Inside the Market’s roundup of some of today’s key analyst actions
Seeing a lack of identifiable operating leverage as it begins to move past its initial phase as a significant media disruptor, Citi analyst Jason Bazinet thinks the Street’s expectations for Netflix Inc. (NFLX-Q) are currently too high.
Accordingly, upon assuming coverage of the streaming company, he lowered the firm's rating for its stock to "neutral" from "buy."
"Netflix’s disruption is unique: it’s ironic," he said. "The irony stems from this: early on, Netflix needed the incumbent media to supply it with content. Uber didn’t need taxis to do anything. Facebook didn’t need newspapers’ help. And, Amazon didn’t need retailers’ assistance. Why is this irony important? As rival media firms adjust their business models to comport to the streaming world – like Disney+, Hulu, HBO Max, Comcast’s Peacock – Netflix’s only enduring advantage is scale: the quantum of its content spend. Netflix, it seems, is acutely aware of this. As such, it has pursued a simple set of tactics: spend heavily on content, attract subs, fetch a higher market value and raise low-cost debt to fund the investments. This has resulted in a wonderful machine for creating paper wealth.
"One day, Netflix will likely flip the switch and migrate from a low-cost web-based premium channel (that complements pay TV) to a consumer’s primary TV experience. Then, and only then, will Netflix have the pricing power to show the Street that it’s both a disruptor and an attractive equity story. Until then, it’s just a disruptor."
Mr. Bazinet said the Street’s implied valuation for Netflix now sits at US$705 per subscription, which he calls fair once it “flips the switch.”
However, he thinks there’s significant risks until that point.
"To us, it seems unlikely that Netflix will be able to make that pricing pivot anytime soon," said Mr. Zainet. "Today – and even three years from now – the vast majority of Netflix’s U.S. subs are cord nevers or they still have a pay TV subscription. That will likely limit the firm’s near-term pricing power to anything above historical levels.
"In parallel, we think Street estimates need to come down. Historically, there is a strong relationship between sequential increases in content spend and net adds. But, Street estimates for the next few years ignore this trend. As such, we think content spending needs to rise (hurting the stock by 15%) or net adds need to fall (hurting the stock by 5 per cent). Or, alternatively, the Street estimates are right. But, that means the next few years will look very different than the last seven years."
Though he said Netlfix “has done a masterful job disrupting the pay TV ecosystem,” he lowered his target for its stock to US$325 from US$410. The average on the Street is US$360.59.
“Using cash outlays on content (versus amortized content expenses), Netflix has not shown material content leverage," he said. "Non-content costs (marketing, G&A, technical expenses) have not shown much operating leverage, either. The source of lackluster operating leverage is simple: the bulk of Netflix’s growth stems from net adds (which require high marginal costs on content, marketing and technical expenses). In our view, to justify the valuation, the firm needs future growth to come from material price hikes (with de minimis marginal costs). But, pricing power above historical cadence is unlikely until the majority of Netflix’s U.S. subs are cord-cutters and competition moderates. This will take many, many years.”
In separate research reports released Tuesday, Citi’s Mr. Bazinet also initiated coverage of the other FANG stocks.
Despite warning of the potential for significant long-term regulatory risks, he thinks the Street’s estimates for Facebook Inc. (FB-Q) are currently too low.
"We see three potential regulatory risks," he said. "First, [the U.S. Department of Justice] could unwind the Instagram merger. Second, DoJ could force Facebook to offer a paid service (that is ad free and anonymous). Third, U.S. could pass legislation that mirrors EU’s GDPR. Collectively, these actions pose a $55 to $60 risk to the equity. Risks are unlikely to be resolved in the next 12-24 months. And,some may not pass at all."
That overhang led him to cut the trim his target for Facebook shares to US$240. The average is currently US$238.77.
“We apply a 25 times P/E [price-to-earnings multiple to 2021 estimated EPS to arrive at $273 per share," he said. "When we deduct $33 for regulatory risks. The haircut we’ve applied for regulatory risks is lower than the sum of all the risks ($57 per share) because we are not certain all these actions will be taken. Moreover, it’s unlikely that investors have regulatory clarity over the next 12-24 months.”
Mr. Bazinet kept a “buy” rating for Facebook, seeing upside to the Street’s expectations.
“Top-line growth should slow materially going forward driven by: 1) slower smartphone adoption, 2) slower sub growth, and 3) lower growth in ad volume per user,” he said. “This will likely be partially offset with more robust ad pricing. However, Street estimates are too low in our view. We’ve drawn this conclusion based on a careful analysis of the interplay between ad loads and ad pricing. We expect Street estimates to rise over the next year. This should provide a $10-15 tailwind for the equity.”
Conversely, seeing “scant” regulatory risk and “many years of growth,” Mr. Bazinet assumed coverage of Amazon Inc. (AMZN-Q) with a “buy” rating and US$2,200 target. The average on the Street is US$2,167.56.
