Wednesday’s analyst upgrades and downgrades

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

Seeing its management’s plans to address its balance sheet problems as “likely too little, too late,” Eight Capital analyst Ty Collin dropped his target price for shares of Canopy Growth Corp. (WEED-T) to zero on Wednesday.

“We believe it is no longer appropriate to value Canopy as a going concern, given our view that it has a) less than 12 months of cash runway, b) a lack of viable financing alternatives, and c) large ongoing losses without a clear path to profitability,” he said. “We therefore apply an asset-based/breakup valuation for Canopy, where we find a net asset value of zero after accounting for the Company’s substantial debts. With the recent bankruptcy of leading cannabis retailer Fire & Flower (FAF; not rated) and the distressed sale of Hexo (HEXO; NR) to Tilray (TLRY; NR), we think investors should be awake to the fact that no Canadian cannabis company is too big to fail in this environment.”

In a research report titled Last Puffs of the Roach, Mr. Collin emphasized Canopy’s inability to slow its rate of cash consumption after it burned through $143-million in the fourth quarter of fiscal 2023. That came despite several “longstanding efforts to streamline costs.”

“We believe the Company continues to consume cash at a rate that will deplete its coffers within the next year absent drastic interventions and a speedy slashing of cash costs, which we deem improbable in view of Canopy’s track record,” he said. “We estimate that Canopy exited Q1/F24 (June 2023) with $637-million of cash (including recent debt pay-down and asset sales). With $225-million of debt due on July 15, and a US$100-million (C$130-million) minimum liquidity covenant on its senior debt, this implies that Canopy has 3 quarters of cash runway at its current burn rate.

“While the Company has several arrows in its quiver to bolster the balance sheet, we believe these are insufficient and will only serve to prolong the exhaustion of cash resources given the magnitude of ongoing losses.”

Mr. Collin is skeptical about the company’s plan to shore up its balance sheet, which involves further sales of noncore assets, reductions to cash costs and negotiations with lenders.

“The Company expects up to $700-million of additional proceeds from the sale of idle facilities (for a total of up to $150-million), but half of those proceeds must go towards paying down senior debt,” he said. “We believe management may also look to divest its Biosteel business and its minority interest in Terrascend (TSND; NR). However, large losses and recently discovered financial reporting malfeasance at Biosteel are likely to restrict potential bidders, and we believe that Canopy would have difficulty monetizing its bespoke financial assets.

“The Company continues to negotiate with its lenders, but we believe that the $225-million of notes due on July 15 are likely to be settled in cash, and that any other forbearance would come on punitive terms. We believe that Canopy’s recent US$100-million convertible note offering, which allowed the noteholder to convert to equity at a discounted price (we estimate up to 90 million new shares were issued), was a principal cause of the ensuing 84-per-cent decline in WEED’s share price (through June 30) and reflects the Company’s lack of remaining financing alternatives and the risk of further dilution.”

Reiterating his “sell” recommendation for Canopy shares, Mr. Collin cut his target to $0 from $1.75. The average on the Street is $1.78, according to Refintiv data.

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Following its “modest” $5-million financing, PI Financial analyst Ben Jekic downgraded Good Natured Products Inc. (GDNP-X) to “neutral” from “buy,” expecting continued volume softness to persist.

“Our sense after the deal is that GDNP continues to face very tough markets in the Industrial business, unlikely to reset this year,” he said. “June financing provides modest liquidity to weather tough period and pursue initiatives to add more life to a declining sales growth. We do not expect the stock to draw significant interest until the material turn in the signs of recovery.”

“GDNP ended Q1/23 with $11.6-million cash, and will end 2023 at $10.5-million following this deal. GDNP expects its demand will still face short-term macro & competitive pressures for Industrial segment while lower input costs will limit GDNP’s ability to raise prices if volumes remain stagnant.”

Mr. Jekic cut his target to 20 cents from 40 cents based on a valuation change “that better balances trajectories of peers with specific short-term demand and industry risks.” The average on the Street is 20 cents.

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Analyst Jonathan Goldman said Scotia Capital’s inaugural powersports dealer survey pointed to a strong second quarter for manufacturers, driven by positive sales growth and a lack of promotional activity.

