Inside the Market’s roundup of some of today’s key analyst actions
Earnings uncertainty stemming from the impact of the spread of COVID-19 prompted Raymond James analyst Daryl Swetlishoff to adjust his valuation methodology for Canadian forest products companies.
“While 2020 began with much promise, COVID-19 induced impacts on forest products market demand has weighed heavily on commodities and sector valuations with year-to-date shares down an average of 44 per cent (vs. the TSX down 20 per cent),” he said in a research note released before the bell. "An examination of asset values reveals current valuations approaching 2007/08 financial crisis levels despite what we would argue as multiple positive differentiators e.g., tree product companies generally maintain solid financial liquidity reserves with limited near term maturities.
“With very weak commodity demand amid uncertain operating environments (for at least the next two quarters) we elected to reduce target multiples to the bottom of the historic range. This resulted in reduced target prices across the board, although the average implied upside remains a healthy 42 per cent.”
Citing “uncertainty surrounding recovery timing,” Mr. Swetlishoff lowered his stocks with “strong buy” ratings to “outperform.” That move affected three companies:
Interfor Corp. (IFP-T) with a $9.50 target from $16.50. The average on the Street is $13.75.
Norbord Inc. (OSB-T) with a $25.50 target from $44. The average is $36.89.
West Fraser Timber Co. Ltd. (WFT-T) with a $40 target from $64. The average is $57.67.
His target price changes were:
Acadian Timber Corp. (ADN-T, “outperform”) to $15 from $20. Average: $17.
Canfor Corp. (CFP-T, “outperform”) to $10 from $13.50. Average: $13.67.
Canfor Pulp Products Inc. (CFX-T, “outperform”) to $10 from $7. Average: $7.10.
Conifex Timber Inc. (CFF-T, “market perform”) to 50 cents from 80 cents. Average: 85 cents.
Mercer International Inc. (MERC-Q, "outperform) to US$11 from US$16. Average: US$10.60.
Western Forest Products Inc. (WEF-T, “outperform”) to 80 cents from $1.50. Average: $1.21.
“We highlight that the industry has been quick to shut in capacity, and we expect more to come,” said Mr. Swetlishoff. “Also, aggressive government stimulus has the potential to further boost already buoyant pre-COVID-19 housing demand which could dramatically tighten markets once social and economic disruptions abate. Accordingly, despite a high probability of continued stock market volatility we advocate investors with 6-12 month time horizons opportunistically continue to add to positions.”
Though its macro outlook remains “uncertain,” Industrial Alliance Securities analyst Elias Foscolos raised his rating for Mullen Group Ltd. (MTL-T) on Tuesday, citing its “survivable balance sheet, and a resilient business model that is attributable to diversification and cost management.”
"We believe that the stock has become sufficiently discounted to justify upgrading from a Hold," said Mr. Foscolos, who moved the Alberta-based transportation and oilfield services company to a "speculative buy" rating.
The analysts sees 2020 as a “challenging year with heightened uncertainty.” However, he thinks Mullen has the capacity to generate positive cash flow after the three-month suspension of its dividend and despite assuming it’s unlikely to complete any acquisitions during the year.
"MTL has repurchased 1.3 million shares since initiating its NCIB in March, buying back 67,000 shares/trading day since March 9 and effectively replacing the dividend," he said. "Recall that MTL’s previously stated intention was to target $100-million in buybacks over a three-year period."
“MTL has $90-million-plus in cash and a $150-million undrawn credit facility. MTL does not have any debt maturities until 2024. The company’s private placement debt carries a covenant total debt/operating cash flow ratio (covenant operating cash flow ≈ EBITDA) of 3.5 times. Based on our estimates, we project an 3.2-times ratio. As the total debt calculation does not deduct cash and equivalents, MTL could reduce the numerator in a pinch simply by extinguishing debt with excess cash.”
Mr. Foscolos maintained a $6.50 target for Mullen shares. The average on the Street is currently $8.21, according to Thomson Reuters Eikon data.
