Inside the Market’s roundup of some of today’s key analyst actions
RBC Dominion Securities’ Maurice Choy remains “positive” on TransAlta Corp. (TA-T) heading into 2023, believing the guidance introduced at its Investor Day event is “conservative” and pointing to a “modestly improved project return forecast for its Clean Electricity Growth Plan.”
Equity analysts on the Street reacted enthusiastically to the company’s plans for the next year, however its shares fell 1.7 per cent on Thursday over concerns about subsidiary TransAlta Renewables Inc. (RNW-T), which plummeted 17 per cent following lighter-than-anticipated expectations for 2023.
“Whilst we wonder if TA’s management anticipated RNW’s negative share price reaction to the strategy update, a prolonged material RNW share price underperformance (particularly versus TA’s shares) should rekindle the prospect of a simplification of TA’s structure (with better economics),” Mr. Choy said.
“TransAlta noted that it expects to prioritize new growth investments within the TransAlta parent company and RNW will continue to retain growth opportunities where it has a right of first offer on organic expansions or where there is a mutual benefit to manage its tax horizon in order to sustain its current dividend.”
TransAlta is projecting earnings before interest, taxes, depreciation and amortization (EBITDA) for 2023 to be in the range of $1.2-$1.32-billion (versus the consensus estimate of $1.216-billion), and free cash flow of $560-$660 million or $2.07-$2.44 per share.
“We have revised our EBITDA estimate to $1,35-billion for 2023 (up from $1.215-billion) and $1.155-billion for 2024 (up from $1.145-billion) to primarily reflect higher power price assumptions in light of recent Alberta forward power price movements, disclosures as part of the 2023 outlook release, as well as lower contributions from RNW-related assets,: he said.
While raising his forecast for TransAlta, which was his sector’s Dark Horse stock pick in the firm’s 2023 Global Energy Outlook, Mr. Choy did lower his target by $1 to $16 to reflect a lower valuation for TransAlta Renewables, keeping an “outperform” rating. The average is $16.36.
“With much of the projects under the 2 GW Clean Electricity Growth Plan potentially staying at TransAlta (versus being dropped down to TransAlta Renewables, and pivoting the EBITDA towards renewables rather than thermal generation) and with the final coal unit in the company’s portfolio shutting down in 2025, we see potential for the stock to be viewed and valued closer to its pure-play renewable peers, which trade higher than TransAlta’s stock and that of its closest peer,” he said.
For TransAlta Renewables, his target dropped to $12 from $17 with a “sector perform” rating. The average is $15.92.
“RNW announced its 2023 guidance that was below our expectations, with an implied payout ratio of 100 per cent,” he said. “In addition, management highlighted the potential for incremental cash taxes of $55 million in 2024 (vs. 2021) due to its upcoming cash tax horizon if no incremental capital is deployed in Canada and Australia. We believe a dividend cut is inevitable, which may increase the prospects of a merger with its parent TransAlta Corporation.”
Elsewhere, CIBC World Markets’ Mark Jarvi downgraded TransAlta Renewables to “neutral” from “outperformer” with a $15 target, down from $17.
“The outlooks for TransAlta Corp. (TA) and TransAlta Renewables (RNW) are diverging,” said Mr. Jarvi. “TA is seeing strong underlying fundamentals and strong FCF growth that allows it to fund more growth in higher-value renewables. On the other hand, RNW’s outlook is quite tempered, with a muted growth outlook given constrained funding capacity and an elevated payout ratio. There’s clearly now questions of dividend sustainability — we believe RNW’s dividend can be maintained, but with little buffer. Ultimately, we believe RNW could be internalized by TA, which would simplify the structure, but there’s no rush to do so, in our view. In the meantime, we believe RNW could languish. While the move lower today might be more severe than warranted, we see few catalysts to lift the shares.”
Others making target adjustments for RNW are:
* Raymond James’ David Quezada to $16.50 from $18 with a “market perform” rating.
“While we see much to like in shares of RNW, including a discounted valuation, attractive dividend yield, and ongoing resolution to challenges at Kent Hills, we believe the outlook described in the company’s 2023 guidance release underscores our view of modest growth relative to peers,” he said. “We have made tweaks to our estimates and reduced our target multiple resulting in our target price moving down ... reflecting the challenges RNW faces in making accretive acquisitions in the current environment.”
