Inside the Market’s roundup of some of today’s key analyst actions
National Bank Financial analyst Gabriel Dechaine is turning “more cautious” on Canadian life insurance companies heading into 2024.
“The lifecos have been strong performers over the past two years, relative to the market and to the Big-6,” he said. “We believe that performance will be more subdued in the coming year, reflecting: 1) valuation multiples that are above their historical average and that reflect a wider than normal premium to the Big-6 banks on a P/B basis; 2) Street expectations that are nearing double-digit growth; and 3) a historical track record of margin compression during periods of Central Bank loosening.
“Our top pick in the space is IAG, which we believe offers attractive valuation, a flexible balance sheet and potentially improving financial performance in its P&C operations in Canada and the U.S. in 2024.”
In a research report released Tuesday, Mr. Dechaine argued one of the “biggest risks” to the performance of the industry’s stocks is a rebound in the Canadian banks. He also warned the implementation of a IFRS 17 accounting principles will continue to be “a net negative for sector valuation.”
“Lifecos outperformed the market in 2023 by 13 per cent,” he said. “Also noteworthy, they outperformed the Big-6 banks for the second consecutive year, which is a rare occurrence. We recently turned positive on the banks ... as we believe rate cut activity reduces downside risk to the Canadian housing market and to the broader economy.”
“In our view, the adoption of IFRS 17 has been a net negative for sector valuation, if only because of its inherent instability. Core EPS was 30 per cent above Reported EPS over year-to-date 2023. Such a variance reduces confidence in consensus forecasts and in the definition of Core EPS itself, which varies between companies. Another factor worth noting is the heavy emphasis on the Contractual Service Margin as a measure of value, as it represents future ‘locked in’ earnings. While mostly true, nearly two-thirds of CSM earnings emergence will take place over five years from now.”
Ahead of the start of fourth-quarter 2023 earnings season, he maintained his forecast through 2024 while introductng 2025 earnings per share projections that imply growth of 7 per cent on average.
With that view, he raised his target prices for stocks in his coverage universe by an average of 6 per cent, despite seeing “uncompelling” valuations.
“Earnings multiples garnered by the lifecos appear attractive, at least in a superficial manner,” he said. “On a standalone basis, the group’s 9.3 times forward P/E multiple represents an 7-per-cent discount to the 10-year 10.0 times historical average. On a relative basis, the lifecos are trading at a discount of 11 per cent to the Big-6 banks, as opposed to the historical average discount of 8 per cent. Now one could simply state that these valuation metrics are attractive. However, since we believe IFRS 17 has reduced the reliability of earnings forecasts in the sector ... we would counter-argue that these discounts are warranted. Moreover, other valuation measures and trends paint a different picture for the lifeco sector.
“In contrast to earnings multiples, the lifecos are trading pretty richly on price-to-book metrics. In relation to their 10-year historical average of 1.5 times, lifeco stocks are trading at 1.6 times. Relative to the banks, they are currently trading at a 12-per-cent premium. We note that we have adjusted historical book values by 15-20 per cent to account for IFRS 17 (with the exception of IAG, where no adjustment has been made). One of the reasons lifeco stocks are trading more richly than bank stocks on a P/B basis is simply that bank stocks have corrected more severely in anticipation of a recession. Whereas lifeco P/B multiples are only off 4 per cent from their 2022 highs, bank stocks are off 30 per cent. According to our methodology, the latter correction implies a 75-per-cent chance of a recession. Granted, bank earning streams are more linked to economic cycles, but at the very least, we can argue that downside risk associated with a downturn has been more clearly reflected in their multiples.”
Mr. Dechaine’s target changes are:
- Great-West Lifeco Inc. (GWO-T, “sector perform”) to $42 from $40. The average on the Street is $42.75.
- IA Financial Corp. Inc. (IAG-T, “outperform”) to $104 from $100. Average: $100.13.
- Manulife Financial Corp. (MFC-T, “sector perform”) to $29 from $28. Average: $30.33.
- Sun Life Financial Inc. (SLF-T, “sector perform”) to $72 from $71. Average: $73.75.
- Sagicor Financial Company Ltd. (SFC-T, “outperform”) to $8 from $7. Average: $8.83.
