Inside the Market’s roundup of some of today’s key analyst actions
Analysts at TD Securities lowered their recommendation for equities in Canada’s energy sector on Thursday to “market weight” from “overweight” alongside “significant” changes to their oil price assumptions.
“We are updating our commodity price deck, industry forecasts for Q3/23 actuals, and sector outlook,” they said. “Relevant adjustments to our commodity price outlook include raising 2024E WTI to US$80/bbl from US$70/bbl, and reducing 2024E NYMEX to US$3.40/mcf from US$3.50/mcf, while lowering 2024E AECO to C$2.95/mcf from C$3.15/mcf. Despite these changes to our commodity price outlook that we view as net positive, we believe E&Ps continue to exercise caution following the steep reduction in crude oil and natural gas prices earlier this year. As a result, we are making modest downward revisions to our Canadian and U.S. drilling activity forecasts for both 2023 and 2024.
“We previously expected that pent-up demand resulting from wildfire activity in Q2/23 would have had a positive impact on Q3/23 activity in Canada, and while we expected declines in U.S. activity, the reductions to the rig count were more severe than expected. As a result, many companies in our coverage universe feature downward estimate revisions. That said, we are pleasantly surprised by the level of pricing discipline exhibited by the peer group during a period of eroding demand. Based on the factors outlined above, 2023 and 2024 EBITDAS estimates for the coverage universe decrease by an average of 1.5 per cent and 2.6 per cent, respectively.”
While the firm sees valuations remaining “attractive” across the sector, it warned stock selection is “more important” in the near term, particularly for energy producers.
“The Integrateds are currently trading at a 2024 estimated strip FCF [free cash flow] yield of 17 per cent (vs. 15 per cent in late-June), and the smid-caps at 17 per cent (vs. 14 per cent in late-June),” the analysts said. “However, we believe many investors/producers still anchor to US$60-US$70/bbl ‘mid-cycle’ prices, meaning much less confidence in the long-term strip. Therefore, the temptation to crystallize significant trailing-three-year gains is now higher, and while stock selection always matters, it matters even more today, in our view.
“Lastly, we note that the sharp rally off the bottom for the XEG/WTI and IYE/WTI ratios has stalled out. This may also represent a marginally less bullish tone and less temptation to ‘chase the strip’.”
With that view, TD downgraded a group of stocks. They are:
* Crew Energy Inc. (CR-T) to “hold” from “buy” with a $7 target down from $7.50. The average is $7.92.
Analyst Aaron Bilkoski: “Crew has a large BC-based Montney portfolio that is well-positioned along key pipelines. The company has done an impressive job in recent years, growing volumes and reducing debt. Ultimately, we believe this will become a key strategic asset once LNG-Canada has started. However, on the back of lower forecast growth through 2025, no return-of-capital strategy, and a comparable valuation to the group, we are lowering our rating to HOLD.”
* Kelt Exploration Ltd. (KEL-T) to “hold” from “buy” with an $8 target . Average: $8.79.
Mr. Bilkoski: “Operationally and strategically, there is much we like about Kelt. However, even after we apply a historically robust (versus three-year average) multiple to cash flow predicated on a relatively robust commodity price, we do not calculate a 12-month return that meets the threshold for a Buy rating. As such, we are lowering our rating to HOLD.”
* North American Construction Group Ltd. (NOA-T) to “hold” from “buy” with a $36 target. Average: $40.40.
Analyst Aaron MacNeil: “NACG continues to diversify its operations outside the oil sands with its recent acquisition of MacKellar. Alongside the transaction, we increased our terminal multiple in our NAV to 7.0x, and we are reluctant to make a case for further multiple expansion at this time as we believe investors have already priced in NACG winning its fair share of oil sands contract renewals that are expected in Q4/23 and strong execution on the MacKellar transaction. That said, our implied return to target is no longer sufficient to justify a Buy rating. As a result, we are downgrading our recommendation to HOLD (from Buy previously) with an unchanged $36.00 target price.”
