Inside the Market’s roundup of some of today’s key analyst actions
In a research report of Canadian life insurance companies released Wednesday, Mr. Malhotra downgraded his rating for its stock to “sector perform” from “sector outperform.”
“The step-up in buyback activity exhibited by the Canadian life insurers over the past few months in our view speaks to the disconnect between the solid fundamental performance of the companies (from both an earnings and capital perspective) and the sluggish return profile of the stocks (TSX Life & Health Insurance Index has declined 18 per cent over the past year),” he said. "While we agree with the merits of deploying capital towards share repurchases given the sharp retrenchment in valuations (8.7 times our 2019 estimate, 1.17 times our Q4/18 estimated book value per share), in our view the bigger question to be answered is the magnitude of multiple expansion that investors can realistically expect from the stocks in what we expect will be a more constrained backdrop for EPS growth.
“To wit, after the reductions we have enacted ... our 2019 estimates for the sector implies a skinny 1-per-cent operating EPS increase in the coming year, and our estimate for earnings power has declined 2 per cent from where it stood a year ago. Though we expect capital deployment will help to backfill some of the deceleration in organic growth, we are less confident in the outlook for a few components that acted as a benefit to lifeco EPS in 2018 (asset management, bond yields, policyholder experience gains).”
In response to this view, Mr. Malhotra reduced his target sector multiple for stocks in the sector, and lowered his rating for Sun Life, which currently possesses the highest price-to-earnings multiple.
“Over the past year the P/E premium accorded to shares of SLF has expanded from 5% to the current 14%, as the combination of a lower risk profile and stronger balance sheet position has underpinned the outperformance of the stock,” he said. “That said, we think the relative premium has peaked, and when coupled with the fact that our 2019 estimate is now 3 per cent below consensus (which includes a year-over-year decline for MFS as sizable net outflows continue) we are moving to the sidelines and taking our rating down to a Sector Perform.”
Mr. Malhotra lowered his target for Sun Life shares to $53 from $58. The average on the Street is $54.24, according to Bloomberg data.
He also lowered his target for Manulife Financial Corp. (MFC-T) to $26 from $28. The average is $27.81.
“After the move down to a Sector Perform on SLF shares our only Sector Outperform-rated stock in the life insurance space is MFC, which we note currently trades at just 0.98 times our 2018 estimated BVPS, an attractive valuation given that we expect an operating ROE [return on equity] in the 13-per-cent range in 2019,” the analyst said. “Candidly, given that the issues constraining the valuation accorded to MFC shares are well-understood (concern over reserve strengthening required for LTC, timing of litigation resolution in the Mosten case), in our view the best course of action for the company is to continue to deliver the strong operating trends that have been exhibited in the past two years while demonstrating the ability to free up capital while managing down their legacy exposure.”
He also reduced Great-West Lifeco (GWO-T) to $33 from $36 (average: $32.90), while maintaining a $57 target (versus a $60.25 average) for Industrial Alliance Insurance and Financial Services Inc. (IAG-T)
Both have “sector perform” ratings.
“We are of the view that each of GWO and IAG can have a positive near-term impact on their share prices via their activity levels on the NCIB,” he said. “While this is clearly a shorter-term factor, given the depressed valuations accorded to the sector on the whole, the greater percentage of their respective share float that these companies are targeting in their buyback programs (7 per cent for GWO and 5 per cent for IAG) can have a meaningful effect. This tactical opportunity would obviously be enhanced if the potential fundamental risk factors that we are sensitive to for each name (Brexit / real estate related credit weakness for GWO in the UK, material step-back in Canadian Wealth Management flows or profitability for IAG) end up being overstated.”
“We liked Domtar even without Georgia-Pacific's exit from the UFS space, but that development certainly has added a strong tailwind to the stock,” he said. “While we continue to see upside in Domtar's shares, we believe the narrative is a bit less attractive. Bottom line: If you are in it, stay. If not, Domtar is worth a close look but investors can be selective with their entry.”
In the wake of Tuesday’s release of in-line fourth-quarter financial results, Mr. Quinn moved the stock to “sector perform” from “outperform,” feeling its current valuation is less “compelling” following its “significant” run-up in price since Georgia-Pacific’s Jan. 10 announcement that it is exiting the communication papers business.
Mr. Quinn thinks the industry-wide price hikes that followed that news “have dispelled investor concerns.”