Elsewhere, Evercore ISI’s Thomas Gallagher raised his targets for Sun Life to $78 from $76 with an “outperform” recommendation and Manulife to $30 from $26 with an “in line” rating.
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Alongside a “rough start” to 2024 for the Canadian energy sector with “commodity price weakness driving sluggish equity market performance,” Desjardins Securities analyst Chris MacCulloch expects similar turbulence through upcoming fourth-quarter 2023 earnings season as “softer cash flow generation (relative to 3Q23) and operational hiccups from the mid-January deep freeze come to light.”
“Although we remain constructive on the sector given improved industry resiliency from balance sheet strength and an unwavering commitment to returning the lion’s share of FCF to investors, we have trimmed price targets for nearly every producer under coverage, which is primarily a reflection of our reduced commodity price forecast,” he said,
“We have updated our estimates ahead of 4Q23 reporting, which should be highlighted by strong operational results for most producers given the mild temperatures experienced throughout the basin (until January), offset by softer quarterly cash flow following the moderation in commodity prices. That said, the sector is well-positioned to weather nearterm volatility, with defensively positioned balance sheets following several years of debt repayment and the lion’s share of industry FCF now allocated to capital returns.”
In a research report released Tuesday, he cut trimmed his 2024–25 Brent and WTI forecast by US$5 per barrel each to US$80 and US$75, respectively, to reflect a “cautious” near-term economic outlook.
“Our revised price deck better aligns with our view that WTI prices will remain range-bound at US$70– 80/bbl until the next major shoe drops, either from a macroeconomic or a geopolitical perspective,” said Mr. MacCulloch. “Although we remain optimistic on the prospect of TMX linefill commencing in 2Q24 following the CER’s recent granting of a minor project variance, we have slightly widened our 2024 WCS–WTI differential forecast to US$16/bbl (from US$15/bbl). We have also cut our 2025 New York Harbor 3-2-1 crack spread forecast to US$17.50/bbl (from US$20.00/bbl), reflecting our cautious longer-term outlook.”
For large-cap stocks, the analyst’s target changes are:
- Arc Resources Ltd. (ARX-T, “buy”) to $29 from $31. The average is $26.70.
- Canadian Natural Resources Ltd. (CNQ-T, “buy”) to $97 from $105. Average: $95.47.
- Cenovus Energy Inc. (CVE-T, “buy”) to $27.50 from $34. Average: $29.63.
- Imperial Oil Ltd. (IMO-T, “hold”) to $77 from $82. Average: $84.75.
- Suncor Energy Inc. (SU-T, “hold”) to $45 from $49. Average: $51.
- Tourmaline Oil Corp. (TOU-T, “buy”) to $76 from $85. Average: $79.53.
“From a valuation perspective, the recent softness in commodity prices has contributed to sluggish equity performance, holding valuations in line with historical levels, although we still believe that the sector offers attractive opportunities for value-focused investors to selectively deploy capital.” he said. “On that note, FCF yields within the Desjardins E&P coverage universe have moderated to the 9–10-per-cent level on average at current strip prices, although we note that 2024 FCF has effectively dried up among small-cap natural gas–weighted producers. However, capital return yields remain attractive, averaging 6 per cent in 2024 at current strip prices, and are expected to accelerate to 7 per cent in 2025 as additional corporate net debt targets are achieved.
“Going forward, we retain our near-term bias toward oil-weighted producers, where we see greater FCF resiliency with TMX coming online later this year. We continue to highlight CVE as our top pick in the large-cap integrated oil space following significant underperformance through the opening weeks of 2024, with the stock trading down 9.1 per cent to date this year (vs peers at down 1.2 per cent). While acknowledging that the market is reacting to disappointing upstream production and sliding crack spreads, the latter of which appears to have removed the potential for meaningful 4Q23 downstream cash flow contribution, we also believe that it is failing to recognize the potential impact of narrowing WTI–WCS differentials when TMX begins linefill.”
Mr. MacCulloch’s other top picks are:
Mid-cap oil: Enerplus Corp. (ERF-T, “buy”) with a $20 target, down from $23. Average: $20.80.