“Our proprietary channel checks reveal that powersports dealers share the same concerns as investors: potential slowdown, higher consumer financing costs, inflation, and expanding inventories,” he said. “However, the market continues to define ‘slowdown’ much more negatively than OEMs and front-line dealers – as well as us. OEMs are still calling for a flattish industry this year and the majority of our survey respondents (60 per cent) expect sales to be flat to up 10 per cent or more over the next six months. Sixty percent of dealers also said current promotions are ‘significantly below’ (40 per cent) or ‘somewhat below’ 2019 levels (20 per cent).

“But, dealer comments also indicate that risks have risen, particularly related to rising inventories. Forty percent of dealers said inventory levels were 0 per cent to 20 per cent above optimal – and 20 per cent said they were more than 20 per cent above optimal.”

In a concurrent note on BRP Inc. (DOO-T), Mr. Goldman sees upside risk to second-quarter earnings estimates given the strong sales growth and below-average promotional activity. He also sees the Valcourt, Que.-based company gaining market share in the off-road vehicle segment.

“We see downside risk to 2H24 and F25 estimates given consumer headwinds (i.e., higher rates, inflation) in conjunction with rising inventory levels (i.e., higher promo, margin compression),” he added.

“F2024 guidance calls for revenue growth of 10 per cent at the midpoint, which assumes: 1) a stable powersports industry; 2) low to mid-single-digit price increases; and 3) volume growth driven by share gains and new product introductions. Based on our survey results, we think there is the most downside risk to pricing. We estimate decremental margins of 25 per cent to 30 per cent.”

Keeping a “sector outperform” rating for BRP shares, he cut his target to $142 from $145. The average is $133.89.

“While we remain bullish on BRP’s prospects – the company has ample internal levers to drive earnings growth, capital optionality, and trades at a severely discounted valuation – we think it is prudent to lower our margin assumptions for the 2HF24 and F25,” he concluded.

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After “multiple false starts,” the move toward hydrogen “appears real,” according to Citi analyst Vikram Bagri.

“Decarbonization incentives across the world as well as self-imposed ESG goals have created demand for green H2 in difficult to abate areas,” he said. “In the long term, government incentives (IRA PTC of up to $3 per kilogram) combined with decreasing electrolyzer capex costs and declining clean energy prices should reduce levelized cost of green H2 (less than $1/kg in the U.S.). This has spurred significant interest in switching to low-carbon H2. Per Hydrogen Council, more than 1k H2 projects have been announced worldwide that will require investments of more than $320-billion, a number that is increasing rapidly. FID has only been reached in 10 per cent of the announced projects but should gain momentum as costs start to fall.

“Citi forecasts electrolyzer capacity globally to reach 88GW in 2030, implying annual average growth of more than 90 per cent. In the U.S., electrolyzer capacity should grow at a similar rate and reach 16GW by the end of the decade. However, most of the growth is back-end weighted with YE23 capacity in North America projected to be 0.8GW. Over the past year, announced renewable hydrogen projects have increased 2.5 times, largely due to the momentum created by the IRA.”

While he’s bullish over the long term, Mr. Bagri warns wider adoption remains “far away” as lower prices are needed. He also thinks an “absence of incentives and lack of urgency towards ESG goals led to lack of interest until now.”

“This time, however, all the impediments are being removed that should lead to large scale buildout of H2 economy,” the analyst said. “That said, the inflection in green H2 demand still appears far out until subsidies reduce cost, electrolyzer capex decreases, and clean energy prices fall. Until then, well capitalized and diversified H2 companies should thrive.”

Mr. Bagri initiated coverage of Burnaby, B.C.-based Ballard Power Systems Inc. (BLDP-Q, BLDP-T) with a “neutral” recommendation and target price of US$4.50. The average is US$6.61.

“BLDP is a leader in PEM based fuel cells (”FC”) for stationary power storage and for medium and heavy mobility including buses, trucks, trains, and marine vessels with combined projected TAM [total addressable market] of $16-billion in 2030,” he said. “The company has sufficient liquidity for near to medium term capital plans, right technology, improving cost structure, strong customer relationships and industry leading market share in its target markets. However, we believe the widespread adoption of H2 FC in BLDP’s target markets is still far away (2026-27). The mobility customers lack clear and tangible economic incentives as well as the necessary infrastructure to switch to H2 in the foreseeable future. However, the stock price trading at close to per share value of cash on the balance sheet (approximately $3 per share) already reflects the absence of inflection demand in the near to medium term.”

