Inside the Market’s roundup of some of today’s key analyst actions
Taking “a positive view on heavy oil pricing,” Scotia Capital analyst Jason Bouvier made a pair of notable rating revisions to Canadian large-cap energy stocks on Tuesday.
“We expect the differential to continue narrowing on the back of improved egress and strong global demand trends,” he said.
In a research report released before the bell, Mr. Bouvier downgraded Suncor Energy Inc. (SU-T) to “sector perform” from “sector outperform,” given it has the least exposure among peers to heavy oil differentials.
Conversely, he upgraded Imperial Oil Ltd. (IMO-T), which possesses the highest exposure, to “sector outperform” from “sector perform” previously.
For Suncor, Mr. Bouvier said the recent appointment of Rich Kruger, the former head of Imperial Oil, as its new chief executive officer, is a “positive step,” but further actions remain necessary to restore investor confidence.
“We believe Rich Kruger will bring a fresh and experienced set of eyes to some of the operational issues SU has experienced over the past few years,” he said. “However, there is still plenty of work to do. Key items include safety, minimizing downtime, reducing operating costs and replacing production at aging mines.”
“In our view, the lack of clarity on future capital costs necessary to replace the Base Plant production (current mine life plan ends in mid-2030′s) continues to weigh on the stock. Production is around 270 mbbl/d, which is not a small amount to replicate. While we believe SU has ample resource and available FCF to fund capex, its simply a question of magnitude and the corresponding impact on shareholder returns. We look forward to more clarity on the company’s plans.”
Noting Suncor’s free cash flow yield continues to sit at the low end of the sector, he maintained a $50 target for its shares. The average on the Street is $54.11, according to Refinitiv data.
“SU trades at a 2023 estimated DAFCF [debt-adjusted free cash flow] yield of 10 per cent, vs CVE, IMO and CNQ at 13 per cent, 11 per cent, and 9 per cent respectively. It is important to keep in mind, that our 2023 estimates do not include any capital for Base Plant production replacement, a cost unique to SU. In addition, our capex estimates have minimal Pathways (i.e., environmental costs) included. We expect these costs to increase materially in 2025+. Although the environmental costs will increase for all of the company’s, SU’s GHG/bbl is at the higher end of its peer group (i.e., due to high level of upgrading/refining and older mines).”
Mr. Bouvier thinks Imperial Oil’s “operational execution has been strong” and sees its balance sheet in “great shape.”
“Over the past couple of years, Kearl has hit several production records with line of site on reaching 280 mbbl/d in 2024, a year before initial plan,” he said. “In addition, Cold Lake production has stabilized with a clear plan on reducing GHG intensity over the next 5-10 years. Utilization at its refineries averaged 98 per cent in 2022, versus historical levels of around 89 per cent.”
“As at year-end 2022, IMO’s net debt was $1.5-billion and we model 2023 ND/CF [net debt to cash flow] at 0.4 times (strip). This should provide the company with increased stability in a world with continued macro issues (i.e., inflation, bank crisis, etc.). In addition, the company’s payout ratio (2023, strip) is only 45 per cent. This provides the company with the ability to increase shareholder returns, even in a weaker oil price environment. With lower oil prices and E&P share prices, in our view, a big SBB would be ideal (IMO bought 14 per cent of their shares in 2022).”
He reaffirmed a $72 target. The averages is $78.75.
Following the close of its US$6-billion acquisition of U.S. firm IAA Inc.. Ritchie Bros Auctioneers Inc. (RBA-N, RBA-T) has a “significant opportunity ahead,” according to RBC Dominion Securities analyst Sabahat Khan, who sees “a favorable risk/reward setup” for investors.
“We believe Ritchie Bros. is well positioned to deliver significant top-line and earnings growth over our forecast horizon, driven by growth in its base/legacy business and contribution from the IAA-related synergies,” he said. “We believe this is an attractive deal/acquisition for Ritchie Bros. and we believe the company will be successful in realizing the stated cost synergies of $100-million-$120-million. As for revenue synergies ($350-million-$900-million of EBITDA contribution), these are the proverbial cherry on top if even partially realized (we see the biggest potential for growing IAA’s domestic sales and Ritchie Bros.’ GTV).
