Inside the Market’s roundup of some of today’s key analyst actions
RBC Dominion Securities analyst Walter Spracklin called the fourth quarter of fiscal 2022 for Canadian Pacific Railway Ltd. (CP-N, CP-T) “weak,” but, seeing a “very strong” volume outlook moving forward, he reiterated it as “a best idea.”
After the bell on Tuesday, the railway company reported adjusted earnings per share of $1.14, exceeding Mr. Spracklin’s expectation by 3 cents and the consensus on the Street by 6 cents. However, that beat came as a result of a 14-cent gain from a lower tax rate.
“Revenue of $2.462-billion was in-line with the consensus $2.450-billion (RBC $2.478-billion); however O/R [operating ratio] was notably weaker at 59.1 per cent (vs. our 57.2 per cent) as tough winter conditions, longer than expected mine outage and slower Potash negotiations between Canpotex and China all weighed on margins,” he noted.
While CP’s management did not provide formal guidance, Mr. Spracklin thinks its general outlook points to volume growth that will be “exceptionally strong (both on an absolute basis and relative to peers) and the structural nature of the growth insulates CP against macro factors like no other railroad.”
“On the back of these growth drivers, we expect CP volume (ex KSU) to be materially ahead of peers and meaningfully less impacted by broader recessionary factors,” he said.
“With structural growth in place, O/R improvement likely and clear line of sight to synergy benefits, we see no reason to adjust our earnings outlook. While we adjust our model to run CP stand alone for an additional quarter in Q1/23, there is no change to our estimates out to 2025.”
Making modest reductions to his 2023 revenue and earnings estimates, Mr. Spracklin maintained an “outperform” rating and $122 target for CP shares. The average on the Street is $115.55, according to Refinitiv data.
“While much of our Q4 assessment and ‘23 outlook is on “CP stand alone”, we expect this to quickly fall away to a focus on integration upside once the deal is approved (expected Q1),” he said. “With synergy upside currently pegged at US$1-billion, we see avenue for that being revised significantly higher, which remains a key driver to valuation in our view.”
Analysts making target adjustments include:
* Stifel’s Benjamin Nolan to US$78 from US$76 with a “hold” rating.
“CP reported earnings that beat our and consensus estimates as the company continues to execute,” said Mr. Nolan. “While the operating margin was worse than we were expecting, there was better performance out of the equity income line for KCS. We believe the company has the best growth prospects and strong synergistic benefits through KCS. However, we expect that growth to take time, and as evidenced by no guidance due to the uncertainty of the timing of the KCS merger and general macro uncertainty, we don’t see much valuation upside in the near term and would remain on the sidelines waiting for a better opportunity.”
* CIBC’s Kevin Chiang to $125 from $128 with an “outperformer” rating.
“CP reported Q4 results that were mixed (miss on operating income but beat on EPS), but we view this as a non-event,” he said. “With CP the last Class 1 to report, there was a clear difference in management’s tone as it looked out into 2023 versus its peers. While the economic environment has become more uncertain, CP’s unique growth levers (market share wins, bulk commodity exposure, KCS merger) should help offset cyclical pressures. CP remains a top pick.”
* Credit Suisse’s Ariel Rosa to US$84 from US$83;
* Cowen and Co.’s Jason Seidl to US$88 from US$81 with an “outperform” rating;
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Scotia Capital analyst Kevin Krishnaratne thinks Shopify Inc. (SHOP-N, SHOP-T) should be “a core tech holding given its position as a category leader helping to rewire the retail industry.”
However, in a research report released Wednesday titled Coding Commerce, he initiated coverage of the Ottawa-based e-commerce giant with a “sector perform” recommendation, citing its “robust” valuation following recent momentum that has pushed its shares up almost 40 per cent thus far in 2023 and near double September lows.
