Wednesday’s analyst upgrades and downgrades

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

Expecting record lumber prices to drive increased profitability, RBC Dominion Securities analyst Paul Quinn upgraded Resolute Forest Products Inc. (RFP-N, RFP-T) to an “outperform” rating from “sector perform” on Wednesday.

"Although lumber prices are up broadly in North America, Eastern Spruce-PineFir prices lead the pack at $850 per thousand board feet (versus Western SPF at $760 and SYP at $716)," he said. "Random Lengths noted last week that supplies fell further behind 'insatiable demand' on order files that currently extend into mid-September or later. Prices are getting so high that even producers are concerned in the region.

"In our view, this should result in very strong results for Resolute in Q3 and Q4 (depending on how long these prices last); the premium in the region also indicates that local market conditions are favorable. While we heard some pushback on Resolute's acquisition of Conifex's U.S. South sawmills, the timing appears to have been extremely favorable, with the sawmills likely generating attractive returns for Resolute."

In a research note released before the bell, Mr. Quinn said the quicker Montreal-based Resolute can "transition away from graphic papers, the better."

"We believe that equity investors attribute little upside to the newsprint and specialty paper assets due to the secular decline in end markets and challenging profitability (which requires a few mills in North America to shut every year)," he said.

"We found that graphic paper producers tend to trade in the 3.0-4.0 times EBITDA range vs. comparable U.S. Forest Product companies in the 6.0-8.0-times EBITDA range. This could result in meaningful multiple expansion opportunities over the longer term. However, we still expect that Resolute will trade below that typical range over the next 12 months given that the transition will take some time."

After raising his price forecast for Eastern SPF due to "strong repair & remodel demand, rebounding new residential construction, and constrained supplies due to COVID-19," Mr. Quinn increased his 2020 earnings per shares estimate to a 15-US-cent loss from a loss of 48 US cents. His 2021 projection jumped to 78 US cents from 68 US cents.

Mr. Quinn also raised his target price for Resolute shares to US$5.50 from US$4. The average on the Street is US$4.13, according to Refinitiv data.

“While we remain negative on graphic paper markets, we expect that record lumber prices, especially in Eastern Canada, will more than offset declines in newsprint & specialty paper,” he said. “In addition, strong cash flow from the lumber business could be used to reduce leverage, which has been a key investor concern. We expect that COVID-19 has accelerated Resolute’s transition to becoming a Lumber-Pulp-Tissue producer, which we view favorably.”

At the same time, Mr. Quinn also adjusted his target prices for several other stocks in his coverage universe in response to what he calls "a most hated rally."

“Lumber and OSB prices have surged to record levels on the back of: 1) record repair & remodel demand; 2) rebounding new residential construction markets; and, 3) limited supplies due to curtailments in late March/April and COVID-19 related staffing problems,” he said. “In addition, de-stocking in the early days of COVID-19 left dealers with extremely low inventories and unprepared for the current boom in demand. While prices are unlikely to remain at such high levels, we still believe that investors are underappreciating the cash generation potential of the businesses given that unit production costs should actually decline given the greater fixed cost contribution per unit and recent investments in efficiency.

“Historically, wood product producer share prices have been highly correlated with commodity prices. That relationship has broken down during the recent rally, with share prices leveling off as we expect investors are waiting to see how the situation plays out. Based on historical relationships, West Fraser could theoretically be trading at $120, Interfor at $35, and Norbord at $65. While we do not think that shares will trade quite that high, wood product producers do deserve some credit for the upcoming cash windfall. We expect the focus will be on debt reduction and shareholder returns; however, M&A could be an option at the right price. In our view, Rayonier Advanced should be a seller in this market.”

His changes were:

• Canfor Corp. (CFP-T, “outperform”) to $26 from $22. Average: $20.
• CanWel Building Materials Group Ltd. (CWX-T, “outperform”) to $7.50 from $7. Average: $6.71.
• Interfor Corp. (IFP-T, “outperform”) to $24 from $22. Average: $20.92.
• Louisiana-Pacific Corp. (LPX-N, “outperform”) to US$42 from US$38. Average: US$35.38.
• Norbord Inc. (OSB-N/OSB-T, “outperform”) to US$57 from US$50. Average: US$38.
• PotlatchDeltic Corp. (PCH-Q, “outperform”) to US$50 from US$49. Average: US$48.17.
• West Fraser Timber Co Ltd. (WFT-T, “outperform”) to $85 from $77. Average: $74.33.
• Weyerhaeuser Co. (WY-N, “outperform”) to US$34 from US$33. Average: US$31.33.

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Raymond James analyst Daryl Swetlishoff thinks the current surge in the North American lumber market appears “much more sustainable” than previous rallies, pointing to Tuesday’s bullish U.S. housing start data.”

