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

Recent share price appreciation has led to a historically high valuation level for Canadian National Railway Co. (CNR-T, CNI-N), according to RBC Dominion Securities analyst Walter Spracklin, leading him to downgrade his rating for its stock.

On Monday after market close, CN reported weaker-than-anticipated first-quarter financial results, due largely to harsh winter weather.

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Adjusted earnings per share of $1.17, which included a 4-cent gain from a lower tax rate, fell short of both Mr. Spracklin’s projection of $1.20 and the consensus estimate on the Street of $1.19. The company’s operating ratio, a key indicator of performance, came in at 67.2 per cent, which fell well short of the analyst’s projection of 64.1 per cent, which he attributed to weather-related issues.

“Despite the weather effect on volumes, which saw Q1 come in at up 3 per cent, management maintained its high-single digit volume growth target for 2019,” said Mr. Spracklin. “To meet this target, it implies a very strong volume pace for the remainder of the year - and we are cautious of risk on three fronts: 1) potential slower growth due to the economy; 2) the volatile nature of certain growth sources (coal and crude); and 3) the capacity risk at CN. Despite these risks, we believe the company has put capital in the right places and our 2019 estimates align with management guidance.”

“We believe CN's network has recovered nicely following the winter weather disruption and we are calling for a meaningful O/R improvement in Q2: 1,000 basis points Q/Q sequentially and 100 basis points year-over-year. As a result, we see the full year O/R improving 140 bps, despite the tough Q1 - translating into EPS growth of 14 per cent to $6.26 (down only slightly from our prior $6.30) and in-line with management's double-digit guidance range. Our 2020 estimated EPS remains unchanged at $6.95.”

Pointing to its current valuation, Mr. Spracklin lowered CN shares to “sector perform” from “outperform” with a target price of $128 (unchanged). The average target on the Street is $124.67, according to Bloomberg data.

“Our estimates call for a significant rebound in operating efficiency, backed by very strong volume and high pricing, leading to EPS growth in-line with guidance,” he said. “Nevertheless, the significant recent share price appreciation has brought P/E [price-to-earnings] levels to 18.2 times (2020 estimate), which is high by CN's historical standards, and a meaningful (albeit well-deserved, in our view) premium to the peers (17.2 times).”

Elsewhere, Veritas Investment Research analyst Dan Fong downgraded CN to "sell" from "buy" with a $120 target.

Citi analyst Christian Wetherbee maintained a “buy” rating and US$103 target.

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Mr. Wetherbee said: “Coming off Canadian National’s 1Q19 earnings conference call, it appears that management’s high-single-digit (HSD) volume guidance is still achievable. Although the RTM comps become more challenging as the year progresses, crude-by-rail, intermodal, automotive and frac sand volumes should all pickup, allowing CN to hit its HSD RTM [revenue ton mile] growth target. Even given the miss this quarter, we continue to believe that the low double digit EPS growth guidance is achievable. First, it appears that the guidance still allows for upside from crude-by-rail, since some contracts which start in July are not incorporated into the guidance. Second the pricing environment remains strong and HSD volume growth is likely to translate into doule-digit revenue growth. Third, although costs were elevated this quarter, it was driven by weather and costs should improve as the year progresses. Collectively, it appears that the performance should pick up considerably and guidance implies rather conservative incremental margins.”

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Fiera Capital Corp. (FSZ-T) is a “fairly valued” diversified global asset manager, said RBC Dominion Securities analyst Geoffrey Kwan.

Believing the stock may appeal to investors with a longer-term view at its current price, he initiated coverage of the Montreal-based firm with a "sector perform" rating.

“Fiera is an attractive growth story within the asset management industry, with historical growth driven significantly by acquisitions (almost 20 in the past nine years adding $100-billion in assets under management) that transformed the company into a diversified global asset manager with almost $150-billion in AUM,” he said. “We see the shares as fairly valued relative to peers but believe the stock could outperform if we see certain catalysts materialize (e.g., improving margins). On a stand-alone basis, we see 20-per-cent valuation upside, which may be attractive for investors.”

However, Mr. Kwan said he's taking a cautious near-term view of asset managers, pointing to a pair of concerns: regulatory risk and fee pressure and the potential impact of the fourth-quarter 2018 market sell-off on sales.

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"For these reasons, we think that there is reduced investor interest in asset manager stocks, as partly evidenced by the decline in asset manager valuation multiples over the past five years (average next 12-month price-to-earnings multiples of 11.2 times today vs. 17.0 times five years ago)," he said. "Notwithstanding this, we think the sector still offers attractive investment opportunities, although investors need to take a more surgical and tactical approach to investing in the sector vs. prior cycles."