“Although recent subscription plan price increases could lead to some upward revisions to Street estimates for Subscription Solutions revenue, downside risks still exist for Merchant Solutions revenue given weakening consumer spending trends,” said Mr. Krishnaratne . “Our consolidated revenue estimates are below consensus. Shopify is also about to enter its biggest capex cycle to date as it ramps Shopify Fullfilment Network, which is expected to pressure FCF over the next two years, with some related questions still outstanding, such as how revenues might scale and whether Amazon’s Buy with Prime poses a real risk to Shopify s fulfilment initiatives.”
The analyst said “bending the learning curve for entrepreneurs is the right strategy,” however he thinks the expectations on the Street “may need to adjust to reflect newer realities.”
“Shopify’s role as the world’s leading retail operating system has never been more important given recent macro softness, making it increasingly challenging for merchants to successfully build and run a business,” he said. “We agree with Shopify’s approach of widening the funnel to add more merchants to its flywheel via multiple initiatives, including free and paid trials; localizing price plans in global markets; and steadily rolling out new services to “arm the rebels” with the necessary tools to ensure merchant success. Shopify’s recent price plan increases, along with its multiple funnelwidening strategies, should benefit Subscription Solutions trends, with our estimates slightly above the Street starting in Q3/23. Offsetting this, and largely out of management’s control, the near-term outlook for retailers is uncertain as the consumer remains under pressure amid heightened levels of inflation and recessionary fears. We think consensus for Shopify’s gross merchandise volume (GMV), which is disproportionately leveraged to discretionary goods, may need to be revised lower, with our forecasts suggesting related growth of 11 per cent and 15 per cent in 2023 and 2024 versus the Street at 14 per cent and 18 per cent, respectively.”
Expecting Shopify to log free cash flow (FCF) losses over next two years as it “embarks on big investment cycle amid a tough macro backdrop,” Mr. Krishnaratne set a target of US$43 per share, which exceeds the average on the Street by 41 US cents.
“Despite the many apparent headwinds facing the company and the broader market in which Shopify and its merchants operate, we would not bet against its visionary leadership team, which is intent on rewriting the centuries-old processes on which the retail industry is built to enable a more efficient, personal, and sustainable model that better connects brands with consumers ... We agree with the strategies the company is currently undertaking and think Shopify’s value proposition and obsession with driving merchant success can ultimately overcome looming competitive pressures that will be ever-present given retail’s multi-billion total addressable market (TAM) worldwide,” he said. “We look forward to pullbacks that may provide a better entry point where we would be more comfortable recommending the stock. In our view, SHOP remains a core holding for growth investors given management’s vision of coding commerce for merchants both large and small and building a successful company for the next 100 years.”
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BMO Nesbitt Burns analyst Peter Sklar is rotating toward consumer staples stocks from their discretionary peers as inflation “abates.”
That led him to upgrade Canadian Tire Corp. Ltd. (CTC.A-T) to “outperform” from “market perform” as well as a trio of auto parts stocks on Wednesday.
“We are arguing we are much closer to the end of the monetary tightening cycle than to the beginning and that discretionary stocks offer value and will outperform staples,” he said. “Canadian Tire has historically traded similarly to auto parts stocks. If inflation continues to abate, there is the prospect of an end to the current round of monetary tightening and the potential for easing, and a lower Fed Funds rate is arguably very positive for discretionary auto parts stocks. We believe Canadian Tire would similarly outperform in 2023.”
Seeing the Canadian Tire banner as “more resilient than expected,” Mr. Sklar expects comparable same-store sales to recover by the second quarter of 2023.
“The core Canadian Tire banner, which contributes over 50 per cent of retail revenue, has surprisingly been more resilient through downturns than generally expected,” he said. “Historically, the banner’s most negative comps were in 2008/2009 with quarterly same-store-sales (SSS) growth declining no more than 4 per cent, which is much less severe than many consumer discretionary stocks. Based on recent management commentary, we believe the core Canadian Tire comps could be under pressure for Q4/22 and Q1/23. However, we believe these weak quarters have been well communicated to the investment community and should already be reflected in analysts’ estimates. By Q2/23, we expect SSS to have lapped against the toughest comps and inventory levels to have re-balanced, resulting in improved comps for the balance of FY2023.”