“With Georgia-Pacific's sudden exit from UFS market taking off 8 per cent of industry capacity and annual demand erosion of 4 per cent, producers effectively have their strong cash flow runway extended by two years,” he said. “As previously announced, Domtar set the stage for an industry wide price hike with a $60/ton increase, effective March 1st. The price hike is estimated to impact 2/3 of its 3 million annual tonnage. The current dynamic is similar to the situation in 2014 after IP announced a nearly 10-per-cent capacity curtailment, when producers immediately raised prices; however, the hike led to an increase in imports. Domtar management sounded pretty adamant that the situation is not the same given duties on key import regions and they do not see a "dramatic increase in imports.”
“Despite recent weakness centered on the key Chinese market, Domtar expects ‘balanced’ conditions in softwood and fluff markets through 2019, particularly as their capacity is limited. With a core base of tissue and absorbent product customers, management sees ‘nothing inherently wrong with the demand of end-use products into which pulp is going.’ While our pulp price forecasts continue to reflect some near-term weakness, we've raised our forecasts on higher paper realizations and improvement in personal care.”
Mr. Quinn raised his earnings per share projections for 2019 and 2020 to US$5.91 and US$6.36, respectively, from US$5.49 and US$5.33.
His target price for Domtar shares rose to US$55 from US$50. The average on the Street is now US$52.27.
“Over the longer term, we like Domtar’s efforts over the past decade to re-position the business away from commodity paper but still retain its dominant market position,” the analyst said. “Domtar has been able to leverage cash flows from a declining business to relatively more attractive markets such as specialty papers, market pulp, and to a lesser degree, personal care. Given a solid balance sheet, we also see Domtar potentially leveraging existing assets (i.e., paper-machine conversion) to also make an entrance into the NA containerboard market or further expand into fluff pulp (which is a growing global market)."
Elsewhere, Raymond James' Daryl Swetlishoff hiked his target to US$52 from US$49.
Mr. Swetlishoff said: “We rate Domtar Market Perform given uncertainty surrounding a shifting business model and headwinds in the personal care segment. We do find recent paper price strength encouraging as rationalization of industry capacity continues, which supports the company’s ability to generate free cash flow, supporting a reasonable dividend. With recent paper price increases, we expect stable results in the near-term, but remain Market Perform given limited upside to our target.”
WestJet Airlines Ltd. (WJA-T) is “regaining lost altitude,” said Raymond James analyst Ben Cherniavsky in reaction to better-than-expected fourth-quarter results.
On Tuesday, the airline reported earnings per share for the quarter of 26 cents, exceeding the projections of both Mr. Cherniavsky (14 cents) and the Street (13 cents).
“Despite the significant size of this beat, we consider the company's numbers to be largely in line with our expectations,” he said. “Revenues exceeded our forecast by a mere $8.3-million (0.7 per cent) while total expenses fell just $7.9-million (also 0.7 per cent) short of our forecast, demonstrating the mighty earnings leverage of the airline business. Although 4Q18 marks a notable improvement in WestJet's performance over prior quarters last year, it still fell considerably shy of 4Q17 EPS of $0.41 and, in fact, represented an eight year low for the period. ROIC of 5.0 per cent also reached an historic low for the company, despite the seemingly favourable results just posted.”
Mr. Cherniavsky called the fourth quarter a “notable inflection point” for WestJet, but he cautioned that it still has “lots of lost ground (or altitude) to recover and much heavy lifting yet to do."
Maintaining a “market perform” rating for its stock, he raised his target to $20.25 from $18.50. The average on the Street is currently $20.78.
“In some respects we see this as an opportunity: sentiment on the stock is very lopsided; the depressed price-to-book value multiple looks compelling; and the comps that WestJet will be lapping this year have setthe bar low to impress,” he said. “Nevertheless, risks prevail as more capacity comes to market, capex continues to accelerate (see Exhibit 4), and the economic cycle looks increasingly long in the tooth. That is not to say we will never support this stock again; however, in light of recent disappointments, we need to see more than one quarter of progress to be convinced that this is not another ‘head fake’ similar to what we have seen from WestJet in the past.”
Harvest Health & Recreation Inc. (HARV-CN) possesses “a solid foundation built from the ground up,” according to Canaccord Genuity analyst Matt Bottomley.
“We believe Harvest is one of a handful of highly capitalized, vertically integrated Multi-State Operators (MSOs) that are strategically positioned (in terms of size, scale and assets) to compete for meaningful market share on a national level in the U.S.,” he said. “After founding its operations in 2011, the company has grown its exposure to 12 states, which includes the number one market position in Arizona and (in our view) soon to be the leading retail presence in Pennsylvania.”
Touting its success in growth its asset base through operational execution and a “a highly successful record in winning licence applications/tenders,” Mr. Bottomley initiated coverage of the Vancouver-based cannabis company with a “speculative buy” rating.
