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

There are “plenty” of potential catalysts for SNC-Lavalin Group Inc. (SNC-T), according to CIBC World Markets analyst Jacob Bout.

“In the near term, SNC will need to post decent H2/19 results (particularly in the SNCL Projects division that has seen several negative project costs reforecasts in the recent past), to help restore confidence and avoid a breach in covenants,” he said. “Potential changes to the Integrity Regime could reduce (or eliminate altogether) a potential disbarment period on federal projects if convicted. A potential sale of Resources would be viewed positively (at the right price) given its exposure to LSTK contracting and the Middle East (particularly Saudi Arabia).”

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On Tuesday, Mr. Bouw resumed coverage following a “prolonged” period on restriction with a “outperformer - speculative” rating, emphasizing headline risks remain for the Montreal-based firm but sees it trading at close to “Concession-only value.”

“We see value in Concessions (we value the remaining 6.76-per-cent stake in 407 at $10/share after tax and other concessions at $3/share) and SNC’s Engineering Services division (note, we are assigning no value to SNCL Projects and just a 5.5 times multiple for Engineering Services in our $25 price target),” the analyst said.

“We agree with the decision to exit the lump-sum turnkey (LSTK) construction projects as it will decrease earnings volatility and reduce overall country risk profile (e.g., Middle East exposure). The biggest near-term hurdle relates to SNC’s ability to generate sufficient cash flow/earnings and maintain a healthy balance sheet. The good news is we are not seeing attrition of SNC’s core operating employee base (engineering, operations, program/project management employee base is flat to up 1 per cent year-over-year) and SNC continues to win new projects (Engineering Services H1/19 book:bill of 1.2 times).”

He dropped his target for SNC shares to $25 from $49. The current average on the Street is $30.50, according to Bloomberg data.

“Our Outperformer-Speculative rating is underpinned by assumptions SNC can pass through this difficult phase (we estimate leverage at Q3/19 could come close to covenant net recourse debt/adj. EBITDA ratio of 3.75 times given three past quarters of weak earnings) and is not disbarred from federal work for a significant period (but note, SNC stopping bidding on LSTK projects greatly reduces federal exposure; we estimate 80 per cent or more of federal work is LSTK)," said Mr. Bout.

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Citing company and sector earnings risk, Barclays analyst James Rowland Clark downgraded Stars Group Inc. (TSG-Q, TSGI-T) to “underweight” from “equal-weight.”

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Mr. Clark, whose earnings per share estimates for 2020 trail the consensus by 9 per cent, said there’s risk to the company’s poker segment in the third quarter, though he did say wagering has momentum.

He lowered his target to a Street-low US$14.30 from US$20.70. The average on the Street is US$21.36.

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Major Drilling Group International Inc.'s (MDI-T) valuation is “too cheap ignore amid improving fundamentals," said Beacon Securities analyst Ahmad Shaath, leading him to raise his rating for its stock to “buy” from “hold” following the release of first-quarter 2020 results that exceed the Street’s expectations.

“MDI reported year-over-year growth in all of its geographical segments, the highlight of which was its core North American market (51 per cent of last 12-month revenues) that posted the strongest quarterly level since Q4/FY13 (April 2013) and its strongest year-over-year increase in 2 years,” said Mr. Shaath. “Overall revenue trends look positive, with MDI continuing to realize better prices, exposure to seniors and intermediates continuing to more than offset the absence of the juniors and copper producers (which are the entirety of MDI’s copper-derive revenue) increasing their activity despite the drop in copper prices. This in turn is helping MDI’s profitability, where adjusted EBITDA was the strongest quarterly EBITDA since Q4/FY13 and adjusted EBITDA margin of 15.2 per cent was MDI’s strongest since Q1/FY14. With MDI expecting increased utilization going into Q2 and the activity from seniors/intermediates to continue, we expect the strength in performance to continue. We note that this was MDI’s third quarterly beat over the last four quarters.”

Mr. Shaath increased his target for Major Drilling shares to $7.50 from $5.75. The current consensus is $6.50.

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“We updated our estimates, with MDI’s outlook pointing to stabilizing levels from Q1/FY20 leading to our revised revenue estimate of $453-million (a positive 7-per-cent revision) driven by a revised year-over-year revenue growth of 18 per cent (from 10 per cent previously) for FY20,” he said. “Management remained very cautious on margins as they continue to point to increased labor costs. Thus we kept our gross margin revision (+0.5pps vs. previous estimate) inline with this cautious view. We note that this could prove to be too conservative, and thus leaves a good room for positive surprise for the remainder of FY20E. Continued discipline on the SG&A line lead to our revised EBITDA/margin of $61-million/13.5 per cent (vs. $50-million/11.9 per cent).”