* iA Capital Markets’ Naji Baydoun to $15.50 from $17 with a “buy” rating.
“The Company noted that it will remain focused on managing its dividend (including the payout) while pursuing minor project opportunities via dropdowns from TA,” he said. “RNW noted that the expected increase in cash taxes and higher-than-forecast sustaining capex are likely to be a drag on cash flow generation going forward. Overall, we view the updates on RNW as underwhelming; with limited growth expected in the business, we are revising our financial forecasts and price target on the stock.”
* Desjardins Securities’ Brent Stadler to $14 from $17 with a “hold” rating.
“In our view, the release was underwhelming. Although EBITDA was in line with our estimate and the Street, CAFD was well below expectations. The growth outlook was disappointing as RNW acknowledged that accretive M&A is challenging given the current environment and lack of FCF,” said Mr. Stadler.
* Scotia’s Robert Hope to $15 from $17 with a “sector perform” rating.
“TA will be the main focus of renewable growth moving forward with RNW focusing on maintaining its dividend, some organic opportunities, as well as some drop downs from TA. Given the lower RNW cash flow outlook, we move down our target price,” said Mr. Hope.
=====
IA Capital Markets analyst Naji Baydoun thinks it is likely that Algonquin Power & Utilities Corp. (AQN-T, AQN-N) will walk away from its proposed $2.6-billion acquisition of regulated utility assets in Kentucky after the U.S. Federal Energy Regulatory Commission rejected the deal on Thursday.
FERC ruled applicants have “failed to demonstrate that the Proposed Transaction will not have an adverse effect on rates” and “failed to provide adequate information to demonstrate what, if any, effect the Proposed Transaction will have on rates.”
“We don’t see a strong case for AQN to continue pushing forward on this acquisition given (1) minor upfront per share accretion (impacted by the hybrid debt offerings completed earlier this year), (2) the challenging underlying fundamentals of Kentucky Power Company (KP), (3) KP having a lower organic growth and financial profile relative to AQN’s existing utilities (i.e., dilutive to AQN’s portfolio from lower rate base growth and utility return profile), (4) greening the fleet upside within KP being well into the future, and (5) the potential for new applications to FERC to take up to another year,” said Mr. Baydoun. “If the transaction is not concluded, AQN would pay a $65-million termination fee.”
Though he doubts Algonquin will continue to pursue the deal, the analyst thinks investors need to “recalibrate” their outlook for Algonquin regardless.
“Recall that alongside the Q3/22 results, AQN noted that it is ‘evaluating its longer-term targets and financial expectations’; we expect the 2023 Investor Day to help reset growth expectations closer to regulated utility peers (potentially closer to 4-6-per-cent rate base and EPS growth).” said Mr. Baydoun. “Overall, although the shares reacted positively to the FERC order, we continue to see significant near-term risks as AQN attempts to (1) reposition its portfolio for more consistent per share growth, and (2) regain investor confidence via improved execution and strategic initiatives.”
Keeping a “hold” recommendation for Algonquin shares, he cut his target to $14 from $16. The average is $13.60.
“AQN offers investors a balanced mix of growth and income with (1) a diversified business model (regulated utilities & non-regulated power), (2) healthy medium-term growth (4-6 per cent per year Adj. EPS and FCF/share growth through 2026), (3)an attractive dividend profile (more than 9-per-cent yield, 80-90-per-cent long-term Adj. EPS payout target),and (4) upside from additional growth initiatives (including M&A; excluded from estimates/valuation),” he concluded. “We are revising our price target to reflect lower estimates from higher costs and interest expense, as well as the removal of Kentucky from our model.”
Other analysts making target adjustments include:
* Credit Suisse’s Andrew Kuske to US$11 from US$10.75 with an “outperform” rating.
“With this decision, we do not believe AQN will proceed with an effective path to closing the deal – albeit the necessary (and required) maneuvers will likely be made to avoid potential liabilities arising from a ‘true walkaway,’” he said. “Given the concurring views in the decision (that were scathing at multiple levels as was the lead judgement), we revised our AQN estimates to exclude the KP transaction. We remain focused on multiple paths for AQN to restore confidence in the stock as per our past playbook exercises.”
* National Bank’s Rupert Merer to US$12 from US$12.50 with a “sector perform” rating.
=====
An unexpected leadership change and shift in strategic direction has brought significant uncertainty to Loop Energy Inc. (LPEN-T), according to Canaccord Genuity analyst John Bereznicki.
