Inside the Market’s roundup of some of today’s key analyst actions
Ahead of the start of third-quarter earnings season for the Canadian energy sector, Desjardins Securities' Justin Bouchard and Chris MacCulloch say they “remain unabashedly bullish on natural gas–weighted equities and cautious on their oil-weighted counterparts.”
In a research report released Tuesday, the analysts say the outlook for natural gas is likely to be “supportive” into 2021, however, citing “depressed” global demand stemming from the COVID-19 pandemic and a large supply overhang, they think both crude and the refined product side are likely to struggle.
“We remain guarded on oil-weighted producers for the time being,” they said. “Globally, substantial volumes from OPEC+ remain behind pipe, and over the foreseeable term, it is entirely conceivable that the cartel may throw everything it has to clip the wings of the U.S. shale juggernaut once and for all. At the same time, many North American producers have demonstrated their ability to survive at US$40–45/bbl per barrel, at least for a time. Ultimately, the problem is global demand—a problem likely to be exacerbated this winter as COVID-19 caseloads escalate. Until the pandemic is brought under control and worldwide economic activity normalizes, refined product inventories are likely to remain elevated, which will weigh on upstream crude pricing. This dynamic is not lost on most of the industry and indeed, capital spending has nosedived. It is here where the longer-term seeds of salvation are being sown for the crude sector—in time, the recovery in demand will coincide with supplies ravaged by reduced drilling activity.”
The analysts made changes to their commodity price deck, highlighted by a drop in their fourth-quarter 2020 WTI forecast to US$40 per barrel from US$42.50 previously. They’ve also “significantly jacked up” their 2021 NYMEX and AECO price forecast to US$4.00 per thousand cubic feet and $4.00 (Canadian) per thousand cubic feet, respectively, from US$3.25 and $3.00.
“We remain of the view that the massive contraction in North American capital spending has been a boon to natural gas–weighted equities,” they said. “The NYMEX natural gas forward strip is supportive of this view, with 4Q20 and 2021 prices now firmly ensconced near the US$3/mcf level. Indeed, indicators for a cold winter — and elevated heating demand — have been encouraging while U.S. LNG exports have recovered from their mid-year lows (despite several hiccups from hurricane activity in the U.S. Gulf Coast). If anything, we believe there is reasonable upside to our admittedly aggressive updated 2021 price deck. Because we are in novel territory and each commodity boom is different, we believe the market will need to see a demonstration of what NYMEX can do this winter before the forward strip (and natural gas–weighted equities) converge with our estimates. Regardless, we believe the Canadian natural gas sector remains the best risk-adjusted play moving into 2021.”
With their changes, Mr. Bouchard adjusted his target prices for five of the six large-cap companies in his coverage universe. They are:
- Cenovus Energy Inc. (CVE-T, “hold”) to $5.50 from $7. The average is $7.36.
- Husky Energy Inc. (HSE-T, “hold”) to $4 from $5. Average: $4.24.
- Imperial Oil Ltd. (IMO-T, “hold”) to $18 from $24. Average: $21.13.
- Suncor Energy Inc. (SU-T, “buy”) to $26 from $29. Average: $28.17.
- Tourmaline Oil Corp. (TOU-T, “buy”) to $33 from $26. Average: $24.82.
Mr. MacCulloch raised his target for three dividend-paying stocks. They are:
- ARC Resources Ltd. (ARX-T, “buy”) to $11 from $9.50. Average: $8.92.
- Enerplus Corp. (ERF-T, “buy”) to $5 from $4.50. Average: $4.94.
- Peyto Exploration & Development Corp. (PEY-T, “buy”) to $5 from $4.50. Average: $3.46.
Raymond James analyst Jeremy McCrea sees “encouraging trends heading into 2021” for PrairieSky Royalty Corp. (PSK-T) following the release of its third-quarter results.
