Inside the Market’s roundup of some of today’s key analyst actions
Recent share price depreciation has brought a higher return potential for TransAlta Corp. (TA-T), according to iA Capital Markets analyst Naji Baydoun, who sees its overall upside remaining “significant.”
Also pointing to the “continued strength” in the Alberta power market, he raised his recommendation for the Calgary-based company to “strong buy” from “buy” on Thursday.
“TA’s shares have depreciated by almost 16 per cent since our rating revision in early July; commentary that tempered the outlook for H2/22 likely affected sentiment in the stock following the Q2/22 results, in our view (despite beating expectations),” said Mr. Baydoun. " Fundamentally, the near-term outlook for Alberta power prices remains healthy (we have increased our near-term forecasts), which could support strong financial performance in H2/22 (leading to revised guidance and higher estimates).
“TA’s shares are currently trading at approximately 7.0 times FY2 estimated EV/EBITDA and 7.0 times FY2E P/FCF; this is below (1) TA’s historical average trading multiple (8.0 times FY2E EV/EBITDA), and (2) peer averages (4.0-5.0 times FY2E EV/EBITDA discount to peers vs. 3.0 times discount historically).”
Mr. Baydoun thinks TranAlta’s share price does not currently place much value in its clean energy transition plan, and he sees “significant valuation multiple re-rating potential in the shares as management executes on its growth strategy (transforming TA into a lower-risk, more diversified, and predominantly renewable power IPP).”
“Overall, we continue to see the potential for the shares to be worth closer to $18-20 per share, with both downside protection and upside optionality from Brookfield’s strategic support,” he said. “Furthermore, we see the potential for TA to actively repurchase shares at current stock price levels; the Company bought back $18-million of shares at $12.50/share on average in Q1/22, and its existing buyback program could support an additional 3-per-cent reduction of outstanding shares ($0.50/share uplift to valuation by our estimate). We also see the potential for TA to increase its buyback envelope (depending on share price levels and immediate funding needs for growth), which could provide additional downside protection for the stock.”
He also sees TranAlta “poised to execute on its substantial growth ambitions on a self-funded basis” based on “elevated” near-term free cash flow generation, which is ”supported by the elevated power price environment in Alberta.”
“So far in 2022, the Company has (1) announced positive FID on 200MW of renewable power capacity (with an additional 100-300MW of growth announcements expected over the coming months), (2) expanded its development pipeline (positioning it to deliver on its 2025 objectives), (3) successfully executed recontracting initiatives (particularly for Sarnia), (4) continued to advance the rehabilitation of Kent Hills, and (5) made steady progress on its ongoing growth projects on time and on budget,” said Mr. Baydoun.
The analyst maintained a $16.50 target for TranAlta shares, matching the current average on the Street.
“We consider TA our preferred merchant and value IPP play in the Canadian IPP sector,” he said. “TA offers investors (1) a balanced mix of contracted and merchant power exposure, (2) improving balance sheet and cash flow fundamentals, (3) long-term upside to rising Alberta power prices, (4) a discounted relative valuation versus IPP peers, and (5) both downside protection and upside optionality from Brookfield’s strategic support. We continue to like TA’s clean energy transition plan, which we believe should (1) reduce the Company’s risk profile, (2) drive additional growth, and (3) support valuation multiple expansion over time.”
In a separate research note, Mr. Baydoun raised his financial forecast for Capital Power Corp. (CPX-T) based on “strength” in the Alberta power market, seeing it “well positioned” to benefit from price upside.
“Alberta power prices have materially increased over the past few months, driven by a combination of higher demand (due to hot weather) and some supply constraints,” he said. “Based on current forward pricing, power prices in Alberta could potentially (1) exceed recent historical record levels in H2/22,and (2) reach $100/MWh+ in 2023.