“Using Amazon’s disclosures – plus regressions of past results – reveals something shocking about the Consumer business: we believe Amazon is intentionally selling goods to Consumers at a loss. But, it’s leveraging dual-purpose infrastructure – servers, fulfillment centers and web traffic – to profitably sell services to Enterprises. As such, the world’s most famous B2C e-commerce firm is really a B2B services firm. In effect, businesses have – and will – subsidize your shopping habit. This means Consumer losses aren’t a flaw….they’re a design feature.”
“For traditional retail, this is an ominous conclusion. Amazon will never need to generate profits – or earn its cost of capital – within Consumer. And, it may be difficult for traditional retailers (or rival e-commerce firms) to replicate Amazon’s Enterprise assets, scale and capabilities. This, in turn, suggests Amazon has many years of growth ahead of it.”
Calling its regulatory headwinds, including the EU’s General Data Protection Regulation, “overblow,” Mr. Bazinet assumed coverage of Alphabet Inc. (GOOGL-Q) with a “buy” rating.
“Most of Alphabet’s profits stem from Search. As such, GDPR apt to impact the firm far less than other big data firms (like Facebook),” the analyst said. “And, if the FTC/DoJ follows the EU (forcing Google to untether its software from OEM Android agreements) we think Alphabet will expand software licensing. This pivot suggests OEMs and, ultimately, consumers – not Alphabet – may bear the brunt of regulatory fallout from Android tying. And, ironically, the shift to software licensing – versus cyclical ads – may cause the firm’s multiple to actually expand.”
Seeing its valuation as “compelling,” he raised the firm’s target to US$1,500 from US$1,450, expecting operating leverage to improve. The average target on the Street is currently xxx.
“Alphabet’s levered FCF is quite low for a firm that is still growing briskly,” said Mr. Bazinet. “We think there are two reasons for this. First, Alphabet has exhibited negative operating leverage over the past seven years. Second, the regulatory scrutiny (primarily in Europe) has been acute. And, regulatory action will likely extend to the US (via anti-trust action or a U.S. version of GDPR, or both).”
Minneapolis-based Ceridian HCM Holding Inc. (CDAY-N, CDAY-T) is “a disruptive innovator leveraging both modern cloud tech with an opportunity to change the fundamental nature of payroll for mid-market and large enterprise clients,” said RBC Dominion Securities analyst Alex Zukin.
“With multiple public vendors growing in excess of 20 per cent (WDAY, PAYC & PCTY), we see a market undergoing digital disruption on a global scale, with the vast majority of share gains from legacy vendors,” he said. “We see global HCM transformation as a sustained trend, and CDAY is attracting industry-leading talent driving share gains for years to come. While we remain positive around accelerating growth we note our operating margins for next year are below consensus as we our conscious of a headwind from float revenues and likely increased pace of M&A to accelerate geographic adoption.”
Mr. Zukin initiated coverage of the stock with an “outperform” rating and US$71 target, which exceeds the current consensus of US$57.58.
“With accelerating growth, strong margins, and still low share, we see a long runway for outperformance,” said Mr. Zukin.
“Despite negative revisions to our forecasts (largely reflecting higher costs), the 2020 guidance signals a much better year ahead for the company,” he said. “Newmont remains a top pick among the senior gold producers. We see the company as offering investors a steady production profile centred on geopolitically stable jurisdictions, with a deep project pipeline, strong balance sheet, and proven operating team.”
Before the bell, Newmont said it expects production of 6.5-7.0 million ounces through 2024, which largely met Mr. MacRury's projections. Cash costs are estimated to decline to US$700 per ounce in 2022 from US$750 in 2020.
“We have updated our forecasts to reflect Newmont’s 2020 and longer-term guidance,” he said. “Overall, we see 2020-2022 production guidance as largely in line with our estimates;however, cost of sales guidance was higher than we expected. ... As a result, we have trimmed our EBITDA forecasts by 6-7 per cent over 2020 and 2021.”
“We now forecast 2020 gold production of 6.7 million ounces (up 6.5 per cent year-over-year) and 3-per-cent higher attributable cash costs to still drive a 40-per-cent increase in EBITDA and 36 per cent in FCF [free cash flow] year-over-year. At spot gold ($1,450/oz), we forecast a still significant 25-per-cent increase in EBITDA and 16-per-cent increase in FCF.”
Keeping a “buy” rating, Mr. MacRury lowered his target to US$55 from US$57 to reflect his negative revisions. The average is US$46.50.
Elsewhere, Citi's Alexander Hacking maintained a "buy" rating and US$46 target.