Calling it a “discretionary COVID darling out of favour” and seeing an attractive valuation, his target for Canadian Tire shares is now $181, up from $160. The average on the Street is $185.60.
“Practically, Canadian Tire has many advantages that should mitigate any reduction in discretionary spend through recessionary periods,” said the analyst. “These advantages include the Triangle Loyalty program, a buy-now-paylater offering, a laddering of assortment (good, better, best), broad number of product categories, owned brands, and leverage over the supply chain due to scale.
“Finally, despite what investors may generally believe, Canadian Tire’s financial services division is also quite resilient through the various economic cycles. Since the beginning of the COVID-19 pandemic, investors have worried that the financial health of the consumer may trigger higher levels of write-offs and defaults at the Canadian Tire financial services division. However, the contrary has occurred with no discernible signs of deterioration through COVID and main consumer financial health metrics, such as write-off rate and delinquencies, remaining below (i.e., better than) pre-pandemic levels.”
On auto parts manufacturers, Mr. Sklar said: “We find that these stocks often underperform the market during periods of monetary tightening as this is clearly an interest-sensitive sector in terms of consumer demand for vehicles where most vehicle purchases are financed either through a loan or lease. These tightening periods typically follow periods of strong economic growth and the resultant inflationary pressures.”
Mr. Sklar raised his recommendation for these stocks:
* Linamar Corp. (LNR-T) to “outperform” from “market perform” with an $80 target, up from $67. Average: $82.17.
Analyst: “Linamar is a high-quality, mid-cap auto parts company that we believe will participate in the outperformance of the auto parts sector that we are predicting. The company has a legacy as a strong manufacturer that punches above its weight given its global scope and footprint.”
* Magna International Inc. (MGA-N, MG-T) to “outperform” from “market perform” with a US$74 target, up from US$65. Average: US$71.50.
Analyst: “Magna is a bellwether global auto parts stock and should participate in the strength we are anticipating for the sector. In terms of valuation, on an EV/EBITDA basis, over the last 10 years, Magna has generally been valued within a range of 4-6.5 times forward EBITDA. Currently, the company is valued at 5.9 times our 2023 EBITDA estimate, suggesting that the stock is well valued.”
* Martinrea International Inc. (MRE-T) to “outperform” from “market perform” with a $15 target, up from $12. Average: $15.83.
Analyst: “Beginning in Q1/22, the company reported three consecutive quarters of upside earnings surprises. We believe investors will be able to benefit from the outperformance of the auto parts sector that we are predicting, compounded by the transition of Martinrea into a higher quality auto parts supplier.”
Conversely, Mr. Sklar downgraded Metro Inc. (MRU-T) to “market perform” from “outperform” with a $78 target, falling from $82 and below the $78.10 average.
“As a result of the magnitude of the 2022 food inflation and the resulting higher level of food prices, we have concerns about developments within the gross margin for the grocers including that of Metro,” he said. “Over the last few quarters, Metro has been able to essentially hold the overall gross margin flat with a slight margin decline in grocery offset by a strong margin in the pharmacy front-of-store. However, in the most recently reported FQ1/23 quarter, overall gross margin deteriorated 34 bps, suggesting that grocery margin is under further pressure. During the conference call, management indicated that the grocery business did experience more of a margin decline as inflation was now so strong that not all of it can be passed through at retail as consumers show reluctance to reach for certain price points on a number of categories. In particular, management called out the high inflationary pressures within produce. Metro also indicated that its promotional/feature weightings were up as the consumer was seeking value, and this trend was also negatively impacting margin on an incremental basis. We are concerned that Metro could potentially report a series of quarters with gross margin under pressure which would have obvious negative implications for the stock.”
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Despite its updated three-year guidance prompting a reduction in his net asset value projection, RBC Dominion Securities analyst Sam Crittenden reaffirmed Teck Resources Ltd. (TECK.B-T) as a “a preferred name as they benefit from high commodity prices.”
Shares of the miner rose 4 per cent on Tuesday after it reiterated its expectation for both copper and zine production increases in fiscal 2023 in the wake of misses in 2022 for both.