“CPX is one of Alberta’s incumbent power generators, and currently operates a large portfolio of merchant capacity in the province. Based on the Company’s latest hedging position, we see substantial upside to H2/22 expectations and 2023E financial forecasts from higher Alberta power prices. We expect an update from management on the Company’s hedging alongside the Q3/22 results, and believe that CPX can strike the right balance between reducing risk (via a certain level of prudent hedging) and maintaining some upside optionality to rising power prices. Overall, if CPX can capture the upside associated with higher power prices in Alberta, we see the potential for upward revisions to 2022 financial guidance and 2022-23E financial estimates. We have updated our financial forecasts to partially reflect this potential upside, which translates into a higher valuation.”
Mr. Baydoun thinks the Edmonton-based company’s “strong” financial position brings the potential for further self-funded growth.
“CPX has already exceeded its annual capital deployment target ($500-million) with the pending co-acquisition of an 1.6GW operating natural-gas power facility in the U.S. (50-per-cent net ownership stake to CPX); however, incremental near-term cashflow generation could support further growth initiatives on a self-funded basis. Overall, we continue to estimate that CPX can deliver low single-digit average annual cash flow per share growth through 2026, which supports its 10-12 per cent per year total shareholder return objective. Despite this positive fundamental outlook, based on (1) the year-to-date share price appreciation in CPX’s shares, and (2) current & historical IPP peers’ valuations, we currently see better relative value elsewhere in the sector.”
Reiterating a “hold” recommendation for Capital Power shares, Mr. Baydoun increased his target by $2 to $50. The average is currently $52.35.
“CPX offers investors (1) a mix of contracted and merchant cash flows, (2) long-term leverage to the Alberta power market, (3) some growth (low single-digit FCF/share growth through 2026), (4) an attractive income profile (4.5-per-cent yield, 6 per cent per year dividend growth through 2025, with an 45-55-per-cent payout), and (5) a discounted relative valuation versus IPP peers. We are increasing our price target to reflect higher near-term forecasts,” he concluded.
While cautioning growth drivers for Aurora Cannabis Inc. (ACB-T) “remain unclear” after “mixed” fourth-quarter results, ATB Capital Markets analyst Frederico Gomes raised his recommendation to “sector perform” from “underperform” previously “as a result of a stronger balance sheet (net cash position of approximately $162-million) and an improved risk-reward given the recent stock pullback.”
After the bell on Tuesday, the Edmonton-based company reported revenue of $50.2-million and adjusted gross profit of $23.9-million, both in line with Mr. Gomes’s expectations. However, an adjusted EBITDA loss of $12.9-million fell short of his forecast (a loss of $9.2-million).
“Sales remained flat quarter-over-quarter, with a 7-per-cent decline in medical cannabis sales offset by a 22-per-cent increase in consumer cannabis sales, driven mostly by the consolidation of Thrive (quarter-over-quarter growth would have only been 8.7 per cent otherwise),” he said. “The weakness in medical cannabis demonstrates that international sales remain lumpy, though management cited progress in Germany, Poland, the UK, and Australia. ACB continues to focus on cost-cutting measures as it pursues adj. EBITDA profitability by Q3/FY23, with guidance of bringing SG&A and R&D below $35-million in Q1/FY23 and exiting Q2/FY23 under $30-million (relative to $49.3-million in Q4). The Company also announced it will change its fiscal year-end to March 31, such that FY2023 will encompass only three quarters.”
While Mr. Gomes said he sees Aurora’s cost-cutting efforts “favorably,” he cut his target for its shares to $2 from $3, citing “the limited visibility into the value, timing, and achievability of international medical sales growth (much of which relies on regulatory developments beyond ACB’s control).” The average target on the Street is $2.74.
Elsewhere, others making changes include:
* Stifel’s W. Andrew Carter to $1.75 from $2.15 with a “hold” rating.
“We believe the shares are likely to trade sideways and generally in-line with cannabis stocks until tangible proof points emerge for the ability to drive underlying sales growth while realizing the benefits of the cost savings given what remains a rich valuation for the shares on EV/EBITDA basis,” said Mr. Carter.