* Suncor Energy Inc. (SU-T) to “hold” from “buy” with a $52 target, up from $49. Average: $51.42.
Analyst Menno Hulshof: “With [Thursday] morning’s concurrent commodity price deck change, our new target price of $52 per share reflects a 14-per-cent target return, which is below our 20-per-cent-plus threshold for BUY-rated stocks.
“Arguably lacking positive near-term operating momentum vs. peers: While SU’s new CEO, Mr. Rich Kruger, has wasted no time in driving positive changes and cost-structure improvements, the Q2/23 cyber-incident, which management considers financially immaterial, somewhat overshadowed these initiatives. In our view, it could take several quarters for the Street to factor in the upside associated with ongoing improvements.”
* Trican Well Service Ltd. (TCW-T) to “hold” from “buy” with a $5.50 target, down from $6. Average: $5.94.
Mr. MacNeil: “Our downgrade to HOLD and reduced target price of $5.50 ($6.00 previously) are a function of both its significantly increased share price and downward revisions to estimates. In our view, Trican’s outlook remains robust, and believe it continues to pursue initiatives that create shareholder value, including its long-term commitment to share buybacks, recently introduced dividend, accretive upgrades to low-emission frac fleets, and maintaining price discipline.”
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National Bank Financial analyst Vishal Shreedhar expects Dollarama Inc. (DOL-T) to “increasingly explore global acquisitions as a growth vector.”
“There are several reasons supporting this view, including: 1. Dollarama’s demonstrated ability to export its business model to different geographies, as evidenced by the success of Dollarcity (DC); 2. Strong cash generation, in excess of needs, and high/stable ROIC (highest in our coverage at 24.8 per cent, versus the average of 12.9 per cent), suggesting strong utility on marginal growth capex; 3. Diminished attractiveness of share buybacks amid higher interest rates and a possible 2.0-per-cent net share buyback tax; and 4. Media speculation that Dollarama had aimed to acquire The Reject Shop, an Australian discount retailer,” he said.
However, in a research report released Thursday, Mr. Shreedhar predicts the discount retailer’s focus will likely remain on domestic growth as well as further development of its holdings in Latin America. Returning excess cash to shareholders “to the extent it’s accretive” will also be a priority.
“We believe that Dollarama’s otherwise conservative management team has been emboldened by the ongoing success in Canada and across numerous regions in Latin America,” he said. “Similarly, we believe that investors would give Dollarama latitude to explore acquisitions and export its business model to other countries.
“We believe acquisitions could be beneficial if executed in the right region, at the right price and with the right strategy (adhering to Dollarama’s operating approach/customer proposition).”
Seeing its balance sheet as “supportive” of a potential deal of up to $1-billion but expressing a preference for the acquisition of a smaller company that it could grow organically, Mr. Shreedhar maintained an “outperform” recommendation and $104 target for Dollarama shares. The average on the Street is $101.46.
“We believe Dollarama has a compelling and credible growth vector in inorganic expansion. That said, continued growth in existing markets is the key driver for the stock in the interim,” he said. “We hold a positive view on DOL’s shares given its defensive growth orientation supported by strong cash flows, a solid balance sheet and resilient sales performance.”
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Citing its relative underperformance and widening valuation discount, ATB Capital Markets analyst Amir Arif raised his rating for Gear Energy Ltd. (GXE-T) to “outperform” from “sector perform” following Wednesday’s announcement of a strategic review.
“The stock has meaningfully underperformed the group since the dividend cut announced with second-quarter earnings on July 26,” he said. “Although only 17 per cent of the float has turned over since the dividend cut, the stock has meaningfully underperformed and the relative discount valuation to the sector has widened. [Wednesday’s] announcement of a strategic repositioning review is the impetus for our upgrade.”