He added: "We think Fiera’s P/E multiple is likely to remain largely unchanged over the next year based on our cautious near-term outlook for the asset management industry. We expect valuation upside over the next 12 months to be driven primarily by EPS growth (we forecast a two-year adjusted EPS CAGR of 13 per cent from 2018 to 2020) and Fiera’s 7-per-cent dividend yield. The combination of these two results in an implied total return of 20 per cent, which is in line with the average and median of our coverage universe."

Mr. Kwan set a target price of $14 per share. The average on the Street is $14.16.

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Calling it an “undervalued driller in a growing sector,” Laurentian Bank Securities analyst Ryan Hanley initiated coverage of Major Drilling International Ltd. (MDI-T) with a “buy” rating.

"We believe that MDI offers investors exposure to the mineral exploration space, without having to take on single company or single asset risk," he said. "With sequential increases in global exploration spending over the last two years, combined with declining global gold reserves and what we believe is a positive underlying backdrop for the price of gold given geopolitical tensions and slowing global growth, we expect further increases in global exploration spending from 2019 onward."

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Noting 55 per cent of the company's revenue stems from gold mines and projects, Mr. Hanley said he sees a "positive" backdrop for gold prices, due largely to geopolitical tensions and slowing global growth.

"We believe that MDI’s production drilling segment (drill & blast, underground longhole, etc.) offers a stable base of revenue given that it is typically not impacted by commodity price volatility (unless the mine is placed on care & maintenance)," he said. "Unfortunately MDI does not breakdown production vs. exploration drilling; however we estimate that production and production-related drilling services represent 35 per cent of MDI’s revenue. The exploration market offers further growth potential, particularly with respect to ‘specialized drilling’ where MDI focuses most of its attention. Specialized drilling consists of more complex work, which not every drilling contractor has the equipment or expertise to complete. This can include drilling in remote locations, directional drilling, very deep holes (typically greater-than 1 kilometre), drilling at high altitudes, drilling through permafrost, and/or when helicopters are required. Specialized drilling typically yields higher margins as it less competitive than ‘conventional’ drilling."

Pointing to its "strong" balance sheet and "compelling" valuation, Mr. Hanley set a target price of $6 per share. The average on the Street is $6.88.

"MDI currently trades at 7.2 times on a forward EV/EBITDA basis, below its 10-times average from 2015 to the end of 2018 despite continued year-over-year growth in both MDI’s revenues as well as global exploration spending," he said. "With our belief that global exploration spending will increase by a further 5-10% in 2019, coupled with the company’s strong balance sheet and experienced management team, we believe that this discount is unwarranted. Not only do we believe that MDI is undervalued, but we also believe that it offers investors a way of gaining exposure to a growing mineral exploration space, without having to take on single asset risk."

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Echelon Wealth Partners analyst Stephan Boire thinks the investor community should give the Mortgage Investment Corporation (MIC) sector “significant attention,” pointing to the “quality and record” of their managers as well as their “relatively attractive risk-adjusted yields.”

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"In essence, MICs offer investors exposure to the residential and commercial real estate lending sector," he said. "Operationally, MICs provide short-term real estate funding solutions to investors through Alt-A residential mortgages, commercial and multi-residential mortgages, construction loans, and mezzanine/subordinated debt, and are thus considered alternatives to traditional regulated lenders (including banks). Canada’s larger financial institutions are focused on mortgage loans that comply with the lending criteria of Canadian banks. Generally speaking, this creates opportunities within the mortgage finance market, notably due to the lack of competition. MICs (with the exception of MCAN Mortgage Corporation; MKP-T) are unregulated entities, which implies that they are not subject to federal or provincial mortgage lending rules.

"The non-bank market is currently estimated to be $250-billion, of which MBS lenders represent over $200-billion. The MIC market itself is a small component of the non-bank market, estimated at only $13.5-billion by FSCO, the Ontario regulator for mortgage brokerages. There are an estimated 300 MICs across Canada, most of them relatively small. These smaller MICs deploy their funds by making small first and second residential mortgages to home owners who cannot access sufficient funds from the institutional lending market. ... Generally, MICs are externally managed. In that sense, the manager is a key fundamental aspect to MICs, as it sources financing deals, executes on the investment strategy, and monitors market and operational risks, among other considerations."