* CIBC World Markets’ John Zamparo to $2.25 from $2.50 with a “neutral” rating.
Ahead of third-quarter earnings season, National Bank Financial analyst Cameron Doerksen is maintaining a neutral stance on Canadian National Railway Co. (CNR-T) and Canadian Pacific Railway Ltd. (CP-T).
“Notwithstanding an uncertain macroeconomic backdrop, the volume outlook for CN and CP in H2/22 has arguably improved supported by a significantly better Canadian grain crop (Western Canadian grain crop expected to be 55 per cent higher this year compared to the drought-stricken crop last year and likely better than expectations a few months ago) and strength in other commodities, such as potash,” he said. “Revenue and earnings growth for both rails are also currently being boosted by a weaker Canadian Dollar. We expect solid Q3 results from both railroads and a strong finish to 2022. We nevertheless remain somewhat cautious on both stocks.”
In justifying his stance, Mr. Doerksen pointed to a pair of factors:
* The growing risk of a recession
“If anything, the risk of a recession has grown in recent months and while neither CN nor CP is so far seeing any major red flags, volume growth could be more at risk in 2023 as the housing market softens and the North American consumer becomes more strained from high inflation and higher interest rates,” he said. “Based on their respective exposures to more consumer-driven end markets (intermodal, forest products, automotive), about 45 per cent of CN’s revenue and 35 per cent of CP’s revenue could be directly impacted if the economic slowdown worsens. Based on historical precedent, Canadian railroad stocks will likely outperform much of the broader transportation stock universe in a recession, but we nevertheless see the broader economic uncertainty as a check on higher share prices in the short-to-medium-term.”
* Valuations concerns
“We still do not find the relative valuations of CN and CP particularly compelling, especially given the growing recession risk which we do not think is factored into the earnings outlooks for either railroad,” he said. “The current consensus forecasts imply 2023 EPS growth of 10.1 per cent for CN and 21.9 per cent for CP (noting that most CP estimates for 2023 incorporate the merger with KCS which is driving a large part of the year-over-year earnings growth). On those consensus 2023 earnings forecasts, where the risk is arguably skewing to the downside, CN trades at 19.6 times P/E and CP at 21.4 times, both premiums to the U.S. peer average of 15.6 times. In past economic slowdowns for the rail industry (most recently in early 2020 and prior to that in the 2015-16 timeframe), rail valuations contracted below the current trading multiples (CN and CP traded down to the 16-17-times forward P/E range in early 2016).”
However, after revealing his fiscal 2024 financial forecasts he raised his target prices for both companies, keeping “sector perform” recommendations.
For CN, his target jumped to $173 from $166. The average on the Street is $161.42.
“CN will enjoy volume tailwinds from grain and some other longer-term organic growth opportunities, but the company’s larger exposure to more economically sensitive volumes and a not overly compelling valuation keeps us neutral on the stock,” he said. “We are introducing a 2024 forecast for CN and are therefore rolling the basis for our valuation forward by one year. To reflect the lower visibility on earnings from an out-year forecast, we are also lowering our valuation multiple to 20 times P/E (prior valuation was based on 21 times our 2023 EPS forecast).”
His CP target increased to $105 from $98, below the $107.33 average.
“Given its large exposure to grain, CP will enjoy stronger volumes in the second half of 2022, but we still see the primary upcoming catalyst for the stock being the outcome of the KCS merger review process,” said Mr. Doerksen. “We continue to believe the STB will ultimately approve CP’s merger with Kansas City Southern with minimal concessions and we remain positive on the strategic benefits and long-term growth prospects of the merged company. The STB will hold public hearings on the proposed merger at the end of September and a final decision is still expected sometime in Q1/23. We are also rolling the basis for our valuation on CP to our newly introduced 2024 forecast, which we think better reflects the potential synergies from the KCS merger.”
