Inside the Market’s roundup of some of today’s key analyst actions
Fairfax Financial Holdings Ltd.'s (FFH-T) current valuation is “unfair,” according to Raymond James analyst Brenna Phelan.
In a research report released Wednesday, Ms. Phelan initiated coverage of the Toronto-based financial holding company with an "outperform" rating.
"Fairfax Financial has an impressive life-time track record of growing BVPS [book value per share] at an 18.7-per-cent CAGR [compound annual growth rate] since 1985," she said. "However, performance against its own target of 15-per-cent annual BVPS growth has been sub-par over the last few years, pressuring its valuation on a P/B basis to nearly a full standard deviation below its 10-year average. Although we think that some of the assumptions required to generate a 15-per-cent ROE [return on equity] may be slightly aggressive near-term, we think that the outlook across insurance subsidiaries, coupled with the composition and optionality of the current investment portfolio, represent good visibility into a 10-per-cent-plus book value CAGR, on average. Based on our forecasts, we think the current valuation of 1.06 times BVPS is too low and believe that more consistent double-digit returns will push that multiple higher."
Ms. Phelan thinks a "mixed performance" over the past three years has "depressed a base-case assumption for the returns Fairfax’s operations and investments are capable of delivering from here, particularly when considered over a multi-year time horizon."
"Fairfax's insurance subsidiaries' large, diverse and increasingly profitable operations represent a meaningful competitive advantage in their ability to generate investable float at an attractive cost," she said. "Recent results show that pricing is firming into mid-single digits increases across most lines of business, and we think the targeted 95-per-cent combined ratio is very much achievable, absent a catastrophe year like 2017."
“Investment portfolio repositioning during 2018 saw $10-billion shifted from cash to bonds, increasing the investment income run-rate from 1.65 per cent in 2017 to an annualized 2.12 per cent in 1Q19. FFH’s targeted interest and dividend run-rate of $1-billion represents a contribution of 2.4 per cent to FFH’s 7-per-cent investment return goal. While gains on investments are more challenging to predict, the outlook for some larger investments is brightening, and we think that the comprehensive review of the portfolio that is currently underway should help to drive stronger performance.”
Ms. Phelan thinks that a return to double-digit BVPS growth will be a catalyst to return Fairfax Financial stock to a more warranted valuation. The stock currently trades at 1.06 times price-to-book value per share, while comparable P&C insurance companies, which are projected to deliver 10-11-per-cent ROE on average, are now trading at 1.85 times. She also noted reinsurers, which are also expected to deliver a 10-per-cent ROE, trade at 1.12 times.
She set a target price of $780 per share. The average target on the Street is currently $760.80, according to Bloomberg data.
"Our target is based on 1.15 times our 2Q20 BVPS forecast, which yields a C$ target of $780, to which there is 25-per-cent upside (including a 2.1-per-cent dividend yield) at current levels," said the analyst.
=====
There is "light at the end of the rail tunnel" for Canadian oil patch companies, according to Citi analyst Prashant Rao, who thinks the Alberta provincial government is "poised to administer the right tonic for curtailments and CBR."
"Over the course of the past several weeks, we have met with or otherwise spoken to Canadian investors and oil & gas industry management teams and participants, and via the Citi Transports team, gathered takeaways from management teams at both of the Class I Canadian rails," said Mr. Rao in a report released Wednesday. "Many of these parties have had direct contact with Premier Kenney and/or his administration. The consensus takeaways have consistently pointed to a willingness to extend mandated production cuts into 2020, as a primary tool to normalize excess inventories. Additionally, we think the path to privatizing the previous Notley administrations' CBR contracts with CP and CN likely is smoother than many expected at the beginning of the year. Key to this is an expressed willingness by the rails to make CBR work in a mutually beneficial manner. To this end, another of our big consensus takeaways is that the current Alberta government seems inclined to incentivize privatization of its contracted capacity by potentially offering curtailment relief for the parties willing to purchase rail capacity. We think this alignment of interests would make perfect sense.
"Putting all of this together, we present an updated picture of how we think the export S/D picture may play out. We see a gradual ramp in 1H20 to 5 per cent unhindered year-over-year production growth as mandated curtailments come off, versus the previous base case of a winding down in curtailments by end-2019. This allows for a reasonable rail capacity ramp from our expectations for at least 210 mbpd in 2Q19 to an exit rate of 400 mbpd at end-2020 and an acceleration in 2020 to a similar endpoint as our prior estimate: between 650-700 mbpd on exit in 2020."