On Monday after the bell, PrairieSky reported quarterly production results that fell below the analyst’s expectations (18,745 barrels of oil equivalent per day versus a 19,400 boe/d estimate). However, its funds flow of 17 cents per share fell in line with his forecast.
“There is no other company quite like PrairieSky in our view - despite the company still down 45 per cent year-to-date (XEG: down 54 per cent),” he said. "Between its extremely low leverage position and its ability to see some of the highest ‘value creation’ in the mid-cap sector (given limited need for capital), there should be considerable long-term comfort for investors. Concerns on spending this year have hurt share performance but we are starting to see a number of indicators of activity plans picking up through the fall ... With Friday’s announcement by the Alberta Government to lift oil production curtailment come December, this could allow some larger operators to potentially bring back some production that was previously shut-in.
“After a dividend reduction earlier this year, the company is now returning cash to shareholders via share repurchases with 8.9 million shares repurchased and canceled in the quarter for $81.8-million. PSK has now moved to a position with a small amount of debt ($67-million, 0.3 times 2020 estimated D/EBITDA) which management expects to fully repay within three quarters. If commodity prices remain at current levels, we also expect that there could be room to possibly see a dividend bump when 4Q results are announced in February.”
Keeping an “outperform” rating, Mr. McCrea raised his target to $13.25 from $13. The average on the Street is $11.46.
Seeing “deteriorating” office fundamentals, Desjardins Securities analyst Michael Markidis trimmed his financial expectations and target price for units of Allied Properties Real Estate Investment Trust (AP.UN-T) ahead of the release of its third-quarter results on Wednesday after the bell.
“Demand has contracted in Canada’s largest office markets over the past two quarters,” he said. “Office-using employment has been comparatively resilient; however, given (1) the magnitude of the current economic downturn, and (2) widespread adoption of work-from-home, absorption will likely remain weak for the next few quarters.”
He warned that a “quick” rebound is “unlikely at this juncture,” adding: “it is important to note that, perhaps in contrast to previous economic downturns, office-using employment (down 1.4 per cent vs the seasonally adjusted level for February 2020) has been considerably more resilient compared with the overall market (down 3.7 per cent). On the other hand, the magnitude of the current economic contraction is much more severe, and a significant proportion of office-using employees have transitioned to a work-from-home arrangement. On top of this, we have entered a ‘second wave’ and a return to pre-pandemic normalcy does not appear likely in the short term. Based on these observations, we believe absorption trends will remain weak for at least the next several quarters.”
Mr. Markidis also sees Allied’s development activity in both downtown Toronto and Vancouver adding “another layer of uncertainty.”
“The 1.2 million square feet of new space added to the downtown Toronto inventory in 3Q20 was more than 80 per cent leased,” he said. "Taking this into account, the demand contraction within the pre-existing stock was greater than the overall net absorption of negative 0.7 million square feet in 3Q20. This marked the early stages of the next significant supply wave; 8.9 million square feet of new space is scheduled for completion prior to the end of 2023. A substantial proportion of this space is pre-leased; however, employing a simplifying assumption that overall absorption tracks consistently with what was recorded over the previous five years, market vacancy could rise to 10 per cent.
“The backdrop in downtown Vancouver is similar. New supply under construction as a percentage of existing inventory is 15 per cent and increasingly weaker absorption figures in 2Q20 and 3Q20 have already pushed the overall vacancy rate to 4.6 per cent (from 2.2 per cent in 1Q20). Employing the absorption assumption (trailing-five-year quarterly absorption), market vacancy could rise to 12 per cent.”
Mr. Markidis cut funds from operations per unit expectation for 2021 to $2.28 from $2.34.
Keeping a “buy” rating, he reduced his target for Allied units to $40 from $52. The average is $49.95.
