro.
“The Fed continuing to hike to finally crush brutal inflation is a dynamic that will take the headlines over the coming months but ultimately is coming to an end by the summer timeframe. Finally, our checks with CIOs and initial IT budget conversations into 2023 is not the doomsday scenario that many had predicated. Clearly we are seeing some reductions in spending, but areas such as cloud, cyber security, AI, and next generation technology spending remain healthy and are not coming to a halt. We remain in the beginning of a 4th Industrial Revolution that will spur the next growth cycle and ultimately that creates a number of opportunities across the tech sector to own in our opinion. We double down on our call that we believe tech stocks will be up 20 per cent this year and are way oversold at current levels.”
Mr. Ives said Apple Inc. (AAPL-Q) “firmly” remains his top tech pick for 2023, noting: “We believe the demand story holds up in this storm and the risk/reward is a table pounder at current levels.”
He has an “outperform” rating and US$175 target for its shares, exceeding the average on the Street by 38 US cents.
“Cyber security names such as PANW, CHKP, CYBR, TENB, ZS, and CRWD remain our favorites with stalwarts Microsoft and Salesforce our top cloud picks for 2023 despite many yelling fire in a crowded theater on the names,” he added.
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Despite relative outperformance in 2022, RBC Dominion Securities analyst Christopher Carril is taking a “more cautious view” on North American restaurant stocks this year, seeing a “more challenging consumer backdrop ahead.”
His coverage universe slipped just 8 per cent last year, versus a decline of 19-per-cent for the S&P 500, which he attributed to a “solid top-line” and “stabilizing” earnings outlook for 2023. However, given a “seemingly still volatile and macro-focused market”, he warned “last year’s tailwinds — including elevated pricing, pent-up demand, and incremental mobility benefit — [are likely to] further fade.”
“Restaurant demand levels remained healthy throughout much of last year (industry sales grew 6 per cent year-over-year, and to nearly 105 per cent of 2019 levels), with better-than-expected top line in-part driving outperformance of our coverage,” said Mr. Carril in a report released Thursday. “However, looking to 2023, we do see potential for more muted demand in 2023, as consumer headwinds become more pronounced. As such, we expect ongoing focus on the macro to continue to have outsized impact on group performance, at least in the near-term and until there is greater clarity on the overall health of the economy and the consumer. Meanwhile, relative valuation levels (vs. the S&P 500) appear less accommodating — thanks to stronger late 2022 group performance — with the group trading at 1.3 times forward (FY2) estimates, versus the recent historical average of 1.2 times.
“We expect more pressure on industry top-line in 2023, but fast food continues to be well-positioned: For 2023, foodservice consultant Technomic has forecasted domestic restaurant industry growth of mid single digits, roughly in-line or better than average annual industry growth in the years preceding the pandemic (of approximately 4 per cent). However, our inclination is to lean more cautious given potential for growing headwinds to demand/traffic (e.g. potential for incrementally higher unemployment, elevated credit balances + reduced savings levels, etc.), as well as potential for still-muted industry unit growth.”
Mr. Carril reaffirmed his preference for stocks of the “more insulated” franchised fast food companies, maintaining Restaurant Brands International Inc. (QSR-N, QSR-T) as his “favourite name” in the group. The Tim Hortons parent was the best performing stock in his coverage universe in 2022 with its U.S.-listed shares rising 7 per cent.
“We see potentially improving Burger King U.S. trends, accelerating development and shifts in capital allocation (toward growth investments and reduction in leverage) driving stock performance,” he said. “Relative valuation for QSR remains compelling (16 times 2023 estimated EBITDA, versus global peer average of 18.5 times), particularly as we are taking a more cautious stance on the overall group.”
He maintained an “outperform” rating and US$80 target for Restaurant Brands shares. The current average is US$67.79.
Elsewhere, Barclays’ Jeff Bernstein hiked his target to US$80 from US$68, keeping an “overweight” rating.
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Benchmark analyst Mike Hickey sees Bragg Gaming Group Inc. (BRAG-Q, BRAG-T) as “a unique and compelling investment opportunity within the online gaming ecosystem that is participating in an expansionary market growth from existing and new markets, including the U.S.”
In a report released Thursday, he initiated coverage of the Toronto-based business-to-business online casino technology provider company with a “speculative buy” rating.
“Key themes driving our positive view include BRAG’s 1) expanding core business growth through existing and new relationships and leveraging success in European and Latin American markets by diversifying product offerings, 2) entry into expansionary B2B online gaming markets including the U.S. and Canada, 3) a revenue shift toward proprietary internally developed casino games that should provide profit expansion opportunities, 4) an expectation that gaming will remain resilient to negative macroeconomic trends, and 5) delivering profitable growth, a compelling financial forecast, strong balance sheet, and positive free cash flow,” he said.
Mr. Hickey think Bragg’s growth catalysts include “rapid” market expansion on both sides of the border.
“We estimate the U.S. online casino market could achieve a more than $20-billion TAM [total addressable market], assuming 40 per cent of the population legalized,” he said. “Online casinos are currently legal in 6 states including: CT, DE, MI, NJ, PA, and WV, representing 11 per cent of the U.S. population. Online casino legalization has lagged online sports betting. An est. 24 states representing 48 per cent of U.S. population has legalized OSB. We anticipate online casino legalization will accelerate over the medium term. We believe the rapid growth of the U.S. online gaming market will provide a catalyst for BRAG’s B2B products, services, and tech.”
Pointing to its “elevated revenue growth opportunity and emerging profit margin,” he set a target of US$8 per share. The average is US$11.40.
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Acumen Capital analyst Jim Byrne thinks Cathedral Energy Services Ltd. (CET-T) is “poised for significant growth over the short-, medium-, and long-term.”
He raised his financial estimates for the Calgary-based directional drilling services provider based on “another strong” quarter of activity to end in fiscal 2022 as well as contributions from its recent US$100-million acquisition of U.S.-based Altitude Energy Partners LLC.
“We have revised our Q4/22 estimates higher as well as increased our 2023 outlook,” said Mr. Byrne. “Recent forecasts for activity in Canada predict an increase of 15 per cent in active rigs and operating days in 2023. Consensus estimates have the rig count increasing 9 per cent in 2023 in the U.S. as well.
“We believe Cathedral is uniquely positioned in the oil field service space as they look to consolidate the directional drilling sector and expand their market share.”
Maintaining his “buy” recommendation for Cathedral shares, he bumped his target to $2.50 from $2.25. The average on the Street is $3.53.
“In our view, the shares are attractively valued at current levels given the prospects for strong organic and acquisitive growth,” the analyst said. ‘The company has aggressive growth targets for 2025 which we believe are achievable with the company’s platform and talent.”
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In other analyst actions:
* Credit Suisse’s Andrew Kuske increased his target for shares of Boralex Inc. (BLX-T) to $38.50 from $36, below the $47.31 average, with a “neutral” rating.
* Piper Sandler’s Abbie Zvejneks cut her Lululemon Athletica Inc. (LULU-Q) target to US$385 from US$390 with an “overweight” rating. The average is US$395.75.
“We maintain our OW rating on LULU, but we are lowering our estimates and PT given elevated promotions,” she said. “We continue to be bullish on LULU’s brand strength and opportunity for men’s and international expansion, and we think LULU is a core holding for long-term focused investors. However, we have seen a notable increase in promotions as well as increased digital advertising related to LULU’s ‘We Made Too Much’ inventory. This leads us to believe that 4Q gross margin guidance may be aggressive, and we are taking a more conservative approach to 2H topline growth based on exposure to a more affluent consumer which has been resilient to date.”
David Leeder