Inside the Market’s roundup of some of today’s key analyst actions
Canadian railway traffic appears to be “on the mend,” according to Raymond James analyst Steve Hansen, who thinks 2020 looks “better” for both Canadian National Railway Co. (CNR-T, CNI-N) and Canadian Pacific Railway Ltd. (CP-T, CP-N).
“As previously indicated, stiff traffic headwinds emerged last fall across three key categories, namely: Grain (late harvest), Crude-by-Rail (Alberta production caps, low spreads), and Potash (international contract dispute),” said Mr. Hansen in a research note released Tuesday.
“Forestry and Frac sand were also highlighted as segments facing structural headwinds. Three months later, after significant pressure across all three categories, we now see this same trio of headwinds rapidly fading. Frac sand has also staged a surprising move to the upside.”
Mr. Hansen said his constructive view of the two railway companies still “favours” CP, seeing headwinds subsiding and traffic turning positive toward the end of the fourth quarter of 2019.
“CP 4Q19 traffic more clearly demonstrates the fading ‘Big 3’ headwinds described,” he said. “After starting the period deep in the red (RTMs [revenue ton miles]: down 12.8 per cent first 5 weeks), QTD [quarter-to-date] volumes finished week 13 down only 3.7 per cent, with the past 4 weeks flirting intermittently with positive territory—largely thanks to a sharp upturn/ recovery in Potash, Grain, and Crude.”
Pointing to “the carrier’s obvious traffic momentum, healthy 2020 growth prospects, and superb operating track record,” Mr. Hansen raised his target price for CP shares to $365 from $340, keeping an “outperform” rating. The average on the Street is $342.47, according to Bloomberg data.
Though he said he’s “slowly warming” on CN, he lowered his target to $130 from $135 with a “market perform” rating (unchanged), citing “the railroad’s more significant lingering headwinds.” The average is currently $123.28.
“Exacerbated by an 8-day strike, CN 4Q19 QTD traffic/RTMs ended down 13.3 per cent year-over-year, with the most significant weight experienced in PetChem. (down 21.4 per cent, tough CBR comps), Coal (down 20.1 per cent, weak exports), Metals & Min. (down 11.7 per cent, sand-driven, weaker E&P activity), and Forest Products (down 12.8 per cent, B.C. curtailments),” said Mr. Hansen. “While the strike clearly magnified these 4Q declines, we note that material pressure was evident across these same categories prior to the strike.”
=====
Canaccord Genuity analyst Dalton Baretto sees a “more positive” environment for industrial commodites, particularly copper, in 2020.
“Key to this thesis being realized will be a perceived comprehensive deal between the U.S. and China on the trade front,” said Mr. Baretto. "With U.S. President Donald Trump up for re-election in November, we believe his administration will be significantly motivated to present the American public with a deal. As such, we believe the onus remains on Chinese President Xi Jinping, and we believe Mr. Xi will be more motivated to come to an agreement given a slowing economy at home and rising political pressure from the Hong Kong protests and the Uyghur situation. With a Phase 1 deal (however opaque) being announced in December, we believe further, and accelerated, progress is likely over the course of 2020.
“In the absence of progress on the trade front, we continue to expect further fiscal and monetary stimulation by Central Banks around the world, particularly in emerging markets where low inflation relative to interest rates provides substantial headroom.”
Mr. Baretto said copper is his preferred commodity for the year, seeing “tightness” in the physical market. He also said he’s “modestly constructive" on metallurgical coal based on current prices, while he sits neutral on iron ore and zinc.
“We remain constructive on the outlook for industrial commodities in 2020, but we also acknowledge the significant macroeconomic uncertainty,” he said. “As such, we advocate exposure to companies with sound financial and operational outlooks, positive company-specific catalysts, relatively attractive valuations and meaningful share price leverage to copper. Our preferred picks are LUN [Lundin Mining Corp.] among the larger producers and CS [Capstone Mining Corp.] among the smaller producers.”
In his research report, which also reviewed 2019 performance, Mr. Baretto lowered his rating for Trevali Mining Corp. (TV-T) to “hold” from “buy," seeing limited upside to his revised target price of 25 cents per share (down from 35 cents). The average on the Street is currently 43 cents.
