Inside the Market’s roundup of some of today’s key analyst actions
Husky Energy Inc. (HSE-T)’s decision to abandon its hostile takeover offer for MEG Energy Corp. (MEG-T) is “very negative” for MEG shareholders in the near term, according to AltaCorp Capital analyst Nick Lupick.
“Heavy oil weighted mid-cap energy producers have seen their equity value fall by an average of 40 per cent since July 2018 (when Canadian differentials began to widen materially), a decrease that MEG was insulated from due to the offer from Husky – with the stock falling 22 per cent over the same time period,” he said.
That led Mr. Lupick downgrade his rating for MEG shares to “underperform” from “tender.”
“With the recent reduction in our commodity price outlook and the ongoing uncertainty in the global landscape, we now see MEG’s leverage ratios escalating to 11.3 times in 2019 and 7.7 times in 2020 on the ACC price deck,” he said. “As of Sept. 31, the company has $3.5-billion of long term debt due between 2023-2025. In the event that commodity prices do not recover in the medium term (as we expect them to) we believe that it will be unlikely that MEG’s stock outperforms the Large Cap Integrated space.”
His target for the stock fell to $8 from $10.25. The average on the Street is currently $9.31, according to Bloomberg data.
“The continued weakness in the commodity will weigh on MEG’s standalone equity value with our sum-of-the-parts NAV amounting to $8.00 per share, implying an implied target return of negative 6 per cent compared to today’s share price,” said the analyst. “As a result we are revising our rating … Recall that our previous target price of $10.25 per share was based on the takeover offer from (and price target of) Husky. Our price target is based on our standard 1.0-times multiple applied to our risked PV10 net asset value (NAV) per share of $8.03.”
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Emphasizing “exploring new opportunities brings risk,” Raymond James equity analyst Kurt Molnar downgraded his rating for shares of Peyto Exploration & Development Corp. (PEY-T) in reaction to the release of its three-year strategic plan after market close on Wednesday.
The Calgary-based energy company revealed the scheme in order to “address the natural gas price crisis currently affecting the entire Alberta natural gas market and Canadian natural gas producers.” Its initiatives included a cut to its monthly dividend of 67 per cent (to 2 cents per share from 6 cents); a reduction in its 2019 capital expenditure budget by $100-million (to a range of $150-$200-million from $250-$350-million) and the introduction of new strategic ventures, such as “actively marketing midstream processing opportunities.”
“We have long argued that dividends for any capital intensive commodity business are only rarely appropriate, and should always be modest,” said Mr. Molnar. “We have doubly argued, that management teams that are particularly strong at capital allocation and operations execution, should also pay minimal dividends. This doesn’t mean that all retained capital should be spent at all times. Capital retained and kept on the balance sheet simply offers the potential to be opportunistic and adds a large degree of confidence and flexibility in business plans. So with all that said, those were the broad stroke benefits we see in the announced new strategic direction from Peyto.”
Moving the stock to “market perform” from “outperform,” Mr. Molnar added: “The net effect for the investor will be less near-term growth, less income and an acceleration in debt reduction. In the mid to longer term, the intent is obviously an improved and more differentiated business model. It was becoming increasingly debatable that Peyto was no longer the pinnacle lean gas stock opportunity versus its peer group. The space has become crowded with many challenging for that title while the macro for natural gas prices remains muted precisely due to too many highly competitive lean gas business models. So reducing capex and dividends just to buy back stock in a business model whose competitive position had become more challenged probably was an alternate strategy rightly rejected by Peyto. Rather, Peyto has chosen to conserve capital and future financial flexibility for future differentiating business investments (gas storage, 3rd party processing of other producers gas and/or selling gas to power gen). Which all makes perfect sense (and is a tangible way to strengthen competitive position), but the pay-offs from these efforts are going to take time.”
His target for Peyto shares dropped to $7.50 from $12. The average target on the Street is $10.54, according to Bloomberg data.
“Given that we expect weakness in the stock relative to that new target we obviously have to also downgrade our recommendation from Outperform to Market Perform as directly comparable lean gas peers can offer production growth, free cash flow growth, dividend growth and rapidly dropping D/CF ratios,” he said. “Until valuation adjusts lower, and/or tangible progress on new efforts can be seen, the market will likely seek out other lean gas options as preferable investments in the near-term at least. Our target comes from our standard sum-of-parts valuation.”
