Inside the Market’s roundup of some of today’s key analyst actions
RBC Dominion Securities analyst Paul Quinn expects COVID-19 will “negatively impact” most North American forest product producers.
In a research report released Tuesday before the bell, Mr. Quinn lowered his financial expectations for the 18 companies in his coverage universe, pointing to the near-term headwinds. However, he also raised his ratings for several stocks in order to reflect “significant decline in their share prices and more attractive returns.”
“While the ultimate short- and long-term impact of COVID-19 on the economy remains unclear, the RBC Economics team currently forecasts negative GDP growth during Q2 for the United states and negative GDP growth for both Q2 and Q3 in Canada,” he said. “Given the expectation for more challenging economic conditions, we have reduced valuations for our coverage to more accurately reflect market valuations and near-term headwinds. We expect to revise our financial forecasts as we gain more visibility on near-term prospects.”
Mr. Quinn expressed a preference for tissue and oriented strand board producers, feeling they are “best positioned” to tackle the difficult conditions. Conversely, he thinks packaging companies will be “the most challenged.”
“In our view, tissue producers are very well positioned to weather the current environment given their defensive attributes and the unique nature of the current situation (whereby consumers are stocking up on household tissue products and putting a greater emphasis on cleanliness),” he said. "Our favorite tissue producers are KP Tissue and Cascades. We also like OSB producers, given that capacity has already been rationalized to reflect a lower level of housing starts and that valuations have dropped well below what we view as fair value. We rate both Louisiana-Pacific and Norbord as Top Pick.
“On the flip side, we expect that packaging will be negatively impacted by the economic slowdown, with declines in containerboard and SBS demand likely to push past global financial crisis lows as the economy effectively shuts down. Some have pointed to e-commerce as a continued boon; however, we expect the shift of consumers to a more defensive posture will limit discretionary purchases. This will largely offset any bump from increased consumer staple shipments. We rate both International Paper and WestRock as Sector Perform.”
Mr. Quinn made rating changes to six stocks.
“Our positive ratings largely reflect the recent pullback in the companies’ share prices, which has materially increased the implied returns to our price targets and set up attractive investment opportunities, in our view,” he said. “While markets are likely to remain volatile in the short term, we think that the valuation on all three businesses has varied materially from our view of underlying fair value.”
Calling it an “attractive investment opportunity,” he raised Norbord Inc. (OSB-T) to “top pick” from “outperform” with a $44 target, down from $50. The average target on the Street is $49.29.
His other moves were:
Western Forest Products Inc. (WEF-T) to “outperform” from “sector perform” with a $1.25 target (unchanged). Average: $1.50.
Canfor Pulp Products Inc. (CFX-T) to “outperform” from “sector perform” with a $6 target, down from $8. Average: $10.60.
“Domtar shares have been under significant pressure since November, with COVID-19 driving additional downside for the company,” he said. 'While COVID-19 will surely have a negative impact on uncoated freesheet demand (as schools and offices shut down), we think the deterioration will prompt additional closures and lengthen the runway for Domtar’s paper business. In addition, pulp is proving resilient, as it was already amidst a downturn prior to COVID-19."
James Hardie Industries PLC (JHX-N) to “sector perform” from “underperform” with a US$23 target (unchanged). Average: US$12.16.
“Mercer’s share price has declined materially over the last year, driven by the historic decline in pulp prices,” the analyst said. “Under more normal conditions, we think that pulp prices would have room to fall as the economy slowed; however, we think most of the excess has already been squeezed out of the industry. Given capacity reductions and limited additions, we think that the future looks brighter for pulp.”
Industrial Alliance Securities analyst Michael Charlton downgraded PrairieSky Royalty Ltd. (PSK-T) following the Monday after-market announcement that it has adjusted its free cash flow allocation and moved from a monthly to quarterly dividend in reaction to “unprecedented volatility” stemming from the drop in crude prices and market reaction to COVID-19.