“2019 was a transformative year for TV, with both a new Chair and a new CEO and a new commitment to operational excellence,” he said. "Unfortunately, however, this ongoing turnaround has been more than offset by a 10-per-cent decline in the zinc price over the year, along with a substantial increase in treatment charges for zinc concentrate. While a number of margin improvement efforts remain underway at all four assets, our estimates indicate that at the corporate level TV will continue to generate minimal free cash flow without a meaningful improvement in the zinc price.
“For 2020, we project a modest decline in zinc production, driven by the anticipated grade profile at Perkoa. We also project increases in cash costs, as operating improvements are offset by another increase in treatment charges. As such, we forecast 2020 to be a FCF-negative year given our zinc price and treatment charge forecasts.”
Concurrently, Mr. Baretto raised his target prices for the following stocks:
Capstone Mining Corp. (CS-T, “buy”) to $1.30 from $1. Average: $1.05.
Ero Copper Corp. (ERO-T, “buy”) to $27.50 from $23. Average: $22.95.
Hudbay Minerals Inc. (HBM-T, “buy”) to $7 from $6. Average: $6.95.
Lundin Mining Corp. (LUN-T, “buy”) to $9.50 from $8.50. Average: $8.96.
“LUN is our top pick, with an unrivalled balance of growth, margins, shareholder returns, valuation and risk,” said Mr. Baretto. “Over 2019, LUN answered its primary strategic question – putting the balance sheet to work – in style, with the acquisition of Chapada. The company’s share price appreciated 39 per cent over 2019 vs. the peer group average of 20 per cent In 2020, we believe the market will be watching LUN for execution. With optimization and strategic planning underway at Chapada, the completion of various projects at Candelaria, and the pending ramp-up of the ZEP project at Neves-Corvo, we believe the company is poised to have a strong operating year.”
Turquoise Hill Resources Ltd. (TRQ-T, “buy”) to $2.50 from $1.25. Average: $1.60.
He lowered his target for Teck Resources Ltd. (TECK.B-T, “buy”) to $28 from $31. The average on the Street is $31.98.
“TECK had a tough year in 2019, with its share price declining 22 per cent,” said Mr. Baretto. "By contrast, its Canadian-listed larger base metals peer group returned 15 per cent on average, while the London-listed diversified miners returned 10 per cent. The primary driver behind the share price underperformance in 2019 was the coal business; in addition to a 27-per-cent decline in the coal price, TECK’s coal business suffered a number of logistical and operating challenges over the course of the year.
=====
RBC Dominion Securities analyst Russell Stanicky thinks Pfizer Inc. (PFE-N) is poised to inflect through 2025 based on its best-in-class growth and limited loss of exclusivity (LOE) risk.
He initiated coverage of the U.S. drugmaker with an “outperform” rating on Tuesday, calling it his “top idea” in the large-cap pharma space.
“We model 2021 to 2025 revenue and EPS CAGR’s [earnings per share compound annual growth rates] of 6 per cent and 11 per cent,” said Mr. Stanicky. “Margins are set to materially kick in with 570 basis points of expansion through 2025 off Upjohn re-set driven both by product mix and operating leverage on what is set to become a smaller base. While best in sector growth, we also see portfolio as lower risk with few LOE’s over next 5 years. We think improved P&L [profit and loss] visibility through Upjohn separation will serve as catalyst for shares.”
“We like the strategic moves sending its Consumer business into a joint venture with GlaxoSmithKline and forming a Newco by combining its Upjohn business with Mylan. These two moves leave a leaner and faster growing Pfizer despite the EPS step-down that can deliver a 6-per-cent revenue CAGR through 2025 under realistic expectations. That drives an EPS CAGR of 11 per cent on the back of one of the sector’s best margin stories given mix shift to higher margin products and notable operating leverage.”
He set a target price of US$46 for Pfizer shares, which exceeds the current consensus on the Street of US$42.54.
“Recent strategic moves to JV the Consumer business and separate Upjohn have left a near-term stepped down messy P&L set-up weighing on shares and sentiment,” he said. “But set to emerge is a best-in-class growth story on smaller, more innovative base with under-levered balance sheet to deploy and reverse overdone out-year LOE concerns.”
=====
Separately, calling it a “solid growth story" but expressing concern about its “healthy” share price appreciation, Mr. Stanicky initiated coverage of rival Merck & Co. Ltd. (MRK-N) with a “sector perform” rating.