After the bell, the Calgary-based company said it has initiated a strategic repositioning process with a plan to explore moves to enhance shareholder value. It acknowledge it has been “approached by a number of parties interested in potential transactions,” but it has not yet received a formal proposal.
“GXE has underperformed the group by 29 per cent over the past two months alone, despite its higher oil weighting,” said Mr. Arif. “As a result, the Company now trades at 2.7 times 2024 strip EV/DACF [enterprise value to debt-adjusted cash flow]. Additionally, on a consensus forward EV/EBITDA basis, the valuation to the group has widened from a 0.7 times discount to a current 1.7 times turn discount. Given the relative underperformance, the wider discount to the group, current strip valuation, high oil weighting of 81 per cent (86 per cent based on total liquids), and the start of a strategic review process, we upgrade the stock to Outperform.”
The analyst maintained a target of $1.50. The average is $1.20.
“The Company has been improving its sustainability with an improved balance sheet, capital allocation to waterfloods, and capital spending to reduce remaining ARO,” said Mr. Arif. “The Company’s asset base remains heavy oil-focused with plenty of drilling opportunities in its three core areas – Lloydminster, SE Sask, and Central Alberta. The improving sustainability and economic drilling should allow Gear to maintain modest production growth while spending significantly less than cashflow. Additionally, Gear provides meaningful torque to movements in WCS and WTI pricing given its heavy-oil weighting.”
In a separate note, Mr. Arif raised his target for Surge Energy Inc. (SGY-T) to $13 from $12.50, reaffirming an “outperform” recommendation following meetings with its management. The average is $12.30.
“We believe that the outperformance showing up for SGY stock is in its infancy,” he said. “Heading into 2024, we view SGY as very well positioned, with room for a dividend bump, significant further debt reduction, a firming up of its current open hole multilateral successes, and optionality for to find additional pockets where open hole multilaterals would make economic sense on its existing acreage − highlighting the free call option associated with its large oil in place. Additionally, divcos like SGY are well positioned to be consolidators and acquirers in its existing core areas of Sparky and SE Sask, and with the equity markets opening up on both sides of the border, the potential for accretive acquisitions could also enter the picture in 2024. Finally, as highlighted in our Chart of the Day on September 15, we believe SGY offers among the best exposures in the midcap space for WTI sensitivity, from both a CFPS sensitivity perspectives as well as a stock price sensitivity associated with EBITDA trading multiples. Therefore, despite the move up in the stock stemming from the late-June rally in crude, we believe that SGY has significantly more room to run given its current 2024 strip valuation of 3.0 times 2024 EV/DACF.”
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Following Wednesday’s release of “mixed” fourth-quarter results, H2O Innovation Inc. (HEO-T) is likely to continue to face a significant drag on profitability from weaker demand for maple farming equipment, according to Desjardins Securities analyst Frederic Tremblay.
However, he thinks Quebec City-based company’s water solutions business is “well-positioned to capture incremental opportunities” within a rapidly growing market.
“While maple’s 4Q difficulties were disappointing, management is taking actions to mitigate the headwind in FY24 and position its maple operations for a recovery,” he said. “Meanwhile, HEO’s core category — water —continues to fire on all cylinders. Its record backlog, persistent organic growth levers, margin improvement efforts and potential acquisitions bode well for the future. We believe HEO’s depressed valuation offers a buying opportunity.”
Before the bell on Wednesday, H2O reported total revenue of $65-million, up 24.8 per cent year-over-year and exceeding Mr. Poirier’s $56.7-million estimate. Adjusted EBITDA of $3.1-million fell short of his $4-million forecast and fell 34.2per cent year-over-year.
“4Q FY23 results had pluses (water) and minuses (maple),” he said. “On the positive front, demand is persistently strong across HEO’s broad portfolio of water and wastewater treatment products and services, as shown by the 4Q revenue beat, double-digit organic growth and a record backlog. The strength of water-related businesses (85–90 per cent of total revenue) in 4Q was partly offset by the impact of weak maple syrup production in Quebec (down 60 per cent year-over-year in 2023) on demand for HEO’s maple farming equipment.
