Wednesday's analyst upgrades and downgrades

Share

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

Metro Inc.'s (MRU-T) third-quarter financial results were "short on summer sizzle," according to Raymond James analyst Kenric Tyghe, who emphasized the grocer's stock is "still a buy."

"We believe that investors should look through the largely mix-driven F3Q17 miss (on EPS of 78 cents versus consensus of 79 cents), and that the 2018 wage inflation fears' impact on earnings power currently priced into the grocery group overstates the reality," said Mr. Tyghe. "While our estimate revisions provide for cost pressures on (what we characterize as) the comically short notice, largest proposed minimum wage increases in a generation, we believe that the potential mitigating actions are more pronounced than recognized."

Noting inflation for fresh products turned positive in June, Mr. Tyghe said the inflation backdrop is "more favourable than imputed" by Metro's "mixed" quarterly results, which were impacted by weather.

"While 0.3-per-cent fresh inflation in June doesn't sound particularly captivating, it is the first positive read since August of 2016 (and the comps get easier through at least April 2018)," he said.

"Metro reported a SSS [same-store sales] decrease of 0.2 per cent on internal food deflation of 1.0 per cent (versus Food CPI of a decline of 1.9 per cent) as challenged industry traffic upped the competitive ante. There is some consistency in grocer reporting on the impact of a rained out early summer (BBQ) on traffic (and mix) and the increased (but rational) promotional activity."

Mr. Tyghe did lower his 2017, 2018 and 2019 earnings per share projections to $2.58, $2.68 and $2.92, respectively, from $2.63, $2.77 and $2.98.

"While there was lot that was working well in the quarter, it was (literally and figuratively) clouded by very atypical weather that negatively impacted sellthrough of higher priced (and margin) BBQ friendly cuts of meat and supporting fresh items (further compounded by the impact on traffic in Quebec of the timing of key public holidays)," he said. "We remain buyers of Metro."

Keeping an "outperform" rating on the stock, his target price fell to $48 from $52. The analyst consensus price target is $48.73.

Elsewhere, Desjardins Securities analyst Keith Howlett kept a "buy" target and $48 target.

Mr. Howlett said: "The scheduled minimum wage increase in Ontario on January 1, 2018 is unusually large, and poses a significant headwind. Our expectation is that Metro will offset the increase over a 1–2-year period through cost reductions and price increases. The benefits of available labour-saving technologies and alternative work processes will be revisited. Metro's earnings will benefit from full control of Adonis stores in FY18 as well as higher earnings from Couche-Tard."

CIBC World Markets analyst Mark Petrie lowered his target to $46 from $48 with an unchanged "neutral" rating.

"Metro remains a best-in-class operator, but faces a modest pick-up in competitive activity, slow top-line growth and the 2018 challenge of navigating a minimum wage hike in Ontario," said Mr. Petrie. "Though the stocks of grocers and retailers overall have come under pressure, we still see limited catalysts to push the valuation higher."

=====

Multiple questions linger following the second-quarter financial results for RMP Energy Inc. (RMP-T), according to Raymond James analyst Kurt Molnar, who suggested its "equity value" has taken a significant hit.

Predicting a harsh reaction from the Street, he downgraded the stock to "underperform" from "market perform."

On Monday, the Calgary-based company reported production for the quarter of 3,556 barrels of oil equivalent per day, topping his estimate of 3,200 boe/d, driven by gas and NGL volumes. Oil volumes and total liquids leverage both missed his expectation. Combined with higher operating costs, cash flow of $2.8-million missed his forecast of $3.4-million.

"The 2Q news noted the new management team would 'develop the appropriate go-forward business plan in light of the current commodity price environment and prevailing capital market conditions,'" said Mr. Molnar. "This statement is a real consideration/challenge for all small cap business models today but perhaps doubly so for RMP in light of the commodity cocktail and water-cut news from RMP's Elmworth thus far. Add into this that RMP is in the midst of a borrowing base review right now and we expect the market may react poorly to this news. It is admittedly early days, and better news may yet follow, but investors have not reacted well to 'surprises' in recent weeks and months. We did not hear from management [Monday] night on questions around some of the issues noted herein, so a future discussion may moderate our concerns but we will also need to learn whether the newly started infrastructure is appropriate for the potential of higher than anticipated gas or higher than anticipated water. This may or may not be an issue. We simply don't know at this time."

"In the absence of explicit guidance from RMP we have maintained a 4,500 Boed production forecast for the 2H of 2017 but have reduced oil leverage. We actually bumped up total production in 2018 but reduced oil production and increased gas leverage. All of these changes consume balance sheet more rapidly than previously forecast, and most importantly, reduce expected cash netbacks/returns on invested capital. The last of these points is frankly the most 'damaging' to the prospect of equity value in our view. Further discussions with management may prove our initial concerns to be overdone but this kind of market merits caution."

