Inside the Market’s roundup of some of today’s key analyst actions
North American railway companies are facing significant near-term volume headwinds, according to Citi analyst Christian Wetherbee.
After third-quarter volumes came in almost 2.4 per cent lower than his target, he reduced his earnings per share projections by 3.6 per cent, noting “operating efficiencies should modestly offset some of the negative operating leverage.”
"September carloads were particularly weak and raise the likelihood for 3Q misses and support a more cautious starting point for 2020 revenues," said Mr. Wetherbee in a research note released Thursday. "As such, we would expect pressured rail performance through earnings. That said, we don’t think the volume issues, even if they persist through 1Q20, actually derail the broader thesis based on continued operational improvement driven by PSR initiatives, which we discuss in detail in this note. We remain broadly constructive on the group as operating ratios fall, and believe the set up into 2020 is more favorable than the near-term outlook for the rest of 2019, as incremental operating leverage can be realized as volumes stabilize."
Mr. Wetherbee also lowered his 2020 estimates by an average of 4 per cent due to an increasingly “cautious” view on volumes, noting he’s now “starting from a lower base” due to 2019 weakness.
"We continue to expect volume to grow modestly in 2020, particularly in 2Q-4Q and arguably there could be upside to our estimates as PSR progress could yield robust incremental margins on the return of revenue growth," he said. "This upside potential keep us constructive on shares in 2020."
With that revised stance, he made the following reductions to target prices for companies in his coverage universe:
Analyst: "We are trimming our 3Q19 EPS estimate by 2 per cent to C$4.48, leaving us 2.5 per cent below consensus for the quarter. In addition, we are reducing our 2019 and 2020 EPS estimates by 2 per cent and 5 per cent to C$16.45 and C$18.60, respectively, as we now expect the company to face volume sluggishness through early 2020. As a result, we are reducing our price target."
CSX Corp. (CSX-Q) to US$80 from US$86. Average: US$77.79.
Norfolk Southern Corp. (NSC-N) to US$210 from US$228. Average: US$207.11.
Union Pacific Corp. (UNP-N) to US$180 from US$195. Average: US$185.25.
“In our opinion, Canadian National and Union Pacific appear the most at risk during the quarter, with our EPS estimates for both coming in 4 per cent below consensus," he said. “These two companies saw the largest reductions in our revenue growth estimates of all the Class 1 rails.”
Conversely, he raised his target for Kansas City Southern (KSU-N) to US$144 from US$135 in order “to capture improving PSR execution and stronger fundamentals on its network versus U.S. peers.” The average target for KSU is US$138.13.
Mr. Wetherbee maintained “buy” ratings for all the stocks, and added: “We are also updating or preference list, which is now Norfolk Southern, Kansas City Southern, Union Pacific, Canadian Pacific, CSX and Canadian National.”
Minto Apartment Real Estate Investment Trust (MI.UN-T) appears poised to benefit from taking a “data-driven approach to maximize its embedded rent growth prospects,” according to Industrial Alliance Securities analyst Brad Sturges.
Following the REIT’s Investor Day event last week, Mr. Sturges thinks that strategy as well as the execution of long-term value creations plans will help augment embedded rent growth prospects.
"Over the past four quarters, MI has realized improving gains on new leases signed, improving from 7.5 per cent in Q3/18, up to 11.5 per cent in Q2/19," he said. "In addition, new leases signed by the REIT exceeded the CMHC posted AMR by 126 per cent in Q2/19, up from 118 per cent for MI in Q3/18, and exceeding its competitors’ estimated average rent penetration over the past four quarters that ranged from 107 per cent in Q3/18 to 111 per cent in Q2/19."
Also emphasizing “development and intensification opportunities” in Toronto, Mr. Sturges raised his target for Minto units by a dollar to $26. The average on the Street is $24.28.
“We maintain our Strong Buy rating for MI based on its Ontario urban-weighted portfolio that is well positioned to capture robust underlying urban Canadian apartment asset fundamentals, above-average NAV/unit and AFFO/unit growth prospects that may benefit from its strategic sponsorship that may provide a possible acquisition pipeline, and the potential for future distribution increases,” the analyst said. “The REIT’s investment risks include geographic concentration in the rent controlled market of Ontario, potential competition from the new supply of condominium rental suites, and below-average unit liquidity.”
Though methanol prices are “still scraping” near multi-year lows, Raymond James analyst Steve Hansen is maintaining a long-term constructive view on both the market and Methanex Corp.'s (MEOH-Q, MX-T) “strong” associated free cash flow profile.