“MRK’s robust growth story is largely appreciated by the Street,” he said. "We model a 3-per-cent revenue and 8-per-cent EPS CAGR 2020-2025E through the JANUVIA [diabetes medicine] LOE, which is healthy growth but also generally in line with consensus. While we like the P&L set-up, our concern is that most upward KEYTRUDA [cancer medicine] revision has played out and the margin story has become a central theme, albeit a favorable one. Overall, we think MRK can move higher but see upside as more limited at this level.
“We expect KEYTRUDA to remain a steady grower but less of a driver of upward revision. KEYTRUDA consensus forecasts have moved higher by 18 per cent over the last 12 months and a primary driver of the upward EPS revision story. That should continue and we are modestly above Street in the outer years. Margin expansion story clear but baked into Street models. MRK is holding expectations down for a 2020 'investment year’ but one that should still deliver expansion followed by a more meaningful move higher in 2021+. We have margins improving 450 basis points largely on lower operating expenses through 2025 but that still puts us 100 basis points below Street equating to $0.20 in EPS or 3 per cent. We understand the bear case around KEYTRUDA LOE concerns representing near-term valuation risk but think it is too early; at the same time we do not see meaningful SOTP-driven upside as per the bull case either.”
Mr. Stanicky set a target of US$99 for Merck shares. The average is IS$98.53.
He also initiated coverage of AbbVie Inc. (ABBV-N) with a “sector perform" rating and US$86 target, which falls short of the US$95.67 average.
“The pending AGN [Allergan] acquisition bolsters ABBV’s size into the HUMIRA LOE but fails to address the growth issue despite favorable swing in sentiment.,” the analyst said. “That growth issue could change in subsequent strategic moves but we also think the Street has underestimated the margin headwind and with the stock up 41 per cent since mid-August, we await a better entry point. In meantime, dividend and valuation should add support.”
=====
Kellogg Co. (K-N) is “poised for positive inflection in 2020,” according to Credit Suisse analyst Robert Moskow, who thinks "reinvestment spending over the past two years have set the stage for sustainable revenue growth, margin expansion, and high-single-digit EPS growth.”
Pointing to “underappreciated” revenue growth and seeing its margins set to expand, he raised his rating to “outperform” from “market perform," expecting an increased commitment to North American cereal boosting its stock.
“The North American cereal category is now showing signs of stabilization even without Kellogg’s contribution. This reinforces our view that the majority of Kellogg’s problems in this business (19 per cent of sales) are self-inflicted and can be addressed effectively once management makes a bigger commitment to the category. As demonstrated by Campbell Soup in 2019, the market willingly bids up the valuation multiple of a stock when its management team provides a credible plan for reinvestment in a troubled category.”
Mr. Moskow increased his fourth-quarter 2019 EPS estimate 89 US cents, which tops the Street by 3 US cents. He also hiked his 2020 and 2021 projections to US$3.97 and US$4.21, respectively, versus the consensus of US$4.02 and US$4.97.
His target jumped to US$78 from US$60. The average is US$67.26.
“With only 33 per cent of sell-side analysts recommending the stock, there is a lot of room for positive re-ratings and some additional multiple expansion as well,” he said. “Continued weakness in the U.S. cereal business represents the biggest downside risk to our target price.”
=====
Citing increased uncertainty following the departure of its chief executive officer, CIBC World Markets analyst John Zamparo downgraded Supreme Cannabis Company Inc. (FIRE-T) to “neutral” from “outperformer.”
“[Monday’s] announcement from Supreme Cannabis that its CEO, Navdeep Dhaliwal, has departed the company likely portends upcoming turbulence, in our view,” he said. “We also believe previously issued guidance looks unattainable given industry roadblocks, and discounting of existing products could suggest a lack of sell-through.”
“Executive turnover is not a new development in this industry, but it typically accompanies other disappointing news. Supreme has over the past few months added senior executives with relevant experience. But it’s hardly encouraging that going into Ontario’s store expansion and the launch of derivative products that the company’s CEO has abruptly exited.”
After reducing his revenue expectation for the current fiscal year, Mr. Zamparo dropped his target to 65 cents from $1.25. The average on the Street is $1.15.
