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

Desjardins Securities analyst Gary Ho made a sizeable boost to his price target on shares of Founders Advantage Capital Corp. (FCF-X) after the investment company’s second-quarter results beat expectations.

Founders owns a 60 per cent investment in DLC, which is the largest mortgage brokerage firm by volume in Canada. The company has been benefiting from the bounceback in Canada’s housing market.

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“2Q20 results were ahead of our expectations, led by another solid beat at DLC with a 12% year over year increase in funded mortgage volumes and a 47% year over year increase in EBITDA,” Mr. Ho said in a note. “We expect DLC to perform well in 2H20 as housing activity rebounds."

The analyst increased his earnings estimates for the company, primarily for DLC. His price target was raised to $1.75 from $1.25 while maintaining a “buy” rating.

Mr. Ho outlined several positives for the stock: “(1) Solid beat at DLC was driven by a combination of increased funded mortgage volumes (+12% yoy) and lower advertising and direct costs. EBITDA rose 47% yoy. The lower cost base is likely sustainable. With strong demand from key housing markets (Toronto and Vancouver), DLC’s outlook for 2H20 appears promising. (2) Increasing focus on Velocity (Newton’s fin-tech platform connecting brokers with lenders) to drive volume submissions could lead to a valuation re-rate; however, we need better financial disclosure and penetration data with mortgage brokers to better assess this potential. (3) Active memberships at Club16 grew 2% yoy despite COVID-19 concerns and its recent private placement validates its valuation (at 6.75x EBITDA). Equipment refresh fees were also collected in early August (~C$2.3m vs our original forecast of C$1.5m). (4) Management noted no immediate risk to liquidity and expects to further pay down its Sagard loan in 3Q20.”

The median analyst price target on the stock is $2.25, according to Refinitiv Eikon.

**

Recent stock price weakness in Morneau Shepell Inc. (MSI-T) is offering an attractive entry point in a high-quality name that has rare “defensive-growth” characteristics., says Scotiabank analyst Phil Hardie.

The analyst reiterated a “sector outperform” rating and $36 price target on the human resources company that provides consulting and administrative services. The median price target on the Street is also $36.

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“MSI has a proven track record of resilience and has demonstrated the ability to grow its revenues under a wide range of macroeconomic and financial market conditions, and to deliver consistent returns to investors,” Mr. Hardie said in a note. “High levels of recurring revenues, stable margins, and low capex requirements are reasons to like the story.”

Morneau Shepell showed resilience during the market sell-off earlier this year, delivering positive growth in the second quarter. Despite this, the stock has sold off in recent weeks.

“Likely investor concerns include: 1) the risk of an extended period of elevated unemployment levels; 2) impact from COVID-19 containment measures leading to expectations for softer revenue growth; 3) stock performance leadership in more beta and cyclical plays over more defensive-oriented stocks in recent weeks; and 4) stock rotation and increased appetite for more value/discounted names compared to those trading at higher multiples,” he said.

Mr. Hardie said these market factors currently weighing on the stock are likely transitory in nature.

**

Citi analyst Paul Lejuez has doubled his price target on Gap Inc. (GPS-N) to US$24 after doing a sum-of-the-parts valuation (SOTP) analysis on the company. He also upgraded his rating to “buy” from “neutral.”

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An SOTP is an attempt to value a company by determining what its divisions would be worth if they were spun off or acquired by another company.

Gap has ditched a plan to spin off its Old Navy stores, but the move does imply the board is willing to take on corporate actions to unlock shareholder value, Mr. Lejuez said. “And with the favorable positioning of athletic/casual retailers in a post-Covid world, GPS’ Athleta brand stands out as having value that may not be getting recognized by the market,” he added.

At the midpoint of Citi’s valuation estimates, Athleta is estimated to be worth about US$3.6-billion on a standalone basis or in a sale. Given that Gap’s current enterprise value is just $6.5-billion, this implies “big upside” based on the SOTP analysis, according to Mr. Lejuez.

