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

Though Canadian grocery stocks have generated better than market returns over the past 10 years, Desjardins Securities analyst Keith Howlett thinks their current prices “reflect much of the good news” in the sector.

The Canadian stock market has lagged the U.S. market over the last 10 years. One sector of relative outperformance has been Canadian grocers,” said Mr. Howlett in a research report released Thursday. "This has, in part, reflected market structure, acquisitions, the power of strong free cash flow to overcome missteps and good management. It is nonetheless surprising that Canadian grocers could perform so well during a period when Walmart and Costco significantly expanded their businesses and market shares in Canada.

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“We see no imminent threat from Amazon (focused on the U.S. grocery market for at least a few years), regulatory reform (pharmacare appears some years off) or new entry by Aldi, Lidl or others. Empire is bringing the Ocado technology to Canada, with a soft roll-out in spring 2020. We are not expecting this to dramatically change the pace of adoption of online grocery retailing in Canada, although we also do not think it will take 20 years to obtain 1-per-cent market share as in the UK.”

Going forward, Mr. Howlett sees “very restrained" square footage growth for the sector’s major players. However, he added: “There is a change of CEO at Walmart Canada, which may portend that other changes will follow. We are not expecting any significant change in retail pricing strategy but will nonetheless keep an eye on market pricing. The circumstances surrounding the change at the top gave the appearance that global Walmart management may not have been satisfied with recent financial performance.”

The analyst also suggested “selective regional" market consolidation is likely, but the timing of any moves is “unpredictable.”

In the note, he raised his target prices for several stocks, including:

Loblaw Companies Ltd. (L-T, “buy”) to $78 from $73. The average on the Street is $74.09, according to Bloomberg data.

“Loblaw is the leading grocer in Canada by revenue but also by innovation," said Mr. Howlett. "Loblaw is the largest grocer by revenue in Canada, with well over 3 times the grocery and pharmacy sales of Walmart. Loblaw has been an innovator in the market, introducing supercentre, hard discount and other formats to the market, as well as expanding the breadth of products and services offered in conjunction with grocery items.”

Metro Inc. (MRU-T, “hold”) to $57 from $54. Average: $54.36.

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Empire Company Ltd. (EMP.A-T, “hold”) to $37 from $36. Average: $39.33.

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With its share price down 14 per cent since August, Laurentian Bank Securities analyst Elizabeth Johnston sees the current price of A&W Revenue Royalties Income Fund (AW.UN-T) as “an attractive entry point.”

A day after it dipped 2.5 per cent on weaker-than-anticipated quarterly results, Ms. Johnston raised her rating to “buy" from “hold” based on its valuation and a positive outlook for same restaurant sales growth.

“On the conference call, management discussed how BC, ON and QC remain the strongest growth regions (unchanged from prior quarters),” she said. "In terms of SSSG, on a 2-year basis growth remains very strong (14.2 per cent) and the pullback this period was anticipated given the 13-per-cent SSSG last year. With the initial tailwinds from the Beyond Meat launch now having waned, the company is working to promote this menu item and believes there are still guests that they can bring in to try it for the first time (recent promotional activity also promoted trial).

“Ontario and Quebec are still a focus and the markets with strong growth, contributing 18 of the 25 stores opened year-to-date. At the end of Q3/19, there were 24 locations under construction (vs 24 at Q2/19). As we have seen historically, the Q4 period frequently represents a strong period for new store openings (we are currently forecasting net 40 openings for 2019, unchanged).”

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Ms. Johnston maintained a target price of $45, matching the current consensus.

“Our SSSG remains unchanged at 3 per cent for Q4/19, in spite of the weaker Q3/19 result,” the analyst said. “Over time, we have seen A&W maintain strong positive SSSG (3-year average of 5.6 per cent) and we expect the company to continue to achieve growth through menu innovation and the focus on customer experience. Furthermore, we believe that the company has generally been successful in passing along price increases, which can make up 2-3 per cent of the growth.”

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RBC Dominion Securities analyst Nik Modi thinks “post ‘3G era’ sensibility and macros” are leading to improved shareholder returns from the U.S. packaged food sector.

“After a few tough years, packaged food stocks seem to have hit an inflection point (up 19 per cent year-to-date, in line with both consumer staples and the S&P 500),” he said upon initiating coverage of the sector. "We attribute improvement to a cocktail of factors, including improved pricing (at a time when investors were questioning the ability to take price), an improving commodity outlook, and ‘less bad’ top-line trends as a result of companies beginning to invest behind their brands/innovation pipelines again post the ‘3G era.’ In addition, moderating interest rates and a general penchant for defensive stocks have added fuel to the packaged food rally.