He gave Plug Power Inc. (PLUG-Q) a “buy” recommendation and US$13 target, below the US$18.70 average.

“PLUG is a fully integrated hydrogen-focused company which has early mover advantage, cutting edge technology and scale,” said Mr. Bagri. “This makes PLUG well positioned to benefit from growing demand for green H2 in hard to abate sectors. The company will achieve positive gross margin this year with a goal to exceed 30 per cent in gross margins by 2026. The company’s aggressive growth plans and substantial operating leverage should allow strong margin expansion. In addition, strong balance sheet with $2.5-billion in cash should allow the company to execute on its plan until early 2025. Financial support from the DOE may extend this flexibility even more.”

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Margins will be focus of investors when Aritzia Inc. (ATZ-T) reports its first-quarter 2024 financial results on July 11 after the bell, according to Canaccord Genuity analyst Derek Dley.

“For Q1/F24, we expect this top-line momentum to persist on both sides of the border, helped by (1) the company’s store opening and expansion pipeline, which includes the opening of another boutique in the U.S. and the expansion of another in Canada and (2) better availability of Aritzia’s best-selling products as a result of the inventory build-up seen last quarter,” he said. “However, we do expect modest headwinds driven by unfavourable weather conditions during the spring in Aritzia’s primary markets. Accordingly, we are forecasting same-store sales growth of 23.1 per cent, which drives our revenue estimate of $451 million, in-line with the lower range of the company’s guidance range of $450-$460 million.

“From a margin standpoint, we expect headwinds driven by DC pre-opening costs, inflationary pressures and inventory storage costs before moderating more substantially in the latter half of F2024. Accordingly, we are forecasting gross margins of 37.8 per cent, down 650 basis points year-over-year, in-line with management expectations. Looking further out, we anticipate inventory growth which was up 125% in the previous quarter, to show improvement in the latter half of this quarter, and normalize by the end of Q2/F24.”

Mr. Dley is forecasting revenue of $451-million for the quarter, which is at the low end of management’s guidance ($450-$460-million) and lower than the consensus projection of $462-million. His EBITDA expectation of $30-million is also lower than the Street ($31-million).

He maintained a “buy” recommendation and $50 target for Aritzia shares. The average target is $50.25.

“In our view, Aritzia has done a great job navigating a changing retail landscape by offering an aspirational customer experience within its brick-and-mortar locations and an improved e-commerce platform,” said Mr. Dley. “With a healthy track record of comparable sales growth and strong growth for the latest quarter, a robust pipeline of new store openings, a healthy balance sheet to support growth and margin enhancement initiatives, and a well-aligned management team, we believe Aritzia deserves a premium valuation.”

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ATB Capital Markets analyst Frederico Gomes sees U.S. cannabis multistate operators as “undervalued on fundamentals,” however near-term catalysts are dependent on regulatory changes that do not appear to be imminent.

“The market is loaded with negative sentiment on failed regulatory reform, neglecting the industry’s growth runway and margin potential,” he said. “In 2023, we expect pricing headwinds to continue, but we expect margins to stabilize as MSOs cut costs and focus on cash flows. We believe near-term top-line growth will be moderate as markets mature and consolidate, and as new states marginally add to sales. In a starved-for-capital, lower-growth environment with evolving state regulations, investors should focus on names with near-term cash flow generating ability, diversified footprints, and balance sheets with lower leverage ratios and no near-term debt maturities.”

In a research report released Wednesday, Mr. Gomes resumed coverage of seven companies, noting: “MSOs are largely undervalued as a sector, but in the current market environment, companies with lower liquidity risks and near-term profitability offer the best risk-reward. In a vertically integrated industry, scale is key to achieving and maintaining higher margins. TRUL, VRNO, and CURA stand out given their scale and visibility into near-term cash flow generation; we expect all three to generate positive FCF in 2023. We think TSND, AAWH, and AYR also offer attractive upside, with caveats on margin expansion, balance sheets, and market-specific circumstances. We are cautious on JUSH due to its high interest costs and lagging margins versus peers.”

His top picks are:

* Curaleaf Holdings Inc. (CURA-CN) with an “outperform” rating and $9 target. The average on the Street is $9.18.