After lowering his revenue and cash flow per share projections for both 2017 and 2018, Mr. Molnar dropped his target price for the stock to 40 cents from 60 cents. Consensus is 80 cents, according to Thomson Reuters data.

"We note that RMP has a large land position at Elmworth (80+ sections) offset by neighbors enjoying success with the drillbit," he said. "This frankly means that the RMP business plan does have options available as even raw land in this neighborhood is valued by others and having more than one interested party offers RMP the potential for gaining some bid tension should they choose to seek value in their lands. But in the immediate context, we are left to judge value and recommendation based on total capital likely available, and the likely return on capital going forward, if recent well news is the norm."

=====

BMO Nesbitt Burns analyst Alex Terentiew downgraded Nevsun Resources Ltd. (NSU-T) in reaction to a "disappointing" technical update for its Bisha mine in Eritrea.

"Along long with the Q2/17 earnings, management provided an updated Bisha technical report, which saw the mine life shortened to four years from eight years, with management deciding to mine a smaller pit over four years, as opposed to the deeper open pit due to what it sees as the deeper pit having higher execution risk with significant capital injections," said Mr. Terentiew. "While management believes that the deeper pit remains an option, the longer mine life would have required higher capital allocation, unlikely to be funded from current operating cash flows, while almost doubling ore and waste movement from approximately 22 million tons to 40 million tons in 2019."

"Recoveries, one of our main areas of focus of the technical report, have consistently improved since the zinc circuit achieved commercial production in Q3/16, but management's focus in Q2 on improving copper recoveries took attention away from the zinc circuit, leading to the first decline in Zn recoveries since commercial production. However, despite these improvements, potential upside to recovery rates has been trimmed, with management's best estimate for Zn and Cu recoveries of 77 per cent and 70 per cent, respectively, to be achieved at the latest by Q2/18, which is below the previous technical report guidance of 80 per cent and 85 per cent, respectively. Given the pre-existing recovery issues, however, we had already assumed long-term recoveries of 73 per cent for Zn and 70 per cent for Cu (new estimate of 73 per cent and 68 per cent)."

In response to the update, Mr. Terentiew's net asset value projection for Nevsun fell 19 per cent to $3.77.

That prompted a downgrade of the stock to "market perform" from "outperform" and a lower target price of $3.25 (from $4). The consensus price target is $4.38.

"While our estimates were pre-emptively conservative, the updated technical report disappointed by decreasing the reserve estimate and the life of mine by over 50 per cent, demonstrating that management is taking a more cautious tone with the focus now being on Timok [in Serbia]," he said.  "With Timok's upcoming PEA, however, we are taking a more conservative approach, given the disappointing Bisha update from the new management team. Our near-term estimates, however, have risen as Nevsun pursues the higher-grade, but shorter life mining option at Bisha."

=====

CanniMed Therapeutics Inc.'s (CMED-T) industry-leading production track record and "advanced" revenue mix "position it well competitively," according to Echelon Wealth analyst Russell Stanley.

"CMED has been the strongest performing cannabis stock in our tracking group over the last month, which we attribute to an overdue re-rating of its multiple that has not yet run its course," he said.

Mr. Stanley initiated coverage of the Saskatoon-based company with a "speculative buy" rating.

"CanniMed just completed its IPO last December ($69-million at $12.00 per share), though it actually has 3 times the production history of its closest peers, having been the sole cannabis supplier to Health Canada from 2001 to 2014," he said. "We believe this gives CMED a significant advantage over competitors that are still 'early days' in their production story. Approximately 49 per cent of the company's revenue now comes from the sale of high-value cannabis oils, which is the largest revenue share amongst its peer group. Many producers have only recently obtained their licenses to sell cannabis oils, and only a handful of them have developed oil sales to a meaningful share of revenue thus far. We therefore believe CMED has a demonstrated ability to develop and monetize new products, which we view as a competitive necessity for mid/long-term success in this industry."

Mr. Stanley set a price target of $14 for CanniMed shares. The analyst consensus price target is $15.35.

"We view calendar 2019 as the most relevant year for valuation purposes, as that should be the first full year with a legalized recreational/adult-use market in Canada," he said. "While we expect CMED to continue its focus on the medical market, we believe the bulk of the peer group has eyes on the adult-use market, making the multiples for C2019 the most relevant from an investor perspective."

=====

Though HNZ Group Inc. (HNZ-T) suffered through a "noisy" second quarter, "significant" improvement is expected, according to Desjardins Securities analyst Benoit Poirier.