“Teck’s 3-year guidance update took our NAVPS estimate down 4 per cent and 2023 and 2024 EBITDA down 6 per cent and 4 per cent,” said Mr. Crittenden. “The biggest change was the expanded coal guidance range of 24-26 million tons (the 3-year target was 26-27 million tons to start 2022 later trimmed to 25-26 million tons in Q3/22), so we have taken our run-rate estimates to 25.0 million from 25.5 million tons (sales averaged 22.5 million tons from 2020-2022 after averaging 26.1 million tons from 2012-2018). Other changes included lower copper production, higher zinc, higher costs, while capex was similar to our prior estimates.”
Calling its new targets “achievable,” the analyst sees “strong” free cash flow potential moving forward.
“Met coal remains elevated at $335 per ton due to supply constraints and China has started buying Australian coal which has tightened the seaborne market,” said Mr. Crittenden. “While we forecast prices to fade in H2/2023, we estimate $250/t for 2023 which remains a robust price for Teck. At our forecast prices for 2023 ($3.75/lb copper, $250/t met coal, and $1.38/lb zinc) we estimate $2.5-billiob in FCF implying a yield of 8.2 per cent. At spot prices ($4.12/lb copper, $335/t met coal, $1.55/lb zinc) we calculate FCF of $5.0-billion (16.5-per-cent yield, vs. copper peers 6.7 per cent and diversifieds 12.3 per cent). Together with proceeds from the sale of Teck’s Fort Hills interest of $1.0-billion (expected to close in Q1/2023), we could see additional shareholder returns, after paying out $1.4-billion in buybacks, $0.5-billion in dividends, and $1.2-billion in debt repayments from Q1-Q3/2022.”
Much of the investor enthusiasm surrounding Teck comes from the potential brought by its Quebrada Blanca Phase 2 project.
“Executing on the copper growth at QB2 could drive a re-rating,” said Mr. Crittenden.
“Teck noted first production at the large QB2 copper project in Chile is close with a further update expected on February 21st with Q4/2022 results (in Q3/22 they targeted first production in January). The construction capex guidance of U$7.4-U$7.75-billion was unchanged with production of 150-180,000 tons expected this year and 285-315,000 tons from 2024-2026. We believe this guidance lines up well with the historical rampup trajectory for large greenfield projects. QB2 can take Teck’s copper production to 600,000 tons in 2024 from 300,000 tons in 2021 with further optionality from San Nicolas (121,000 tons per year CuEq 100-per-cent basis), Zafranal (134,000 tons per year), while a 50-per-cent expansion at QB2 could add 150,000 tons per year.”
The analyst raised his target for Teck shares to $64 from $62, reaffirming an “outperform” rating. The average is $58.92.
“We believe Teck provides investors exposure to long-life, highquality coking coal, copper, zinc, and bitumen production in a diversified Canadian mining company with a low geopolitical risk profile. Teck has a portfolio of five copper growth projects at pre-feasibility to feasibility stages in the Americas and is in a strong financial position,” he said.
Elsewhere, Stifel’s Alex Terentiew bumped his target to $70 from $64 with a “buy” rating, while B. Riley’s Lucas Pipes trimmed his target to $54 from $56 with a “neutral” rating..
“Despite a weak Q4 (10-per-cent copper production miss) owing to extreme weather at Andacollo and geotechnical issues in HVC, which have since been addressed, we remain positive on our 2023 operational outlook for Teck as our 2023 production estimates were squarely within, or below the lower end of 2023 production guidance,” said Mr. Terentiew. “Importantly, Teck guided to QB2 2023 production guidance of 150-180 kt, vs our already cautious and unchanged estimate of 150 kt. Additionally, QB2′s steady-state operating cost guidance of $1.40-$1.60/lb was better than our $1.60+ forecast with near-term production start-up reiterated. Furthermore, 2023 cost guidance for copper mirrored our forecast, while coal costs were guided to be marginally above. Capex guidance was marginally better than our forecast, but higher capitalized stripping at the coal division offset the beat. Incorporating guidance, our NAV increased by 6% and our target price has moved higher.”