“Management places a strict focus on the return of its invested capital in its business initiatives and has focused a great deal of its attention over the past seven years on winning licenses from the ground up in building its diversified U.S. portfolio,” he said. “This was most recently demonstrated in December when the company announced that it was awarded every retail licence it applied for in Pennsylvania in all six of the state’s designated zones. As 2019 progresses, we believe the company is soon set to be the leader in PA with the ability to open more than 3 times as many locations as its closest peer in the state.
“As a result, we believe Harvest is likely the most efficient MSO in the industry to date with respect to its capital allocation and investments in relation to the size and exposure it has already secured in the US. After 2018 saw a flurry of go-to-market financings, state licence wins and M&A activity, we believe success in 2019 (and beyond) will be rooted in execution. In our view, Harvest has likely demonstrated the highest degree of operational execution among its peer group of MSOs in the industry today.”
Mr. Bottomley set a target price of $15 for Harvest Health shares, which exceeds the consensus by 83 cents.
“As Harvest and many other MSOs already have access to a greater population base than Canada and are able to operate in more favourable vertically integrated models, we believe this valuation gap will eventually close and MSOs could begin to re-rate against the relatively more expensive Canadian names over the near- to medium-term,” he said. “However, due to the risks and uncertainties surrounding execution, regulatory changes, licensing and other market factors, we believe a SPECULATIVE BUY rating is appropriate at this time.”
Desjardins Securities analyst Bill Cabel expects investor focus to remain on quarterly generation as Canadian power and utility companies begin reporting their results.
“Volatility in our coverage universe was elevated in 2018 around quarterly earnings; however, we continue to believe that investors should be focused on the long-term performance of our coverage companies due to their long-term contractual cash flows,” he said in a research report released Wednesday. “Forecasts of electricity production for our IPPs are generally driven by estimates of weather resources, which are based on long-term historical averages (generally 30 years or more of data). Wind resources are prone to periods when they are above or below LTAs [long-term average], but ultimately should revert to the mean. As a result of generally poor weather resources in 2Q18 and 3Q18, generation was light, which drove a number of EBITDA misses vs consensus and caused relatively significant volatility in some of our stocks.
“While we maintain our view that these knee-jerk sell-offs create buying opportunities, the impact on positions due to below-LTA generation has been significant over the past two quarters. As a result, we believe there is a greater emphasis on quarterly generation and we continue to focus on wind speed data for several regions in an attempt to directionally predict generation for our names under coverage.”
Mr. Cabel expects “decent” generation results for the companies in his coverage universe, admitting he does not see “major” announcements stemming from the quarterly releases.
“The stocks in our coverage universe have had a very good start to the year, with our IPP coverage up 11.8 per cent year-to-date on average vs 9.2 per cent for the broader S&P/TSX Composite Index,” he said. “The various headwinds that our coverage companies faced in 2018 (specifically, fears of rising interest rates and company-specific concerns about LTAs) have moderated thus far in 2019. Future rate hikes now appear less certain and wind resources seem to be tracking much closer to LTAs.”
After rolling forward his valuation for its utilities business, Mr. Cabel raised his target price for Algonquin Power and Utilities Corp. (AQN-N, AQN-T) to US$12.50 from US$12, keeping a “buy” rating. The average is $15.39.
“AQN has a proven track record of growth and strong total return performance,” he said. “We have high conviction that AQN will deliver on growth through continued power development project commissionings, investments in the utilities segment and likely additional acquisitions on either the power or utilities side of the business.”
He also raised his target for Valener Inc. (VNR-T) to $22.50 from $22 with a “hold” rating. The average is $21.75.
“We believe investors are drawn to the name as VNR offers good defensive cash flows with long-term visibility and attractive dividend growth,” the analyst said. “However, we believe there are other opportunities in our coverage universe with similar defensive attributes and more robust growth prospects.”
Citing a cautious outlook for the subtle changes in chemical industry fundamentals, Cowen analyst Charles Neivert downgraded Methanex Corp. (MEOH-Q, MX-T) to “market perform” from “outperform” after the firm revised its outlook for chemical prices.
His target fell to US$62 from US$74. The average target is currently US$63.
The firm pointed to multiple risks that may constrain earnings and lead to weaker share price performance, including an expanding supply/demand imbalance, strained feed-stock supply and logistics, low oil prices and slowing GDP growth.
In other analyst actions:
GMP analyst Himanshu Gupta initiated coverage of Dream Hard Asset Alternatives Trust (DRA-UN-T) with a “buy” rating and $8.75 target. The average is $8.50.
With a file from Reuters