Emphasizing its “attractive dividend yield supported by strong returns on equity,” Canaccord Genuity analyst Christopher Koutsikaloudis initiated coverage of MCAN Mortgage Corp. (MKP-T) with a “buy” recommendation on Thursday.
“MCAN’s access to low-cost deposit funding, coupled with greater exposure to single-family residential mortgages where origination activity is more stable, enables the company to operate with higher leverage than peers, which should result in higher returns on equity (ROE),” he said. “Over the past five years, MCAN has generated an ROE of, on average, 14.2 per cent, compared to 8.3 per cent from its Canadian MIC peers. MCAN’s healthy return profile supports an attractive dividend yield of 9.6 per cent based on the current share price, which we believe is sustainable notwithstanding recent adjustments in the Canadian housing market.”
Seeing alternative lenders, like Toronto-based MCAN, currently trading below average earnings multiples, Mr. Koutsikaloudis set a target of $18.25. The average is $18.13.
“Challenging” market conditions are creating a “clear dislocation” between Enthusiast Gaming Holdings Inc.’s (EGLX-Q, EGLX-T) operations and share price, said H.C. Wainwright Scott Buck after meeting with the Toronto-based company’s management at his firm’s annual global investment conference.
“Importantly, the company has yet to see any meaningful deterioration in advertising demand, despite growing uncertainty surrounding the macro economic environment in North America,” he said. “In fact, the company continues to develop new advertising opportunities, most recently developing NFL Tuesday Night Gaming, in cooperation with the National Football League. This multi-year collaboration pins current and retired NFL players against members of the gaming community in popular videogame competition. On September 12, 2022, the company announced its first sponsorship deal with streaming service Hulu, a current NFL advertising partner. We expect additional advertising partners to be announced in coming weeks.”
Mr. Buck thinks Enthusiast is likely to reach its target of achieving breakeven or positive adjusted EBITDA by the fourth quarter, pointing to “meaningful operating leverage in the business model as the company’s higher margin business lines, including direct sales and subscription services continue to see higher levels of revenue growth.”
“Despite progress towards stated targets, market conditions continue to be challenging for small capitalization technology companies, resulting in a year-to-date decline of 61.9 per cent in EGLX shares, versus a 21.5-per-cent decline in the Russell 2000,” he noted. “As a result, EGLX shares currently trade at just 0.8 times 2023 Street revenue estimates, which compares to an average 2.7 times since the company began trading in 2019.
“We continue to see a significant opportunity in EGLX shares, especially as the company begins to deliver positive adj. EBITDA and continues to grow revenue at more than 20.0 per cent. However, we cannot ignore the broader market sentiment.”
Accordingly, he trimmed his price target to US$4 from US$6, keeping a “buy” rating. The average is $6.52 (Canadian).
“As the long-term opportunity remains significant, we recommend investors take advantage of current market conditions to accumulate undervalued EGLX shares,” Mr. Buck said.
In other analyst actions:
* Stifel analyst Cole Pereira initiated coverage of Cathedral Energy Services Ltd. (CET-T) with a “buy” rating and $1.65 target. The average is $1.70.
“From 2019-2020 CET struggled with declining market share and profitability but since President & CEO Mr. Tom Connors was brought on in 2021 the company has conducted six acquisitions, and we forecast it to achieve 2023 market shares of 21 per cent in Canada and 7 per cent in the U.S., vs. 5 per cent and 1 per cent, respectively in 2020,” he said. “We believe investors should consider taking positions in CET for three main reasons: (1) its unique strategy to consolidate the highly fragmented directional drilling market; (2) its strong management team with a solid track record in the sector; and (3) its attractive valuation at 1.9 times 2023E EV/EBITDAS vs. the sector average of 3.1 times and its closest peer PHX-TSX at 2.6 times.”
* Following Tuesday’s Investor Day event, Scotia Capital’s Michael Doumet bumped up his Badger Infrastructure Solutions Ltd. (BDGI-T) target to $38.50 from $38 with a “sector outperform” rating. The average is $35.34.
