Tuesday’s analyst upgrades and downgrades

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

Ahead of the start of fourth-quarter earnings season for the sector next week, Credit Suisse’s Joo Ho Kim sees Canadian banks remaining “well-positioned to weather through a downturn given the resilient earnings generation and balance sheet strengths.”

The equity analyst also thinks “strong upside exists” for the sector despite several approaching headwinds.

“Although Q4 tends to be a guidance-heavy quarter for the Canadian banks, it remains uncertain whether a further positive forward outlook (whether for NIMs, credit, or others) would be enough to send the sector valuation higher, especially in the absence of further macro clarity,” he said in a research report released Tuesday. “Even as we forecast a more challenging growth environment in F2024, our estimates suggest a still very respectable mid-teens ROE for that year.”

For the quarter, Mr. Kim expects core earnings per share for the Big 6 to be essentially flat-over-year on average, which is in line with the consensus view on the Street. On a pre-tax, pre-provision (PTPP) basis, he sees earnings growth of 5 per cent quarter-over-quarter and 12 per cent year-over-year.

“For the quarter, we assume dividend increases across all the banks in our coverage universe,” he said.

While maintaining his recommendations for the stocks in his coverage universe, Mr. Kim did adjust his pecking order heading into earnings season.

“While CM has been our top pick in the sector since we launched back in May, we now move the shares down to the bottom of our Outperform pecking order,” he said. “That is driven by our view of negative housing market dynamics (from growth and the sentiment from a credit perspective) that could disproportionately impact CM’s valuation, as well as lower short-term relative upside on margins. Our pecking order accordingly moves to BMO, NA, RY, and CM among our Outperform names.”

Mr. Kim raised his targets for these stocks:

• Bank of Montreal (BMO-T, “outperform”) to $152 from $150. The average on the Street is $147.39.
• National Bank of Canada (NA-T, “outperform”) to $111 from $106. Average: $102.13.
• Royal Bank of Canada (RY-T, “outperform”) to $150 from $143. Average: $137.61.
• Toronto-Dominion Bank (TD-T, “neutral”) to $96 from $95. Average: $98.91.

He cut his target for these stocks

• Bank of Nova Scotia (BNS-T, “neutral”) to $73 from $84. Average: $81.53.
• Canadian Imperial Bank of Commerce (CM-T, “outperform”) to $72 from $76. Average: $73.59.
• Canadian Western Bank (CWB-T, “neutral”) to $27 from $29. Average: $32.86.
• Laurentian Bank of Canada (LB-T, “underperform”) to $33 from $39. Average: $41.62.

“We take this opportunity to introduce our new F2024 estimates, reflecting a more challenging growth environment,” he added. “Our F2024 core EPS estimate implies an average year-over-year growth of just 1 per cent, reflecting a further slowdown in loan growth, flattish NIMs, good expense management, and rising PCLs. Our core ROE estimate for the sector ticks down to a still respectable 14.6 per cent across the Big Six banks.”

“We make very modest changes to our F2023E and on average, our core EPS estimate for that year goes up by 1 per cent. We now base our target price calculation off the new F2024 estimates, and our recommendations for the banks remain unchanged.”

Elsewhere, a trio of other analysts also made target adjustments on Tuesday.

* Scotia Capital’s Meny Grauman recommends investors take a defensive approach to the sector heading into earnings season.

Mr. Grauman’s changes are:

• Bank of Montreal (BMO-T, “sector outperform”) to $156 from $19. Average: $147.39.
• Canadian Imperial Bank of Commerce (CM-T, “sector outperform”) to $75 from $83. Average: $73.59.
• Canadian Western Bank (CWB-T, “sector perform”) to $29 from $30. Average: $32.86.
• EQB Inc. (EQB-T, “sector outperform”) to $82 from $79. Average: $78.75.
• Laurentian Bank of Canada (LB-T, “sector perform”) to $37 from $43. Average: $41.62.
• National Bank of Canada (NA-T, “sector outperform”) to $115 from $112. Average: $102.13.
• Royal Bank of Canada (RY-T, “sector outperform”) to $149 from $144. Average: $137.61.
• Toronto-Dominion Bank (TD-T, “sector perform”) to $100 from $101. Average: $98.91.

