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

Ahead of third-quarter earnings season, Industrial Alliance Securities analyst Elias Foscolos sees a more “modest” uptick in drilling rig activity in Canada and a decline in the United States.

“Discipline is a virtue, and there certainly seems to be no shortage of that going around these days, as E&Ps in Canada and the US, for different reasons, are cutting spending,” he said in a research note released Tuesday. "As such, we have trimmed our Q4/19 and 2020 rig counts both north and south of the border.

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“Wet weather in Canada resulted in an extended low season for drilling. Typically, we see a much more significant increase in Canadian rig counts through July and August as we exit spring break up in Q2. However, this year, July rig counts only increased 6 per cent on a month-over-month basis. From June to August, average rig counts only increased 25 per cent relative to historical changes, ranging anywhere from 40 per cent to 100 per cent, averaging 70 per cent. Furthermore, we estimate that completions activity was even weaker than drilling.”

With that new outlook, he trimmed his financial expectations for all of Secure Energy Services Inc.'s (SES-T) operating segments for the remainder of 2019 and 2020, leading him to downgrade his rating for the Calgary-based company’s stock to “buy” from “strong buy.”

“We are right-sizing our estimates for SES, as we are taking a more conservative stance,” said Mr. Foscolos. “We expect that the extended low drilling season in Canada coupled with weak completions activity will lead to a Q3/19 miss across all of SES’s operating segments. Our near-term outlook is cautious, as we believe suppressed drilling & completions activity will continue through 2020, and we have moderated our expectations for margins and returns generated from [Midstream Infrastructure].”

Mr. Foscolos reduced his 2019 and 2020 adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) forecast by 14 per cent and 17 per cent, respectively, citing reduced revenue projections in all its segments as well as “moderated” expectations for margin expansion.

“Due to SES’s asset heavy business, this translates into material reductions to our 2019 and 2020 OI [operating income], which impacts our valuation based on 2020 Adj. OI,” he said.

With those changes, he dropped his target for Secure shares to $7.75 from $10. The average target on the Street is currently $9.63, according to Bloomberg data.


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Seeing a “favourable” path to organic revenue growth, Desjardins Securities analyst Maher Yaghi raised his rating for CGI Inc. (GIB.A-T, GIB-N) to “buy" from “hold” ahead of reporting season, seeing its stock “well-positioned for a re-rating of its valuation over the next few quarters.”

“We believe organic growth at CGI is likely to continue to improve and surpass the 5-per-cent range in the next few quarters, a level of growth that would give the company the same organic growth prospects as Accenture,” the analyst said.

“Second, at a recent investment conference, management emphasized that teams from every major geographical segment in which the company operates have now completed the integration of a significant target. We believe management’s greater confidence in the company’s capability to undertake large transactions and improved valuations for European companies have increased the odds of more M&A.”

In justifying his belief that CGI’s stock is set up well for a valuation improvement in comparison to its peers, Mr. Yaghi pointed to a combination of increased expected organic growth, a “healthy” balance sheet and improved M&A prospects.

Emphasizing its “strong financial position is a valuable tool,” he hiked his target for CGI shares to $120 from $105. The average on the Street is $109.85.

“While GIB’s stock has performed well over the last few months, we highlight its valuation has become cheaper in relation to Accenture (CAN-N, not rated),” he said. “This occurred despite ACN’s expectation for slower local currency revenue growth for FY20 of 5–8 per cent vs 8.5 per cent in FY19. Of that growth, management expects 2 per cent will stem from inorganic sources, resulting in expected organic growth of 3–5 per cent in FY20 — below our expectation of 5.5 per cent for GIB in 4Q FY19. In terms of profitability, ACN expects year-overyear EPS growth of 3.5–6.5 per cent in FY20, down from 9 per cent in FY19 on an adjusted basis. This is significantly lower than the 15.7-per-cent EPS growth we expect for GIB. In the past, we argued that GIB should trade at a discount to ACN given the latter’s much faster organic growth. As this gap has now been bridged, we believe the valuation gap should also narrow.”

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In the wake of a 100-per-cent rebound in its share price over the last month, Canaccord Genuity analyst Raveel Afzaal lowered his rating for Just Energy Group Inc. (JE-T) to “hold” from “speculative buy,” seeing a “less attractive” risk-reward proposition for investors.

“At the current share price, we see $1 per share of upside if the company is successfully acquired and $2 per share of downside if the strategic review does not result in an sale,” said Mr. Afzaal.

In explaining his upside scenario of $4 per share, Mr. Afzaal pointed to the recent acquisition of Crius Energy Trust (KWH-UN-T) by Vistra Energy Corp. (VST-N) for 1.0 times its embedded book value.

“Under normal circumstances, we would expect JE to command a premium to its Embedded Book value given its greater scale and exposure to Texas,” he said. "However, we believe potential bidders may apply a discount to its book value given (1) significant AR write downs, (2) related and on-going litigation issues, (3) desire to hedge against potential future write downs, (4) strategic versus financial buyer, and (5) likely aim to capitalize on JE’s liquidity constraints.