“So while there will be plenty of ‘wood to chop’ for Ritchie Bros. over the coming quarters, we believe that the upside potential from this deal is material, particularly given where Ritchie Bros.’ shares are currently trading. As of market close on March 20, Ritchie Bros.’ shares are trading at 19 times our 2024 EPS, which we believe provides a very attractive entry point. For context, on a standalone basis, Ritchie Bros. and IAA have traded at average 3-year NTM P/E [next 12-month price-to-earnings] multiples of 30 times and 24 times, respectively. Our (and investors’) focus over the coming quarters will be on how the integration is progressing, and we will look for early updates on synergy realization through late-2023 and 2024.”
Resuming coverage of the Burnaby, B.C.-based company, Mr. Khan called Ritchie Bros. and IAA “a winning combination,” , noting the “mix shift by transaction type (i.e., Services and Inventory/Vehicle) is relatively modest (slight shift of 4 percentage poings in favor of Services vs. Ritchie Bros. standalone), while mix shift by end-market is considerable.”
“Ultimately, we believe this is an attractive deal for Ritchie Bros. under the assumption that cost synergies are realized, and we ascribe a high probability to this occurring given the nature of the cost savings,” he said. “We estimate Ritchie Bros. is paying 9.7 times IAA’s 2022 EBITDA (based on Ritchie Bros.’ share price as of market close on March 17, 2023) assuming run-rate cost synergies at the mid-point of the target, which we see as attractive given the duopoly nature of IAA’s industry and the opportunity to improve the underlying business. As for revenue opportunities, these are the proverbial cherry on top if these are even partially realized (we see the biggest potential for growing IAA’s domestic sales and Ritchie Bros.’ GTV).”
Reinstating an “outperform” recommendation for Ritchie shares, Mr. Khan trimmed his target to U$70 from US$73. The average is US$66.93.
Elsewhere, Baird’s Craig Kennison cut his target to US$64 from US$66 with an “outperform” rating.
In a separate report, Mr. Khan assumed coverage of BRP Inc. (DOO-T) with an “outperform” rating, seeing it “well positioned for growth in both the Powersports and Marine industries given its rich legacy of innovation and track record of delivering against its targets.”
“We believe the company will be able to successfully deliver against its medium-term targets, and we view the current share price as presenting an attractive entry point,” he said.
Mr. Khan raised the firm’s target for the Valcourt, Que.-based recreational vehicle manufacturer to $137 from $124. The average is $133.89.
“BRP stands out for its inventions/innovations which have historically driven strong market share gains,” he said. “The company has delivered strong growth since its 2013 IPO (Revenue CAGR [compound annual growth rate] of 11 per cent and Normalized EBITDA CAGR of 19 per cent over the last decade), driven in part by its innovative/new-to-market offerings. We believe this tradition and culture of innovation distinguishes BRP from its peers and positions the company for long-term growth in both the Powersports and Marine industries. We see runway for continued growth and believe the company is well positioned to deliver against its Mission 2025 (’M25′) targets. Furthermore, we believe the current share price offers an attractive entry point with shares trading below historical levels (current NTM EV/EBITDA of 6.1 times is below the 3-year average of 7.4 times and long-term average of 7.9 times) and below BRP’s closest peer, Polaris (which is trading at 7.1x). In our view, BRP should trade at least in line with Polaris given its stronger growth outlook over our forecast horizon and superior margin profile. See here for our Polaris assuming coverage report. We believe the current trading multiple already reflects some level of concern related to the uncertain macro backdrop and potential for an economic slowdown.”
Seeing the death care industry as “appealing” and potentially lucrative for investors, Stifel analyst Martin Landry resumed coverage of Park Lawn Corp. (PLC-T) with a “buy” recommendation, seeing “significant growth potential.”
“PLC is a consolidator of the fragmented North American death care industry,” he said in a research report. “The death care industry offers interesting characteristics such as stable growth, high margins, and barriers to entry. PLC is managed by an experienced team with strong industry roots and a successful track record. The industry is faced with succession issues, which creates strong underlying consolidation trends for several years ahead.”