The analyst said he came away from the recent Argus Global Methanol Forum in Houston with increased confidence that “prices are close to a floor (if not there already) as cost curve fundamentals, global energy values, and seasonal constraints increasingly exert their influence.”
"Given this backdrop, we believe the market is setting up for a staged recovery in the coming months, a view further supported by last week’s uptick in the China contract — the first in several month," said Mr. Hansen.
“While global spot prices continue to trade near multi-year lows, incremental signs of life have emerged in recent weeks on the back of: 1) escalating geopolitical tensions (i.e. military strikes on Saudi refining facilities); 2) a handful of unplanned supply methanol outages (US Gulf, Iran, Egypt, Oman); 3) incremental Chinese demand (MTO, seasonal); and 4) mounting pressures on high-cost Chinese producers.”
Mr. Hansen did make a “modest” reduction to his financial projections for Methanex to account for price weakness, an extended outage in Egypt and higher operating costs. His full-year 2019 estimates also fell to " account for recent price trends and a moderated seasonal upturn."
Accordingly, with an “outperform” rating, he lowered his target for Methanex shares to US$50 from US$62. The average on the Street is US$42.80.
“Notwithstanding recent macro volatility,we continue to see solid value in Methanex shares, with the stock currently trading at just 6.2 times consensus 2020 EBITDA estimates, a multiple perched at the low-end of the company’s historical range,” he said. “At the same time, we note the stock is currently trading at less than half of replacement cost, a threshold we do not view as sustainable.”
RBC Dominion Securities analyst Kenneth Lee sees opportunity for investors in U.S. mortgage REITs amid a "challenging environment."
"We acknowledge the macro backdrop, which includes a flattening yield curve, has been especially challenging, though we note mortgage REITs have been adjusting their cost of funding hedges accordingly, and selectively re-allocating their portfolios," he said. "We would point out mortgage REIT returns are driven by MBS spreads, which have held up well. Further, our analysis of average estimated economic returns across our coverage shows resiliency despite a flattening yield curve. To be sure, there is warranted concern around re-investment risks associated with elevated prepayments due to declining interest rates, though this should in theory benefit mortgage REITs going forward, as mortgage REITs earn prepayment risk premiums."
In a research report released Thursday, Mr. Lee initiated coverage of the sector with a “constructive outlook,” pointing to four factors driving his “favourable” view.
They are: “1) favorable housing markets, with continued home price appreciation and mortgage delinquencies still very benign, which is supportive of mortgage credit (and can benefit legacy MBS assets as well); 2) continuing opportunities for mortgage REITs to deploy capital for attractive risk-adjusted returns, including within agencies and residential whole loans; and 3) yield-oriented with low stock betas, mortgage REITs may be very attractive to investors and can be viewed as relatively defensive plays; and 4) longer term, there could be significant opportunity for private capital to increase presence in the U.S. residential mortgage markets as the Fed reduces its balance sheet over time.”
Mr. Lee called Annaly Capital Management Inc. (NLY-N) is “favourite idea.” He initiated coverage with an “outperform” rating and US$10 target, which exceeds the US$9.47 consensus.
“We like the company’s diversified investment strategy and think the company can pivot between different asset categories, which includes agency MBS, CRT, non-agency MBS, CMBS, MSRs, residential whole loans, and first-lien middle market corporate loans, in order to seek attractive risk-adjusted returns,” he said. “While Annaly has historically focused on investing in agency MBS, the company had embarked on an ongoing plan to diversify towards growth-oriented, credit assets, which includes residential and commercial mortgage credit and middle markets lending. Credit assets now account for 22 per cent of the company’s allocated capital (with agency MBS accounting for the remainder) and is consistent with our favorable views on mortgage credit exposure.”
He also initiated coverage of the following equities:
AGNC Investment Corp. (AGNC-Q) with a “sector perform” rating and US$16 target. Average: US$17.15.
Chimera Investment Corp. (CIM-N) with an “outperform” rating and US$21 target. Average: US$19.30.
MFA Financial Inc. (MFA-N) with an “outperform” rating and US$8 target. Average: US$7.67.
Two Harbors Investment Corp. (TWO-N) with an “outperform” rating and US$15 target. Average: US$14.58.
Saputo Inc. (SAP-T) “has the assets and the balance sheet that position it for success,” said Desjardins Securities analyst Keith Howlett, who thinks the Montreal-based company is “well-positioned” to benefit from improved dairy market conditions when they arrive.