He added: “We believe one of the options that may be available to the company is to sell its U.S. book to a strategic buyer and look to privatize the remaining business. We believe this may be a viable option given insiders, which include Jim Patterson and Ronald Joyce’s estate, own 30 per cent of the company. Further, Rob Snyder’s increasing position in the company (8.3 per cent as of Sep 27th; commenced buying on Aug 22nd) should add further urgency to successfully conclude the strategic review as soon as possible.”

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Mr. Afzaal’s downside scenario is 85 cents per share, noting: "The ongoing litigation issues due to AR write-downs may result in potential bidders requiring more time to quantify potential liabilities (if any), and this could hamper the sales process. If the strategic review fails, we see the share price declining to under $1 per share (6.5 times EV/2020 EBITDA) temporarily. This is a discount to JE’s historical average multiple of 7.5 times but which we believe is justified given its over-levered balance sheet resulting in liquidity constraints.

“If this scenario plays out, we believe it would offer an excellent entry point back in the name. This is similar to what we saw with Crius Energy (competitor to JE), where the initial strategic review failed and was followed by a steep share price decline, activism driving board changes, significant operational improvements by management, and eventual sale to Vistra.”

Mr. Afzaal raised his target for Just Energy shares to $2.80 from $2.50. The average is currently $3.70.


Calling it a “gold darling with a rich valuation,” Credit Suisse analyst Fahad Tariq initiated coverage of Kirkland Lake Gold Ltd. (KL-N, KL-T) with a “neutral” rating, seeing a lack of near-term catalysts beyond exploration updates.

“Though we appreciate KL’s growing production, long-term exploration upside at Fosterville and Macassa, and bottom-quartile cost profile that results in substantial FCF, we are cautious on the stock based on the valuation," he said. “We do not anticipate future discoveries at Fosterville will necessarily match the high Swan Zone grades, and therefore, the upside potential, while still there, does not seem as exciting at the current stock price.”

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Despite his guarded stance, Mr. Tariq did suggest investors are “missing the boat” on the Toronto-based miner.

“The most common investor questions on KL are regarding the amount of upside left, given the stock’s strong performance to date, and whether investors who have not already bought KL have missed the story,” he said. "We continue to see upside, albeit more limited than the recent trend, from Fosterville and Macassa exploration, but the valuation gives us pause, as it seems to price in continued jumps in reserves. We believe that even a single weaker reserve/exploration update at Fosterville and/or Macassa that curbs the positive grade trend could see the stock pull back.

Mr. Tariq set a target price of US$47 per share, which falls short of the consensus on the Street of US$49.55.

“KL has been one of the best performing stocks on the TSX this year, with a 70-per-cent share price return (495 per cent over the past three years)," he said. "This performance has been driven mainly by increased production/reserves on higher grades at KL’s flagship Fosterville mine.”


The third quarter was “challenging” for Canadian railway companies, according to CIBC World Markets analyst Kevin Chiang.

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In a research report previewing the start of earnings season, he lowered his estimates to reflect a “softer” volume environments.

“Q3 carloads are down 4.4 per cent year-over-year, the worst showing since Q3/16, with weakness across a number of commodities,” said Mr. Chiang. "The focus during Q3 earning season is signs of whether we are about to enter another freight recession and commentary around volume trends over the next 6-12 months. We expect volume growth in 2020, but the key will be whether a number of non-cyclical commodities can bounce back (i.e., Canadian grain, crude, potash), offsetting commodities we know are facing cyclical/structural decline (i.e., auto, U.S. coal). The Canadian rails are in a better position than their U.S. counterparts given structural volume tailwinds, industry pricing above inflation, industry-leading margins, and strong FCF generation. The Canadian rails have a more balanced earnings growth story, with CP our preferred name.

“While the volume environment has been soft, the rails are adjusting their cost structures and resources while benefiting from inflation-plus pricing. We continue to see the rails moving towards their OR [operating ratio] targets and expect the Class 1s to generate on average double-digit EPS growth for 2019.”

Based on that view, Mr. Chiang lowered his third-quarter earnings per share projections for Canadian National Railway Co. (CNR-T, CNI-N) and Canadian Pacific Railway Ltd. (CP-T, CP-N) by an average of 5 per cent. He’s now projecting CN’s EPS to come in at $1.61, which is 3 cents below the consensus on the Street. His estimate for CP is $4.47, which is 10 cents lower than the average.

With those changes, his target for CP shares fell to $327 from $345 with an “outperformer” rating (unchanged). The consensus on the Street is $334.83.

Mr. Chiang’s target for CN slid to $122 from $126 with a “neutral” rating. The average is $127.31.


In other analyst actions:

Macquarie analyst Susan Donofrio initiated coverage of Air Canada (AC-T) with an “outperform” rating and a Street-high $58 target. The average on the Street is $52.97.

Tudor Pickering & Co analyst Matthew Murphy downgraded Canadian Natural Resources Ltd. (CNQ-T) to “hold” from “buy” with a $38 target, down from $42. The average is $45.06

Tudor Pickering’s Jordan McNiven downgraded Whitecap Resources Inc. (WCP-T) to “hold” from “buy” with a target of $4.50, sliding from $5.75 and below the $7.19 consensus.

Veritas Investment Research analyst Henry Yu upgraded Maple Leaf Foods Inc. (MFI-T) to “buy” from “sell” with a target of $31, up from $30. The average is $40.57.

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