“MDI currently trades at 6.5 times our forward EBITDA estimate vs historical average of less than 7.5 per cent. We believe current levels represent an excellent entry point as in addition to the aforementioned upside to our current forecasts, there is potential upside from the current gold price environment that could lead to further rig utilization/margin expansion as well as further multiple expansion. We note that even in a depressed commodity environment such as the 2013/2014 period, MDI traded above its historical valuation multiple, thus we believe the current valuation is simply too attractive to ignore.”

Elsewhere, TD Securities analyst Daryl Young raised his rating to “buy” from “hold" with a target of $6.50, rising from $5.50 and matching the current consensus on the Street.

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H2O Innovation Inc.'s (HEO-X) strategy of operating three complementary segments focused on serving water utilities “appears to be paying dividends,” according to Acumen Capital analyst Nick Corcoran.

Believing the Quebec City-based water treatment solutions company is exhibited “strong growth” that places it on track to reached its three- to five-year goal of $250-million in revenue and a 10-per-cent EBITDA margin, Mr. Corcoran initiated coverage of its stock with a “buy” rating.

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The analyst called its three segments - projects, specialty products, and operations and maintenance - “complementary” and believes it promotes synergies and cross selling.

In justifying his bullish stance on its future, he emphasized the “successful” grown of its backlog from $36.5-million in the fourth quarter of 2015 to $138.7-million in the third quarter of 2019, a “strong” track record of accretive acquisitions and the expectation that margins will expand through “a focus on higher margin specialty products, higher margin projects (wastewater and industrial over water and municipal), and increasing recurring revenue.”

“We believe catalysts for the story include the Q4/FY19 results on Sept. 25 (before market open), additional operations and maintenance contracts wins, and acquisitions,” said Mr. Corcoran.

He set a target price of $2 per share. The average on the Street is $1.90.

“We note that regional (North American) water treatment companies trade at a significant premium to the large, multinational companies,” he said. “HEO is the only pure play water treatment company on the TSX or TSX Venture. We believe that as HEO grows in scale through organic growth and acquisitions that it will trade in line with the regional (North American) peer group.”

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Desjardins Securities analyst Keith Howlett trimmed his earnings per share expectation for Dollarama Inc.'s (DOL-T) second quarter by a penny on Tuesday ahead of the release of its financial report on Thursday before the bell, believing it will take two or three more quarters to “establish the parameters” of the retailer’s revised growth trajectory.

“Dollarama ignited same-store sales growth in 1Q FY20 (5.8 per cent) but posted a 170 basis points decline in gross margin,” said Mr. Howlett. “The decline was attributed to a small decrease in product margin, higher sales of lower-margin items and timing of certain logistics costs related to constructing the expanded distribution centre. Management maintained gross margin rate guidance for the year of 38.0–39.0 per cent. As a directional signal, we are reducing our gross margin for 2Q by 50 basis points and lowering our EPS estimate to 48 cents (from 49 cents).”

Mr. Howlett is projecting Dollarama’s same-store sales growth to shrink to 4 per cent from 5.8 per cent in the previous quarter.

“In its recent quarterly call, Dollar Tree did not refer to its operations in Canada, after regularly commenting on them over the prior five or six quarters,” he said. "This may reflect the low priority of the Canadian business relative to the much greater and more pressing issue of integrating Family Dollar stores (after four arduous years of ownership) in the US market. While Dollarama remains the unrivaled leader in the small-format discount segment in Canada, an increasing array of competitors is nibbling on the edges (Dollar Tree, Miniso, Oomomo, Party City, etc). Major competitors such as Walmart, Loblaw, Canadian Tire and others want to contain the scope of Dollarama’s ever-expanding price points.

“In terms of the sale of higher margin seasonal products at Dollarama, the poor spring weather in Canada was noted by Canadian Tire and Couche-Tard as affecting their sales and margins. We would expect this had a modest negative impact at Dollarama as well.”

Mr. Howlett maintained a “hold” rating and $49 target for Dollarama shares. The average is currently $50.35.

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Though he sees longer-term competitive risks in wireless “on the upswing," Citi analyst Michael Rollins said he expects Verizon Communications Inc. (VZ-N) to exceed the Street’s third-quarter revenue expectations, leading its shares to trade higher.

Accordingly, following recent meetings with the company’s investor relations team, Mr. Rollins added Verizon to the firm’s “Positive Catalyst Watch List (30 Days).”

“We understand Verizon is still succeeding at up-selling customers onto higher ARPU [average revenue per user] unlimited plans that include hot-spot capacity," the analyst said. "The auto-pay discounts require customers to link payment to their checking account or debit card (not a credit card), which provides some savings to Verizon by avoiding credit card fees. The combination of a new fee structure (we expect $0.55 per month for a large portion of retail lines), higher prices for device insurance, and up-selling opportunities (especially given more than half of its postpaid base is not on an unlimited plan yet) should support solid wireless service revenue growth. The growth rate for service revenue does get complicated by the company’s decision to include items, such as fees and device insurance, in its other revenue line (which most of its competitors consider as part of their service revenue line).