Based on this view, Mr. Rao expects a normalization of inventory levels by the first quarter of 2020, while, at the same time, "keeping the incremental barrel moving by rail."
He also sees the Canadian crude differential volatility de-risking, noting: "Against an increasing backdrop of global demand concerns, the Canadian oil patch remains governed by slightly separate parameters, centered on transport bottlenecks versus healthy US refiner demand. Our checks over the past several weeks indicate a consensus expectation for mandated curtailments lasting longer, and to be utilized as a tool for incentivizing greater private sector rail capacity usage. This combination of factors points to a less volatile widening of WCS differentials back out to rail transport economics (US$18-$20/bbl to Maya)."
After tweaking his financial projections, which include second-quarter funds from operations projections that exceed the Street by 5 per cent, Mr. Rao trimmed his target for Cenovus Energy Inc. (CVE-T, “neutral”) to $13 from $15, which falls short of the $15.45 consensus.
"Based on our updated commodity price forecasts, 2019 guidance, and the company's 2Q19 operational update, we are lowering our 2Q19E EPS to 40 cents (from 46 cents) and 2019E EPS to 87 cents (from $1.48)," said the analyst. "Our $13 per share target price is based on our DCF, which uses a 5-year explicit forecast period, a 0.5-per-cent terminal growth, and a 8.7-per-cent discount rate."
He maintained his targets for the following companies:
Husky Energy Inc. (HSE-T, “neutral”) at $14. Consensus: $16.47.
"During HSE’s recent Investor Day, management expressed strong willingness and confidence in sustainably growing dividends as new assets (and accompanying FCFs) come online over the next few years," he said. "Despite a lack of specific payout ratios, HSE’s reduced capital profile, low debt repayment need, and concentrated ownership make growing dividend ratably the preferred way to return excess capital to shareholders. We expect HSE to increase its dividend at 20-per-cent CAGR in the next 5 years."
Suncor Energy Inc. (SU-T, “buy”) at $59. Consensus: $54.06.
Imperial Oil Ltd. (IMO-T, “neutral”) at $36. Consensus: $41.17.
=====
Osisko Mining Inc.'s (OSK-T) Windfall Lake property may prove to be much larger than previously though, said Haywood Securities analyst Mick Carew.
"Our asset review of the Windfall project reinforces Osiskos’s interpretation that suggests there is significant expansion and exploration potential well beyond the 3 million ounces currently defined as resources to date," he said. "Importantly, Osisko recognized this potential by re-evaluating work completed at Windfall by previous operators and identified key geological characteristics that suggested Windfall more closely resembled an intrusion related system as opposed to the more typical orogenic-type gold deposits that the Abitibi Belt is well known for. This insight can be partly attributed to managements experience at Canadian Malartic, an Archean porphyry gold system and currently the largest gold mine in Canada, which was discovered and developed by the Osisko team and sold for $3.9-billion in 2015. Importantly, Osisko's $100-million in working capital enables the Company to continue to define the potential scale of the Windfall project, which will be important when market conditions are more favorable for M&A activity so Osisko can demonstrate the project’s long-term value. Expansion potential at Windfall exists in all directions both within, adjacent to and well beyond the current resource envelopes."
Mr. Carew said he remains "steadfast" on his model assumptions and project NAV for Windfall, adding: "Osisko has weathered the adverse market conditions in the mining and exploration space in Canada. Not only does Osisko own what is fast developing into a Tier 1 gold project, the Company is also aided by a safe/mining-friendly jurisdiction, proven management team, attractive capital structure and $70-million in cash. We expect Osisko will garner significant attention when market conditions turn, and gold producers start looking downstream at development-stage projects to bolster their production pipelines."
Recommending investors accumulate shares of Osisko at current levels, he maintained a "buy" rating and $4.50 target. The average is $4.06.
"Our bullish view on Osisko is predicated on a proven management and technical team advancing a unique gold deposit in the Abitibi that has all the characteristics of a multi-million-ounce, Tier 1 gold producer," said Mr. Carew.
=====
Backed by a “strong” asset base, Altius Minerals Corp. (ALS-T) possesses a “compelling combo of sum-of-the-parts [net asset value] and growth,” said Laurentian Bank Securities analyst Jacques Wortman.
He initiated coverage of the St. John’s-based company with a "buy" rating in a research report released Wednesday.