Analyst: “We believe CURA will remain a top-quartile performer among MSOs. Due to its scale, diversification, and vertical integration, we think CURA can capture margin and benefit from adult-use legalization in catalyst states such as Florida and Pennsylvania. In a potentially federally legal industry, CURA (as a top five MSO) could attract capital as new investments flow into the space and consolidation occurs. In addition to the US, CURA is the only MSO with relevant international exposure, and we expect international sales to become a key long-term growth driver, mostly due to regulatory changes in Germany. Near term, we believe the Company will generate low sales growth but meaningful FCF in 2023 through prudent working capital and capex management.”

* Trulieve Cannabis Corp. (TRUL-CN) with an “outperform” rating and $20 target. Average: $20.18.

Analyst: “We believe TRUL is a top-quartile performer among MSOs; TTM [trailing 12-month] sales ($1.2-billion) is among the highest of its MSO peers, and its TTM adj. EBITDA margin of 30.8 per cent is 780 basis points above the MSO average. Despite near-term margin headwinds (especially as the Company looks to monetize inventory), we think TRUL will remain a top performer due to its scale, a particularly important feature in a sector in which vertical integration is a key driver of profitability. With one of the largest cash balances in the industry (ended Q1/23 with $188-million), reasonable leverage ratios (TTM net debt/adj. EBITDA of 1.3 times), and guidance of $100-million in cash from ops. in 2023, we think TRUL has a strong balance sheet to fund growth. Notably, TRUL has material exposure to Florida and Pennsylvania, which are catalyst states that could provide significant upside to our base case valuation in case of adult-use legalization.”

* Verano Holdings Corp. (VRNO-CN) with an “outperform” rating and $13.50 target. Average: $12.63.

Analyst: “Verano is one of the top-performing MSOs in terms of scale and profitability. We believe the Company will remain among the top operators in the space due to its diversified state exposure, vertically integrated strategy, and higher-than-average margins. In a potentially federally legal industry, Verano, as a top five player, could attract capital as new investments flow into the space and consolidation occurs. Over the near term, we think the Company will generate low sales growth but material FCF through lower capex and inventory reduction.”

He also resumed coverage of these companies:

* Ascend Wellness Holdings Inc. (AAWH.U-CN) with an “outperform” rating and US$4 target. Average: US$3.83.

Analyst: “We believe Ascend will be one of the few MSOs with double-digit sales growth in 2023 due to its outsized relative exposure to Maryland, which will launch its adult-use sales program on July 1, 2023. Additionally, Ascend’s outlet model (which has now been applied to five of the Company’s retail locations) is a key differentiator, and it supports the Company’s higher-than-average sales per store. We believe the focus on high-volume locations within the outlet model will be a meaningful driver of long-term revenue growth and margin expansion.”

* Ayr Wellness Inc. (AYR.A-CN) with a “speculative buy” rating and $3.50 target. Average: $15.08.

Analyst: “We believe Ayr’s improved competitive position in Florida, performance enhancement initiatives, and exit from unprofitable states will improve its growth prospects and profitability. We think AYR has visibility into margin expansion via cost cutting initiatives and gross margin expansion, and the exposure tilt to catalyst states (Florida and Pennsylvania, in particular) provides material upside to our base case estimates. The Company’s balance sheet is a point of concern. We estimate that AYR has a LTM [last 12-month] Net debt/adj. EBITDA ratio of 4.1 times (vs. the peer average of 3.2 times), leading to relatively high interest costs that may be a drag on near-term cash flow generation. The Company has hired a financial advisor to explore capital structure alternatives to extend upcoming debt maturities. Despite balance sheet risk, the material upside implied by our base case and bull case valuations support our Speculative Buy rating.”

* Jushi Holdings Inc. (JUSH-CN) with a “sector perform” rating and 80-cent target. Average: $2.02.

Analyst: “We believe Jushi will maintain its trend of margin expansion in 2023, driven by efficiency enhancements and cost rationalization efforts (particularly retail labor costs). While we expect margins to expand, we think near-term sales growth catalysts are limited, as the Company is mostly exposed to Pennsylvania, a state that continues to struggle with price compression and excessive competition. We view the balance sheet as an overhang, as the Company may need to refinance its debt and raise additional capital to fund its operations. We see significant cash interest costs relative to the Company’s size, which could hinder near-term cash generation, therefore justifying out neutral stance on the stock.”