“For investors, we think the simplified takeaway is: following several years of heavy lifting, all the pieces are now in place – now look for Badger to execute, grow, reinvest, and compound,” said Mr. Doumet. “The road for BDGI has been bumpy since 2019. BDGI has evolved into to a more coordinated and professionalized business, but the operational adjustments added costs and compressed margins. COVID made things much harder. However, at this juncture, the foundation appears strengthened and, with its operational groups aligned and its sales/marketing capabilities expanded, we see a clearer path for margins to expand in the coming quarters/years with higher utilization and more trucks.”
* Canaccord Genuity’s Tania Armstrong-Whitworth lowered her target for Medexus Pharmaceuticals Inc. (MDP-T) to $2.75 from $3.50, below the $4.45 average, with a “speculative buy” rating.
* Taking a “more conservative stance with respect to near-term mortality rates and cadence of recovery in pre-need sales and M&A,” RBC’s Irene Nattel cut her Park Lawn Corp. (PLC-T) target to $44 from $49 with an “outperform” rating ahead of its Sept. 29 Investor Day, which she thinks should " provide better clarity on the latter along with organic growth levers, opportunity to leverage FaCTS and the path to 2026 EBITDA target US$150-million.” The average is $40.89.
“We are raising the discount rate we apply to our ten-year target by 150 bps to 11.5 per cent consistent with similar tweaks across our universe of coverage,” said Ms. Nattel. Relative to other SMID-cap names in our universe, our revised discount rate is consistent with NBLY, another high-growth, roll-up story with a demographic tailwind, a premium to PET (9 per cent) to reflect relative mix of organic vs M&A driven growth, and a modest discount to ATZ (12 per cent) reflecting the latter’s more discretionary positioning. We reiterate our favourable long-term view and recommend investors benchmark valuation against broader attributes, namely: i) defensive, relatively inelastic demand, ii) demonstrated resilience through downturns, iii) demographic tailwind, and iv) industry fragmentation with succession challenges.”
* In response to the announcement of a structural failure of the plant feed conveyor belt at its Elkview steelmaking coal operation in B.C., CIBC’s Bryce Adams reduced his Teck Resources Ltd. (TECK.B-T) target to $56.50 from $58, keeping an “outperformer” recommendation. Others making changes include: Raymond James’ Brian MacArthur to $56 from $57 with an “outperform” rating and BMO’s Jackie Przybylowski to $48 from $50 with an “outperform” rating. The average is $51.79.
“Teck has lowered its coal sales volume guidance for Q3/22 to reflect a plant outage at the Elkview mine and recent labour action at Westshore Terminals. Accordingly, we are reducing our estimated coal sales for the quarter to the midpoint of the new guidance range. We have also modestly cut our Q4/22 estimated coal sales estimate given Teck expects the Elkview outage will last for two months,” said Ms. Przybylowski.
* TD Securities’ Craig Hutchison lowered his Trilogy Metals Inc. (TMQ-T) target to $1.15, below the $1.67 average, from $1.30 with a “hold” rating, while Scotia’s Eric Winmill cut his target to $1.50 from $2.50 with a “sector perform” rating.
“Trilogy Metals announced that the US Bureau of Land Management (BLM) published a notice of intent that it will prepare a Supplemental Environmental Impact Statement (SEIS) for the proposed Ambler Mining District Industrial Access Road,” said Mr. Winmill. “Comments relating to the preparation of the SEIS will be accepted for 45 days and BLM expects that the draft SEIS will be published in Q2/2023, after which time public comments will be accepted on the draft SEIS.
“We view the update as mixed for TMQ shares. While we are encouraged to see a new prescribed timeline for the required Ambler Access Road, we expect investors to adopt a wait-and-see approach pending the release of the supplemental draft EIS targeted for Q2/2023.”
Editor’s note: An earlier version of this article provided an incorrect price target for shares of MCAN Financial Group from Canaccord Genuity. The firm's target is $18.25.