“Global dairy markets have gone through a wild short period, encompassing growth, planned consolidation and competitive rationalization,” he said. “Companies that made bold moves to ride the global ‘dairy wave’ (eg Murray Goulburn and Fonterra) have hit the rocks. A ‘back to basics’ attitude is sweeping major global dairy processors. Saputo is bulked up and relatively unscathed.”
“Recent quarterly results of major dairy processors in the U.S. (Saputo, Land O’Lakes) and Europe (Arla, FrieslandCampina) reflect recovering industry profitability. In Canada, where Saputo is the market leader, industry profits have been declining. Saputo’s two major competitors have, however, both expressed the need to adjust strategies and improve profitability. We infer a sense of urgency. Both have much higher debt ratios than Saputo. In Argentina, Saputo has ascended by internal growth to recently become the largest dairy processor in the country. Its operations are still performing well financially, despite market-specific challenges of hyper-inflation and price controls. In Australia, Saputo has quickly picked up the pieces of failed expansions by others (Murray Goulburn, Kirin) and become the largest dairy processor. While drought in Australia has been a headwind, Saputo appears to have coped reasonably well. Saputo has acquired Dairy Crest, a growing branded cheese player in the UK with good margins.”
Though he maintained a "hold" rating for Saputo stock, Mr. Howlett reduced his risk qualifier to "average" from "above-average" with a $43 target, which falls short of the $44.06 consensus.
"Over the last five years, Saputo improved its position in all of its key existing markets (U.S., Canada, Argentina) and established strong positions in important new markets (Australia, UK). The competition has been rationalized in all of its markets, as a result of both purposeful consolidation and unexpected downsizing due to challenging global dairy markets. Saputo has the strongest balance sheet among its closest peers (Fonterra, Arla, FrieslandCampina), a good set of operating assets and access to lowcost milk. The recent equity issue further increased flexibility. "
Canaccord Genuity analyst Dennis Fong sees Cenovus Energy Inc.'s (CVE-T, CVE-N) capital allocation strategy, which was unveiled as part of its updated five-year business plan before the bell on Wednesday, as “prudent” with the potential of driving returns.
"We view the shift in culture of the company has moved towards alignment with shareholder return," he said. "We view the continued elevated exposure to local commodity prices, the improving diversification of markets and execution of growth (within cost expectations) positively."
Mr. Fong maintained a "hold" rating and $13.50 target for Cenovus shares. The average is $14.87.
“Notwithstanding our HOLD rating, we came away from the investor day incrementally positive on Cenovus’ use of its free cash flow and its focus on returning those streams to investors through a consistently growing dividend,” he said.
Elsewhere, Raymond James analyst Chris Cox kept a "market perform" rating and $14 target.
Mr. Cox said: “With the company hitting its near-term target of less than $7-billion of net debt (including working capital) earlier this year, greater clarity with respect to the capital allocation philosophy was needed. We believe the market will be pleased with the strategy laid out in the 5-year plan at this year’s Investor Day. Debt reduction remains the primary focus, but cash returns are clearly increasing in priority and will become an even bigger focus as the net debt position drops below $5-billion. Alongside this, the company is tentatively bringing organic growth opportunities back into the fold, though still conditional upon improvements in market access.”
Pointing to a “solid, economically resilient base” in Canada and “strong” growth internationally, CIBC World Markets analyst Matt Bank initiated coverage of Jamieson Wellness Inc. (JWEL-T) with an “outperformer” rating.
“Jamieson has a dominant market share in Canada, and a history of outpacing peers with innovation and good performance through downturns,” said Mr. Bank. "Demographics and VMS category expansion are favourable trends, and Jamieson is well-positioned in regards to private label and e-commerce.
“International is 10 per cent of sales (more on earnings) and growing at 30 per cent. This is driven by continued success within markets, the addition of new markets, and a build-out in China — all of which we believe are sustainable drivers. We view International as a potential source of outperformance should efforts to develop a domestic Chinese business prove successful.”
He set a $27 target. The average target on the Street is $24.33.
“Jamieson’s business model is, in our view, deserving of a premium multiple,” said Mr. Bank. “Its consistent underlying growth as a dominant CPG player augmented by excellent international growth and significant potential upside in China make for an attractive combination of safety and reward. Consumer staples have become in-favour stocks in an uncertain macro environment. While Jamieson’s shares have performed well of late, they are still only up 6 per cent year-to-date (below the market and peers) given a rough start to the year.”
In other analyst actions:
TD Securities analyst Derek Lessard cut Dorel Industries Inc. (DII-B-T) to “hold” from “buy” with a $7.50 target, dropping from $13. The average on the Street is $10.