* TerrAscend Corp. (TSND-T) with an “outperform” rating and $3.50 target. Average: $3.05.

Analyst: “We believe TSND will accelerate growth and continue to improve margins in H2/23, driven by the start of adult-use sales in Maryland on July 1, improvements in Michigan, and consistent performance in New Jersey. Long term, we think TSND could outperform the industry’s growth due to its competitive position in Michigan (a market poised for consolidation) and Pennsylvania (if and when it approves adult-use) and as it closes its margin gap to top-performing peers. The TSX up-listing could be a near-term catalyst supporting a lower cost of capital and an acceleration of share-based M&A. While we are cautious about the balance sheet, TSND has largely unencumbered assets that could unlock capital if needed, and management’s deal-making trackrecord is positive.”

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After a “rollercoaster” start to 2023 for Canada’s real estate sector, TD Securities analysts Jonathan Kelcher and Sam Damiani reduced their targets for equities by an average of 6 per cent on Wednesday in response to higher short term interest rates.

“The REIT Index (price only) started 2023 strong, increasing 9 per cent through March 6 (week of the SVB failure),” they said. “The index gave back its year-to-date gains during the rest of March and stayed range bound until the beginning of June when the BoC’s surprise 25 basis points overnight rate increase and general increase in short term interest rates (2-year GOC bond yield up 100bps since mid-May) resulted in another leg down before a 5% bump the last week in June. Overall, the REIT index (price only) is down 2 per cent year-to-date versus the S&P TSX at up 4 per cent. However, despite a challenging H1/23, we still believe the index can make the bottom end of our original 15-20-per-cent 2023 total return forecast if short-term rates cooperate.”

“While asset values appear to be holding up in most sectors YTD with strong NOI growth offsetting modest cap rate expansion, REIT trading prices continue to be driven by the yield curve inversion over the past year as GICs/term deposits continue to see accelerated inflows). TD Economics most recent interest rate forecast has 2-year bond yields 120 basis points higher on average through Q4/24 versus the December 2022 forecast. On that basis, we are lowering target prices across our coverage by 6 per cent(weighted average). By sector, Office (down 15 per cent) saw the steepest target price reductions followed by Retail (down 8 per cent), Diversified (down 7 per cent), and Seniors’ Housing (down 4 per cent), while the Residential and Industrial sectors saw more modest 3-per-cent reductions. Despite the reductions, our target total returns still average a healthy 24 per cent, and we are maintaining our OVERWEIGHT sector rating.”

Mr. Kelcher’s changes include:

• Allied Properties REIT (AP.UN-T, “buy”) to $27 from $32. The average on the Street is $29.50.
• Automotive Properties REIT (APR.UN-T, “hold”) to $12.50 from $13. Average: $12.72.
• Boardwalk REIT (BEI.UN-T, “buy”) to $73 from $74. Average: $71.45.
• CAP REIT (CAR.UN-T, “action list buy”) to $62 from $63. Average: $56.77.
• Chartwell Residential REIT (CSH.UN-T, “buy”) to $11 from $11.50. Average: $11.60.
• Dream Residential REIT (DRR.U-T, “buy”) to US$12 from US$13. Average: US$11.50.
• European Residential REIT (ERE.UN-T, “buy”) to $4 from $4.75. Average: $4.04.
• InterRent REIT (IIP.UN-T, “hold”) to $14.50 from $15. Average: $15.44.
• Killam Apartment REIT (KMP.UN-T, “buy”) to $21 from $22. Average: $21.29.
• Minto Apartment REIT (MI.UN-T, “buy”) to $20 from $21. Average: $19.31.
• Morguard North American Residential REIT (MRG.UN-T, “buy”) to $23 from $24. Average: $23.33.
• Sienna Senior Living Inc. (SIA-T, “buy”) to $14 from $15. Average: $13.64.
• Slate Office REIT (SOT.UN-T, “hold”) to $2.25 from $2.50. Average: $2.56.
• Storagevault Canada Inc. (SVI-T, “buy”) to $7.50 from $8. Average: $7.14.