On Monday, the Quebec-based company, an international provider of helicopter transportation and related support services, reported revenue for the quarter of $56.4-million, a drop of 2 per cent from the previous year and missing the projections of both Mr. Poirier ($63.7-million) and the Street ($62.1-million). The result was due largely to lower onshore activity in Western Canada and the completion of an Asia-Pacific contract.

Adjusted earnings before interest, taxes, depreciation of $6.6-million (11.7-per-cent margin) also missed the analyst's estimate $10.2-million (16 per cent) and the consensus ($9.6-million and 15.5 per cent). Adjusted earnings per share of 12 cents also fell well short of expectations (30 cents and 29 cents, respectively).

"Management still expects the ramp-up of four long-term contracts signed over the past nine months to add $90-million per year of sustainable revenue for at least the next three years," said Mr. Poirier. "According to management, these contracts should improve HNZ's profitability significantly in 2H17 and 2018. It also expects a stronger 2H, driven by a more normal contribution from wildfires, which drive higher margins. Management referred to the absence of these contracts vs a year ago as a reason for the margin compression in 2Q17 (HNZ was more actively involved with wildfires during 2Q16 due to large fires in Fort McMurray)."

Though he lowered his 2017 EPS projection from a 19-cent profit to a 9-cent loss and his 2018 estimate to 67 cents from 76 cents, Mr. Poirier did note "tough" market conditions are also affecting HNZ's peers.

"Current market conditions continue to put pressure on industry players' results," he said. "On Aug. 3, Bristow (BRS-N) reported weak results, with revenue and adjusted EBITDA down 5 per cent year over year and 20 per cent year over year, respectively, and adjusted EPS of an 83-cent (U.S.) loss versus a 34-cent loss a year ago due to the difficult offshore oil & gas environment. PHI (PHIIK-Q) also reported challenging results, with adjusted EPS of a loss of 21 cents (U.S.), also due to the challenging oil & gas environment. Overall, market participants are still waiting for a recovery in the oil sector and continue to diversify their exposure into less commodity-dependent services, such as medical and rescue services.

"HNZ currently sees nine sizeable opportunities at the bidding stage. This compares with 12 as of 1Q17, although it excludes opportunities from Norway (following the divestiture of Norsk). These opportunities are equally distributed between offshore oil & gas production and exploration support operations. Nevertheless, we believe HNZ is well-positioned to win opportunities, given its lower cost structure vs some competitors."

Mr. Poirier maintained a "buy" rating for the stock and dropped his target price to $16 from $17. Consensus is $15.75.

"We are encouraged by management's confidence in improving profitability, despite the declining demand for helicopter services in this low commodity-price environment," he said. "In addition, we believe HNZ's balance sheet should remain strong, as FCF generation and profitability are expected to improve, reinforcing its credibility vs peers in connection with long-term contract bids. In the meantime, the fleet appraisal value of $12/share should provide downside support, especially at the current valuation."

=====

Desjardins Securities analyst Gary Ho lowered his target price for Mosaic Capital Corp. (M-X) in response to weaker-than-expected second-quarter financial results.

On Monday, the Calgary-based company reported adjusted EBITDA of $5.4-million, missing both Mr. Ho's $8-million projection and the $7.6-million consensus. Free cash flow of $1.7-million also missed his $3.5-million forecast.

"Adjusted EBITDA in the infrastructure segment was below our forecast due to softness in the western Canada economy, weather and increased competition," said Mr. Ho. "Corporate expenses were above our estimate but were partially offset by solid results in the diversified segment."

"Income from legacy businesses was reduced by a decrease in contracting activity and increased pricing competition, partially offset by incremental income from new investments. In 2H17, management expects this segment's financial performance to post strong year-over-year growth, driven by contributions from Cedar and Bassi more than offsetting the slowdown in the western Canadian businesses. In addition, 3Q is typically a strong quarter for construction businesses and management has already begun to see positive quarter-to-date results."

Mr. Ho said he's "less fussed" about weather-related issues, but he warned that weakness in the economy in Western Canada and the impact of increased competition could persist.

Maintaining a "buy" rating for the stock, his target fell to $8.50 from $10.75. Consensus is $10.31.

He said: "Our investment thesis is based on: (1) the company's disciplined M&A approach, (2) aging business owners fuelling the M&A pipeline, (3) benefits through affiliation with a strong financial backer (Fairfax), (4) business diversification from growth outside of western Canada, and (5) its track record of dividend increases."