“Our estimates are unchanged, but we are taking the opportunity to move to a Speculative Buy (previously Hold) ahead of any material flattening of the curve which should spur a recovery in equities,” he said.
In a separate research released early Tuesday, Mr. Foscolos raised his rating for Pason Systems Inc. (PSI-T), believing the recent selloff “makes the stock sufficiently discounted to warrant taking a position.”
The analyst thinks the Calgary-based provider of specialized data management systems for drilling rigs possesses a strong enough balance sheet to “survive a downturn of prolonged duration,” even without a reduction in its dividend.
“North American E&Ps have reduced CAPEX budgets by approximately 30 per cent, implying a year-over-year decline in spending of 30 per cent,” he said. "This should translate into a substantial decline in rig counts (Industrial Alliance 2020 estimated average: Canada 116, U.S. 533). We believe that energy demand will take some time to normalize, and see the effects from COVID-19 reverberating into 2021.
“PSI has a cash balance of $160-million, enough to weather a downturn of short to medium duration. There appears to be limited visibility as to when oil & gas demand will be able to normalize from current COVID-19 levels. As such, we could see PSI taking a cautious approach and moderately reducing its dividend to maintain its industry leading balance sheet until there is more clarity. Based on the difference between PSI’s listed shares outstanding disclosed by TMX and PSI’s shares outstanding at 2019 year-end, the company has repurchased 400,000 shares year-to-date. We believe that PSI could continue flexibly repurchasing shares with a reduced dividend.”
Mr. Foscolos noted Pason shares have dropped by 35 per cent since he revised his drilling outlook and target price on March 10. He now said he's projecting a 38-per-cent price return even if it cuts its dividend to zero, which he feels justifies an upgrade.
The analyst maintained an $8.50 target for Pason shares, which falls below the current average of $12.75.
“We are cautiously optimistic as we like PSI’s current valuation and strong fundamentals, but believe there is too much uncertainty to predict when a recovery in drilling will occur,” he said. “PSI may not have an immediate need for a dividend reduction, but we could see the company taking a cautious approach in order to prevent substantial cash drawdowns. PSI’s cash position with zero debt should allow it to survive a prolonged downturn, and we believe the stock has the potential to deliver solid returns at the current price.”
Pointing to “uncertainty with the unemployment outlook and duration of the pandemic,” Desjardins Securities analyst Gary Ho felt compelled to lower his rating for People Corp. (PEO-X).
Mr. Ho said he remains in "favour its solid management team and recession-resilient business model," however he was surprised by the timing of its $20-million equity raise.
On Monday, the Winnipeg-based provider of group benefits, group retirement and human resource services announced the bought-deal offering of 2.8 million common shares priced at $7.15 each with a 15-per-cent overallotment option. The net proceeds will be used growth initiatives (including future acquisitions) and general corporate purposes.
"Although PEO has been acquisitive in 2Q FY20 after acquiring RVARC and Integrated Benefit Consultants (we assume a $23-million combined purchase price after accounting for a 25-per-cent retained interest), as well as spending $9.2-million to purchase an additional economic interest in Coughlin, we project the company still has $28-million available on its credit facility plus the $22.7-million of cash on hand as at 1Q FY20," said Mr. Ho.
"In previous calls, management has indicated it is comfortable taking leverage up to 2.5–3.0x (vs less than 2.0 times, by our math). Its credit agreement also provides for an increase in the revolving commitment for up to an additional $50-million. Further, we note that the offering was priced below the two prior equity offerings in 2018 and 2019 at $7.70 per share and $9.10 per share, respectively."
In explaining his downgrade, Mr. Ho also noted Peope's clients tend to be from small and medium-sized enterprises, and, though "well-diversified," susceptible to being "impacted to some degree from mass business and store closures across the country." He also expects slower organic growth and a pause in deal activity stemming from the impact of COVID-19.
Moving the stock to “hold” from “buy,” Mr. Ho cut his target for People shares to $8.50 from $12. The current average is $10.83.