“After walking away from the planned spin of Old Navy (which didn’t make sense to us at the price they announced it – it didn’t unlock anything), we believe it is time to revisit a SOTP for several reasons now that the stock is at $15-16. (1) We believe the Board is open to taking corporate actions, which could include monetization as well as spin-offs. (2) Athleta is one of the few athletic brands with a combination of scale but plenty of room for growth (which could be attractive to several acquisitive companies). (3) Old Navy’s off-mall value positioning is a favorable one in a post-Covid world. (4) LB’s VS brand showed it is possible to get out of a significant number of leases without much financial burden (good news for Gap and BR),” the analyst said in a note.

The median price target among analysts is US$12.

**

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At least five brokers initiated coverage on Vital Farms Inc. (VITL-Q), with most seeing good potential for the provider of pasture-raised eggs, but some raised valuation concerns.

Goldman Sachs started coverage with a “neutral” rating and price target of US$37. Jefferies initiated coverage with a “buy” rating and $47 target. Stifel gave it a “buy” rating and a target of $43.

Credit Suisse was perhaps the most cautious, giving it a “neutral” rating and $35 target, even as it called Vital Farms “a highly compelling investment proposition.”

Credit Suisse analyst Robert Moskow listed a number of positives for the stock: “1) it is the market leader in the small, but fast-growing pasture-raised egg category with 75% market share; 2) it has strong marketing and compelling line extensions, and has tapped into the growing consumer desire for more transparency in the food chain and ethical treatment of livestock; 3) it has a unique network of 200 egg farm suppliers and a state-of-the-art egg distribution facility, and is the only pasture-raised egg company with enough scale to expand on a national level into mainstream retail grocers; 4) its sales growth spiked to 79% in 2Q during the height of COVID-19 (well above the 33% pace of growth over the past four years), which pulled forward the company’s expectations for consumer adoption and expansion.”

But, he said the stock is already trading at 26 times his 2024 EBITDA estimate. “We believe that investors should wait for a pullback before building a new position,” he concluded.

BMO analyst Kenneth Zaslow gave it a “market perform” rating and $40 target price, summing up his view as “Egg-citing growth opportunity, though a bit too “Egg”-xpensive.”

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**

CIBC analyst Hamir Patel upgraded Mercer International Inc. (MERC-Q) to “outperformer” from “neutral,” citing “signs of life” in softwood pulp prices in China, as well as the company’s potential to grow its lumber platform further. He also raised his price target by 11 per cent to US$10. The median price target among analysts is $9.

“With softwood prices having bottomed in China in June (and having shown upward momentum in recent weeks), we are increasingly comfortable that the rebound in pulp prices we have been forecasting for 2021-22 will materialize,” Mr. Patel said in a note.

“At the same time, we believe Mercer will remain active on the M&A front. The company is currently the stalking horse bidder (with a $26MM bid) for the Klausner Lumber One mill in Florida (~200 mmfbm/yr) with that mill’s auction expected to be concluded at bankruptcy court proceedings in Delaware over the next week. We view this potential acquisition positively for Mercer as the company has a proven ability to operate the unique European technology (Linck) Klausner installed, and MERC should be able to solve the wood supply challenges Klausner faced (which we understand stemmed from irregular payments to suppliers not a lack of fiber availability),” he said.

CIBC analysts led by Mr. Patel also raised price targets on 12 other names in the materials sector on Tuesday, largely driven by higher commodity pricing assumptions.

Price targets were raised on Acadian (from C$18 to C$19), Canfor (from C$19 to C$25), CanWel (from C$5.75 to C$7.00), Conifex (from C$1.15 to C$1.85), Hardwoods (from C$25 to C$27), Interfor (from C$22 to C$23), Norbord (from C$50 to C$58), Resolute (from $3.75 to $4.75), Richelieu (from C$33 to C$37), Stella-Jones (from C$48 to C$50), West Fraser (from C$75 to C$89) and Western FP (from C$1.20 to C$1.40).

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**

In other analyst actions:

Nutrien Ltd. (NTR-T): Atlantic Equities downgrades rating to “neutral” from “overweight.”

Starbucks Corp. (SBUX-Q): Stifel raises rating to “buy” from “hold” and raises target price to US$90 from $78.

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