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Though he expects “good” fourth-quarter results from Genworth MI Canada Inc. (MIC-T), CIBC World Markets analyst Paul Holden downgraded its stock to “underperform” from “neutral” with the expectation of a “muted” 2019 outlook.
“We believe that the two primary drivers of earnings growth, lower claims losses and higher short-term interest rates, have largely played out,” the analyst said. “In addition, the outlook for housing volumes and premium growth is relatively muted. We view Genworth largely as a return of capital story and we are not sure that is enough to generate excess returns. Unlike most of the stocks in our coverage universe MIC has not priced lower for potential economic risks, despite the fact that it might be the most economically sensitive name we cover.”
Mr. Holden maintained a $45 target for Genworth shares. The average on the Street is $48.50.
“Genworth Canada is one of the few stocks in our coverage universe that is not trading at a discount to its historical valuation multiples,” he said. "Price-to-book value is at a modest premium to its historical average (roughly a 5% premium).
“The Canadian banks, which are also economically sensitive names with housing exposure have seen more multiple pressure. Since the financial crisis, Genworth Canada has traded at a forward price-to-earnings discount of 26-per-cent relative to the Big-6 banks. That discount has been narrowed by more than half and currently stands at 11 per cent.”
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Citing a “skewed” risk-reward proposition for investors, RBC Dominion Securities analyst Mark Mihaljevic lowered his rating for shares of Alio Gold Inc. (ALO-T, ALO-N).
Moving the Vancouver-based miner to “underperform” from “sector perform,” Mr. Mihaljevic pointed to a trio of factors: ongoing operational challenges, including the suspension of active mining at its San Francisco mine in Mexico and a lower output forecast for its Florida Canyon mine in Nevada; limited near-term free cash flow with a “tight” balance sheet and a “less attractive” valuation.
“Our NAV [net asset value] for Alio has declined to $2.13 per share from $2.69 after updating our model for the new mine plan at Florida Canyon, suspension of San Francisco, and updated assumptions for Ana Paula. While recent updates have reduced uncertainty around the shares, our overall valuation has declined and Alio's relative valuation appears less attractive,” said the analyst.
He maintained a target price of $1.50 per share, which falls below the average on the Street of $2.04.
“We believe driving a re-rating will require: (1) demonstrating FCF upside at Florida Canyon; (2) outlining a longer-term strategy for profitability at San Francisco; and (3) strengthening the balance sheet,” Mr. Mihaljevic said.
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In a separate note, Mr. Mihaljevic also downgraded Hecla Mining Co. (HL-N) to “underperform” from a “sector perform” rating, expecting a “challenging” 2019 for the Idaho-based precious metals company.
“We believe Hecla's operating outlook is challenged given the slow turnaround of the recently acquired Nevada operations, declining production from San Sebastian, and ongoing strike at Lucky Friday,” he said. “The turnaround of under-invested and challenging underground mines is typically a slower and more capital intensive process than originally expected. Specifically, we expect limited FCF from the Nevada assets until at least 2021 given (i) increased development and rehabilitation needs at Fire Creek to ramp-up output by H2/19, (ii) limited contribution from Hollister beyond 2019, (iii) capital expenditures to bring the Hatter Graben into production by late-2020, and (iv) elevated exploration spending.
“As expected, San Sebastian's cash flow potential has declined as mining transitioned underground. While Hecla is evaluating extending the life by mining sulfide ore from the Hugh zone, we estimate only limited upside given the underlying cost structure and relative grades. We continue to expect the ongoing strike at Lucky Friday to persist, with limited production forecast until 2021. On a positive note, Casa Berardi delivered a strong 2018 with record throughput and improving cash flow after a significant effort to revitalize the operation (see our recent site visit note). At Greens Creek, we model a 10-per-cent improvement in grades in 2020/21 given the opportunity to accelerate mining of a higher grade zone.”