That prompted him to lower his recommendation for the Vancouver-based hydrogen fuel cell manufacturer to “hold” from “speculative buy” previously.
On Thursday before the bell, Loop announced the addition of Paul Cataford to its Board of Directors, while Allan Collings and Peter Johansson have resigned from the board.
“According to Loop, Mr. Cataford is a seasoned executive with more than 30 years of success in finance, governance and strategy with a focus on emerging and high-growth technology companies,” said Mr. Bereznicki. “Loop believes Mr. Cataford’s track record of raising capital for emerging technology companies as well as securing strategic partners and investors will support Loop as it executes its growth plan.
“Loop will also be taking a more targeted approach to capital deployment to preserve cash and accelerate its path to profitability. In our view, these initiatives speak to the difficulty the company (and the cleantech space in general) faces as it attempts to attract capital in the current macro environment. While these initiatives may prove fruitful longer term, we believe they will likely add a further element of uncertainty for shareholders in the near to medium term.”
Increasing his cost of equity assumptions to reflect Loop’s deteriorating share price, the analyst cut his target for its shares to $1.50 from $2.75. The average is $3.20.
=====
Desjardins Securities analyst Chris Li expects the “tug of war” between Canadian staples and discretionary stocks to continue in 2023 with “defensives (ATD, DOL and grocers) likely continuing to outperform at the start.”
“While the risk/reward for discretionary seems favourable, we believe better macro visibility is needed to attract incremental interest,” he said.
“Desjardins Economics’ outlook for next year calls for a short and shallow recession, albeit one that could stretch into 3Q, with risks tilted to the downside as households face higher mortgage-servicing costs. Against the backdrop of high inflation, rising borrowing costs, ongoing geopolitical uncertainty and contracting consumer demand, we expect defensives (ATD, DOL and grocers) to continue to outperform in the near term, supported by good earnings visibility.”
In a research report released Friday previewing the next year, Mr. Li said “clear winners are once again difficult to identify,” seeing staples as “well priced” and discretionaries lacking catalysts. However, he named Alimentation Couche-Tard Inc. (ATD-T) his “top pick” for 2023, citing its “‘all-season’ attributes and reasonable valuation.”
“Our top pick view is based on: (1) sustainable solid c-store trends driven by multiple initiatives (eg Fresh Food, Fast, localized pricing/promo/assortment, new loyalty program) and moderating inflation/higher traffic; (2) funds flow to staples that will benefit from an improvement in macro conditions; and (3) upside to FCF from fuel margins remaining elevated and value creation from a strong balance sheet (acquisitions and/or share buybacks). We believe the valuation is reasonable at 16.3 times forward P/E (vs the long-term average of 17.5 times),” he said
He increased his target for Couche-Tard shares to $72 from $69, maintaining a “buy” rating. The average on the Street is $70.25.
Mr. Li also raised his targets for Loblaw Companies Ltd. (L-T), Metro Inc. (MRU-T) and George Weston Ltd. (WN-T), noting: “We expect near-term grocery fundamentals to remain favourable, with inflation remaining higher for longer, rational competition, improving tonnage (shift to food at home in a recession) and pharmacy/front-store benefiting from the reopening and being recession-resilient.”
His Loblaw target rose to $133 from $120 with a “hold” rating . The average is $136.05.
His Metro target increased to $77, above the $76.10 average, from $73 with a “hold” rating.
For George Weston, his target jumped to $189 from $174, keeping a “hold” rating. The average is $189.14.
“While we expect outperformance to continue in the near term, we are more cautious on a 12-month basis as we believe their premium valuation is vulnerable to moderating food inflation and sector rotation later next year,” said Mr. Li.
=====
In his 2023 preview of the Canadian financial services industry titled Ready to shift gears with easing fears, Desjardins Securities analyst Doug Young thinks the outlook “looks to be tempered,” given the firm’s expectations for a “mild” recession in the first half of the year.
“If this occurs, the market could start looking across the valley midway through next year — a positive for financials, which are not a late-cycle sector,” he said. “With this in mind, we recommend starting 2023 slightly overweight Canadian banks and P&C insurers, and slightly underweight Canadian lifecos. But be ready to pivot. Once we obtain more details on the lifecos’ new accounting guidelines (IFRS 17 and 9), and assuming a constructive equity market environment, we plan to revisit our views on the sector. And while we like the fundamentals for the P&C insurers, the sector outperformed in 2022 in a choppy environment. In a more constructive market environment, we would expect this defensive sector to underperform the banks and lifecos and will be revisiting our views accordingly.”