"With domestic E&P’s rapidly cutting planned 2020 capital budgets in response to weakening commodity prices of late, PrairieSky and its Board of Directors are proactively taking decisive action now with regards to its future free cash flow allocation," the analyst said. "The new, lower, dividend rate is anticipated to be well below managements’ forecasted cash flow given the decreases seen in E&P activity/investment levels that continue to be rapidly revised lower (and lower) in response to the deteriorating underlying commodity prices. Reducing the dividend will also increase PrairieSky’s financial flexibility potentially allowing it to acquire additional assets, expanding its future potential or use excess free cash flow to repurchase shares in this distressed market. With a lower dividend rate and also with reduced dividend payment frequency, we believe that the Company is better positioned to weather a longer term commodity price storm."
Pointing to “uncertainty surrounding the capital plans in its lessees and the reduced dividend,” Mr. Charlton moved PrairieSky to “hold” from “buy” and lowered his target to $8 from $14.75. The average on the Street is $15.25.
“The company looks to be well positioned to continue delivering dividends to its shareholders through the continued leasing and development of its royalty holdings in highly active parts of the WCSB,” he said. “For investors seeking income in a company that pays a stable, sustainable monthly dividend while waiting for a broader recovery in investor sentiment towards the Canadian E&P space, we believe those investors need look no further. In our view, PrairieSky offers exactly that — balanced exposure to multiple plays and formations in all stages of development. As we have said, holding PrairieSky is like holding 5 per cent of future drilling and development activity across the entire WCSB, with optionality on technology!”
Elsewhere, Canaccord Genuity's Dennis Fong maintained a "buy" rating and $15 target.
Mr. Fong said: “While we note that the dividend cut was larger than we expected, the lower payout ratio and free cash flow generation provides flexibility that operating E&Ps do not have. We view this to be the prudent move, and we would be buyers on any share price underperformance. While the company has maintained the flexibility to repurchase shares with existing free cash flow (existing Board approval and NCIB allow for up to $50 million or 1.2 per cent of the float to be repurchased), the building up of dry powder could allow PrairieSky to be opportunistic in an environment where companies are looking for liquidity.”
Citing the potential for slower near-term leasing activity as a result of COVID-19, Industrial Alliance Securities analyst Brad Sturges lowered his rating for Invesque Inc. (IVQ.U-T) on Tuesday, anticipating a delay in its adjusted funds from operations per share recovery.
"While an impact from the COVID-19 virus outbreak remains unclear at this stage, near-term leasing activity could slow at Commonwealth Senior Living (Commonwealth) communities," he said. "Previously, an increase in Commonwealth’s average occupancy rate from 84 per cent at December 31, up to the 85-per-cent to 90-per-cent range was expected to support a recovery in Invesque’s FD AFFO/share growth in 2020. At this stage, our FD and FD AFFO estimates are reduced to reflect lower average occupancy forecasted for Commonwealth, and higher assumed overhead costs."
On March 11, the Toronto-based company, which focuses on income-producing seniors housing and care properties, reported weaker-than-anticipated fourth-quarter results, due largely to elevated expenses.
“Invesque’s 2020 estimated FD AFFO payout ratio is quite elevated at an estimated 121 per cent,” said Mr. Sturges. “We believe reducing the Company’s annual dividend rate to retain more cash flow is a prudent move at this stage. Also given Invesque’s deep NAV [net asset value] discount valuation, suspension of Invesque’s DRIP may reduce the near-term dilution of its estimated NAV per share.”
Pointing to a need to balance its “deep NAV discount valuation with the heightened uncertainty with respect to any impact from the COVID-19 virus outbreak, and its above-average investment risk profile that includes high financial leverage,” Mr. Sturges moved Invesque to “hold” from “speculative buy” with a US$5.25 target, down from US$7.25. The average is US$6.52.
“We view Invesque’s shares to be deeply undervalued relative to its estimated NAV, which may provide an extremely compelling buying opportunity if Invesque can successfully generate improved FD AFFO/share growth year-over-year,” the analyst said. “However, we believe that many investors continue to wait for Invesque to ‘show me’ better FD AFFO/unit growth metrics. Also, Invesque’s above-average investment risk profile, and the potential for a negative near-term earnings impact from the COVID-19 virus outbreak may constrain any material recuperation in Invesque’s depressed share price in the current market environment.”