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PRO Real Estate Investment Trust (PRV.UN-T) possesses a “defensive asset base with re-rate potential,” according to National Bank Financial analyst Matt Kornack.
He initiated coverage of the Montreal-based REIT with a “sector perform” recommendation on Wednesday.
“The portfolio has expanded but remains smaller in size, although management has a stated goal of scaling to $2-billion in asset value (as they view $1-billion of market cap as a threshold for greater institutional interest),” said Mr. Kornack. “At Q3/22, 68.2 per cent of the REIT’s base rents were derived from industrial properties followed by retail at 21.9 per cent and office at 9.9 per cent with $1 billion in assets owned. Additionally, the REIT owns Compass Commercial Realty, a real estate property manager with $1.6-billion in AUM [assets under management]. PRO has been the beneficiary of significant transaction-driven growth in recent years, particularly in Halifax’s Burnside Industrial Park, where through a joint venture with Crestpoint Real Estate Investments Ltd. (Crestpoint) it enhanced its exposure to the Atlantic Canada industrial market, now owning on a proportionate basis 1.5 million square feet of space (3.0 million sq. ft. at 100 per cent, accounting for 23 per cent of the entire Halifax industrial market GLA [gross leasable area] and 40 per cent of the Burnside Industrial Park).”
Mr. Kornack thinks the private equity partnership with Crestpoint “speaks to the quality of the portfolio and reputation of the REIT’s management team,” which led CANMARC REIT through to its eventual sale to Cominar REIT in March of 2012.
“CANMARC was a successful story with many parallels in asset class and geographic footprint,” he said.
“PRO’s management team has been pursuing a proactive de-leveraging program. Our forecast shows a minimal cash drag related to the ongoing operations of the portfolio, including all capex. This speaks to distribution sustainability, a plus given the high tax-efficient yield to investors.”
While Mr. Kornack likes “the trajectory of fundamentals in the REIT’s industrial segment” and think that “solid” earnings growth is approaching as it moves beyond the recent deleveraging trend, he set a “sector perform” rating based on market volatility and its relative valuation.
“Cost of capital challenges will remain an impediment to growth given size and liquidity concerns and a still diversified offering,” he said. “These are not insurmountable challenges and a re-rating is probable as the portfolio grows and asset exposure becomes more concentrated.”
Mr. Kornack set a target of $6.75 per unit. The current average on the Street is $7.21.
“PRO trades around where we would expect it to in the context of public market comparables on both a discount to NAV and P/FFO multiple basis,” he added. “While a modest re-rating opportunity exists upon achieving pureplay industrial status there isn’t a ton of room between it and Nexus, which would be the closest comp in that segment, whereas the REIT trades at a premium to its high-quality diversified peer (H&R REIT). Given the scale of their offering and strong portfolio attributes for the U.S. apartment and Canadian industrial segments it remains a more interesting value play. Balance sheet, scale and portfolio attributes/geographic concentrations justify a wider spread between PRO and Dream Industrial/Granite. Needless to say, the return to target is modest in light of the relative positioning and the bulk of this comes in the form of the distribution (which we view as sustainable). To truly bridge the gap we would need to see an improvement in the scale and portfolio concentration.”
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With changes to his new asset value projections and seeing “limited excess return potential,” Credit Suisse analyst Andrew Kuske downgraded both TransAlta Corp. (TA-T) and TransAlta Renewables Inc. (RNW-T) to “neutral” recommendations from “outperform” previously.
His target for TranAlta fell to $15 from $17.50, while his TransAlta Renewables target slid to $14 from $17. The average targets on the Street are $15.96 and $13.71, respectively.
“In our Canadian Infrastructure coverage universe, we continue to favour the Renewable/Power sub-sector for exposure amongst the three distinct areas (i.e. the others being Energy Infrastructure and Utilities),” he said. “Three reasons underpin our preference: (a) the growth potential; (b) outright and relative performance (both stock and sector specific); and, (c) valuation dynamics – more relative to history versus outright ... Consistent with other areas of exposure, we transitioned anchor multiples for valuation to 2024 in our renewable power Net Asset Value (NAV) framework.”