Mr. Young thinks the setup for banks “looks good,” noting: “The focus will be: (1) net interest margin (NIM) expansion; (2) normalizing provisions for credit losses (PCLs); (3) continued loan growth; (4) disciplined expense management; and (5) the closing and integration of several pending acquisitions. ... The Big 6 excluding BMO trade at a 26-per-cent discount to their historical average P/BV multiples, so arguably a lot of bad news is priced in.”
The analyst named Toronto-Dominion Bank (TD-T) his “top pick” for the year in the sector, keeping a “buy” rating and $105 target. The average is $101.49.
“There are five themes we like,” he said. “First, TD is the most sensitive to interest rates among its Canadian peers and is therefore best-positioned to benefit in a higher interest rate environment in FY23. Second, it has the lowest exposure to capital markets, a segment where we see headwinds for FY23 (similar to FY22). Third, we expect TD to record the highest cash EPS growth in FY23, partially due to the two aforementioned themes, along with the pending acquisition of First Horizon, which we expect to be 5‒7-per-cent-plus accretive to cash EPS in the first full year post-close. Fourth, TD offers exposure to high-quality Canadian and U.S. banking franchises. Fifth, if we back out its Schwab stake from the ‘P’ and ‘E’, the bank trades at 9.5 times our estimated FY23 cash EPS vs 9.2 times on average for the other Big 6 banks excluding BMO (11.2 times for RY and 9.7 times for NA).”
For lifecos, his “top pick” is Sun Life Financial Inc. (SLF-T) with a “buy” rating and $69 target. The average is $66.65.
“There are four themes we like,” said Mr. Young. “First, its medium-term underlying ROE target of 18-per-cent-plus under IFRS 17; while this will get a boost from a book value reduction under the new guidelines, it will be peer-leading. Second, we see several drivers of earnings growth over the coming year — contribution from the DentaQuest (DQ) acquisition and potentially easier comps (1H23) at its U.S. group insurance business, getting to scale and improving conditions in Asia, SLC Management hitting its stride and potential capital deployment. Third, by our math, SLF has $1.0‒1.5-billion-plus in excess capital and debt capacity, and generates an attractive amount of excess capital annually, partially from MFS. Fourth, MFS has been performing well even in volatile equity markets, with margins at the top end of management’s guidance.”
Concurrently, Mr. Young downgraded Power Corp. of Canada (POW-T) to “hold” from “buy” with a $36 target, which is 56 cents lower than the average.
“While its dividend yield and discount to NAV are attractive, we fail to see a near-term catalyst that could push its discount to NAV down further over the coming year. And we have a neutral view on GWO, which is the largest part of POW’s NAV,” he said.
=====
In other analyst actions:
* Wells Fargo’s Praneeth Satish upgraded Pembina Pipeline Corp. (PPL-T) to “overweight” from “equal-weight” and raised his target to $53 from $46. The average on the Street is $50.69.
* Mr. Satish cut TC Energy Corp. (TRP-T) to “underweight” from “equal-weight” with a $58 target, down from $62 and below the $65 average.
* CIBC World Markets’ John Zamparo upgraded Hexo Corp. (HEXO-T) to “neutral” from “underperformer” with a $2.80 target, below the $4.48 average, while Canaccord Genuity’s Matt Bottomley cut his target to 20 cents from 25 cents with a “hold” rating.
“[Thursday’s] 24-per-cent selloff in HEXO seemed mostly a product of a revenue miss, but we support a lower top line if it means focusing on only higher-margin SKUs,” said Mr. Zamparo. “We expect gross margin dollars to rise modestly in the coming quarters while further SG&A cuts are adopted, and HEXO appears likely to achieve positive adjusted EBITDA in FQ2. Furthermore, the company seems set to narrowly avoid triggering its minimum liquidity covenant. Although regulatory tailwinds have turned into disappointments (in the form of SAFE Banking now likely being pushed to 2023), we believe HEXO has made credible progress on attaining profitability and we see fewer downside risks at this stage.”
* National Bank’s Lola Aganga initiated coverage of American Lithium Corp. (LI-X) with an “outperform” rating and $6.25 target. The average is $9.