“We believe it offers one of the best value propositions in the Canadian energy sector, currently trading at 3.0 times 2025 DACF [debt-adjusted cash flow] multiple (vs peers at 4.0 times) while providing a 12.2-per-cent FCF yield at strip prices,” he said. “We also believe the company could be a beneficiary of booming U.S. M&A activity, either as a consolidator within North Dakota or as a potential target.”
Small-cap oil: Headwater Exploration Inc. (HWX-T, “buy”) with a $8.75 target, down from $10. Average: $9.18.
“We highlight HWX as our top pick in the small-cap oil space given our constructive outlook for WCS prices and the company’s ability to add short-cycle barrels, which we expect to be augmented by its new Clearwater lookalike plays — we expect further details in the not-too-distant future,” he said. “We also note that HWX retains considerable financial dry powder to add scale through M&A given its pristine balance sheet and more than $100-million of cash.”
Large-cap natural gas: Arc Resources Ltd. (ARX-T, “buy”) with a $29 target, down from $31. Average: $26.70.
“We continue to highlight ARX as our favourite large-cap natural gas name given its pristine balance sheet, strong growth visibility from Attachie and advantaged position as the leading condensate producer in the basin, with TMX linefill expected to drive increased diluent demand,” he said.
Small/mid-cap natural gas: Advantage Energy Ltd. (AAV-T, “buy”) with a $13 target, down from $13.25. Average: $12.51.
“Our top pick in the small/mid-cap natural gas space is AAV, which offers 14-per-cent PPS growth, augmented by share repurchases with 100 per cent of FCF currently allocated to buybacks. We also anticipate a meaningful acceleration in CCS developments this year for Entropy in the U.S. and Canada, the latter of which will be backstopped by the recent partnership with the Canada Growth Fund.,” he said.
Royalty: Topaz Energy Corp. (TPZ-T, “buy”) with a $26.50 target, down from $27.50. Average: $27.04.
“We believe the company is well-positioned to capitalize on our expectation for a more robust Canadian M&A market while retaining strong organic growth visibility from its extensive holdings in the Montney and Clearwater plays. Despite near-term natural gas price weakness, we believe the dividend is wellprotected by the stable cash flow stream provided by the infrastructure assets,” he said.
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Scotia Capital analyst Michael Doumet thinks 2024 will be a “return to ‘normal’” for the Canadian heavy equipment dealers following what he sees as “an above-mid-cycle year.”
“To us, that means sales will moderate as deliveries more closely match end-user demand and gross margins will gravitate back to 2019 levels as inventories have been largely replenished and price increases will slow,” he said. “We expect this normalization to result in a moderate year-over-year EPS decline in 2024. However, increased prospects of a soft landing suggests a re-acceleration of EPS growth in 2025.
“Our 2024 estimated EPS is below consensus for all heavy equipment dealers. Despite expecting downward EPS revisions, we think the best way to be position in the 1H24 is with the cheaper/more cyclical names. Here’s why: FTT/WJX trade at a 30-per-cent/15-per-cent discount to mid-cycle. We do not expect EPS declines in 2024 to be material. Beyond that, we believe the outlook for continued product support growth and capital deployment is sufficient to drive a re-acceleration in EPS in 2025. A more resilient 1H24 EPS trend and improved visibility of EPS re-acceleration in 2024 should catalyze a positive re-rate for the sector — we think, more so for FTT/WJX.”
In a report released Tuesday, he downgraded Toromont Industries Ltd. (TIH-T) to “sector perform” from “sector outperform” previously, seeing “less relative upside.”
“TIH is not expensive on a historical basis (and non-residential construction appears strongest in Ontario),” he said. “The one knock on the name: since 2019, TIH has generated the most gross margin expansion, which we believe is at risk of normalizing. How could we be wrong with our downgrade? TIH has $2-billion of debt-capacity to fund a deal. While visibility on the timing of such a transaction (or what the acquired asset could be) is limited, we believe a sizable transaction would act as a meaningful positive catalyst for the shares (given its successful track record for capital deployment).”
His target for Toromont is $125, up from $124 and above the $127.11 average on the Street.
Mr. Doumet also raised his target for Wajax Corp. (WJX-T) to $36 from $34, maintaining a “sector outperform” recommendation. The average is $33.67.
For Finning International Inc. (FTT-T), his top pick in the space, he has a “sector outperform” rating and $54 target. The average is $48.22.