In a research note, he upgraded a pair of stocks on Wednesday in response to record free cash flow from producers.

“The summer of 2020 will surely go down as the most unlikely on record for North American lumber industry participants, as a COVID-19-induced market freeze gave way to the biggest lumber bull market of all time with benchmark WSPF 2x4 lumber prices hitting new record highs of US$760/mfbm last week (up 170 per cent from April 2020 lows),” he said. “The closest comparable market was the 2018 bull run where WSPF 2x4s peaked at US$655/mfbm in June 2018. What’s more, the current rally is broad-based (extending beyond 2x4s), with the North American framing lumber composite 24 per cent and OSB panels 33 per cent higher than 2018 peak levels. Also perplexing, the normally strong correlation (r=0.80) between building materials commodity pricing and share prices has broken down with lumber stocks discounting low US$400s WSPF lumber pricing and Norbord discounting sub-US$300 OSB panel pricing (40-50 per cent of current spot levels).

“We attribute this to a few factors: 1) materials sector investors are much more focused on Mining & Metals which have also performed well and have a much higher TSX weighting (12 per cent vs. 1 per cent for the Forest sector), 2) block trading liquidity has compressed vs. 2018 and most importantly, 3) the 2018 lumber rally was short-lived and investors suffered large losses in the subsequent market meltdown.”

Mr. Swetlishoff raised Interfor Corp. (IFP-T) and Norbord Inc. (OSB-T) to “strong buy” ratings from “outperform” previously.

His target for Interfor increased to $23.50 from $20.50. The average on the Street is $20.92.

For Norbord, his target jumped to $56 from $51, which exceeds the consensus of $48.67.

The analyst also made the following target price changes:

• Canfor Corp. (CFP-T, “outperform”) to $23.50 from $19.50. Average: $20.
• Conifex Timber Inc. (CFF-T, “outperform”) to $1.75 from $1.25. Average: $1.30.
• Western Forest Products Inc. (WEF-T, “outperform”) to $1.40 from $1.25. Average: $1.19.
• West Fraser Timber Co. Ltd. (WFT-T, “outperform”) to $82 from $74. Average: $74.33.

“That said we have elected to maintain our (conservative) 2021 commodity forecasts on which our valuations are based and are leaving our forecast 2021 EBITDA and target multiples unchanged,” said Mr. Swetlishoff. “We do,however, account for the effect of strong forecast 2H20 free cash flow (FCF) which leads to a 15-per-cent boost in targets across the board. Applying 2021 forecast FCF would result in a 25-per-cent lift to theoretical equity values. We acknowledge that all building materials stocks will benefit from the current environment; however, we elected to up ratings on Interfor and Norbord to Strong Buy given high commodity torque. We also highlight Canfor and Western Forest with attractive relative valuation and material lumber duty deposits and West Fraser for market cap and trading liquidity.”

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Canaccord Genuity analyst Scott Chan expects Canada's Big 6 banks to show improvement in earnings and capital positions during the coming third-quarter earnings season.

“We made numerous assumption changes that were net positive to our FQ3, fiscal 2020, and fiscal 2021 EPS estimates, which all put together included: (1) slightly lower NIM (e.g. full quarter of Fed and BOC rate cuts, higher liquidity, product mix); (2) CA loan growth deteriorated in May with residential mortgages (insured) one of the only product categories up year-over-year; (3) global equity market rebound benefiting AM/WM operations with likely positive net sales traction; (4) improvement in Capital markets, particularly highlighted by strong banking and trading trends; (5) better credit trends (except for BNS International) supported by positive changes in economic factors (e.g. equity markets, WTI oil, housing prices) compared to FQ2; and (6) stable to improving CET 1 ratios (e.g. lower RWA inflation, credit),” he said.

Emphasizing credit provisions are likely to prove to be the “largest wildcard toward earnings variability,” he increased his earnings per share projections by an average of 10 per cent from the second quarter. His lone downward revision was Bank of Nova Scotia (BNS-T), which he expects will see a 8-per-cent EPS drop as he expects its international operations to yield a larger provision for credit losses.

"Our positive EPS revisions on the rest mainly relate to better credit with Banks that prudently reserved more last quarter, and have larger domestic exposure, particularly pertaining to residential mortgages (e.g. CM, RY, NA)," said Mr. Chan. "Overall, we expect Group EPS to be down 35 per cent year-over-year, but up 44 per cent quarter-over-quarter. On a sequential basis, we forecast BNS core EPS to be down 5 per cent, while CM improving most at 106 per cent.

"For fiscal 2020, our Group (average) EPS forecast declines 28 per cent year-over-year and rebounding by 21 per cent in fiscal 2021. The Big-6 banks have average 7-per-cent EPS growth over the past 14 years (F2019: 3 per cent). With our revised annual EPS forecasts, the Group currently trades at a P/E (NTM) [price-to-earnings next 12 months] of 10.5 times (in line with historical average)."