“Development is risky business,” said Mr. Markidis. “Project returns and development profits can be negatively impacted by several factors including cost inflation, lower-than-anticipated NOI on stabilization and terminal cap rate risk. In assessing the risk of AP’s development pipeline, we note than (1) more than 50 per cent of costs have already been incurred, and (2) these will be brand-new, best-in-class assets. Cap rates for commercial properties at the high end of the market tend to be more sticky than lower-quality product during periods of contraction and expansion. The bottom line: we are less confident about the potential for fair value increases as milestones are achieved and projects are completed compared with six months ago; however, we believe there is significant buffer to protect against significant fair value writedowns.”
In a research note titled Is It Time to Look Beyond the Pandemic?, Scotia Capital analyst Many Grauman thinks there’s reasons to be hopeful entering earnings season for Canadian life insurance companies.
“Top of the list is the financial results themselves which showed remarkable resiliency in Q2, including solid capital levels and very modest negative credit experience even during the height of the economic shutdowns," he said. "We expect financial results to continue to hold up well in Q3, especially since this quarter coincided with the reopening of economies in North America and across the globe. In addition, we believe that the nature of this crisis also plays to the lifecos strengths given that the impact is very bifurcated and skewed towards smaller firms that these insurers have less exposure to. The big x-factor remains the rate environment, but even here are signs that the long tide of lower rates may be changing.”
For the quarter, Mr. Grauman is expected sector earnings per share to fall by 4 per cent from the second quarter and 7 per cent from the same period a year ago.
“The year-over-year decline certainly reflects an ongoing drag from the pandemic but is being magnified by unusually strong performance for GWO in Q3/19," he said. “Overall, our estimates are better than consensus for each of the lifecos in our coverage universe, led by Sun Life where we are 5 per cent above the Street. We believe that this is optimism is justified given the beats we saw in Q2, and think that this resiliency will extend to Q3 as well. Meanwhile headline EPS should be up 29 per cent year-over-year, mostly due to the URR charges that MFC, SLF, and GWO all recognized last year."
Mr. Grauman raised his IA Financial Corp. (IAG-T, “sector outperform”) target to $64 from $56, and reaffirmed its stock as his top pick in the sector. The average target on the Street is $56.67.
“Given our improving outlook for the sector, it is probably not surprising that we would focus our attention on the hardest-hit stocks in the space, namely IAG and MFC,” he said. “That said, although both names are trading at a discount to book value, we are most bullish on IAG as we enter Q3 reporting and believe that it is the name most likely to benefit from re-rating coming out of earnings season. This is based on our view that the company will continue to demonstrate strong capital levels even in the face of an expected URR charge, and even more importantly that it is likely to deliver better-than-expected results out of its newly acquired IAS business, in line with the significant recovery we have seen in US auto sales. Meanwhile, although MFC’s results should be solid despite the ongoing absence of core investment gains, concerns about ALDA returns should continue to weigh on valuation until we see at least a few quarters of positive investment-related experience.”
Mr. Grauman also raised his target for Sun Life Financial Inc. (SLF-T, “sector perform”) to $61 from $57. The average is $59.31.
His target for Great-West Lifeco Inc. (GWO-T, “sector perform”) increased to $33 from $28, which is the current consensus.
Mr. Grauman maintained a “sector outperform” rating and $25 target for Manulife Financial Corp. (MFC-T). The average is $23.54.
Following “exceptional” third-quarter results, Raymond James analyst Daryl Swetlishoff hiked his target for shares of West Fraser Timber Co. Ltd. (WFT-T), pointing to its “epic” free cash flow.
Last week, the Vancouver-based company reported adjusted EBITDA of $545-million, exceeding both Mr. Swetlishoff’s $525-million projection and the Street’s $502-million expectation.
“Like other companies, West Fraser responded to 2Q20 COVID19 inspired market weakness by extending credit lines, however, the subsequent extreme lumber rally boosted FCF to record levels,” he said. “After repaying operating loans and hoarding cash ($300-million) net debt fell to $376-million at quarter end (down $563-million or $8 per share quarter-over-quarter!). From over $1-billion at the end of 1Q20 we project net debt falling $673-million or $10 per share during calendar 2020, with West Fraser approaching debt free status during 1H21. As [Monday’s] markets underscore, COVID19 uncertainty remains, however, and we expect the company to be content building cash on the balance sheet for the near term before allocating the capital.”