Elsewhere, expecting the third quarter to offset a "disappointing" second quarter, Canaccord Genuity analyst Raveel Afzaal lowered his target price to $7.75 from $8.50 with a "buy" rating (unchanged).

"We believe string of weak quarterly results has taken the steam out of the story following excitement over Fairfax financing secured at the end of last year," said Mr. Afzaal. "However, we expect performance to improve in H2/17. This coupled with recent share price decline and upside from new potential acquisitions results in our recommendation remaining a BUY."

=====

It's hard to know where the earnings bottom is for Dick's Sporting Goods Inc. (DKS-N), said RBC Dominion Securities analyst Scott Ciccarelli.

After second-quarter financial results failed to meet projections, he downgraded the retailer to "sector perform" from "outperform."

"After better-than-expected results following last year's [Sports Authority Inc.] liquidation, industry consolidation has driven an unpredictable pricing environment, elevated channel inventories, and broadened vendor distribution, even as DSG is accelerating its promotional cadence to protect share," said Mr. Ciccarelli. "While the consolidation should be positive for DKS over the long-term, earnings risk is high and could last into 2018 and beyond, in our view."

On Tuesday, the company reported quarterly earnings per share of 96 cents (U.S.), missing the analyst's projection by 2 cents and the guidance of $1.02 to $1.07. Comps were up a mere 0.1 per cent, below the analyst's estimate of 1.6 per cent and guidance of 2-3 per cent.

However, Mr. Ciccarelli said management "took a hatchet" to its second-half expectations, with EPS now at $2.85-$3.05, down from $3.65-$3.75. He projects comps are expected to be negative 2-3 per cent based on the guidance.

"There are negative conference calls … and then there was [Tuesday's] DKS call – Management tried to be blunt in its assessment that industry trends remain in great disarray, even highlighting how irrational many players had become," the analyst said. "In their view, pricing had become 'unpredictable' from many players, including both retailers and vendors. They also commented that the market seemed 'almost panicked' from a pricing standpoint. This is the environment that DSG is operating in and, in management's view, may be the 'new normal' for margin rates, which is likely to continue into 2018. While we appreciate their candor, it was difficult to walk away from the conference call without thinking that things could get even worse than what was outlined today.

"Proactive price investments can boost share over time, but it's painful while it is going on – We think many retailers are going to have to move to 'price matching' Amazon, just to put themselves on more-even competitive footing from a pricing standpoint. In addition, and perhaps more importantly, DSG also plans to aggressively and proactively lower prices to improve positioning and consumers' 'price impression' versus a multitude of competitors, including Amazon; brick-and-mortar retailers (e.g., sporting goods retailers, department stores); and, more recently, even some vendor DTC programs. As we have previously detailed, we think that price matching Amazon (along with improving its own e-commerce capabilities, providing an improved store environment and accelerating vendor partnerships – all of which DSG is trying to do) was a key element of Best Buy's turnaround strategy. However, this was a painful process. From 2010-2012, Best Buy's GMs declined by 110 basis points and GP$s dropped by $500-million – leading into the price match strategy. However, once price match started (2012-2013), GMs dropped another 150 bps and GP$ fell by almost another $800-million. Thus, while we think the more aggressive price stance was critical to Best Buy's turnaround success, it was painful while it was going on."

Based on the guidance, Mr. Ciccarelli cut his third-quarter EPS estimate to 28 cents from 56 cents with his fourth-quarter forecast at $1.11 from $1.53. His full-year projection for 2017 is now $2.87 from $3.60 with his 2018 estimate dropping to $3.02 from $4.00.

His target price for the stock fell to $29 from $46. Consensus is $39.71

"The key part of our thesis when we upgraded DKS (and called it a 'trade' at that time) was that we believed the company should be a major beneficiary of industry consolidation," said Mr. Ciccarelli. "In our view, DSG should end up with 'last man standing' benefits, much like what Best Buy seems to enjoy today. However, the disruption in the sporting goods space has become so aggressive in such a short period of time, that we believe earnings risk will be greatly heightened for the foreseeable future. Unfortunately, this renders normal valuation work moot, because it is hard to have a high degree of confidence in the earnings outlook. As a result, despite the sharp drop in DKS shares, we are moving to the sidelines until we can gain more clarity and confidence in the near-to-mid term outlook."

BMO Nesbitt Burns analyst Wayne Hood dropped his target to $37 from $62, but he kept an "outperform" rating.

Mr. Hood said: "Management is making the correct decisions to 1) reset margin rate and use its strong balance sheet in the short term to protect/grow market share, 2) slow new store growth to capture future lower rent rates; and 3) lessen the dependence on national brands by developing private brands. The stock's correction leaves us seeing more upside than downside risk asthese strategies are implemented."