Mr. Landry said the Toronto-based company, which operates 144 cemeteries and 167 funeral homes across three Canadian provinces and 18 U.S. states, has the potential to see earnings per share grow at a compound annual growth rate of more than 20 per cent through 2026, pointing to 3-4-per-cent organic growth and “a strong M&A pipeline.”
“Given Park Lawn’s reliance on equity financing to fund its acquisitions, the company’s EPS CAGR of 13 per cent since 2016 has lagged revenue growth,” he said. “Moving forward, given our view that PLC will likely increase its reliance on debt to finance its acquisitions, we would expect EPS growth to better align with revenue growth. PLC’s EPS CAGR since 2016 compares favorably to Carriage Services Inc. (CSV) at 8 per cent, but has historically lagged Service Corporation International (SCI) at 20 per cent.”
“Our analysis suggests that Park Lawn can deploy $100 million per year on M&A until 2026 while maintaining a sub 3.5 times net debt to EBITDA ratio, and finance acquisitions with internally generated funds and debt without requiring equity. According to our analysis, despite no equity issuance, the company would not breach its financial covenants of 3.75 times debt/EBITDA. According to our analysis, in order to reach its $2.00 per share target by 2026, Park Lawn’s EBITDA margins would have to increase by 300bps from 2022 levels of 23 per cent. Industry peers generate EBITDA margins higher than 30 per cent, which gives us confidence that margin expansion is likely for PLC. In addition, management seems confident in their ability to expand margins from 2022 levels. However, it will require a strong execution which adds a level of risk to achieving the $2.00 EPS target.”
Mr. Landry did point to several investment risks, including the rising cost of capital have the potential to slow M&A activity, a slowing of the death rate following the COVID pandemic spike and “changing social practice” leading to an increased penetration of direct cremation.
However, he thinks Park Lawn now has a “reasonable” valuation to attract investors.
“Despite Park Lawn’s shares having rebounded from its October lows, the current valuation offers a good entry point for long-term investors, in our view,” he said. “PLC’s valuation is appealing at 17 times forward earnings, roughly five multiple points lower than the company’s 5-year average of 22 times. This valuation erosion is larger than peers SCI and CSV which are trading at 3.75 times and 1.5 times lower than their respective 5- year forward P/E averages. In our view, the larger erosion experienced by Park Lawn reflects the potential impact of rising interest rates on the company’s business model, which is tilted more towards acquisitions. However, at $28.38, PLC’s shares are off 32 per cent from their all-time high of $41.55 on November 19, 2021, while the company’s long-term earnings power remains unchanged.”
The analyst set a target of $34 per share. The average target on the Street is $35.75.
“Baking in a return to typical seasonal patterns,” National Bank Financial analyst Zachary Evershed trimmed his first-quarter financial expectations for Richelieu Hardware Ltd. (RCH-T) ahead of the April 6 release of its results.
“Q4/22 peer reporting (partially overlapping with RCH’s FYQ1/23) indicated softer-than-expected volumes partly offset by pricing gains,” he said. “While the recent significant uptick in mortgage rates should incentivize owners to remain in their current homes as they generally cannot afford the higher mortgage payment associated with a move, thus increasing the probability of repair and/or remodel spending and likely backstopping RCH’s 75-per-cent exposure to renovation spending, the year-ago comparable period nevertheless represents a high bar. We moderate our expectations to reflect stiffening headwinds in volumes reflected in peer results, and a resumption of usual seasonal patterns, resulting in our organic growth forecast shifting to an 8.1-per-cent year-over-year contraction (was negative 2.3 per cent) in the quarter.”
Mr. Evershed is now projecting sales of $376.9-million for the quarter, down 2 per cent year-over-year and below the Street’s estimate of $387.3-million. His earnings per share forecast of 39 cents is a decline of 26.7 per cent and matching the consensus.
“RCH’s M&A pipeline remains healthy and the company’s nearly debt-free balance sheet (0.8 times Net Debt/EBITDA) is poised to help offset organic weakness,” he said. “Targeting transaction multiples of 4-6 times sustainable EBITDA, management looks to strengthen both product offering and geographic footprint. With management commentary indicating there are no whales in their crosshairs, and no spurt of distressed sellers looking to exit at this time, however, we adjust our M&A premium to 2 times (was 4 times), equivalent to $75-million in revenue added annually through acquisitions, just above the 5-year average of $65-million.”