“PEO was our top pick heading into 2020, primarily due to its defensive attributes and growth profile. The stock has been the second best performer in our coverage universe in the year to date,” he said.
“Given an 11.4-per-cent potential return to our target, we are moving to a Hold rating (from Buy).”
The impact of the spread of COVID-19 has created “heightened risks surrounding supply chains, consumer demand, distribution and B2B sales” that are likely to weigh on Canadian cannabis companies, according to Canaccord Genuity analyst Kimberley Hedlin.
“For the time being, it is somewhat business as usual for Canadian cannabis companies, most of which have indicated they are increasing sanitation and distancing efforts,” said Ms. Hedlin. "With the exception of NL, PEI and ON, cannabis retailers remain open in Canada, although some retailers have made the decision to close, reduce hours or move to click and collect models. For both LPs and retailers, staffing disruptions have occurred due to employees staying home due to minor illness or needing to care for children. Since the outbreak escalated in early March, LPs and retailers have reported an uptick in sales. However, as we look to the U.S., states like CA, WA and CO have now started to see a decline in sales.
"While we believe cannabis is relatively recession resilient, given the magnitude of layoffs and initial stockpiling behaviour, we believe Canadian companies will likely see volume and pricing pressure into Q2 and Q3. Another area that could be impacted by COVID-19 is the pace of physical inspections, whether for cultivation licences, sales amendments or GMP certifications. Lastly, we believe COVID-19 raises the risk profile of B2B sales throughout the industry owing to force majeure clauses that may be embedded in existing contracts."
Ms. Hedlin emphasized Ontario move to suspend private retail sales adds further uncertainty to the industry.
In a research note reviewing early earnings season in the sector, she also pointed to the slow rollout of cannabis 2.0 products, despite "strong" demand, and "ongoing pricing weakness."
Ms. Hedlin lowered her rating for Decibel Cannabis Company Inc. (DB-X), formerly known as Westleaf Inc., to “hold” from “speculative buy” with a 15-cent target, down from 55 cents and below the 35-cent average.
“The reduction is largely due to DB’s premium value proposition in the context of a weak economy, along with expected licensing delays, both of which could create challenges in gaining market share,” she said.
Ms. Hedlin also lowered her target for the following stocks:
High Tide Inc. (HITI-CN, “speculative buy”) to 45 cents from 50 cents.
Valens Groworks Corp. (VLNS-X, “speculative buy”) to $8.25 from $7.25.
Canaccord Genuity analyst Yuri Lynk sees SNC-Lavalin Group Inc. (SNC-T), Stantec Inc. (STN-T) and WSP Global Inc. (WSP-T) are “particularly well positioned” for investors seeking shelter from the COVID-19 market fallout.
"Professional services firms have defensive characteristics that uniquely position them within the broader industrial space. This is due to their multi-year backlogs, the ability of their employees to work remotely (AKA social distancing), and their acyclical end-market exposure. Additionally, SNC (esp. through Atkins), WSP (esp. through Louis Berger), and Stantec have all played critical roles assisting governments in disaster recovery.
“To be clear, however, these companies are not immune to a slowdown. Construction sites in some regions have been closed and where construction has been deemed an essential service, work has slowed. Our checks have also revealed a lack of responsiveness from public sector clients when it comes to approving project completion (making it tough to move to the next stage), approving new work, and paying receivables; so expect days sales outstanding (DSOs) to lengthen. Private sector clients, especially in mining, oil and gas (O&G), and buildings, have moved quickly to reduce capital expenditures. This is likely to lead to lower demand for associated engineering services.”
Though he sees all three positioned to be "earliest beneficiaries of any upcoming infrastructure-laden fiscal stimulus," Mr. Lynk reduced his target price for shares of all three. His changes were:
SNC (“buy” rating) to $41 from $43. The average on the Street is $36.46.
