Inside the Market’s roundup of some of today’s key analyst actions
Citing wireless pricing risk stemming from its new rate plan structure, Citi analyst Adam Ilkowitz lowered his rating for Telus Corp. (T-T) to “neutral” from “buy” on Wednesday.
"When Rogers launched the Infinity plans, we were taking ‘a more cautious view on the sector until we see whether Rogers sticks with the current pricing over the medium term,’” he said. “With Telus conforming to the new rate plan structure on a permanent basis, and Bell likely to follow suit as a result, we see reason to move to the sidelines on the category. The ability for consumers to optimize their wireless bill by either (1) lowering the total price for similar data amounts or (2) getting more data for the same price has dilutive near-term revenue and cash flow implications for the category. Pushing unit pricing ($/GB) lower has long-term implications to potential revenue growth.”
“Reiterating our previous view, the new rate plans are dilutive to per-subscriber economics since the reduction in service revenue ($600-840 over two years for a single line customer) is greater than the existing $500 device subsidy. Two things could potentially make the calculation worse: 1) the device subsidy is being reduced, not eliminated; and 2) multi-line discounts increase the reduction in service revenue. History has shown us that the transition to these new rate plans and equipment financing models is a multi-year process, with the pain of revenue dilution felt more immediately than the potential for upselling and customer care cost reduction, in our view.”
With the downgrade, Mr. Ilkowitz said he now longer as any stocks with a “buy” rating in the Canadian communications sector.
He maintained a target of $52 for Telus shares. The average target on the Street is $52.71, according to Bloomberg data.
“We see valuation as balanced,” he said. “Changes in wireless industry pricing may lead to re-pricing risk and the overhang from recent rate plan changes may lead to multiple compression, offsetting the underlying attractive dividend and potential for free cash flow growth.”
Secure Energy Services Inc. (SES-T) is well-positioned for a period of range-bound commodity prices, according to RBC Dominion Securities analyst Keith Mackey, pointing to its “high weighting” toward recurring revenue, an increased mix of longer-term revenue contracts and strong EBITDA margins.
On Wednesday, Mr. Mackey initiated coverage of a series of Canadian energy services companies in conjunction with a sector outlook, in which he projected flat commodity prices into 2020 that will lead to reduced industry-wide capital spending.
For Calgary-based Secure, Mr. Mackey gave an “outperform” rating.
“On balance, we believe Secure is a hybrid midstream company as many of its assets generate recurring revenue, have strategic location advantages, and facilitate the transportation of hydrocarbons,” he said. “In the market, we see investors placing a premium valuation (e.g., 12-13 times EBITDA) on midstream companies that satisfy three criteria: 1) contain take-or-pay contracts with minimum volume requirements on long-term contracts (10+ years); 2) capex funded within cash flow; 3) ability to build assets within 7 times EBITDA. We believe the majority of Secure’s assets fit criteria #2 and #3, but few contain long-term contracts (e.g., its Kerrobert Light Pipeline System). Therefore; we expect Secure to trade at a discount to companies with a high portion of take or pay contracts, but a premium to companies that earn most of their revenue from one-time E&P capex. We expect Secure to increasingly focus on building assets that support long-term contracts to increase EBITDA stability.”
Mr. Mackey emphasized that a large portion of Secure’s revenue exposure stems from existing fluid production, rather than requiring the need for new capex spending, which has dropped by almost 40 per cent from 2014 levels.
“We project Secure to generate $90-million in discretionary free cash flow in 2019 after its maintenance capex requirement of $20-million,” he said. "We believe this provides Secure with capability to expand its asset base organically or through M&A, similar to its 2018 investment in the KindersleyKerrobert oil pipeline and 2019 investment in Cushing, OK storage infrastructure.
“We project the WCSB rig count and wells drilled to decline between 16-21 per cent in 2019. Secure’s position as the second largest drilling fluids provider in the WCSB provides exposure to increase in WCSB activity. We estimate a 10-per-cent increase in activity could drive a 3-per-cent increase in Secure’s EBITDA.”
Believing the “strength” of its balance sheet allows it to continue to expand its midstream asset base, Mr. Mackey set a target price for Secure shares of $10. The average on the Street is $10.94, according to Bloomberg data.