Mr. Damiani’s changes are:

• Choice Properties REIT (CHP.UN-T, “buy”) to $16 from $17. Average: $15.88.
• Crombie REIT (CRR.UN-T, “buy”) to $17 from $19. Average: $17.89.
• CT REIT (CRT.UN-T, “hold”) to $16 from $17. Average: $17.42.
• Dream Industrial REIT (DIR.UN-T, “buy”) to $16.50 from $17. Average: $17.31.
• Dream Office REIT (D.UN-T, “buy”) to $15 from $17. Average: $16.33.
• Dream Unlimited Corp. (DRM-T, “buy”) to $30 from $35. Average: $42.50.
• First Capital REIT (FCR.UN-T, “action list buy”) to $19 from $21. Average: $19.11.
• Granite REIT (GRT.UN-T, “action list buy”) to $97 from $100. Average: $98.
• H&R REIT (HR.UN-T, “buy”) to $13.50 from $15. Average: $13.92.
• Primaris REIT (PMZ.UN-T, “buy”) to $16 from $17.50. Average: $17.38.
• Pro REIT (PRV.UN-T, “buy”) to $6 from $6.50. Average: $6.75.
• RioCan REIT (REI.UN-T, “buy”) to $24 from $26. Average: $25.06.
• SmartCentres REIT (SRU.UN-T, “hold”) to $26 from $29. Average: $30.06.

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In other analyst actions:

* In a report titled Easy to Model, Hard to Replicate, TD Securities’ Aaron MacNeil initiated coverage of Pason Systems Inc. (PSI-T) with a “buy” rating and $16 target, seeing it leveraged to North American drilling activity and touting its “resilient competitive moat.” The average target on the Street is $16.57.

“We believe Pason offers investors who are seeking North American drilling activity exposure to several desirable qualities, including a technology-focused, capital-light business, limited competitors, lack of financial leverage, and a long history of providing returns to shareholders,” he said. “As a result, Pason has historically traded at a premium valuation to the Energy Services coverage universe. However, its relative premium has eroded in recent months, and we view the current valuation as attractive in the context of historical relative valuation trends. Despite recent North American natural-gas commodity price weakness and its impact on near-term activity, our longterm industry outlook remains positive.”

* After receiving notice from the Environmental Service Assessment in Chile of its decision to terminate the review of the company’s application for an environmental impact assessment of its Penco Module project, RBC Dominion Securities’ Andrew Wong downgraded Toronto-based Aclara Resources Inc. (ARA-T) to “sector perform” from “outperform” and lowered his target to 60 cents from $1.10. The average is 50 cents.

“We think withdrawal of Aclara’s environmental permit application for the Penco module adds an extra layer of uncertainty to the development timeline, and see the potential for environmental challenges and activist pressure to remain an overhang on bringing the Penco module into production,” said Mr. Wong. “The risk/reward skew is becoming more neutral in our view with significant optionality still present via environmental resolutions at Penco or exploration success in Brazil, but the uncertainty on permitting leads us to revise our rating.”

* ATB Capital Markets’ Waqar Syed and Tim Monachello trimmed their targets for a group of energy services companies. Their changes include: Calfrac Energy Services Ltd. (CFW-T, “outperform”) to $9 from $11, Ensign Energy Services Inc. (ESI-T, “outperform”) to $8 from $8.50, Precision Drilling Corp. (PD-T, “outperform”) to $140 from $143 and Step Energy Services Ltd. (STEP-T, “outperform”) to $7.50 from $8. The averages are $8.70, $4.61, $124.28 and $6.50, respectively.

* Jefferies’ Chris Lafemina cut his Barrick Gold Corp. (GOLD-N, ABX-T) target to $18 from $18.50 with a “hold” rating. The average on the Street is $23.26.

* Following its Investor Day event, Credit Suisse’s Ariel Rosa raised his Canadian Pacific Kansas City Ltd. (CP-N, CP-T) target to US$87 from US$81 with a “neutral” rating. The average is US$89.96.

“The company expects mid-single digit EPS growth in 2023, with double-digit annual EPS growth over 2024-28,” he said. “We believe CPKC almost certainly has the best growth prospects among North American rails, but remain concerned about its valuation premium at 27.2 times EPS, well above peer CN at 21 times and U.S. rails average of 17.5 times.”