“We applaud management teams across the packaged food space for stepping up investments, but a year of increased spending does not undo several years of aggressive cost cutting. Additionally, many of the challenges facing packaged food over the last few years (changing consumer behavior, smaller competitors operating at low or no margins, private label, etc.) have not gone away. We are concerned that recent stock price performances could be giving management teams a false sense of security. In our view, much work needs to be done to justify current valuations.”

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Though Mr. Modi sees the potential for investing opportunities moving forward, he did caution that most stocks currently sit at “fair value.”

In a research report released Thursday, he initiated coverage of six powerful industry stalwarts. They are:

Campbell Soup Co. (CPB-N) with an “outperform” rating and US$55 target. The average on the Street is US$44.04.

Analyst: “CPB shares have performed well since Mark Clouse joined the company as CEO. Most of the improvement has been a function of improving business trends against easy compares and a much more consistent delivery on earnings expectations. However, we would argue we are still in the early stages of a recovery. Yes, it will likely be choppy as stepped-up spending and reduced promotional intensity (against lots of promotions a year ago) creates quarterly volatility, but we believe the company’s improved capabilities around consumer insights and R&D are just now starting to take hold.”

Mondelez International Inc. (MDLZ-Q) with an “outperform” rating and US$66 target. Average: US$60.74.

Analyst: “At the time of the Kraft spin-off (in 2012), the remaining Mondelez (aka GrowthCo) seemed to have the potential for 6-per-cent revenue growth – the approximate growth rate of its category exposure in the preceding 1-2 years. Since that time, Mondelez’s category growth rate has dipped to under 3 per cent and it has largely been a market share donor. In the post 3G era in food, MDLZ is shifting focus from just margin expansion to be more growth oriented (by reinvesting into advertising, sales and digital capabilities). We also believe the organizational changes MDLZ is making to become more nimble (shifting decision making to local business units, increase investments based on financial performance, re-energizing local brands) will lead MDLZ to accelerate share gains and outperform its categories. We view MDLZ’s long-term targets of 3-per-cent top line and high single-digit EPS as achievable and beatable.”

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Hershey Foods Corp. (HSY-N) with a “sector perform” rating and US$158 target. Average: US$147.13.

Analyst: “While a more rational pricing environment suggests an improved top-line trajectory, we believe the snacking occasion is rapidly evolving to include competition outside of Hershey’s traditional peer set, partially offsetting the benefit. And though we believe management is appropriately investing behind data, technology, and human capital, we are not convinced current innovation will lead to share gains. We expect 1-3-per-cent top-line growth near term and modest gross margin expansion, which is likely already baked into shares.”

General Mills Inc. (GIS-N) with a “sector perform” rating and US$57 target. Average: US$54.87.

Analyst: “After a thorough brand/category review and examination of the input cost environment, we believe current FY’20 expectations are reasonable and see limited upside/downside risk (ignoring potential dilution from additional divestitures). We expect strong U.S. consumption trends (and easy comps) will support continued progress in cereal, yogurt and meals/baking, aided by the benefit from the Blue Buffalo acquisition. Snacks/granola bars (11 per cent of sales) will likely remain under pressure for the foreseeable future driven by intense competitive activity.”

Kellogg Co. (K-N) with a “sector perform” rating and US$65 target. Average: US$64.16.

Analyst: “We think management is making the right choices to position the company for future growth, but it will take time and progress likely won’t be linear. We have an upside bias but need some more proof points that new capabilities are manifesting into a sustained recovery in top line.”

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Conagra Brands Inc. (CAG-N) with a “sector perform” rating and US$30 target. Average: US$32.29.

Analyst: “While the Pinnacle acquisition brought with it increased exposure to favorable categories, it’s clear to us that management underestimated the health of some of the brands within the portfolio. And while we give management credit for quickly identifying the problem areas and proposing solutions, our experience with transformative deals in the CPG space leads us to tread with caution – we are looking for better clarity on efficacy of new innovation before getting more bullish.”

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Despite seeing Russel Metals Inc. (RUS-T) as “one of the most attractively priced dividend stocks available in Canada today,” Raymond James analyst Frederic Bastien lowered his target price for shares of the Mississauga-based metals distribution and processing company ahead of the Nov. 6 release of its third-quarter financial results, pointing largely to “steep" steel price contraction.