In a research report released Tuesday, Mr. Boire initiated coverage of Atrium Mortgage Investment Corp. (AI-T) and Timbercreek Financial Corp. (TF-T) with “buy” ratings.

He set a target price of $10 for Timbercreek. The average on the Street is $9.82.

"Generally speaking, TF provides financing solutions to real estate investors looking for funding in a transitional phase of the investment process (shorter duration, structured financing), a market segment not adequately serviced by traditional lenders," the analyst said. "Real estate investors use short-term loans (one- to five-year terms) when conducting redevelopment or repositioning projects, or when acquiring assets."

Mr. Boire set a $14 target for Atrium, versus the consensus of $13.44.

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“AI is a mortgage lender essentially benefiting from the fragmentation of Canada’s lending environment,” he said. “The MIC lends in major urban areas and aims at a weighted average LTV ratio of the mortgage portfolio of less than 75 per cent. More specifically, a typical loan from AI would have an interest rate within a range of 7.75-10 per cent per year, with a one- to two-year term and monthly interest-only payments.”

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Ahead of the release of its first-quarter results on Thursday, Laurentian Bank Securities analyst Nauman Satti said he sees “subsiding headline risks” for SNC-Lavalin Group Inc. (SNC-T).

"We believe 2019 to be a reset year for SNC as it works its way to overcome the challenges, stemming from: a) headline risks related to legal and political risks, b) an underperforming mining & metallurgy segment amid the Codelco project, and c) headwinds in the oil & gas segment relating to procurement of new projects in Saudi Arabia," he said. "While we recognize that some of the factors are beyond the control of the company, investors’ trepidation remains, which should continue to negatively weigh on the stock price. However, project wins such as Trillium Line Extension and decommissioning of a nuclear power plant (Holtec) in the U.S. should build up the backlog and improve the future outlook of the company."

With his estimates for the quarter falling in line with the Street, Mr. Satti added: "Although we view the sale of 407 positively as it strengths the balance sheet and allows SNC to maintain its credit ratings, redeployment of excess cash (after partial debt repayments) can become challenging and this is something investors should keep a close eye on."

He maintained a “hold” rating and $39 target, which falls below the average on the Street if $43.17.

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Canaccord Genuity analyst Mark Rothschild said European Residential REIT (ERE.UN-X) presents investors with the “opportunity to gain exposure to the extremely strong rental housing market in the Netherlands.”

“The Netherlands is projected to experience above-average economic growth, and there remains a shortage of rental housing, which is likely to persist for at least the next few years,” he said. “Therefore, we believe ERES is well positioned to achieve steady rent growth while operating with low vacancy.”

Mr. Rothschild initiated coverage of the Toronto-based REIT with a “hold” rating.

“The REIT currently owns 41 properties with a total of 2,091 rental apartment suites in the Netherlands, and recently agreed to acquire an additional 1,768 suites in two transactions that are expected to close over the next few months,” he said. “Currently, 53 per cent of the suites are located in Utrecht, Amsterdam and The Hague, three of the Netherlands’ four largest cities.”

“While the REIT was initially formed to consolidate a commercial portfolio, with the acquisition of a large portfolio of rental housing suites from CAP REIT, it is transitioning into a residential REIT. The REIT also owns three commercial properties in Germany and Belgium, although we expect these properties to be sold over the next year. Despite the fact that the residential portfolio acquisition was dilutive to FFO per unit, it was accretive to NAV and should produce growing cash flow through our forecast period.”

He set a target price of $4.50 per unit. The average on the Street is $5.25.

“Notwithstanding the positive view, the units are, in our view, fairly valued at current levels,” he said. “With strong demand, limited new supply and a growing economy and population, the REIT is well positioned to produce stable and growing cash flow for the foreseeable future. In addition, the REIT is supported by an experienced and well capitalized manager in CAP REIT. Longer term, the REIT can grow in other European markets as well. ERES trades at an implied cap rate of 4.5 per cent, or a 4.5-pert-cent discount to our NAV estimate. Our target price of C$4.50 equates to our NAV estimate, and implies a total return of 8.4 per cent. Reflecting the relatively modest return, we are initiating with a HOLD recommendation.”

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In other analyst actions:

Cormark Securities analyst Brent Watson downgraded Inter Pipeline Ltd. (IPL-T) to “market perform” from “buy” with a $25 target, down from $27. The average is $24.91.

Beacon Securities initiated coverage of Curaleaf Holdings Inc. (CURA-CN) with a “buy” rating and $21 target. The average is $17.11.

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