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National Bank Financial analyst Vishal Shreedhar predicts “strength” from its Shoppers Drug Mart chain will “aid” the fourth-quarter financial performance of Loblaw Companies Ltd. (L-T)
“We project positive Rx sssg [same-store sales growth], reflecting solid growth in services related to expanded scope of pharmacy services, as well as strong growth in specialty drugs, partially offset by lower year-over-year influenza cases; ongoing strength in beauty is expected to aid F/E sales,” he said. “Overall, we expect 3.9-per-cent sssg in SC, despite a high comparable base (Q4/22 was 8.7 per cent).”
Ahead of its Feb. 22 quarterly release, Mr. Shreedhar is forecasting earnings per share of $1.90, falling in line with the consensus expectation and rising from $1.76 during the same period a year ago. He attributes that 8.2-per-cent growth to “positive” food retail sssg, momentum in Shoppers Drug Mart, benefits from growth/ efficiency programs, and the NCIB. He’s expecting total revenue of $14.573-billion, narrowly above the Street’s $14.556-billion and up from $14.007-billion a year ago.
“We estimate Q4/23 food store inflation of 4.9 per cent versus 7.2 per cent last quarter. In December, inflation moderated to 4.7 per cent; we expect further moderation, reflecting a decline in the price of major inputs and base effects,” he said. “Our review of peer commentary suggests: (i) Inflation moderated further; (ii) Ongoing cautious consumer spending behaviour (trade-down, discount, private label, etc.); (iii) Higher promotional penetration, although we understand promotional intensity is largely unchanged; and, (iv) Margin headwinds from shrink (albeit moderating sequentially).”
The analyst also thinks investors shouldn’t be concerned about the release of the company’s guidance.
“We expect Loblaw to announce its outlook during the Q4/23 release, which should largely fall within the financial framework of delivering 8-10-per-cent year-over-year EPS growth (driven by share repurchases and earnings growth),” said Mr. Shreedhar. “In 2024 NBF models 7.7-per-cent EPS growth year-over-year and consensus reflects 9.4-per-cent EPS growth year-over-year.
“Media reports indicate that Melanie Singh has joined the management board as President of the Hard Discount Division from SVP of the Hard Discount Division, and Frank Gambioli will take on an expanded role as President of the Market Division from President of the Discount Division. We believe these changes signal an increased focus on value across both, discount and conventional, banners.”
Maintaining an “outperform” recommendation for Loblaw shares, Mr. Shreedhar raised his target to $149 from $142 after advancing his valuation period. The average on the Street is $144.88.
“We continue to maintain a favourable view on Loblaw and recommend it as our preferred grocer supported by several key themes: (1) Benefits from management’s improvement initiatives; (2) Ongoing stable EPS growth, and (3) Favourable trends in discount and drug store (where Loblaw over-indexes),” he said.
Elsewhere, Scotia’s George Doumet raised his target to $137 from $127 with a “sector perform” rating. Conversely, he cut his Metro Inc. (MRU-T) target to $74.50 from $77, below the $76.50 average, with a “sector perform” recommendation.
“For the upcoming reporting quarter, we anticipate a continuation of trends seen in previous quarters in the food retail space, as disinflation steadily develops and value-seeking behaviours remain status quo,” said Mr. Doumet. “We will pay special attention to margin performances as good execution on the cost front will be key. On the top line, we continue to monitor the evolving dynamic between tonnage improvement and lower pricing growth and their net impact on SSS growth. We note that in drug retail, front-end performance has been more resilient than expected, helped by relatively healthy beauty demand and (significant) price inflation in the category. In the NT, we see L as having higher earnings visibility than MRU, before the new DC learning curve plateaus for the latter. We continue to prefer food processors over grocers in our coverage under the disinflation setup and their ongoing self-help initiatives.”
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During fourth-quarter 2023 earnings season for North American waste sector companies, RBC Dominion Securities’ Walter Spracklin expects pricing to remain “strong” alongside “stabilizing” volumes and margins that are likely to “trend higher.”