Reiterating his “outperform” recommendation for the Montreal-based company’s shares, he reduced his target to $49 from $54 to account for the estimate revisions and M&A premium adjustment. The average target on the Street is $47.50.
“We remain bullish on management execution, end market growth in the long term, and we believe the market has more than priced in risks,” said Mr. Evershed.
High Tide Inc. (HITI-X) is making “the right shift at the right time,” said ATB Capital Markets analyst Frederico Gomes following the release of first-quarter 2023 financial results that “showcase the success of HITI’s discount club model.”
On Friday, the Calgary-based cannabis retailer reported revenue of $118.1-million, up 9.1 per cent from the previous quarter and above the estimates of both Mr. Gomes ($109.8-million) and the Street ($111.8-million). He attributed the beat to a 6.3-per-cent increase in Canadian retail sales and 29.2-per-cent gain in its United States and International segment. Earnings per share of a loss of 5 cents also topped estimates (losses of 8 cents and 7 cents, respectively).
“Sales have increased rapidly over the past two years (fueled by acquisitions), but HITI has now decided to shift its focus from growth to FCF generation,” said Mr. Gomes. “Management withdrew its guidance of 40-50 new stores in calendar 2023 (now guiding to 10-20) and issued guidance for positive FCF within the year. We like this strategic shift given the subdued share price (additional M&A would be dilutive) and current capital market conditions (it is better to preserve cash).
“We think the guidance is achievable, even before the end of calendar 2023, given management’s track record and HITI’s operations; quarterly FCF already stands near breakeven (FCF would have been positive this quarter excluding working capital changes). As growth slows, we think HITI could reach positive FCF by Q4/FY23 (from H1/FY2024), driven mostly by lower capex and working capital investments. Achieving the FCF target could be a catalyst for the stock, as it could lower cost of capital and trigger multiple expansion, helping to close what we view as a large valuation gap to fair value.”
Mr. Gomes did reduce his near-term store count estimate to 158 from 175 by the end of 2023, leading to lower projections for sales ($477.1-million from $478-million) and adjusted EBITDA ($22.7-million from $29.3-million).
“The impact of fewer stores is partially offset by higher CBD and accessories e-commerce sales,” he said. “We expect gross margin to remain steady at 27 per cent in FY2023 as higher retail prices are offset by lower data sales, with a slight sales decline in Q2/FY23 due to seasonality and three fewer days in the quarter. The impact of our lower adj. EBITDA in our valuation is partially offset by higher near-term FCF conversion from lower working capital investments and capex.”
With his reduced forecast as “the company’s growth is delayed to outer years,” Mr. Gomes trimmed his target for High Tide shares to $6 from $6.50, reaffirming an “outperform” rating. The average is currently $5.80.
While lithium stocks have recently been hurt by the volatility in the spot Chinese lithium price, Eight Capital analyst Anoop Prihar emphasized the long-term macro view for the sector “remains intact,” pointing to “supply/demand fundamentals.”
Number cruncher: Lithium stocks that may be undervalued
“Despite the fact that relatively little volume transacts in the spot market as producers typically sell the majority or all of their production on a long-term contractual basis, spot pricing volatility does affect sentiment, which can impact share prices,” he said.
“We believe the recent spot lithium price volatility likely reflects two developments: 1) The expiration of Chinese EV subsidies; and 2) CATL (300750-SHE, Not Rated) offering discounted prices on batteries to Chinese EV manufacturers. Despite EV subsidies ending in China on a federal level, some subsidies do remain at a regional level. Moreover, EV sales are expected to continue to grow in China. China’s Association of Automobile Manufacturers (CAAM) is expecting EV sales to surpass 9 million units in 2023, compared to the 2022 total of 6.87 million units.”
Seeing the European EV market remaining “robust” and the momentum appearing in the United States, Mr. Prihar raised his lithium suppply and demand forecast for 2030.