“In terms of sector themes, the most significant and overarching theme continues to revolve around energy transition efforts – occurring in all markets of relevant exposure at various paces. Clearly, energy transition efforts became enhanced with the U.S. Inflation Reduction Act (IRA) along with efforts to ‘level the playing field’ that are in focus with Canadian specific catalysts likely unveiled with the forthcoming Federal budget. Sector growth trends are more favourable than other sub-sectors, however, competitive advantages vary amidst a secular wave of capital inflows. Stock specifics include: (a) Alberta’s abundance via Capital Power Corporation (CPX) and TA; (b) engaged on the European experience (Boralex Inc. (BLX), Brookfield Renewable Partners LP (BEP), Innergex Energy Renewable Inc. (INE) and NPI); (c) the potential turnarounds or other consequences – Algonquin Power & Utilities (AQN) and RNW; and, (d) a diversification dilemma (BEP).”
Mr. Kuske also made these target adjustments:
- Boralex Inc. (BLX-T, “neutral”) to $43 from $38.50.Average: $47.58.
- Capital Power Corp. (CPX-T, “outperform”) to $53.50 from $56. Average: $52.12.
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In other analyst actions:
* JP Morgan’s Kenneth Worthington trimmed his Brookfield Corp. (BN-N, BN-T) target to US$46 from US$46.50 with an “overweight” rating. The average is $47.19.
* CIBC’s John Zamparo lowered his Canopy Growth Corp. (WEED-T) target to $2.50, below the $4.06 average, from $3 with an “underperformer” rating.
“We continue to expect WEED to show significant operating losses and minimal sales growth in FQ3. Cannabis GM% likely remains in the low-single digits, marketing and distribution investments will weigh on profitability of the high growth BioSteel segment, and enterprise-wide cost savings initiatives will take time to be fully captured. With U.S. regulatory reform likely deferred and no visibility to profitability, we reduce our price target,” he said.
* JP Morgan added Cenovus Energy Inc. (CVE-T) and Rogers Communications Inc. (RCI.B-T) to its U.S. Analyst Focus List.
* Raymond James’ Michael Shaw increased his Imperial Oil Ltd. (IMO-T) target to $74 from $70 with a “market perform” rating. The average is $77.41.
“Imperial followed up a strong 3Q with another beat in the fourth quarter,” he said. “Cash flow before working capital changes was $4.07 per share, ahead of the $3.56 per share consensus and our own estimate of $3.75 per share. Reported $2.8-billion EBITDA was behind our estimate of $2.9-billion with Upstream coming in-line and Downstream modestly behind. The beat on the cash flow line was the result of lower than expected cash taxes.
“Operationally, IMO had an impressive 4Q. Upstream production averaged 441 mboe/d with strong results from Kearl and Cold Lake despite a deep December cold snap that impacted production across the Oil Sands. Downstream throughput was equally impressive with utilization averaging 101% during the quarter, taking full advantage of the high crack spreads despite the difficult operating environment.”
* Stifel’s Cody Kwong trimmed his Obsidian Energy Ltd. (OBE-T) target to $12.75 from $13 with a “buy” rating. The average is $12.06.
“Obsidian announced its 2023 capital and production guidance in conjunction with its release of its 2022 year-end reserves. The 2023 plan incorporate capital guidance that was lower than expected as we believe Obsidian is now prioritizing liquidity and debt repayment to facilitate a share buyback program it plans on executing prior to the end of 1H23. We believe this is a step in the right direction for a company we believe is currently trading below intrinsic value, and expect the market to take notice when buybacks commence. The Company also released its 2022 year-end reserves which presented moderate growth in all reserve categories with reasonable FD&A performance and recycle ratio markers.”
* Canaccord Genuity’s John Bereznicki lowered his Superior Plus Corp. (SPB-T) target to $12 from $13 with a “hold” rating. The average is $12.91.
David Leeder