“As we approach year-end reporting season investors are once again faced with the prospect of navigating the gap between recession fears and the reality of a quarterly earnings season that despite some challenges is likely to keep pointing to economic resiliency,” said Mr. Grauman. “Market declines will still weigh on wealth and capital markets-related fee income streams, and provisions should head higher thanks to a deterioration in forward-looking economic indicators, but underlying performance should remain underpinned by further sequential margin expansion (albeit much more modest in Canada for most banks except for RY), still remarkably strong loan growth (despite a modest slowdown in mortgage growth, commercial loan growth remains on fire), and no sign of a spike in actual credit losses. The bottom line is that those looking for proof of a recession in this latest batch of bank results will be sorely disappointed once again. And yet we continue to believe that a defensive posturing remains appropriate heading into F2023, even as we remain very confident that credit conditions will hold up remarkably well.

“Heading into Q4 earnings season we believe that RY, TD and BMO are best positioned to outperform given their more favorable exposure to rising rates. In our view they are the banks that should see the most Q/Q margin expansion in the quarter, which we believe will remain the key metric on which investors will judge this earnings season. Margin expectations have become more modest heading into reporting which is a positive for the shares, and we continue to believe that the group is already pricing in a mild recession which remains our base case scenario. Yesterday’s buyout offer for HCG (covered by Phil Hardie) at 1.1 times P/B and 8.6 times 2023E EPS highlights unrealized value for the group as a whole, but especially for the banks we cover that are currently trading below 8.6 times consensus F2023 EPS, which include CM and EQB among our Sector Outperform rated names.”

* After cutting his cash earnings per share projections by an average of 3 per cent, Canaccord Genuity’s Scott Chan made these target revisions:

• Bank of Montreal (BMO-T, “buy”) to $148 from $150.50. Average: $147.39.
• Bank of Nova Scotia (BNS-T, “buy”) to $83.50 from $86.50 Average: $81.53.
• Canadian Imperial Bank of Commerce (CM-T, “buy”) to $75 from $79. Average: $73.59.
• National Bank of Canada (NA-T, “hold”) to $101.50 from $100. Average: $102.13.
• Royal Bank of Canada (RY-T, “hold”) to $131 from $130.50. Average: $137.61.
• Toronto-Dominion Bank (TD-T, “hold”) to $95 from $94.50. Average: $98.91.

“Since FQ3 reporting, Group performance has varied with BNS (exposure to International such as Pacific Alliance regions) and CM (largest Cdn. mortgage book) as the clear laggards,” said Mr. Chan. “Both Banks Q3/F22 NIM were underwhelming particularly compared to peers. We believe the same theme could play out this quarter with our CM (down 1 per cent) and BNS (1 per cent) F2023E EPS growth rate below the Big-6 banks (avg.) of 4 per cent. As a result, we are lowering our relative P/E target discount on BNS to 6 per cent (from 3 per cent) and on CM to 2 per cent (from 0 per cent). We suggest more strategic uncertainty at BNS near term from their new incoming CEO (see link). Overall, we are lowering our Group (avg.) target prices by 1 per cent (most at CM and BNS; slightly positive with NA and TD). Heading into FYE results, we can envision a ‘kitchen sink’ quarter potentially highlighted by higher-than-expected costs and performing reserve builds.”

* Keefe, Bruyette & Woods analyst Mike Rizvanovic made these reductions:

• Bank of Montreal (BMO-T, “outperform”) to $158 from $159. Average: $147.39.
• Bank of Nova Scotia (BNS-T, “market perform”) to $75 from $86. Average: $81.53.
• Canadian Imperial Bank of Commerce (CM-T, “market perform”) to $69 from $72. Average: $73.59.
• Laurentian Bank of Canada (LB-T, “market perform”) to $38 from $40. Average: $41.62.
• Toronto-Dominion Bank (TD-T, “outperform”) to $102 from $103. Average: $98.91.