“We saw forward multiples expand approximately 1 time on average over the quarter,” he said. [Waste Connection’s] premium to the market expanded, ending the quarter at a 7.3-per-cent premium to the S&P 500 index, an increase from 3.4 per cent last quarter, but below the historical average of 11 per cent. We view GFL as the most attractively valued, trading at the low of its historical 5-year valuation range, followed by WCN, which has gained ground during the quarter. Finally, RSG and WM are trading at the high end of their ranges, reducing the relative opportunity, in our view.
“Looking ahead, we believe valuations will be driven primarily by 1) the ability to maintain price-led growth and capitalize on rebounding recycled commodity prices, 2) accretive M&A and sustainability investments, 3) the impact of economically sensitive volumes, and 4) the extent to which the risk-on trade emerges.”
In a research report released Tuesday, the equity analyst said the release of 2024 guidance is likely to be “a key differentiator” for investors.
“We expect 2024 formal guidance updates across our coverage in conjunction with Q4 results and expect them to embed solid price-led revenue growth, outsized margin expansion, and tailwinds from recovering recycled commodity prices,” he said. “Last quarter, GFL, WCN and RSG provided encouraging 2024 (preliminary) guidance of mid-to-high single-digit revenue growth and high single-digit EBITDA growth. We note WCN’s guidance will likely not include contributions from the acquisition of Secure Energy Services’ waste energy assets as the deal is expected to close in Q1/24. In addition, we expect the majors to provide detailed contributions from sustainability investment this year as contributions from previous outlays begin.”
The lone change to his estimates was an earnings reduction to Waste Connections Inc. (WCN-N, WCN-T) for one-time landfill charges related to the Seabreeze landfill in Texas. However, he raised his target for its shares to US$169, exceeding the US$162.91 average, from US$164 to reflect higher expectations in 2025 stemming from the Secure deal. He kept an “outperform” recommendation.
His other targets and ratings are:
- GFL Environmental Inc. (GFL-N, GFL-T) with an “outperform” and US$43. Average: US$40.11.
- Republic Services Inc. (RSG-N) with a “sector perform” and US$166. Average: US$174.53.
- Waste Management Inc. (WM-N) with a “sector perform” and US$163. Average: US$184.53.
“Our preferred names in the waste sector remain our two Outperform-rated names: GFL and Waste Connections,” said Mr. Spracklin. “We see WCN as the best-in-class operator with tailwinds driven by the Secure acquisition and the greatest ability for meaningful margin expansion. WCN is trading at the mid to lower end of its 5-year historical 1-year forward valuation range after partially rebounding from negative sentiment around landfill issues last quarter. On the other hand, GFL remains the most attractively valued, trading at the low of its historical 5-year valuation range. We see upside given new spending guardrails, which should reduce earnings and leverage volatility, consistent FCF generation, and the fact GFL would benefit the most should the risk-on trade return in a lower rate environment next year.”
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In a research report titled So, You’re a Generalist Investor in 2024…, Eight Capital analyst Ty Collin named two top picks for the year ahead from his Consumer/Diversified coverage universe.
They are:
* Decisive Dividend Corp. (DE-X) with a “buy” rating and $11 target. The average is $10.50.
“Decisive Dividend acquires profitable, private manufacturing businesses with enterprise values up to $25-million that are going through a succession,” he said. “This is a transaction size band with relatively light competition, and the Company’s good reputation makes it an acquirer of choice for legacy-minded exiting business owners. The pipeline of opportunities is rich as Baby Boomers retire en masse over the next two decades, affording the Company a high degree of selectivity in the acquisition process. DE creates value twofold: by acquiring attractive businesses at reasonable valuations and reinvigorating their growth under its ownership. It has been a quiet few months for DE since their last acquisition on July 20, 2023, but we expect an active start to the year that could include multiple acquisitions, supported by recent additions to their headcount. Acquisitions have been a catalyst for the stock, which on average has traded up 5 per cent/9 per cent one/three months after an announcement, or up 10 per cent/36 per cent excluding April’s equity financing. On top of M&A, we expect that DE will soon announce a key debt syndication that brings bigger lenders into the cap table, validating its strategy and adding borrowing power to support growth.”
“While the Company has recently begun to attract some institutional investors, we believe its size still keeps it under the radar for many – though not for long if it continues to execute on deals, in our view. DE was the best performing stock in our diversified coverage universe last year at 59 per cent, and we expect that per-share earnings growth from accretive M&A and organic growth can drive further outperformance in 2024.”