Canaccord Genuity analyst Doug Taylor reduced his financial expectations and target price for shares of Air Canada (AC-T) following its moves aimed at dealing with the “unprecedented uncertainty” stemming from COVID-19.
"On Monday, Air Canada revealed the adjustments it has made to address the collapse of demand caused by the rapidly evolving COVID-19 situation," he said. "The moves are aimed at ensuring the company has as much liquidity as possible to ride out a prolonged period of depressed revenue.
“We have revised our model lower for the second time in less than a week, this time with more information from Air Canada directly. The company has $7.3-billion in liquidity available and has taken measures to further strengthen its cash position; our revised model suggests that the company has more than enough capital to ride out the summer with traffic down 50 per cent. This is before taking into consideration assistance from the government, which has yet to be finalized.”
Mr. Taylor said Air Canada’s balance sheet is “positioned to weather the storm,” noting: “Net debt/EBITDA was 0.8 times as of Q4; it is now 2.6 times using our new forward estimates. We forecast net debt/LTM EBITDA [last 12-month earnings before interest, taxes, depreciation and amortization] to peak in Q4/20 at 4.0 times, and that the company could still manage a 4.3-times net debt/LTM EBITDA at the end of Q2 with zero passenger revenue, demonstrating its ability to withstand a significant further shock. While the U.S. may provide financial assistance to its airlines, our forecast does not include any potential government assistance.”
Mr. Taylor's revenue projections for 2020 and 2021 slid to $12.672-billion and $16.404-billion, respectively, from $17.047-billion and $19.157-billion. His earnings per share expectations are now a loss of $1.87 and gain of $1.57, respectively, from a $1.57 profit and $4.32.
Keeping a "buy" rating, he dropped his target to $30 from $40. The average is $44.08.
“We continue to believe the bottom will be tough to call but think this pullback will ultimately yield an extraordinarily attractive entry point,” the analyst said.
Elsewhere, seeing 2020 as "a lost year," CIBC World Markets analyst Kevin Chiang cut his target to $37 from $44 with an "outperformer" rating.
Mr. Chiang said: “The situation facing the global airline industry is going from bad to worse as countries are now closing their borders which is creating an unprecedented decline in demand. But we see AC with sufficient liquidity and cost flexibility to manage through this very challenging period even as we forecast a loss for this year. While AC (and the airline industry overall) is navigating through unchartered territory, we do expect air traffic to return as we have seen throughout history post a major macro shock. And we openly wonder once the industry moves past this headwind, with permanent capacity exiting the market, if this should result in a stronger relative yield and margin environment for the surviving airlines. We put AC in this camp. We expect AC will get through this period temporarily bruised but still intact, further reinforcing our argument that it should trade at a structurally higher valuation.”
Pointing to its asset quality and long-term value, Citi analyst Alexander Hacking raised Vale SA (VALE-N) to “buy” from “neutral.”
“We are not calling a bottom in the sector and acknowledge very high likelihood of a sharp fall in global steel demand and iron ore prices,” he said. "That said, we see no change to the structural view on iron ore. The world will still need cars and buildings, in our view.
"And on a relative view we see key positives to Vale: Iron ore may be better cushioned than base metals if China aggressively stimulates its economy; Vale generates FCF at $50/ton & has no balance sheet or liquidity concerns; Vale’s overall enterprise value is only 20% below trough 2016 levels when iron ore was in the $40’s & Vale’s cost structure was materially higher (and above trough 2008 levels); If Vale suffers any operational challenges from COVID-19 this may reflect also in the iron ore price given the consolidated nature of supply (as per Brumadinho)."
Mr. Hacking trimmed his target to US$12 from US$14. The average is $14.29.
Raymond James analyst Jeremy McCrea called Vermilion Energy Inc.'s (VET-T) dividend cut and latest reduction to its capital expenditure budget “further prudent moves.”