“Secure is currently trading at a consensus EV/EBITDA (FY20) of 6.9 times versus Canadian OFS [oilfield services] at 4.9 times,” he said. “Secure has traded at approximately a 2.0-times multiple premium to the broader Canadian OFS group, in line with our relative positioning. We believe this premium reflects the improving visibility of its revenue and EBITDA base relative to the broader group.”
Mr. Mackey initiated coverage of Enerflex Ltd. (EFX-T) with an “outperform” rating, believing it provides low-beta exposure to Canadian oilfield services and expecting it to outperform despite stagnant commodity prices.
“Enerflex has higher exposure to recurring revenue through its compression rental and services fleet than our Canadian peer group average, at 26 per cent of 2019 estimated revenue (peers: 16 per cent),” said the analyst. "We believe the stock is well-positioned to deliver continued ROCE [return on capital employed] and free cash flow in a range-bound commodity price environment.
“Enerflex’s expansion into several key international markets has enabled the company to offset a decline in Canadian revenues from 2014 peak levels. We expect Enerflex to generate 79 per cent of its revenue outside of Canada in 2019 (peers: 60 per cent). As a result, the stock has outperformed the Canadian OFS index since 2014. We expect continued focus on U.S. and international markets to continue to drive share price performance.”
Mr. Mackey set the company’s “strong” balance sheet allows for the possibility of continued growth of its gas compression rentals fleet organically or through acquisitions. He projects an acquisition of $500-million would lead it to accelerate recurring revenue growth while maintaining a net debt-to-EBITDA leverage below 2.5 times.
He set a target price of $25 for its shares, which exceeds the consensus of $23.78.
Suggesting it is “becoming a Permian contender,” Mr. Mackey also gave Ensign Energy Services Inc. (ESI-T) an “outperform” rating.
“We believe we are in the early stages of seeing what the combined Ensign-Trinidad platform can do," he said. “The company has leveraged its upgraded fleet to become one of the most active Permian operators, with a 10-per-cent market share. By our count, Ensign owns 20 per cent of the deepest-capacity rigs in Canada, which we expect to have higher utilization vs. the broader market."
“In addition to improving year-over-year EBITDA margins as the company chips away at its $40 million annual synergy target, we expect drilling tech adoption to drive the next leg of margin growth. Ensign has developed advanced drilling technologies to add client value through decreased non-productive time and enhanced drilling accuracy. Drilling apps provide a 4-5% uplift in day rates with minimal variable costs.”
Pointing to the “benefit of international diversification,” which he said mitigates country-specific risks, Mr. Mackey set a target of $8. The average is $7.09.
“We believe Ensign ranks ahead of peers in international presence, exposure to growth trends, including its enhanced presence in the Permian, and stronger relative EBITDA margins,” he said.
Mr. Mackey gave “sector perform” ratings to the following companies:
CES Energy Solutions Corp. (CEU-T) with a $3 target. The average is $4.57.
“We see CES’s recurring revenue exposure from its production chemicals division and international presence as clear investment positives,” he said. “We believe the key to re-rating lies in improved growth and margin realization outlook from its position in the North American drilling fluids market and currently see higher potential return prospects in other names.”
Shawcor Ltd. (SCL-T) with a $21 target. Average: $26.31.
“We view Shawcor as a high-quality business with distinct competitive advantages in specialized pipe coating, peer-leading international presence, and diversified exposure to growth trends,” he said. “In our minds, backlog growth and margin improvement from increased offshore activity is key before potentially becoming more bullish on the stock.”
STEP Energy Services Ltd. (STEP-T) with a $2.75 target. Average: $3.77.
“While we believe STEP’s entry into the U.S. frac services market has increased its international presence, we see more attractive risk/return profiles in other stocks in a range-bound commodity environment,” he said.
Tervita Corp. (TEV-T) with a $9 target. Average: $9.03.
“We see Tervita’s exposure to recurring revenue, strong EBITDA and free cash flow margins as clear positives that enable the company to continue to grow its waste management footprint, particularly under range-bound commodity prices,” he said. “In the near-term, we see greater return potential in other names in light of a perceived stock liquidity discount and higher financial leverage.”