“HEO posted a seventh consecutive quarter of double-digit organic growth (16.1 per cent) .... Revenue exceeded our expectations in all three segments, with WTS and Specialty Products posting the largest beats. The challenges in the maple business contributed to a 34.2-per-cent year-over-year decrease in adjusted EBITDA to $3.1-million vs our $4.0-million forecast (consensus $4.5-million). We believe the difference vs our forecast is largely explained by the maple headwind being slightly larger than we had thought (we had assumed a $1.5-million hit).”
While noting the company is taking actions to counter the softness in the maple industry, inccluding price adjustments and cost structure, Mr. Poirier sees “rising tide” for water solutions.
“Backlog of $250-million is a new record and HEO looks well-positioned to capture other opportunities within the buoyant water/wastewater market in both industrial (reshoring, water reuse adoption) and municipal (upcoming deployment of stimulus money),” he said. “Following the 4Q profitability miss, we believe investors will closely monitor efforts to improve consolidated margins. We were therefore pleased to hear that margins embedded in the WTS backlog are superior to historical levels. Other tailwinds include price increases on certain specialty products, CPI adjustments in O&M and the insourcing of some product manufacturing. In terms of cost inflation (eg wages, materials), management sees more stability on the horizon.”
Seeing its financial position “supportive” of growth initiatives, he trimmed his target for its shares to $3.50 from $3.65, maintaining a “buy” recommendation. The average on the Street is $3.67.
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Acumen Capital analyst Jim Byrne thinks Sangoma Technologies Corp.‘s (STC-T, SANG-Q) near-term outlook is “a little less clear” as its new leadership group delineates their strategy.
Alongside the release of in-line fourth-quarter results on Wednesday, the Markham, Ont.-based company suspended its 2024 earnings guidance as “part of a strategic transformation led by the Company’s new CEO, Charles Salameh to position Sangoma for long-term success and sustainable growth.”
“We believe the long-term story for Sangoma is stronger now with the new senior leadership team in place,” said Mr. Byrne. “They are an experienced team with the opportunity to take the company to the next phase of its development. The focus on assembling the right services mix, the proper bundling of those services, and targeting the best markets for STC should happen over the next few quarters.”
The analyst emphasized the new team is “confident in the continued growth in the higher margin services revenue stream, which should support margins in similar levels to the past number of quarters.”
Maintaining a “buy” rating for Sangoma shares, he trimmed his target to $8 from $10 “mainly due to lower valuation multiples.” The average is $11.52
“STC shares trade at a significant discount to the peer group and we believe the shares are quite attractive at these levels,” he said. “Like STC, peers such as 8x8 and Ring have been under pressure with significant margin compression in the past two years.”
Elsewhere, others making target adjustments include:
* Canaccord Genuity’s Robert Young to US$8 from US$10 with a “buy” rating.
* Cormark Securities’ Gavin Fairweather to $11.50 from $14 with a “buy” rating.
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Benoit Poirier, an analyst at Desjardins Securities, reaffirmed his bullish stance on Stella-Jones Inc. (SJ-T) after hosting marketing meetings earlier this week, saying management’s “positive tone” increased his confidence and believing “future capital deployment should unlock value for long-term investor.”
“Given SJ recently completed two acquisitions (not part of 2025 targets) as well as the robust demand across many categories, its 2025 targets are poised for upward revisions, in our view,” he said.
“Strong market fundamentals across utility poles and railway ties. Key levers include (1) an ageing network, (2) more recurring weather events, (3) heavier loads requiring bigger poles, (4) increased demand for electricity due to EVs, and (5) the sizeable ongoing infrastructure plan in Canada and the US. The acquisition of 1 million additional untreated railway ties should provide greater availability to better serve non–Class l/ commercial customers, which have a better margin profile and should impact 2024 revenue positively.”