Mr. Hacking said: “We update our Newmont model to reflect updated 2020-2024 guidance. Production guidance was reduced to the 6.5-7.0-million ounce range, below previous, but was largely factored into the stock which traded mostly inline yesterday (Nov. 2). NEM has reset expectations based on deeper insight into GG assets and the key is now to demonstrate sustainable operating improvements. We remain confident that NEM’s methodical full potential approach will yield results. If NEM can successfully reduce AISC by $100-150 per ounce in 2023+, this implies sustainable FCF of $900-million at $1,200 per ounce gold (3-per-cent yield) and $2.1-billion at $1,500 per ounce gold (7-per-cent yield). These are attractive returns on a large-cap gold miner with relatively low jurisdictional risk, in our view.”
Raymond James analyst Brian MacArthur lowered his target price for shares of Centerra Gold Corp. (CG-T) after it halted production at its Kumtor mine in the Kyrgyz Republic on Monday following a “significant rock movement” that caused two workers to go missing.
“While the impact of the rock movement on future years is unknown at the moment, we expect costs will increase as greater haulage distances may be required,” he said. “We note, however, that significant ore needed for 2020 is already stockpiled on surface which should support 2020 production.”
After lowering his 2020 earnings projection, Mr. MacArthur reduced his target to $13 from $14.50, keeping an “outperform” rating. The average on the Street is $13.66.
“Centerra operates two cornerstone assets — Mt Milligan & Kumtor — which offer investors exposure to gold and copper, while generating solid CF. Centerra also has a flexible balance sheet to support its robust project pipeline (Öksüt, Kemess, Hardrock) led by Öksüt which could increase production meaningfully in 2020,” he said. “In addition, the company owns 3 molybdenum assets, which offer optionality on molybdenum prices and may be sold to surface value. Further, Centerra trades at a discount to the intermediate peer group.”
“Solid” tailwinds are emerging for CanWel Building Materials Group Ltd. (CWX-T), said Raymond James analyst Steve Hansen following client meetings with its management last week.
“After a solid/resilient 3Q19 print, management indicated that macro conditions remain supportive of a sustained recovery through 4Q19/1H20, largely underpinned by: 1) the recent surge in LBM prices — benefiting from a pick-up in U.S. housing activity and widespread BC capacity curtailments (i.e. more than 2.0 billion bf); and 2) a healthy uptick in US housing starts/activity—with both California & Hawaii called out as particularly strong thanks to a favorable interest rate backdrop, strong economy, an improved weather (after major spring drag),” the analyst said. "In Canada, while B.C. and Alberta both remain lethargic, management called out incremental signs of growth in Ontario and Quebec.
“Consistent with its recent strategy, management continues to see plenty of of tuck-in opportunities along the U.S. westcoast (priority region) and eastern Canada (Quebec, Atlantic Canada). That said, a recent surge in seller expectations could require some patience. In the U.S. specifically, management expressed interest in further growing its presence in California, Oregon, and Washington, while Arizona/Nevada will be serviced out of its California operations.”
On the heels of a Nov. 19 upgrade to an “outperform” rating, Mr. Hansen raised his target price for CanWel shares to $6 from $5.50, which exceeds the consensus of $4.95.
“Despite some obvious volatility, CanWel’s capital-light, high-payout model has proven very rewarding to shareholders over the past 5 years, with total returns of 37 per cent, handily outperforming the S&P/TSX Composite (17 per cent)," he said.
After resuming coverage following the divestiture of its Economy Lodging porfolio, CIBC World Markets analyst Dean Wilkinson is taking a "bit more of a ‘wait-and-see approach’ to American Hotel Income Properties REIT LP (HOT.UN-T), leading him to downgrade its stock to “neutral” from “outperformer.”
“We continue to believe that AHIP units are favourably positioned to deliver outsized returns in a non-recession/expansionary scenario – it is the probability of such a scenario occurring that has in our view decreased,” said Mr. Wilkinson. “To be clear, we view the refined strategic direction of the REIT as a distinct longterm positive; it is within the context of our 12- to 18-month investment horizon that we must place a relatively higher weighting on a potentially softening U.S. economic outlook. One might say that we’re not quite cancelling our reservation, we’re simply rescheduling until the weather looks a little brighter.”
His target dipped to $7 from $8. The average is $7.05.
Roots Corp. (ROOT-T) is a “show me” story, according to BMO Nesbitt Burns analyst Stephen MacLeod.
Believing “consistent and sustainable” same-store sales and EBITDA growth will be needed for the stock to work, he downgraded the stock to “market perform” from “outperform” with a $3 target, down from $4. The average is $3.56.
Looking across our diverse coverage universe, we see better investment opportunities for new money, into stocks that we feel have a better balance between earnings visibility and valuation (i.e., ATZ, PBH, ZZZ within the consumer space; CCL.b, ITP, IPLP, CIGI, TCN outside of consumer)," said Mr. MacLeod.