CIBC World Markets analyst Jon Morrison called Mullen Group Ltd.'s (MTL-T) acquisition of two small less-than-truckload (LTL) Trucking and Logistics companies in B.C. “nothing thesis-changing in nature.”
However, he raised his rating for its stock to “outperformer” from “neutral.”
“The driver of this is three-fold: 1) the stock has been under strong pressure and has now traded 40 per cent lower over the past year and sits at a two-decade low; 2) the majority of broader Canadian Trucking/Logistics and Oilfield Services industry headwinds have been well telegraphed in the market; and 3) this is a macro backdrop where we believe Mullen will see increased consolidation opportunities, where the company tends to create the majority of value throughout industry cycles,” said Mr. Morrison.
“And while we do not want investors to gloss over the realities of slowing economic growth and the potential for further softening in broader Trucking/Logistics fundamentals, we believe these risks are increasingly discounted in the current share price and view the stock as being attractive with a 6-per-cent dividend yield and trading at compressed multiples. Mullen also has solid access to capital with the company having just completed a $125-million convertible debenture financing.”
He maintained a $15 target. The average is $13.31.
Dollarama Inc.'s (DOL-T) acquisition of a 50.1-per-cent stake in Latin American value retailer Dollarcity for US$85-million to US$95-million is a “positive,” according to Industrial Alliance Securities analyst Neil Linsdell.
Though he expected Montreal-based Dollarama to exercise its option to take a majority position in the rapidly growing company, he felt a move was likely closer to the February, 2020, deadline set in the original working agreement between the two, signed in 2013.
Mr. Linsdell called Dollarcity “a virtual carbon copy, Latin American version of Dollarama.”
“First, the merchandise mix is very similar and consists of: (i) general merchandise (47 per cent vs. 43 per cent at Dollarama), (ii) consumable products (35 per cent vs. 41 per cent at Dollarama), and (iii) seasonal products (18 per cent vs. 16 per cent at Dollarama),” he said. “Also, Dollarcity implements a similar multi-price point strategy. More specifically, merchandise is sold in individual or multiple units at fixed price points ranging from US$0.69 to US$3.00 in El Salvador and the equivalent amounts in local currency in Guatemala and Colombia (vs. $0.82 to $4.00 at Dollarama). Dollarcity currently leases a total of four warehouses (one in each country in which it operates stores and one international warehouse in El Salvador). Finally, 61 per cent of its merchandise is imported (vs. 55 per cent at Dollarama) while 39 per cent is purchased domestically (vs. 45 per cent at Dollarama).”
With its expanded footprint in the “attractive” Latin American market, Mr. Linsdell raised his earnings per share projections for fiscal 2020 and 2021 to $1.85 and $2.16, respectively, from $1.82 and $2.07.
Keeping a “hold” rating for Dollarama shares, he hiked his target to $45 from $43. The average is $49.79.
“We consider Dollarama to be a solid operator, with industry leading margins and further growth opportunities in Canada and now Latin America, which justify a premium valuation,” he said. “However, at the current price level, we maintain a Hold rating.”
“In recent years, CTST’s sales growth has been strong and lumpy .... which is a function of both (i) how quickly the cannabis market is evolving and (ii) how CTST has grown and expanded its business, by establishing relationships with new patients (for its medical products) and more recently, with consumers (for its recreational products),” she said. "Given the rapid rate of change both in the cannabis industry and in CTST’s own business, the ability to forecast CTST’s sales growth is low, relative to our other covered companies. For example, we note that there are nine estimates on the Street for 2Q19 sales (the current period), which range from $21.0-million to $31.9-million (we note that we are at $25.0-million). We expect this degree of uncertainty regarding CTST’s sales growth (which then impacts the company’s profitability) will lead to continued volatility in the stock.
“Of note, at this point, CTST’s operations are substantially limited to Canada, as the company has no operations in the U.S. (though it recently signed a letter of intent to establish a joint venture with a California-based hemp company). And, while CTST has two joint ventures in place that could lead to growth in other international markets over time (Cannatrek in Australia and Stenocare in Denmark), we expect the contribution to CTST’s revenues from these operations to be de minimus for the foreseeable future. This is one reason why we are forecasting revenue growth for CTST to slow from 173 per cent in 2019, to 83 per cent in 2020, to 50 per cent in 2021, to 35 per cent in 2022. To the extent that CTST expands its business beyond Canada over this period, we believe there could be upside to our forecasts for CTST’s revenue growth.”