Keeping an “outperform” rating, Mr. Swetlishoff raised his target for West Fraser shares to $90 from $82. The current average is $83.33.
“Canfor opened strong following their earnings release, however, shares traded off in the subsequent two sessions as investors ‘sold the news,’” he said. “While we expect Fraser’s strong 3Q20 was anticipated we believe the potential for an equally strong 4Q20 is being heavily discounted. Free cash flow during the quarter was sufficient to enable us to hike our target by $8 per share (to $90) and we expect similar FCF gains in the current quarter. Our constructive view of lumber markets is supported by limited system inventories and an excellent U.S. housing outlook featuring record ow interest rates, severely depleted re-sale inventories and accelerating COVID19 induced social and secular demand shifts (along with demographics). Traders indicate lumber sales volumes are starting to pick up which we expect to put a seasonal floor in lumber pricing at the US$550-600 level. We expect this event to be a sustainable catalyst for building materials share prices and advocate investors continue to add to positions.”
Though he does not see the Oct. 30 release of SNC-Lavalin Group Inc.'s (SNC-T) third-quarter results as a share price catalyst, Canaccord Genuity analyst Yuri Lynk said he continues to “see a favourably skewed risk/reward opportunity,” leading him to reaffirm his “buy” rating.
“Similar to prior quarters, we expect solid results from SNCL Engineering Services and see downside risk associated with the lump-sum turnkey (LSTK) business, SNCL Projects, which is being wound down,” he said.
Mr. Lynk is projecting earnings per share of 12 cents, below the 18-cent consensus on the Street and falling from 47 cents during the same period a yea ago.
“We expect SNCL Engineering services to deliver $140-million in EBIT versus $176 million in Q3/2019 on a 2-per-cent year-over-year decline in revenue,” he said. "Q3/2019 featured an SNCL Engineering Services EBIT margin of 11.7 per cent, the highest of any quarter since Atkins was acquired in mid-2017. This was driven by unusually high Nuclear margins and one-time positive adjustments in Infra. Services. All that to say, last year’s third quarter is a tough comp. Q3/2020 will feature slower activity in the Middle East region and in the aviation and commercial buildings end-markets. We expect to to see strong results from Infra. Services, Nuclear, and rail and transit within EDPM.
“We are less confident about how SNCL Projects will perform in the quarter. Our model assumes a Q3/2020 $70-million EBIT loss for this segment. A lot of the issues that drove a $140-million segment loss in Q2/2020 persisted into Q3/2020, namely, restricted travel and slower productivity on construction sites due to COVID-19 containment efforts.”
Seeing its core business as “well positioned,” Mr. Lynk introduced his 2022 estimates, which see earnings per share jump from a 7-cent loss this year to $1.87.
He also raised his target for SNC shares to $40 from $38. The average is $34.
Bird Construction Inc.'s (BDT-T) $96.5-million deal to acquire Stuart Olson Inc. is “highly” accretive and provides “scale, diversification and meaningful cost and revenue synergy opportunities,” according to CIBC World Markets analyst Jacob Bout.
He initiated coverage of Canadian construction company with an “outperformer” rating.
“We also regard Bird as well positioned to benefit from a meaningful step-up in infrastructure spend as part of the government’s fiscal policy response to COVID-19,” said Mr. Bout.
He set a target of $9 per share. The current average is $9.88.