"The market environment and investor returns in the mining industry have generally been challenging for the last 7–8 years," said Mr. Wortman. "In this environment, we favour a strategy of increasing exposure to royalty companies and believe that Altius offers a compelling opportunity based on a combination of the value of its asset portfolio and upside growth potential. We expect a 20-per-cent increase in royalty revenue in 2019 and 2020 relative to 2018 levels due to strong potash and iron ore prices and stable production from underlying operations on which royalties are held. Beyond the higher dividend distributions expected from Labrador Iron Ore Royalty Corp (LIF-T), ALS also has exposure to the current higher iron ore price via its position in Champion Iron (2.5 million shares) and its 40-per-cent interest in the development–stage Alderon Iron Ore. From a defensive point of view, the current share price is well supported by the NAVPS [net asset value per share], but additionally, as we have noted, there are several key catalysts that could unlock additional value in 2019–2020."
Touting its "favourable" valuation relative to its royalty company peers, Mr. Wortman set a target price of $17.50 per share. The average on the Street is currently $17.25.
"Altius trades at 0.98 times NAV and 10.7 times/11.1 times EV/EBITDA [enterprise value to earnings before interest, taxes, depreciation and amortization] for F19/F20 versus its precious metal focused royalty company peers that trade at average multiples of 1.89 times NAV and 20.6 times/17.6 times EV/EBITDA for F19/F20," he said. "While the discount ALS trades at relative to this peer group is not new, we expect it to narrow, based on: i) higher royalty revenue contribution in 2019/20 relative to 2018, ii) additional value that we believe can be unlocked as Altius Renewable Royalties (ARR) advances its strategy and MIN’s Gunnison copper mine reaches initial production in Q4/19, and iii) upside potential associated with ALS’ Project Generator model.
"The core assets have a cumulative valuation that well supports the share price. ALS’ total asset base is $15.87 per share and our sum-of-the-parts NAV is $12.20 per share."
=====
Citing its current valuation, Canaccord Genuity analyst Carey MacRury downgraded Royal Gold Inc. (RGLD-Q) to “hold” from “buy.”
“Since a recent low on May 3, RGLD’s shares are up 18 per cent, outperforming its royalty peers, which have gained 10 per cent on average and the 13-per-cent increase in the S&P/TSX Gold index (all in US$terms),” he said. “We attribute the outperformance to operating improvements at both Mt. Milligan and Rainy River reported with Q1/19 results.”
"Royal Gold has a high-quality royalty portfolio, in our view, and strong balance sheet but now trading at the high end of its valuation range: RGLD's shares are now trading at 1.73 times NAV, well above its historical average of 1.43 times and at the higher end of its historical trading range. By comparison, Franco-Nevada is trading at slight premium at 1.85 times NAV and Wheaton at a discount at 1.52 times. We believe the FNV and WPM should trade at a premium to RGLD given their superior production profiles."
Mr. MacRury maintained a US$98 target for shares of the Denver-based company. The average is US$95.81.
=====
Upon resuming coverage following the completion of its $75-million offering of common shares, Mackie Research analyst Greg McLeish downgraded MediPharm Labs Corp. (LABS-X), suggesting its business model could experience long-term “challenges.”
“MediPharm does not cultivate cannabis and its business model is dependent on acquiring cannabis from third party suppliers in amounts sufficient enough to operate its extraction business,” he said. “The problem with this model is that biomass is the largest input cost when producing cannabis oils, distillate and isolate. Since MediPharm does not cultivate its own cannabis and will have to buy it in the open market it will result in higher overall costs. This will result in higher end product costs and will put MediPharm at a distinct competitive disadvantage compared to companies that produce their own biomass.”
Moving the stock to “market perform” from “buy,” Mr. McLeish also lowered his target to $6 from $7.50. The average on the Street is $7.31.
“Demand for cannabis high margin extraction services has been strong and early movers, like MediPharm, have been the primary beneficiaries,” he said. “However, competition is increasing and both Licensed Producers and third-party extraction companies have been aggressively deploying capital to expand extraction capacity. Once this new capacity comes online it will result in increased competition and, in turn, price and margin compression.”
=====
In other analyst actions:
RBC Dominion Securities analyst Andrew Wong downgraded Cobalt 27 Capital Corp. (KBLT-X) to “sector perform” from “outperform” and dropped his target to $4.50 from $8. The average on the Street is $7.27.
Roth Capital Partners analyst Joseph Reagor initiated coverage of Integra Resources Corp. (ITR-X) with a “buy” rating and $1.45 target. The average is $1.62.
Cormark Securities initiated coverage of Pinnacle Renewable Energy Inc. (PL-T) with a “buy” rating and $14 target. The average is $14.60.
David Leeder