“While our increased demand forecast reflects a more robust EV sales outlook than we had been previously modelling, our revised supply forecast reflects additional production capacity as producers position themselves to maintain or increase market share,” he said.
“Finally, we have incrementally increased our lithium carbonate and hydroxide price assumptions. While we were previously assuming a lithium price of US$20,000/tonne from 2024-2030, and US$17,000/tonne thereafter, we are now using a US$25,000/tonne price from 2024-2030, and US$20,000/tonne thereafter. This relatively modest increase reflects two items. First, as evidenced by our revised supply-demand forecast, we expect the lithium supply deficit to increase over the next eight years. Second, we expect project capex to increase going forward. Given the on-going strength in lithium demand, we anticipate that a higher lithium price will offset some of the higher project costs.”
However, citing increased capex, Mr. Prihar reduced his targets for a pair of stocks:
* Lithium Americas Corp. (LAC-T, “buy”) to US$37 from US$40. The average is US$36.94.
“We believe that LAC’s stock price trading at a significant discount to NAV reflects two factors,” he said. “First, given the lithium industry’s experience with ramping up processing facilities, investors are likely looking for clarity on what the first year of production at Cauchari-Olaroz will look like. As mentioned above, we are assuming FY23 production of 20,000 tonnes (100 per cent) and an average realized price of US$40,000/tonne. Second, we believe investors are also concerned about the ease with which lithium clay can be processed. Although there are no companies currently commercially processing lithium clays, Ganfeng Lithium Group Ltd. (002460-SHE, Not Rated) is presently building the Sonora Lithium Clay Project in Mexico, which is expected to begin production in 2024, and will be the first lithium clay project to enter into commercial production. We believe that, over time, these concerns will be alleviated and the stock price will move closer to NAV.
“As our target price represents an 82-per-cent total potential rate of return, we continue to rate LAC as a BUY. We remain constructive on the outlook for LAC given several near-term catalysts, which include: a DOE funding announcement, the successful commissioning of Cauchari-Olaroz, and a spin-out of LAC’s U.S. assets.”
* Standard Lithium Ltd. (SLI-X, “buy”) to $12 from $16. Average: $13.25.
“As our target price represents a 173% potential return, we continue to rate SLI as a BUY. Near-term catalysts include both a FEED and a DFS on the LANXESS project, both of which are expected to be completed in the first half of 2023, with a final investment decision to follow. SLI is also expecting to complete the SWA Pre-Feasibility Study (PFS) in the first half of 2023 and will commence a DFS shortly thereafter,” said Mr. Prihar.
In other analyst actions:
* Jefferies’ Michael Sarcone downgraded Mississauga-based Profound Medical Corp. (PROF-Q, PRN-T) to “hold” from “buy” and raised his target to US$10 from US$5.50. The average target on the Street is US$15.32.
* BMO’s John Gibson lowered his target for Akita Drilling Ltd. (AKA.A-T) to $2.50, below the $3.38 average, from $3.25 with an “outperform” rating, while ATB Capital Markets’ Tim Monachello bumped his target to $5 from $4.25 with an “outperform” rating.
“AKT’s Q4/22 results were strong, driven by improved pricing and solid cost controls. 1H/23 activity levels should remain robust across North America, although we have moderated expectations for 2H/23 given the recent fall-off in commodity prices,” said Mr. Gibson.
* Scotia’s Justin Strong lowered his target for Ballard Power Systems Inc. (BLDP-Q, BLDP-T) to US$6.75 from US$7.25 with a “sector perform” rating. Other changes include: Raymond James’ Michael Glen to US$5 from US$6 with a “market perform” rating and Jefferies to US$5.50 from US$6 with a “hold” rating. The average is US$7.70.
“While the [fourth-quarter] miss can largely be attributed to lower-than-expected revenue, we remain confident in our near-term growth projections,” said Mr. Strong. “Despite this, our modeled net debt assumptions have moderated post-quarter, leading to a lower target enterprise value.”
* TD Securities’ Arun Lamba trimmed his Filo Mining Corp. (FIL-T) target to $30, below the $31 average, from $32 with a “speculative buy” rating, while BMO’s Rene Cartier reduced his target to $31 from $32 with an “outperform” rating.