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Following Restaurant Brands International Inc.’s (QSR-N, QSR-T) appointment of former Domino’s Pizza Inc. (DPZ-N) chief executive Patrick Doyle as its new executive chair last week, RBC Dominion Securities analyst Christopher Carril reaffirmed the parent company of Tim Hortons and Burger King as his “top pick among the global franchised fast food group.”

He acknowledged some of its peers, include Domino’s, may “represent greater near-term upside,” given Restaurant Brands’ 36-per-cent jump in share price since the end of June (versus a 4-per-cent gain for the S&P 500). However, he thinks its risk-reward is “the most compelling among peers, particularly at a time when valuations are elevated and the consumer macro environment remains debated.”

“Despite MCD and YUM stock also performing well recently (up 11 per cent and 9 per cent to-date in the 2H22, respectively), the valuation gap between QSR and its closest peers has narrowed on the back of QSR’s recent performance,” said Mr. Carril. “We do see further upside to shares (our target multiple shifts to 18.5 times 2023E EBITDA, from 17 times prior).”

“Looking ahead, however, we see continued execution against defined Burger King US and Tim Hortons Canada strategies, accelerating development growth into year-end and capital allocation prioritizing brand investments, dividends and balance sheet deleveraging all as further closing QSR’s valuation gap to peers in the near-to-mediumterm.”

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The analyst said the sentiment around the appointment of Mr. Doyle “was broadly positive, with investors citing Doyle’s experience leading the successful turnaround of DPZ. Investors also highlighted the structure of Doyle’s compensation package, specifically the long-term nature of it, as well as its focus on shareholder value creation.”

“In the very near-term, we expect that Doyle will be focused on connecting with QSR’s brand leadership, as well as with franchisees. Furthermore, despite the recent focus on Burger King U.S. (following the launch of its ‘Reclaim the Flame’ strategy), we think he will not necessarily be focused on one brand in particular, but rather on the overall portfolio, at least at the moment,” said Mr. Carril. “We also don’t expect Doyle to be focused on M&A in the near-term (recall he previously served as an Executive Partner with the Carlyle Group, focused on potential acquisitions). Given QSR’s current capital allocation priorities—including deleveraging its balance sheet—we think M&A likely becomes more of a medium-term focus for the company.”

Maintaining an “outperform” rating for Restaurant Brands shares, he raised his target to a new Street-high of US$80 per share from US$70. The average is US$66.

“Despite above-average global system sales growth and accelerating comp growth at Burger King and Popeyes, QSR’s valuation remains in line with the global “all-franchised” restaurant peer group average, driven in large part by continued weakness at Tim Hortons (responsible for 50 per cent of total op. profit). While we believe that TH sales improvement remains the primary catalyst for QSR shares, we see the combination of BK-driven, near-best-in-class unit growth (normalized 5-per-cent-plus), current momentum at PLK, significant scale, and potential to add brands in the future as key positives for a stock that in our view remains attractively valued,” he concluded.

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The $1.7-billion sale of Home Capital Group Inc. (HCG-T) to billionaire financier Stephen Smith is “good value” for its shareholders, according to National Bank Financial analyst Jaeme Gloyn, moving his recommendation to “tender” from “sector perform.”

The alternative mortgage lender soared 57.1 per cent on Monday following the premarket announcement of the acquisition for a cash offer of $44 per share. It represents a 63-per-cent premium to the mortgage lender’s closing stock price last Friday and a 72-per-cent premium to its 20-day average trading price.