“We believe that the stock’s recent valuation provides investors with a good entry point with a number of potentially value-unlocking catalysts on the horizon,” the analyst said. “We estimate that Bird (pro forma SOX) is trading at 4 times on a forward 2021E EV/EBITDA basis, well below its historical average (range of 3-9 times) and the peer average of 6.2 times. Bird looks particularly attractive on an EV/Backlog basis of just 11 per cent versus a range of 10-25 per cent in recent years. Pro forma net debt/TTM EBITDA is less than 1 times.”
In response to “strong” third-quarter financial results, Citi’s Itay Michaeli raised his earnings expectations for Tesla Inc. (TSLA-Q) through 2022, pointing to higher long-term margin assumptions that reflect “greater confidence in gross margin execution.”
However, the analyst said the stock “still reflects a significantly more robust growth/margin outcome than what we view as most likely,” leading him to maintain his “sell” rating.
“We expect the near-term focus to shift to Q4/'21 demand metrics and FSD [Full Self-Driving] progression,” he said.
On its FSD beta rollout, Mr. Michaeli added: "There are two central investment debates related to Tesla’s FSD effort: (1) Whether Tesla can launch L4 features/services (prior RoboTaxi objectives) under acceptable safety/performance standards; (2) Whether Tesla can safely launch non-highway FSD features at L2 (driver-assist), which if done well, could conceivably drive higher demand.
“Based on videos apparently shared by some initial FSD beta users, we make the following observations: (a) Some of the FSD maneuvers are indeed impressive, providing a glimpse of what AVs can deliver. The system appears noticeably better than what Tesla showed in 2019; (b) On the L4 debate, from what we can tell the initial FSD disengagement rates appear considerably higher than those posted by Waymo/Cruise/Zoox in California during the final two months of 2019 (Waymo & Cruise achieved more than 1.0 disengagements per 12k miles, or 1 yearr of driving). So the debate on Tesla’s L4 position doesn’t change for now, in our view, though it will be key to monitor the rate of OTA improvement. (c) Launching FSD as a non-highway L2 system (like Autopilot) would be a high-risk/high-reward strategy, in our view. The reward is in possibly becoming the only OEM offering non-highway L2 features, something the industry has to-date been reluctant to pursue mainly for safety reasons. If FSD can safely deploy L2/non-highway, other OEMs might follow suit (boding well for ADAS suppliers), but for at least some time FSD could be the only such available feature, benefiting Tesla’s sales/ASPs. The risk comes from relying on drivers to successfully disengage, particularly when disengagements are more than just a rare event. This is true even for trained drivers — as the Uber tragedy taught the industry, after which AV companies often began using 2 safety drivers. So Tesla’s approach does seem to carry higher regulatory, reputational and development risk.”
The analyst raised his 2020 earnings per share projection to US$2.49 from US$2.41. His 2021 and 2022 forecasts rose to US$3.83 and US$5.05, respectively, from US$3.15 and US$4.15.
With his “sell” rating, Mr. Michaeli hiked his target for Tesla shares to US$137 from US$117. The average on the Street is US$337.52.
“Tesla shares have pulled back but we still view risk/reward to be skewed to the downside,” he said. “Relative to other automakers we think Tesla faces somewhat greater uncertainty both on the supply-side (dependence on a single plant that’s currently under a shelter-in-place order) and demand (EV regional concentration in impacted regions). To that point, we note that some of the most impacted U.S. regions are significant EV sales contributors (California, NY/NJ). This too calls into question the pace of demand even if Fremont were to restart production. Lastly, given that start-of-production at Fremont appears dependent on government approval or a lifting of shelter-in-place orders, it’s unclear under what conditions Fremont can return to full production.”
Goodfood Market Corp. (FOOD-T) is likely to benefit from a “favourable backdrop amidst accelerated penetration of Canadian e-grocery and meal kit delivery,” according to Canaccord Genuity analyst Luke Hannan ahead of the release of its fourth-quarter results on Nov. 11.
For the quarter, he’s projecting revenue of $70-million, below the $75-million consensus on the Street but up 54 per cent year-over-year. His EBITDA estimate of $0.7-million exceeds the consensus of a loss of $0.4-million and is “well ahead” of the $4.4-million loss reported during the same period a year ago.