“A few months ago, our thesis on VET was one of profitability given its low sustainable capex requirements and strong reserve reports historically,” he said. "Much of this is due to their international diversification where ‘conventional’ style geology generally has better rates of return than shale/tight oil plays - something important if commodity prices stay subdued. Unfortunately, the rapid decline in commodity prices has had Vermilion playing defense given where its balance sheet had grown over the last several years. Encouragingly, we have now seen management appreciate the unknown risks COVID-19 presents to oil prices and have acted aggressively to protect the balance sheet.
“With a 91-per-cent cut to its dividend now (putting payout at 7 per cent) and further reductions to capex spending for the remainder part of the year, these will be actions that investors (and lenders) should appreciate. We now calculate 2021 D/EBITDA at 3.2 times with much of this debt termed out for the next 4 years. In the meantime, we still expect to see plenty of volatility and we remind investors many of these E&P names remain very high risk.”
Keeping a “market perform” rating, he reduced his target to $6.50 from $7. The average is $11.77.
Meanwhile, CIBC World Markets' Dave Popowich lowered his target to $5 from $8, keeping an "underperformer" rating due to its "relatively high financial leverage, and an uncertain commodity price outlook."
Mr. Popowich said: "Although we are pleased to see Vermilion take the necessary measures to manage its cash outflows in response to weakness in commodity pricing, we do not see a lot of buffer in the event that prices weaken further from here. There is no question that many of Vermilion’s peers are in the same boat at this point, but investors should expect this stock to remain volatile until commodity prices show clear signs of improving."
Believing its leasing momentum “bodes well” for its payout ratio, Laurentian Bank Securities analyst Yashwant Sankpal raised BTB Real Estate Investment Trust (BTB.UN-T) to “buy” from “hold” following the release of in-line fourth-quarter results.
“BTB has been able to achieve robust leasing activity over the last 2-3 quarters as reflected by its historically high occupancy level," he said. "Property fundamentals also remain steady in its core markets. If BTB could sustain its current leasing momentum over the next 3-4 quarters, it would be able to bring its AFFO payout ratio below 100 per cent (by our methodology). The recent market meltdown due to the double-whammy of the Coronavirus scare and the oil price correction have pulled down the valuation of the TSX REIT Index (down 21.6 per cent year-to-date) along with the rest of the broader market (TSX Composite down 27.6 per cent YTD). BTB is down 22.1 per cent YTD. However, we believe that the virus scare is likely to be a temporary disruption in the Canadian business activity and the economy should return to its normal level by Q3/Q4 2020.
"Therefore, given a 35-per-cent total return to our target price, we are upgrading BTB to a BUY. Having said that, we advise that investors be mindful of the heightened market volatility in the near term and build their position cautiously.”
Mr. Sankpal maintained a $5 target. The average is currently $4.83.
In other analyst actions:
Scotia Capital analyst Ovais Habib raised Kirkland Lake Gold Ltd. (KL-T) to “sector outperform” from “sector perform” with a $56 target. The average is $58.50.
TD Securities’ Steven Green raised Kirkland Lake to “buy” from “hold” with a $58 target.
Scotia’s Trevor Turnbull upgraded Dundee Precious Metals Inc. (DPM-T) to “sector outperform” from “sector perform” with a $7 target, rising from $6.50. The average on the Street is $7.47.
PI Financial analyst Philip Ker upgraded Ero Copper Corp. (ERO-T) to “buy” from “neutral” with a $16 target, down from $19.25. The average is $21.52.
TD Securities analyst Aaron MacNeil lowered Tervita Corp. (TEV-T) to “hold” from “buy” with a $5.50 target, falling from $10. The average is currently $9.03.
Jefferies analyst Owen Bennett cut Green Organic Dutchman Holdings Ltd. (TGOD-T) to “underperform” from “buy” with a 15-cent target, down from $1.30. The average is 22 cents.
UBS analyst Shneur Gershuni raised Pembina Pipeline Corp. (PPL-T) to “buy” from “neutral” with a $37 target, down from $51. The average is $54.35.