* Pet Valu Holdings Ltd. (PET-T) with a “buy” rating and $47 target (a high on the Street). Average: $36.22.
“Despite stacking solid comp growth on top of two pandemic boom years, PET stock had a ‘ruff’ 2023 (sorry) as growth expectations reset to more normal levels and concerns festered over softness in consumer discretionary spending and the entry of Chewy (CHWY) into the Canadian market,” he said. “Now, PET begins 2024 trading at just 10.5 times 2024E EBITDA, a significant discount to other Franchisors at 14 times and its average since the IPO of 13 times. While the current valuation implies a very cautious outlook on PET’s growth, we note that the pet industry has not seen a year of declining sales in data going back to the early 1980s, and PET will likely grow its store count by 6 per cent next year (40 – 50 units), while cycling easier comps than in 2023. Additionally, our channel checks indicate that U.S. online competitor, Chewy, is taking a gradual approach to the Canadian market and, in any case, targets a different core customer than PET. This leads us to believe that the bad news is priced in, and sentiment might already have bottomed. The stock has rallied 30 per cent since hitting a low of $23.75 on October 5 (outperforming Canadian consumer discretionary peers by 22 per cent) and reacted 6 per cent to a small top-line miss in Q3. Early indications suggest that Canadian consumer spending surprised to the upside over the critical holiday period, potentially setting up retailers like PET to outperform expectations when they report Q4 results in March.”
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In other analyst actions:
* Ahead of its mid-February quarterly release, TD Securities’ Mario Mendonca bumped his ECN Capital Corp. (ECN-T) target to $3 from $2.50 with a “hold” rating. The average is $2.85.
“We forecast Q4/23E adjusted EPS from continuing operations of $0.00. Consensus EPS stands at $0.01. With the new funding agreements in place for 2024, we view ECN’s priorities for quarter and 2024 as twofold: a) advance the corporate simplification plan (reduce expenses by $6-million in first phase) and b) developing the partnership between Triad and Skyline.,” he said.
“We continue to rate the stock HOLD, reflecting: a) higher balance-sheet usage than we contemplated; b) sharply higher and ongoing non-core losses; c) uncertainty regarding further charges on the exit of RV/Marine; d) weak fundamentals (margins/ originations); and e) weak treasury/risk management as evidenced by the charges in Q2/23 and again in Q3/23.”
* JP Morgan’s John Ivankoe increased his Restaurant Brands International Inc. (QSR-N, QSR-T) target to US$78 from US$74 with a “neutral” rating. The average is US$82.91.
* After lowering his spodumene price assumptions, BMO’s Joel Jackson cut his Sigma Lithium Corp. (SGML-Q, SGML-X) to US$38 from US$40 with an “outperform” rating. The average is $58.41 (Canadian).
“Despite continued noise around Sigma, we still see upside as SGML (with sizable Brazilian spodumene assets) continues to re-rate to lithium feedstock producer, and ramps production over subsequent years. An imminent takeout is still possible, but there is also ample upside if SGML remains an independent spodumene producer,” said Mr. Jackson.
* Canaccord Genuity’s Luke Hannan cut his Spin Master Corp. (TOY-T) target to $51 from $52 with a “buy” rating. The average is $48.25.
“We attended Spin Master’s 2024 Toy & Entertainment Investor Day [Sunday] wherein the company outlined its core priorities for the year ahead and showcased upcoming new toy and entertainment launches. We came away from the day positively, with a reinforced belief that the company remains well positioned to capture market share with its robust portfolio of properties, even amidst a softer backdrop,” said Mr. Hannan.
* B. Riley Securities’ Lucas Pipes dropped his Teck Resources Ltd. (TECK.B-T) target to $59 from $72, keeping a “buy” rating. The average is $59.96.
“We are updating our estimates for Teck Resources Limited following the issuance of the company’s 2023 production and 2024 guidance update,” he said. “We are also removing the coal cash-flow estimates from valuation in anticipation of the business unit sale to Glencore at the end of Q3 2024. For copper production in 2023, Teck came in modestly below our prior estimate (296.5k Mt versus our 302.9k Mt), driven by underperformance at Highland Valley but slightly offset by better than estimated performance at Antamina.”
David Leeder