“Pricing has come off 15 per cent quarter-over-over, bringing bringing the average decline since the Trump Administration removed tariffs in late May to about 20 per cent," said Mr. Bastien. “We expected plate prices to hold up better due to comparatively tighter supplies in both Canada and the U.S., but instead they have mirrored the fall in hot rolled coil (HRC) prices and now hover closer to 2017′s pre-tariff levels. While there is reason to believe conditions will firm up as mills chase a large line pipe order in 4Q19, we have elected to lower our pricing and margin assumptions for both Metals Service Centers (MSC) and Steel Distributors divisions.”

However, the analyst did suggest “industry hangover symptoms” may be easing, noting: “Data from the Metal Service Center Institute (MSCI) show that Canadian and U.S. shipments declined to the tune of 3 per cent and 7 per cent, respectively, in 3Q19. Although such performance may not be anything to write home about, it does represent a modest improvement over 1H19. We see it as a sign that customers may be starting to move inventories after having sat on them for the better part of the past twelve months. Either way, we fully expect that RUS’ value-added processing push helped it outpace the industry from a volume standpoint.”

For the third quarter, Mr. Bastien is projecting earnings per share of 38 cents, which sits 2 cents below the consensus estimate on the Street and representing a steep decline from $1.09 in the same period a year ago. He expects all three of its operating segments to feel the effects of steel price declines, weaker end product demand and a lower net realizable value (NRV) for its inventory.

Accordingly, he lowered his target for Russel shares to $25 from $27, keeping an “outperform” rating. The average on the Street is $23.83.

“Our constructive recommendation on Russel Metals is underpinned by its best-in-class management, nimble operating model and enviable competitive position across North America,” said Mr. Bastien. “But with product demand soft and, to our miscalculation, steel prices giving back all of their remarkable 2018 gains, we now see slightly less potential for capital appreciation over the next 6-12 months. Notwithstanding our reduced target price of $25, we still expect the firm’s strong balance sheet and countercyclical cash flows to lend strong continued support to its dividend beyond our forecast horizon.”

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Canaccord Genuity analyst Mark Rothschild said Crombie Real Estate Investment Trust’s (CRR-UN-T) recent Investor Day event highlighted the long-term potential value creation stemming from its six active developments.

“High-grading the portfolio through noncore asset sales has been a focus, and the REIT has divested $800-million of properties since January 2018, equating to 17.5 per cent of the REIT’s assets," he said. "With continued pressure on retail fundamentals, particularly outside of extremely strong and defensive locations, we view these asset sales as positive for Crombie.

"In addition to asset sales, the REIT is heavily focused on its growing development pipeline, which should add new and well-located properties to the REIT’s portfolio, while also being accretive to both FFO [funds from operations] per unit and NAV [net asset value] per unit. While Crombie has historically been diversified across Canada with a large exposure to Atlantic Canada, its development projects are largely in major markets with a focus in Vancouver.”

Mr. Rothschild said the six developments, which are largely mixed-use projects and stretch from St. John’s to Victoria, are projected to generate yields of between 6.1 per cent and 6.6 per cent, which will result in annual net operating income of between $34-million and $37-million (or 12 per cent of total NOI).

“Based on management’s estimate of value upon completion, these projects would result in value creation of at least $210-million, or $1.39 per unit – growth of 7.9 per cent on our current NAV estimate,” he said.

“Clearly, as Crombie progresses on its development pipeline, there should be solid value creation and NAV growth. From the six current projects, which have a total budgeted cost of $553 million, management expects value creation of between $210-million and $270 million. Based on this additional disclosure, we have increased the value of the development projects in our NAV estimate. As a result, our NAV per unit estimate rises from $16.41 to $17.59, an increase of 7.2 per cent.”

With that increase, Mr. Rothschild hiked his target for Crombie units by a loonie to $17.50, which exceeds the consensus of $16.92.

He kept a “hold” rating.

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In other analyst actions:

Goldman Sachs analyst Eugene King downgraded First Quantum Minerals Ltd. (FM-T) to “neutral” from “buy” with a target price of $11. The average target on the Street is currently $14.57.

GMP analyst Michael Dunn cut PrairieSky Royalty Ltd. (PSK-T) to “hold” from “buy” with a $16 target. The average on the Street is $20.67.

Scotiabank analyst George Doumet initiated coverage of Park Lawn Corp. (PLC-T) with a “sector outperform” rating and $32.50 target. The average is $32.35.

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