Also touting the sector's "strong" capital position, Mr. Chan increased his target prices for the banks. His changes were:

• Bank of Montreal (BMO-T, “buy”) to $80.50 from $79. The average on the Street is $79.80.
• Bank of Nova Scotia (BNS-T, “hold”) to $60.50 from $60. Average: $62.08.
• Canadian Imperial Bank of Commerce (CM-T, “hold”) to $99 from $95. Average: $97.93.
• National Bank of Canada (NA-T, “hold”) to $63 from $61. Average: $65.73.
• Royal Bank of Canada (RY-T, “hold”) to $95.50 from $95. Average: $100.62.
• Toronto-Dominion Bank (TD-T, “hold”) to $60.50 from $60. Average: $64.46.

“We continue to believe the higher quality Big-6 bank stocks include RY and NA (from credit and capital perspective), while BMO and BNS (trading at P/B fwd. of 1 times) should offer more upside in a market recovery,” he said.

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Acknowledging investor sentiment toward Thomson Reuters Corp. (TRI-N, TRI-T) is at “a crossroads,” RBC Dominion Securities analyst Drew McReynolds said the news and information provider is “breaking away from the past with a familiar but refreshed playbook.”

In a research note titled “Sizing Up Thomson 3.0” released Wednesday, Mr. Reynolds sees the pullback in its shares thus far in 2020 as a buying opportunity for investors.

“Thomson Reuters is beginning the 2020s on its strongest fundamental footing in two decades: (i) transformational M&A and F&R [Financial & Risk] turnaround headwinds are now behind the company; (ii) normalized consolidated organic revenue growth is 4–5 per cent with accelerating growth and multiple expansion potential, all standing in sharp contrast to the transformation and turnaround experience through the 2000s and 2010s; (iii) the new management team is deploying a familiar but refreshed playbook; and (iv) longer-term COVID-19-driven growth opportunities await,” he said.

Mr. McReynolds touted the potential for a “multi-year period of double-digit total returns,” believing Thomson Reuters can sustain net asset value compound annual growth of 8-9 per cent, which he said is a “notable” increased from an estimated NAV CAGR of 5-6 per cent through the 2000s and 2010s.

“Over the next five years, we see potential for further multiple expansion as Thomson Reuters continues an evolution from information publisher to software provider,” he said. “We believe current valuation largely reflects the uptick in consolidated organic revenue growth, higher EBITDA-to-FCF conversion, and lower risk profile following the sale of F&R. However, we believe ongoing progress on the company’s evolution to software provider could translate to further multiple expansion driven by: (i) higher revenue growth and/or efficiency rating as the revenue contribution from software increases; (ii) greater appreciation for a content-driven software model; (iii) a de-coupling of valuation comparisons to traditional information publishing peers; and (iv) a strengthening relative standing of Thomson Reuters as a technology company/software provider within major Canadian indices.”

Seeing the “best set-up for the stock in years” and believing it should remain a core holding, Mr. Thomson raised his target price to US$84 from US$79, keeping an “outperform” rating. The average on the Street is US$75.96.

“Under our scenario analysis, our bull and bear cases generate 2025 estimated NAVs of US$140 (15-per-cent NAV per share CAGR) and US$71 (0-per-cent NAV per share CAGR), respectively,” he said. “In a highly uncertain macro environment heading into H2/20 and 2021, we believe this asymmetric payoff looks even more compelling on a risk-adjusted basis. We believe our bull case is achievable with: (i) remaining F&R proceeds and proceeds from a sale of Reuters News and the LSE stake being redeployed into M&A and share repurchases; and (ii) 3.0 times points of EV/EBITDA multiple expansion consistent with reaching 6.7-per-cent organic revenue growth, an efficiency rating approaching 40 per cent, and a revenue contribution from software approaching 60 per cent by 2025.”

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Following a “weak” second quarter, Laurentian Bank Securities analyst Yashwant Sankpal reduced his target for shares of Extendicare Inc. (EXE-T), expecting its price to “be choppy over the next 2-3 quarters until there is more visibility on EXE’s cash flow.”

“We believe that, operationally, EXE has managed to navigate the pandemic relatively better than its average peer, despite its large exposure to older Class B/C beds,” said Mr. Sankpal. “Of course, financially the quarter was painful because of incremental costs incurred during the pandemic and the unavoidable loss of business suffered in the Home Care and Retirement Home segments. We think that financial pain would continue, albeit lower, for a few more quarters given the prospects of a second wave of COVID-19, staff shortages, low demand for elective surgeries and RH suites. On the other hand, this crisis has exposed several weak points of the entire health care system and leveled the playing field in terms of public opinion. As a result, this could be a good opportunity for Extendicare to grab mindshare with its execution.”