* KBW’s Michael Brown cut his target for Brookfield Corp. (BN-N, BN-T) to US$41 from US$65 with an “outperform” rating, while CIBC’s Nik Priebe lowered his target to US$53 from US$62 with an “outperformer” rating.
“The ‘new’ Brookfield Asset Management made its trading debut this week, reflecting the creation of a stand-alone pure-play alternative asset manager focused solely on the expansion of fee-bearing capital and fee-related earnings (FRE).” said Mr. Priebe. “We consider BAM a unique entity in the Canadian asset management landscape, with attributes that also distinguish it and make it a standout vs. global peers. We see a lot to like about the asset manager, which: 1) participates in a segment of the market experiencing long-term secular tailwinds; 2) is expected to produce a high-teens FRE growth trajectory; 3) generates very healthy margins; and, 4) is underpinned by a capital-light balance sheet. We consider BAM to be among the best earnings compounders in the Canadian financials universe.”
* National Bank’s Cameron Doerksen raised his targets for Canadian National Railway Co. (CNR-T, “sector perform”) to $175 from $173 and Canadian Pacific Railway Ltd. (CP-T, “sector perform”) to $106 from $105. The averages are $161.43 and $113.26, respectively.
* BoA’s Lisa Lewandowski reduced her Canopy Growth Corp. (WEED-T) target to $3 from $3.50, keeping an “underperform” rating. The average is $4.23.
“2022 was another tough year for cannabis ... 2023 outlook looks like more of the same,” she said.
* After releasing lighter-than-expected box office trends for November and December, Canaccord Genuity’s Aravinda Galappatthige cut his Cineplex Corp. (CGX-T) target to $12.25 from $13 with a “buy” rating. The average is $13.75.
“While investors would be more circumspect around box office expectations in light of the Q4 tracking, we believe that solid spillover from Avatar into Q1/23 and strong slate in early 2023 in its own right could help build confidence in the industry outlook,” he said. “We also see the prospect of a reinstatement of the dividend at some point, potentially late in 2023 or early 2024 as the financial picture stabilizes, unless Cineplex’s interests in Regal Entertainment comes to fruition.”
* TD Securities’ Steven Green raised his target for Eldorado Gold Corp. (EGO-N, ELD-T) to US$9 from US$7 with a “hold” rating. The average is $13 (Canadian).
* CIBC’s Mark Petrie lowered his Empire Company Ltd. (EMP.A-T) target to $42, matching the average, from $45 with an “outperformer” recommendation. Others making changes include: Scotia’s George Doumet to $42 from $42.50 with a “sector outperform” rating and BMO’s Peter Sklar to $39 from $37 with a “market perform” rating.
“After accounting for one-time gains from the REIT, Q2 results were largely in line with expectations. Top line was solid, with same store sales coming in modestly ahead and Voilà delivering healthy results,” said Mr. Doumet. “We saw a strong performance from discount banners (as expected), but more importantly – a strong show in the company’s conventional banners (with positive same store sales). Given where shares are currently trading (6.1 times and 4.6 times NTM [next 12-month] P/E discount to MRU and L, respectively vs. three-year historical discount of 3.4 times and 1.8 times), we believe a few more quarters of sustained performance there could lead to a material narrowing of EMP.a trading discount. Strong gross margins were offset by higher SG&A (investments in Horizon). Lastly, the company quantified the impact of the cybersecurity event at $25-million (10 cents per share).”
* Canaccord’s Yuri Lynk bumped his H2O Innovation Inc. (HEO-T) target to $3.25 from $2.75 with a “buy” rating. The average is $3.41.
“As a water pure play, we believe HEO is well-positioned to benefit from several secular growth trends driving investments in water infrastructure, including the heightened focus on ESG, increased funding in the U.S. via the Infrastructure Investment & Jobs Act, and increasing water scarcity,” he said.
* IA Capital Markets’ Matthew Weekes raised his Shawcor Ltd. (SCL-T) target to $15.50 from $14, keeping a “buy” rating. The average is $14.84.
" We continue to view the current valuation as an attractive entry point for buy-and-hold investors as SCL looks toward the final stages of its strategic transformation,” he said. “Beyond a pipe coating sale, other potential catalysts include (a) the Q4/22 results (first three quarters have all beat in CS and A&I segments), and (b) a smaller sale of the pipeline inspection services business.”