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“We believe the offer price is favourable given the P/B [price-to-book] valuation of 1.09 times lands (1) well above the current valuation of 0.67 times; (2) above the average P/B multiples in the last two years (0.97 times) and five years (0.84 times); and (3) HCG has traded above 1.09 times only 20 per cent of the time in the last five years,” said Mr. Gloyn. “The transaction is expected to close in mid-2023 and requires 66 2/3-per-cent shareholder approval and court/regulatory/customary approvals. SFC has provided a full and unconditional guarantee in regard to the purchase price. If closed on or after May 20, the purchase price will increase $0.25 per share for every three-month delay. HCG will continue to pay its $0.15 per share dividend in the ordinary course.”

Predicting the deal “will likely close at this level,” Mr. Gloyn moved his target to $44, matching the offer price, from $30. The average on the Street is $43.

Elsewhere, Scotia Capital’s Phil Hardie raised his target to $44 from $35, maintaining a “sector perform” rating.

“Given the sophistication of the buyer and likely limited concern related to impacts on competition, we view the probability of success of the deal going through as relatively high,” said Mr. Hardie.

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In a separate note, Mr. Gloyn said Goeasy Ltd.’s (GSY-T) $58-million equity bought deal “builds balance sheet capacity to fund future growth and also improves the leverage profile of the company.”

Upon resuming coverage of the Mississauga-based alternative financial services company, he said the equity raise is likely to be accretive in the second half of 2023, falling in line with management’s view, and touted its “rapid growth profile.”

“Management expects gross consumer loans receivable growth to track closer to more than $750-million in 2022 and exceed the high end of guidance in 2023 and 2024,” said Mr. Gloyn. “The $58-million incremental equity is expected to unlock $350-million to $400-million of growth capacity. As a result, we expect management to increase 2023 and 2024 guidance with Q4-22 results to be released in February 2022. The transaction is expected to be accretive in H2 2023 as the growth in the loan book generates enough earnings to offset the share dilution (despite the continued shift towards lower yield securitized loans such as HELOCs and auto loans).”

He also thinks Goeasy’s leverage metrics and balance sheet “remain solid,” adding: “Crucially, the decision to improve the leverage profile of the business was made internally. The company lowers its net debt to tangible net worth ratio, which stood at 4.38 times in Q3-22 vs. the covenant of less than 4.50 times, to a more comfortable level in the ‘low 4s. ‘Importantly, we estimate the net debt to tangible net worth ratio will remain roughly flat near term as internal capital generation through earnings offsets higher debt funded growth. Management boasts $1.12 billion in total funding capacity, including cash and recently upsized securitization facilities, sufficient to fund growth through H2-2025.”

Narrowly lowering his adjusted diluted earnings per share for 2022 ($11.27 from $11.31), Mr. Gloyn raised his expectations for 2023 and 2024 (to $14.87 and $18.67, respectively, from $14.70 and $18.31). That led him to raise his target for Goeasy shares to $175 from $170 with an “outperform” rating. The average on the Street is $199.11.

“Our $175 price target (was $170) implies a 10 times target P/E multiple (unchanged) on our NTM [next 12-month] adj. EPS+1YR estimates,” said Mr. Gloyn. “Our target multiple aligns with the five-year average trading multiple of 10 times, which we believe appropriately balances the company’s solid execution against persistent macroeconomic headwinds. GSY is trading at 8 times consensus NTM EPS estimates, slightly below the long-term average trading multiple (compared to ex-COVID low of 6.3 times in 2016 and recent peak of 17 times). We continue to expect GSY will successfully execute on its three-year guidance including i) demonstrating stable credit performance, and ii) executing on several loan growth initiatives (e.g., product, channel, geographic).”

Elsewhere, others resuming coverage include:

* Scotia’s Phil Hardie with a $165 target, up from $164, with a “sector perform” rating.