“SNC is most vulnerable to the idled construction sites across Ontario and Quebec and the drop in oil prices," he said. "However, its Engineering Services business should remain stable. When it comes to valuation, we view SNC as too cheap to ignore.”
STN (“hold”) to $40 from $42. Average: $45.65.
“Stantec is well positioned in defensive end-markets such as water, infrastructure, and transportation,” he said. “However, more than 8 per cent of revenue is tied to O&G while Western Canada is still 14 per cent of overall revenue. This could make Stantec more vulnerable to a decline in demand than WSP.”
WSP ("buy") to $95 from $100. Average: $97.50.
“WSP has de minimus resource exposure with 77 per cent of net revenue derived from end-markets with positive long-term growth trends such as transportation, infrastructure, and critical buildings,” he said. “Furthermore, it has the most balance sheet optionality of the three, in our view.”
In other analyst actions:
* Canaccord Genuity analyst Doug Taylor initiated coverage of Kraken Robotics Inc. (PNG-X) with a “speculative buy” rating and 75-cent target. The average is $1.32.
“Kraken is emerging as a global leader in the niche market for unmanned maritime vehicles, related services and components,” said Mr. Taylor. “This market is being powered by investment in oceanic mapping, subsea infrastructure monitoring and military applications. After a breakout 2019, we expect Kraken will maintain momentum into 2020 and beyond with consistent profitability. This growth is grounded by a strong backlog and pipeline of new work. While COVID-19 is likely to make certain sales activities challenging, we expect the company will continue to demonstrate meaningful growth this year, reinvigorating PNG’s shares. Our C$0.75 target represents a 108% potential return. The SPECULATIVE risk qualifier reflects still lumpy sales and a short history of profitability; both should improve in coming years.”
* TD Securities analyst Brian Morrison raised Canadian Tire Corp. Ltd. (CTC.A-T) to “action list buy” from “buy” with a target of $140, falling from $190. The average is $145.44.
* Scotia Capital downgraded a group of TSX-listed energy stocks to “underperform” from “sector perform.” They are: Athabasca Oil Corp. (ATH-T), Baytex Energy Corp. (BTE-T), Bonterra Energy Corp. (BNE-T), Delphi Energy Corp. (DEE-T), Gran Tierra Energy Inc. (GTE-T), Perpetual Energy Inc. (PMT-T) and Surge Energy Inc. (SGY-T).
* The firm cut the following stocks to “sector perform” from “sector outperform” ratings: International Petroleum Corp. (IPCO-T), NuVista Energy Ltd. (NVA-T), TORC Oil & Gas Ltd. (TOG-T) and Whitecap Resources Inc. (WCP-T).
* Scotia Capital’s Orest Wowkodaw lowered Nevada Copper Corp. (NCU-T) to “sector perform” from “sector outperform”
* PI Financial analyst Chris Thompson cut Fortuna Silver Mines Inc. (FVI-T) to “neutral” from “buy” with a $4.40 target, down from $5.80. The average is $5.12.
* Stifel GMP initiated coverage of Alimentation Couche-Tard Inc. (ATD.B-T) with a “buy” rating and $43 target. The average is $45.56.
* Echelon Wealth Partners analyst Andrew Semple moved iAnthus Capital Holdings Inc. (IAN-CN) to “under review” from “speculative buy” and removed his target price (previously $2.50).
"We make this rating change after iAnthus announced that it withheld a $4.4-million interest payment on a $97.5-million principal amount of secured convertible debentures, putting substantially all its $159.2-million of principal amount of debt into default," said Mr. Semple. "The company stated that it was unable to reach a negotiated agreement with the holders of the secured convertible debentures. iAnthus also noted that it has so far been unsuccessful in closing a further round of secured convertible debenture financing from Gotham Green Partners (“GGP”), or capital from other sources.
“This disclosure impedes our ability to assess how the Company can raise sufficient capital to fund expansion projects and to sustain operations. We still see some prospective alternatives that would see the Company successfully move forward, but these alternatives will almost surely be more punitively priced.”
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