Mr. Poirier said he’s confident the Montreal-based manufacturer of pressure treated wood products can expand its 2024 EBITDA margin through increased exposure to utility poles and the incremental tie opportunity.
“Street consensus assumes 16.1 per cent, which is too pessimistic, in our view,” he said. “Recall that each 1 per cent improvement in EBITDA margin creates $7 per share of value.”
“SJ reiterated that the US$100–150-million of acquirable wood-treating revenue is still on the table, but it remains focused on the core business and will likely not expand into new adjacent markets in the short term. We believe SJ is well on track to achieve its investor day target of more than $500-million of capital returned to shareholders by 2025.”
The analyst maintained his “buy” rating and target of $82 for Stella-Jones shares. The current average on the Street is $77.
“In an environment of increased market volatility, we believe SJ’s return profile is quite compelling for a company with resilient attributes (90 per cent of demand for railway ties and utility poles is driven by maintenance),” he said.
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In other analyst actions:
* In response to Wednesday’s release of its quarterly financial report, CIBC’s Nik Priebe reduced his target for AGF Management Ltd. (AGF.B-T) to $8.25 from $8.50 with a “neutral” rating. The average target on the Street is $9.11.
“AGF’s Q3 results were largely in line with expectations,” he said. “We remain bearish on the outlook for industry fund sales given the persistence of an elevated interest rate environment and the financial strain being felt by consumers. AGF continues to outperform the industry on the basis of long-term fund sales, but we do not foresee a sustained recovery in the trajectory of industry flows being a tailwind in the near term. The next important step in AGF’s evolution is expected to be the acquisition of a private markets business. We continue to await an update on this front and acknowledge that the company has ample liquidity to execute on M&A without diluting its share structure.”
* After resuming coverage following Skyline Champion’s $185-million equity investment, Mr. Priebe also lowered his target for ECN Capital Corp. (ECN-T) to $2.75 from $3 with a “neutral” rating. The average is $3.21.
“We interpreted the new partnership to be a net positive to ECN shareholders, along with a constructive update on the expansion of funding relationships,” said Mr. Priebe. “We continue to rate the stock Neutral as we await more convincing signs that a natural demand recovery is materializing in ECN’s core markets, but acknowledge that there is a lot of torque to the upside.”
* Canacord Genuity’s Aravinda Galappatthige raised his Cineplex Inc. (CGX-T) target to $14, above the $13.17 average, from $12.25 with a “buy” rating.
* JP Morgan’s Jeremy Tonet trimmed his Enbridge Inc. (ENB-T) target to $56 from $58 with an “overweight” rating. The average is $56.30.
* Cormark Securities started Mdf Commerce Inc. (MDF-T) with a “buy” rating and $5.50 target, exceeding the $4.56 average on the Street.
* RBC’s James McGarragle lowered his target for Stelco Holdings Inc. (STLC-T) to $41 from $43 with a “sector perform” recommendation. The average is $45.42.
“We update our Q3 estimates to reflect our updated steel price forecast, recent channel checks, and conversations with management teams at Russel (on September 20th) and Stelco (Wednesday),” he said. “Overall, our Q3 estimates decrease on lower steel prices. We flag valuation at both companies as well below peers, which we view as unwarranted. Key focus into the quarter at Stelco will be on the pricing outlook and colour on the auto strike and at Russel on potential M&A, which we would view as a meaningful catalyst given in our view declining private market valuations and significant dry powder to execute on deals.”
“Russel and Stelco both continue to trade at a discount to peers, which is unwarranted in our view reflecting solid operational performance at both companies and similar end market demand drivers. Russel trades at a 19-per-cent discount to the group, below its trailing 10-year average premium. Stelco is trading at 3.6 times NTM [next 12-month] consensus EV/EBITDA, versus blast furnace peers both at roughly 5 times.”
David Leeder