“The financing came as a bit of a surprise; however, we view it as a strong signal from management that it intends to continue to sustain strong loan growth momentum through 2023 and 2024 and is confident that it will meet or exceed its current targets despite a transitioning economy,” said Mr. Hardie. “We estimate the equity injection will add an additional $350-million to $400-million of loan growth capacity without compromising the company’s financial strength and keep its leverage ratios well within the targeted range. The offerings were met with strong investor demand, despite lingering macro uncertainties and a difficult capital markets environment with equity financings on the Toronto Stock Exchange likely to hit multi-decade lows in 2022 ... GSY shares trade at a relative premium to peers, but we believe its valuation continues to look interesting, though it’s not in value territory. Reduced risk to the economic outlook and a broader shift in investor sentiment and risk appetite are likely needed for the stock to sustain a rebound.”

* Desjardins Securities’ Gary Ho with an unchanged “buy” rating and $185 target.

“The $58-million equity issue helps unlock $350-million in liquidity to support accelerated growth without jeopardizing its current credit rating/covenant metrics,” said Mr. Ho. “Alternatively, management could maintain its steady-state growth outlook (ie within its three-year commercial targets) and not raise equity capital/compromise leverage. This would result in GSY deliberately slowing growth, allowing earnings to build into equity/capital over time. We remain confident that management can hit its credit guidance near-term. GSY expects the transaction to be accretive by 2H23. By its estimate, earnings from C$75‒80-million incremental loan book growth would neutralize the dilution.

“Our investment thesis is predicated on: (1) GSY’s ability to manage in the current challenging macro environment through its robust credit underwriting platform, supplemented by its creditor insurance program; (2) solid loan book growth, particularly on secured products (powersports, auto, home equity LOC); (3) credible management team; and (4) the business has consistently generated a mid-20-per-cent ROE.”

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After a third-quarter revenue and earnings beat, National Bank Financial analyst Cameron Doerksen thinks Exchange Income Corp.’s (EIF-T) outlook through 2023 “looks good.”

“Our confidence in growth in 2023 and management’s guidance (which was increased $10 million to $510-$540 million in EBITDA) is underpinned by our expectation that Legacy Airline passenger volumes and Regional One’s leasing segment still have room to fully recover to pre-pandemic levels,” he said. “Furthermore, EIC’s Quest Windows business will see revenue and earnings growth in 2023 and the Northern Mat business looks poised to have another very strong year.”

Mr. Doerksen said his positive growth outlook was reinforced by recent tours of the company’s s aviation-related operations in Winnipeg and the Northern Mat & Bridge operations in Prince George, B.C.

“Modestly” raising his full-year financial estimates for 2022 and 2023, he increased his target for Exchange Income shares by $1 to $61, reiterating an “outperform” rating. The average is $61.81.

“In addition to the numerous organic growth drivers across both segments, EIC also continues to explore M&A opportunities that could provide upside to our forecast,” he said.

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Predicting the North American battery market will be “significantly under supplied by continental lithium sources,” Stifel analyst Cole McGill initiated coverage of Frontier Lithium Inc. (FL-X) with a “buy” recommendation, calling its PAK Project “North America’s highest grade hardrock lithium resource with significant resource expansion potential.”

“Frontier’s PAK is the highest grade Li resource in North America and top five globally,” he said. “Higher grade resources mean fewer tonnes need be delineated, drilled, blasted, trucked, and processed to produce an equivalent tonne of product, an inherent inflationary hedge. The consolidated PAK project is made up of two deposits – PAK & Spark. PAK’s global resource of 9.3MMt at 2.02-per-cent Li2O is the highest grade consolidated NI 43-101/JORC compliant resource globally. FL has the potential to be the lowest cost integrated producer of LiOH in North America, feeding the Ontario EV build out.”

He set a target of $4.80 per share, exceeding the $4.63 average.

Concurrently, Mr. McGill resumed coverage of Critical Elements Lithium Corp. (CRE-X) with a “buy” rating, seeing the purity from its Rose Li-Ta project as “a competitive advantage.”

“The project is DFS stage with 26.1MMt in reserves, access to provincial infrastructure including roads and Quebec’s globally leading hydroelectric grid,” he said. “CRE’s Rose project is expected to have spodumene recoveries of 87 per cent, the highest amongst North American peers, averaging 80 per cent. High recoveries are driven by industry-low mica and Fe2O3 content, providing a less risky flowsheet build out and the ability to maximize lithium unit recovery.”