“Adding back those benefits to revenue, we expect total service revenue growth to improve to over 3.5 per cent for the back-half of ’19 from 3.2 per cent in C2Q19, while we expect the more conservatively reported service revenue to grow at 2.8 per cent in the back-half of ’19 vs. about 3.1 per cent in C2Q19. In doing so, we now expect an aggregate revenue beat for C3Q19 by about 90 basis points on an in-line EPS print of $1.24. The ongoing cost initiatives remain a source of further near-term upside potential for Verizon OIBDA (aka EBITDA) and EPS, in our view. While we expect Verizon to trade higher near-term on the above-consensus wireless revenue opportunity, we see greater value in Buy-rated AT&T and Buy-rated T-Mobile shares at current prices.”

Mr. Rollins maintained a “neutral” rating and US$62 target for Verizon shares, which exceeds the consensus of US$59.68.

“We maintain our Neutral view on a 12-month basis given limited expected total return and rising longer-term risks for the wireless category,” he said. “Verizon continues to execute on its strategy to focus on network differentiation. Within that framework, Verizon is looking at ways to improve wireless subscriber share by reinvesting some of its margin gains from cost cutting to create more affordable & competitive unlimited rate plan entry points (Just Kids, Start Unlimited). Additionally, VZ is looking to balance revenue performance with recent adjustments in C3Q19 to its fee structure and very specific auto-pay requirements for customers to receive the higher promotional discounts.”

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Credit Suisse analyst Manav Gupta thinks the criticism that Canadian Natural Resources Inc. (CNQ-T) has faced following the $3.8-billion acquisition of Devon Energy Corp.'s Alberta assets is “unfair."

“We continue to believe CNQ is being unfairly targeted for its DVN deal, with critics citing $3-billion in net debt addition as a major negative,” he said. "We would like to remind the skeptics that Jackfish generated $525-million in free cash in 1H19 alone. Even if we haircut EBITDA guidance of $1.3-billion by 40 per cent, we see Jackfish adding materially to free cash flow upside and pushing FCF yield over 15% (best in class). Given current discretionary cash flow (FCF - dividend) of $1.2-billion per per quarter, CNQ can pay down this deal debt by 1H 2020 while maintaining the current pace of buybacks.

“Those objecting to CNQ buying Jackfish for $3.25-billion need to look at the value the company created when it acquired AOSP [Athabasca Oil Sands Project] assets for $12.5-billion. These assets raised oil weightage in CNQ portfolio to 75 per cent from 68 per cent and raised FCF by $700-million annually, which allowed CNQ to not only raise its dividend by 37 per cent but also to initiate a buyback program under which it had already bought back $2-billion of its own shares. Creating value through M&A is CNQ’s key strength, and a company should play to its strength. While the AOSP deal happened at $60k/flowing bbl, Jackfish is only $25.3K/flowing bbl. Given the price discount, we believe Jackfish will be as valuable to CNQ as AOSP has been."

Adjusted his 2019 and 2020 estimates for CNQ based on the firm’s latest price realizations and differentials, Mr. Gupta maintained an “outperform” rating and $48 target. The average is $45.32.

“In a world where some global majors are forced to borrow just to pay a dividend, we do not see CNQ adding $3-billion in debt for a deal that helps push discretionary cash flow yield over 10 per cent as being negative," he said. "We believe the real reason investors are worried is that while volumes have continued to grow at an impressive pace, there has been no progress on the egress front. CNQ needs an egress solution to demonstrate to the investment community that it is serious about lowering exposure to Alberta crude diffs.”

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In other analyst actions:

Scotiabank analyst Trevor Turnbull upgraded Fortuna Silver Mines Inc. (FSM-N, FVI-T) to “sector outperform” from “sector perform” with a target of US$5, rising from US$4. The average target is US$5.01.

Mr. Turnbull also upgraded SSR Mining Inc. (SSRM-Q, SSRM-T) to “sector outperform” from “sector perform” with a US$16.50 target, rising from US$12. The average is US$18.41.

Argus Research analyst William Selesky downgraded Kinder Morgan Inc. (KMI-N) to “hold” from “buy.”

Eight Capital initiated coverage of Willow Biosciences Inc. (WLLW-CN) with a “buy” rating and $4.50 target.

Laurentian Bank Securities initiated coverage of Liberty Defense Holdings Ltd. (SCAN-X) with a “speculative buy” rating and $1.40 target.

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