“Goodfood announced that it added 8,000 net new subscribers in Q4/F20 and ended the period with 280,000 subscribers, a 40 per cent increase from a year ago,” said Mr. Hannan. “The number of net new adds indicates, in our view, that the effect of seasonality was still present in Q4/F20, with potential new subscribers opting to defer subscribing during the summer months. Having said that, we note the company commentary surrounding average order values and order frequency indicates positive trends for both metrics to close out the fiscal year, which is expected given the accelerated shift into ecommerce grocery and meal solutions due to COVID-19. Consequently, we expect gross merchandise sales of $81-million, a 45-per-cent increase from Q4/F19.”
After raising his revenue and earnings expectations for both 2020 and 2021, Mr. Hannan increased his target for Goodfood shares to $11.50 from $9.50, keeping a “buy” rating. The average is $9.07.
“Our target represents 1.9 times our F2021 sales estimate of $360 million (previously 1.6 times our F2021 sales estimate of $357-million),” he said. This compares to our meal-kit provider peer group, with significant operations in the United States, which trades at 1.4 times FY+2 sales, and remains below best-in-class peer HelloFresh, which trades at 2.4x. We have increased our target multiple to reflect sectorwide multiple expansion.
“We believe the shares offer significant value to investors at current levels, given the company’s robust growth outlook and scale within the relatively underpenetrated Canadian market.”
In other analyst actions:
* Stifel Canada analyst Michael Dunn upgraded Husky Energy Inc. (HSE-T) to “buy” from “hold” with a $5.10 target, topping the $4.29 average.
Mr. Dunn also raised Cenovus Energy Inc. (CVE-T) to “buy” from “hold” with a $6.50 target. The average is $7.36.
* TD Securities analyst Graham Ryding lowered Genworth MI Canada Inc. (MIC-T) to “hold” from “buy” with a $43.50 target, up from $39. BMO’s Tom MacKinnon lowered his target for the stock to $43.50 from $38 with a “sector perform” rating. The average is $40.
* BMO Nesbitt Burns analyst Thanos Moschopoulos cut his target for Constellation Software Inc. (CSU-T, “outperform”) to $1,600 from $1,800. The average is $1,766.75.
* RBC Dominion Securities analyst Irene Nattel raised her target for Canadian Tire Corp. Ltd. (CTC.A-T, “outperform”) to $173 from $168. The current average is $147.90.
* Cormark Securities analyst David Ocampo raised his target for TFI International Inc. (TFII-T) to $80 from $68 with a “buy” rating, while Stephen’s Jack Atkins increased his target to $82 from $71, keeping an “overweight” rating. Both exceed the $75.38 average. Stifel’s David Ross raised his target to $86 from $77 with a “buy” rating.
* Scotia Capital analyst Michael Doumet increased his target for shares of Stelco Holdings Inc. (STLC-T, “sector outperform”) to $21 from $16. The average is $14.60.
“We hosted a group call with Stelco’s Executive Chairman and CEO, Alan Kestenbaum, and CFO, Paul Scherzer. It was a very bullish call. We share the same bullishness – despite the recent rally in the share price, we still see significant upside,” he said.
* Scotia Capital’s Phil Hardie cut his target for Fairfax Financial Holdings Inc. (FFH-T, “sector perform”) to $500 from $600. The average is $563.94.
“We have made downward revisions to our 2021 and 2022 forecast largely reflecting reduced expectations for investment gains given headwinds related to the interest rate environment,” he said.
* National Bank Financial analyst Richard Tse hiked his target for Altus Group Ltd. (AIF-T, “sector perform”) to $52 from $45, exceeding the $50.83 average.
* Mr. Tse also raised his target for Absolute Software Corp. (ABT-T, “sector perform”) to $18 from $17. The average is $17.64.
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