“We believe the Rose Project is relatively low risk which, in our view, enhances the likelihood of commercial success.The mine plan incorporates a conventional open pit, truck and shovel operation and a crushing, grinding and flotation process flow sheet. Furthermore, the CRE management team includes Steffen Haber, President, and Marcus Brune, both of whom have extensive experience in the lithium business having been part of the senior leadership team at Rockwood Lithium GmbH prior to its US$6.2B acquisition by Albermarle Corp. in 2015.”

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In other analyst actions:

* Seeing an attractive valuation following a period of underperformance, Goldman Sachs’ Neil Mehta upgraded Canadian Natural Resources Ltd. (CNQ-N, CNQ-T) to “buy” from “neutral” with a US$69 target, up from US$62 and above the US$66.18 average.

* JP Morgan’s lowered his Alimentation Couche-Tard Inc. (ATD-T) target to $54 from $55, below the $69.39 average, with an “overweight” rating.

* In response to its Investor Day event last Friday, CIBC World Markets’ Anita Soni cut her target for Barrick Gold Corp. (GOLD-N, ABX-T) to US$24 from US$25, above the US$20.36 average, with an “outperformer” rating. Others making changes include: Stifel’s Ingrid Rico to $29 (Canadian) from $33 with a “buy” rating and Canaccord Genuity’s Carey MacRury to $28 from $29 with a “buy” rating.

“Barrick reiterated its overall strategy of focusing on Tier 1 and 2 assets globally and maintaining discipline with a now $1,300/oz base gold price (up from $1,200/oz) to underpin its mine plans and investment strategy,” said Mr. MacRury. “The company also provided updated high-level five-year outlooks for each of its mines. Overall, the company sees gold production rebounding modestly off of what looks to be a near-term low in 2022 at 4.2Moz and back towards 4.5-5.0Mozs. Longer term, the company remains focused on advancing organic opportunities in its portfolio to sustain gold production (versus M&A) but also expects to be able to materially grow copper production to potentially over 1 billion pounds per year over the next decade. We maintain our BUY rating reflecting what looks to be a nearing inflection point in gold production, strong balance sheet, and increasingly inexpensive valuation, trading at 0.69 times NAV and in line with the senior average of 0.71 times.”

* In response to its commencement of a strategic review process, BMO’s Stephen MacLeod raised his Dentalcorp Holdings Ltd. (DNTL-T) target by $1 to $14 with an “outperform” rating. The average is $14.89.

“We view the strategic review process positively, as it provides a catalyst to potentially close the valuation gap vs. peers,” he said. “The stock is down 51 per cent year-to-date and trades at an unjustified steep discount to the peer group average. While there is a range of potential outcomes, we believe that a takeout is the most likely to realize full value for shareholders. Absent a transaction materializing, we continue to appreciate the recurring and essential characteristics of the dental market, and believe dentalcorp is well-positioned to drive double-digit revenue and EBITDA growth.”

* Credit Suisse’s Fahad Tariq raised his targets for Hudbay Minerals Inc. (HBM-T) to $8.50 from $7 with an “outperform” rating and Lundin Mining Corp. (LUN-T) to $8.50 from $7.75 with a “neutral” rating. The averages on the Street are $9.28 and $9.26, respectively.

“In our base metals coverage of Lundin Mining and Hudbay, we note that the former continues to face operational issues (most recently a slower than expected ramp-up of the ZEP, elevated costs, and some supply chain driven delays on the Candelaria pebble crusher debottlenecking) while the latter is tracking 2022 production guidance (Q4 expected to be strongest quarter this year), albeit at higher costs than previously expected, and has higher production and free cash flow growth over the medium term,” he said. “This explains, in part, the recent convergence of HBM and LUN year-to-date share performance, with both stocks now down 23.5 per cent, vs. earlier in the year when HBM was significantly underperforming LUN.”