Also emphasizing a “limited” free cash flow forecast, projecting only 3 US cents per share in 2019 given limited contributions from both its Nevada and San Sebastian projects, he lowered his target for its stock to US$2.75 from US$3.25. The average on the Street is currently US$3.30.
“With the company generating limited near-term cash flow and ending 2018 with only $27-million in cash, we believe Hecla's financial leverage is elevated for the current market,” he said. “At spot prices, we estimate the company ending 2019 with net debt-to-EBITDA of 2.26 times, which is at the upper-end of the precious metals universe and noting we do not expect a material improvement until 2021.”
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TMAC Resources Inc. (TMR-T) has “world-class potential” with its 100-per-cent-owned Hope Bay underground gold operation in Nunavut, said Canaccord Genuity analyst Rahul Paul.
He initiated coverage of its stock with a “speculative buy” rating on Thursday.
“[Hope Bay] is materially derisked to production, entails very low geopolitical risk (located in Nunavut, Canada) and host to a large high-grade resource (6.6 million ounces at 8.1 grams per ton) that holds significant expansion and exploration upside,” said the analyst. “Hope Bay benefits from less than US$2-billion spent over 30 years including infrastructure investments that enable efficient operations in the Arctic.
“The ramp-up to steady state (2,000 tons per day throughput, 91-per-cent recovery) appears to be nearing completion. Plant upgrades/optimizations to mitigate the challenges have shown results, including record performance in Q3/18 (1,385 tpd, 80-per-cent recovery) and a further improvement in October (1,900 tpd, 82 per cent). Additional gravity concentrators, installed in November, are expected to better recover ultra-fine gravity gold, taking recoveries to design levels. Due to the high fixed costs, ramping up production should also significantly lower all-in sustaining costs (we forecast US$746/oz by fiscal 2020 vs US$1,452/oz in FY18) and increase free cash flow (we estimate C$161-million in FY20, representing a 35-per-cent FCF yield).”
Mr. Paul thinks a large reserve life points to the potential for expanded production, lower AISC and a boost in free cash flow once the plant is fully operationally.
“We believe an expansion could be very accretive considering the infrastructure investments already in place, relatively low capital associated with increasing plant throughput, and the relatively high fixed costs,” he said. “We are not aware of any expansion plans (and no guidance has been provided), but our conceptual analysis suggests that a potential expansion to 4,000 tpd could boost annual production up to 427,000 ounces, lower AISC to US$537 per oz and add C$5.04 per share (44 per cent) to our NAVPS estimate. Our current valuation and forecasts assume no expansion beyond design throughput of 2,000 tpd.”
His target for TMAC shares was set at $8.50. The average on the Street is now $8.30.
“TMR trades at 0.50 times price-to-NAV, in line with junior producer peers,” he said. “Considering the low geopolitical risk, large resource base and significant expansion/exploration upside, we see the potential for a premium pending completion of the ramp-up. These attributes should also enhance the company's appeal as an M&A target for a senior producer seeking production and reserve growth in Canada.”
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The current valuation for Kneat.com Inc. (KSI-X) does not properly reflect expected revenue inflection in a large market, according to Mackie Research Capital analyst Nicola McFadden, who initiated coverage of software company with a “buy” rating.
“On a 2020 basis, Kneat trades at 6 times sales versus U.S. software and SaaS [software as a service] companies at 7 times 2020 Sales and Canadian companies at 6 times, with 2020 year-over-year revenue growth at 20 per cent and 15 per cent respectively,” she said.
“That said, we believe KSI’s valuation and upside to become increasingly compelling as the company demonstrates a revenue inflection towards the $20-million of ARR [average recurring revenue] from contracts already signed (total revenue will naturally attain that level sooner, we expect in 2022).”
Ms. McFadden set a target price of $2.50 per share, falling below the consensus target of $3.
“Our target has upside from additional contract wins and the pace of contract win to revenue conversion,” she said.
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In other analyst actions:
National Bank Financial analyst Leon Aghazarian downgraded New Look Vision Group Inc. (BCI-T) to “sector perform” from “outperform” with a $34 target, falling from $38 and below the average of $38.25.
Mr. Aghazarian raised Savaria Corp. (SIS-T) to “outperform” from “sector perform” with $17 target. The average is $18.75.
David Leeder