“CEO departures rarely signify steady or positive short-term stock performance,” he said. “The abruptness of Mr. Dhaliwal’s exit, combined with revenue guidance that looks unachievable as well as recent discounting of the company’s products leads us to a more cautious approach for both valuation and financial projections.”
=====
National Bank Financial analyst Maxim Sytchev thinks free cash flow generating firms in the engineering and construction sector “deserve more attention” in 2020.
“We see resumption of value stocks ‘working’ against an uncertain macro backdrop (hence why SVX Index – ‘value’ doing better vs. SGX – “growth” in 2019 could be an early innings trade),” he said in a research report. “Cash-generative firms should therefore deserve more attention during the last hurrah of this cycle. We are also seeing some incremental sector rotation into the cyclical names that have rejuvenated our coverage universe as the majority of our stocks have rallied back into positive-sentiment territories; trade normalization between China / U.S. being the largest contributing factor. In a “watch out” column, we do want to highlight to investors that some of the recession indicators started to perk up recently.”
He added: “We believe FCF and conversion into FCF from EBITDA have become increasingly important valuation/operating metrics, as cash generation provides a meaningful read-through for profitability, quality of earnings, working capital management and capital allocation. In 2020, we expect FCF yield to range from low single to high single digits for our universe.” Mr. Sytchev made a series of target price changes for stocks in his coverage universe.
For engineering and construction firms, he made the following adjustments:
WSP Global Inc. (WSP-T, “outperform”) to $98 from $92. The average on the Street is $89.77.
Stantec Inc. (STN-T, “outperform”) to $40 from $36. Average: $39.50.
Bird Construction Inc. (BDT-T, “outperform”) to $10 from $9.50. Average: $8.25.
North American Construction Group Inc. (NOA-T, “outperform” to $24.50 from $23.50. Average: $24.70.
For equipment distributors, Mr. Sytchev’s changes were:
Finning International Inc. (FTT-T, “outperform”) to $29 from $29.50. Average: $27.80.
Toromont Industries Ltd. (TIH-T, “outperform”) to $82 from $79. Average: $72.96.
Ritchie Bros. Auctioneers Inc. (RBA-N/RBA-T, “underperform”) to US$38 from $35. Average: US$39.
For diversified industrial product companies, his changes were:
ATS Automation Tooling Systems Inc. (ATA-T, “sector perform”) to $22.50 from $22. Average: $24.75.
AutoCanada Inc. (ACQ-T, “sector perform”) to $11 from $10. Average: $14.18.
Stella-Jones Inc. (SJ-T, “sector perform”) to $43 from $43.50. Average: $48.06.
For large-cap stocks, Mr. Sytchev said he’s “sticking with quality,” calling WSP Global, Toromont Industries and Stantec his top picks.
“The three names share commonalities in consistent FCF generation, capital discipline (still a show-me for STN but current management has taken the right steps), and end-market exposure (de minimis commodity-related work for WSP and STN, QC and ON skew for TIH)," he said. “SNC post unexpected legal resolution is a dark-horse pick as the name became “investable” again. Assuming no execution hiccups on legacy fixed-price contracts, we see tremendous value in “good” parts of the business, i.e., EDPM, Nuclear and Concession.”
=====
In other analyst actions:
BMO Nesbitt Burns analyst Ryan Thompson downgraded New Pacific Metals Corp. (NUAG-X) to “market perform” from “outperform” with a $6.50 target, up from the current consensus of $5.75.
“Our view on the large-scale potential of Silver Sand hasn’t changed," said Mr. Thompson. "That said, with the shares up 400 per cent in the past year, 120 per cent since mid-September, and a market cap now over $1-billion, we think the risk/reward is more balanced at the current valuation. Therefore, we are downgrading our rating.”
TD Securities analyst Timothy James cut Exchange Income Corp. (EIF-T) to “hold” from “buy” with a $47 target (unchanged). The average is $48.64.
TD’s Graham Ryding lowered TMX Group Ltd. (X-T) to “hold” from “buy” with a $120 target. The average is $126.25.
Cormark Securities analyst Tyron Breytenbach raised K92 Mining Inc. (KNT-X) to “top pick” from “buy” and increased his target to $4.50 from $4. The average is $4.25.
David Leeder