With a “hold” rating (unchanged), his target slid to $6 from $8. The average on the Street is $6.92.

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Though the early fervor over Walmart Inc.‘s (WMT-N) second-quarter financial results quickly wore off amid concerns about a slowdown in July, Citi analyst Paul Lejuez sees reasons for optimism.

On Tuesday, the U.S. retail giant jumped in pre-market trading following the release of earnings report, which featured its biggest-ever jump in online sales. However, Walmart shares closed down 0.7 per cent on the day.

“The market’s initial enthusiasm for WMT’s 2Q performance (comps up 9 per cent) was tempered by concern over the deceleration in comps in July (up 4 per cent) as the benefit from stimulus checks diminished,” said Mr. Lejuez. “But we believe it is worth pointing out that sales of higher margin general merchandise were strong in the quarter and strength continued into July (albeit not as strong as the quarter as a whole). We have said previously that we believe one of the keys to WMT’s success in the future will be its ability to attract and retain grocery customers and convert them into (higher margin) general merchandise customers. 2Q is a positive development in this respect.”

In reaction to the second-quarter beat and a “slight” rise in his second-half margins projections, Mr. Lejuez increased his 2020 and 2021 earnings per share estimates to US$5.44 and US$5.93, respectively, from US$5.01 and US$5.51.

Maintaining a “buy” rating for Walmart shares, he also hiked his target to US$155 from US$140. The average on the Street is US$142.66.

“This is WMT’s time to shine,” he said. “When we think about what has been working (and what will continue to work) in general within the U.S. retail landscape, we would characterize it as online, off-mall, convenience and value. WMT checks all four boxes. But we believe even more so in the current COVID-19 crisis, WMT is in the right spot. It is a largely consumables based business (grocery is 55 per cent of sales) and they are value-priced. Because the company is there to serve customers through this period, we believe it will result in more customer loyalty and help WMT gain new customers that might not have shopped there before.”

Elsewhere, RBC Dominion Securities analyst Scot Ciccarelli nudged his target to US$137 from US$132 with a "sector perform" rating (unchanged).

Mr. Ciccarelli said: “In our view, this was clearly an impressive quarter, as government stimulus and more eating/entertainment at home drove strong demand for electronics, outdoor living products, food/consumables, etc. However, the pandemic is negatively affecting BTS sales and high single-digit grocery comps lagged those of Albertsons and Kroger (up 26.5 per cent and up 19 per cent respectively), resulting in some concern over ongoing market share gains in food retail. While we believe out of stocks and reduced hours are headwinds that have dissipated, we think the outsized gains experienced over the past few months are starting to subside. Given that companies in other sectors like home improvement and auto parts are maintaining their sales growth as stimulus fades, we would prefer to lean into those stocks more so than WMT at this stage.”

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Though Walt Disney Co. (DIS-N) continues to endure near-term operating headwinds stemming from the COVID-19 pandemic, Citi analyst Jason Bazinet thinks investors are “increasingly focused” on the prospects of its operations to “gradually return to normal.”

“Going forward, we continue to expect a measured recovery within Disney’s core businesses (Parks, Studio, and Media Nets). At the same time, we continue to forecast robust growth at Disney’s Direct-to-Consumer segment (including Hulu, Disney+, ESPN+, and the firm’s newly-announced Star DTC platform),” he said.

Following Disney’s third-quarter beat, Mr. Bazinet raised his 2020 earnings per share projection to US$1.58 from US$1.38. However, his 2021 and 2022 estimates slid to US$2.33 and US$4.44, respectively, from US$2.52 and US$4.69.

Maintaining a “buy” rating for its stock, he also increased his target to US$150 from US$135. The average on the Street is US$132.74.

“We expect the market to continue to embrace the firm’s strategic pivot, embodied by the growth of its direct-to-consumer platforms,” he said.

In a separate research note, Mr. Bazinet lowered his 2020 and 2021 EBITDA projections for SeaWorld Entertainment Inc. (SEAS-Q).

He maintained a “buy” rating and US$24 target, which exceeds the US$21.09 consensus.

“We continue to expect SeaWorld’s attendance recovery to be volatile, most likely tied to COVID-19 case trends in the near-term,” he said. “As such, we look to 2022 as a more normalized environment, but still model 2022 financials below 2019 levels. SeaWorld has bolstered its liquidity through debt offerings amid the pandemic, and management noted with 2Q20 earnings that it may look to ‘take advantage of strategic opportunities that may arise from market dislocations.’ While there is significant uncertainty about the trajectory of the recovery, we continue to see compelling risk-reward.”

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