Ms. Nicholson initiated coverage of the Vaughan, Ont.-based company with a “buy/high risk” rating, calling it “well-positioned to compete in the rapidly-evolving global cannabis market.”
“While Citi’s quant model does not classify CTST as a high risk stock today, our take is that there are significant moving pieces to this story, some of which are outside of management’s control,” she said. “For example, while we had hoped that CTST would be able to start to sell certain new cannabis-based products in 4Q19 (including vape pens and BrewBudz), given that Health Canada recently issued some updated guidelines regarding the sale of these types of products, we now expect CTST to being selling these products in 1Q20 (and hence our below-consensus forecasts for 2019).”
She set a target of US$7 for the stock, which falls short of the consensus target on the Street of US$8.98.
Desjardins Securities analyst Keith Howlett raised his financial expectations for Cascades Inc. (CAS-T) in the wake of its acquisition of the assets of Orchids Paper Products Co. for US$207-million.
The Kingsey Falls, Que.-based company announced the definitive agreement on Monday after a United States Bankruptcy Court for the District of Delaware approved the deal.
“Cascades appears to us to be the ‘natural’ buyer of the assets of Orchids Paper, in terms of geographic and business mix fit. Cascades’ manufacturing footprint in the U.S. tissue business will be greatly improved, with eight plants (from six),”said Mr. Howlett. “Coverage of customers in the US southeast, southwest and lower mid-west will be much more efficient. The acquired QRT machine will be tweaked to facilitate production of multiple grades of tissue, from conventional to ultra-premium. The transaction is expected to close in August or September 2019. It will be financed from existing lines of credit, with net debt to EBITDA increasing modestly to 3.5 times from 3.4 times (assuming operations are at planned levels). Management is confident in its ability to get the new QRT machine (cost of US$165-million) in South Carolina operating efficiently.”
Mr. Howlett bumped his EBITDA estimates for 2019 and 2020 to $597-million and $656-million, respectively, from $590-million and $618-million.
He kept a “buy” rating and $13 target. The average on the Street is $11.93.
"Cascades is making good on its commitment to modernize and optimize the assets of its tissue business, which generates 70 per cent of its revenue in the U.S. market. “The cost of the commitment is substantial in terms of recent and prospective capital spending, as well as the pending US$216-million acquisition of the assets of Orchids. The acquisition will increase Cascades’ tissue revenue by 20 per cent and its tissue EBITDA by multiples of that. Cascades has a long history of buying troubled plants and turning them around. There is clearly risk, but the necessary actions are directly within the company’s ‘wheelhouse’.”
Elsewhere, National Bank Financial analyst Zachary Evershed upgraded Cascades to “outperform” from “sector perform” with a $13 target, rising from $10.
With its shares “approaching fair value,” Beacon Securities analyst Michael Curran downgraded Osisko Mining Inc. (OSK-T) to “hold” from “buy.”
“We consider Osisko Mining to have above average potential to successfully transition from explorer to more than 200,000 ounce per year producer over the next few years at Windfall Lake,” he said. "However, with limited upside to our revised target, we currently see better investment opportunities in the advanced developer space."
Mr. Curran lowered his target to $3.65 from $4, which is below the $4.07 consensus.
BMO Nesbitt Burns analyst Andrew Kaip upgraded Barrick Gold Corp. (GOLD-N, ABX-T) to “outperform” from “market perform” with a US$20 target, rising from US$14.50. The average on the Street is US$15.30.
“In our view, the formation of the Nevada Joint Venture (JV) is a positive for Barrick as the synergies derived from consolidating the Nevada operations with Newmont Goldcorp do, in our view, unlock value,” he said.
“While integration risks in realizing the full potential of the JV do exist, we are confident the near-term benefits outweigh the risks.”
In other analyst actions:
BMO’s Tamy Chen initiated coverage of Green Organic Dutchman Holdings Ltd. (TGOD-T) with a “market perform” rating and $3.50 target. The average is $6.21.
Cormark Securities initiated coverage of Cargojet Inc. (CJT-T) with a “buy” rating and $105 target. The average is $98.13.