KSM

Sep 18, 2023

Monday’s analyst upgrades and downgrades Inside the Market’s roundup of some of today’s key analyst actions Pointing to “growing evidence” of multiple expansion following recent share price outperformance, Desjardins Securities analyst Chris MacCulloch said he’s becoming “more cautious” on the energy sector, particularly on the oil side, expressing a preference for natural gas–weighted equities. “Let’s cut to the chase — Canadian oil & gas equities have been on a stick since the beginning of the summer, coinciding with the movement in global oil prices which has propelled WTI back up to approximately US$90 per barrel. “While we largely ascribe surging oil prices to deep Russo-Saudi supply cuts which have been extended until year-end, there is also growing optimism that a much anticipated global economic downturn may not prove as corrosive for fuel demand as previously feared. When combined with relatively tight differentials, a lethargic loonie and strengthening balance sheets triggering increased FCF allocation to capital returns, there has arguably never been a better time to be a Canadian oil producer, let alone a refiner given the recent surge in crack spreads. Meanwhile, natural gas producers have survived what was widely expected to be a miserable summer for AECO prices largely unscathed, and with clear visibility to much stronger 2024–25 cash flows given the contango in the futures strip while LNG Canada is coming into view. “Here comes the ‘but’. Although industry balance sheets have improved markedly in recent years, which has effectively removed downside tail risk from most stocks, we are beginning to see evidence of multiple expansion in Canadian oil & gas equities (see Exhibit 10), along with a contraction in FCF yields. Based on Bloomberg consensus estimates, the one-year rolling forward sector EV/DACF multiple recently eclipsed its five-year average while the FCF yield has dipped below at 5.3 times and 10.8 per cent, respectively. Granted, both metrics remain highly attractive within the context of longer-term trends; we highlight that sector EV/DACF multiples routinely averaged closer to 8 times in the preceding five years (2013–18), a period during which FCF was a foreign concept for most producers!” In a research report released Monday, Mr. MacCulloch said the recent multiple expansion “warrants at least some degree of investor caution given the inherent volatility in commodity prices.” “We do not believe it’s a stretch to suggest that most of the easy gains in Canadian oil & gas equities have now occurred following a 3.5-year period of supernormal performance, although it’s a deeply unpopular view in some quarters,” he added. “Barring another sharp leg-up in commodity prices, which may be forthcoming on the natural gas side, investors need to become more discriminating with respect to security selection. Implied returns to target have thinned for all names under coverage in recent months, although we still see deep value in select corners of the sector.” Citing limited potential returns, the analyst downgraded his recommendations for the two top-performing stocks in his coverage universe on Monday: * Athabasca Oil Corp. ( ATH-T ) to “hold” from “buy” with a $4.50 target (unchanged). The average target on the Street is $4.39, according to Refinitiv data. “The stock has been on a run for the ages, racking up a 52.3-per-cent return since late June — the best-performing name in the Desjardins E&P coverage universe and massively outpacing the S&P/TSX Capped Energy Index (up 25.0 per cent, before factoring in dividends),” he said. “Naturally, with a strengthened balance sheet which was further bolstered by the completed disposition of some of the company’s non-core Montney and Duvernay assets—not to mention renewed strength in Canadian heavy oil prices prior to the upcoming commissioning of the TransMountain Expansion (TMX) project—the corporate outlook has improved in recent months. However, valuation is also beginning to stretch with a 2024 strip EV/DACF multiple of 3.7 times, which screens toward the upper end of the small- and mid-cap Canadian oil space. Moreover, there are lingering questions surrounding the company’s eventual plans to increase Leismer production to the 40,000 bbl/d regulatory-approved level, which would require a significant capital outlay, potentially necessitating alternative financing and/or a slowdown in the FCF allocation toward share buybacks. That said, our downgrade should by no means be construed as a pessimistic tone on the company, which we still believe has a very promising future as investor focus begins shifting back to the Canadian oil sands. Simply put, we see better opportunities for short- and medium-term upside elsewhere in our coverage universe following a phenomenal run in the stock, and we believe investors should look to put new money to work in other names.” * Suncor Energy Inc. ( SU-T ) to “hold” from “buy” with a $49 target, up from $48. The average is $50.94. “We are downgrading SU ... reflecting limited return potential to our revised $49.00 target price (from $48.00) and our more cautious outlook on forward M&A activity,” he said. “The stock has been on an absolute tear since the company reported 2Q23 financial results in mid-August — trading up 10 per cent — the second-best performance in the Desjardins E&P coverage universe. With CEO Rich Kruger now at the helm for roughly six months, SU has trimmed overhead costs while also completing its portfolio clean-up of non-core assets following the recent UK North Sea disposition. More importantly, the company appears to have taken the necessary steps to improve operational performance following a steady string of disappointing results in recent years and is also benefiting from a commodity price tailwind on the back of strengthening Canadian heavy oil prices and crack spreads. However, ConocoPhillips’ recent consolidation of Surmont has arguably set the company’s Base Mine replacement plans back by removing an attractive potential substitute as the asset approaches end of life in the mid-2030s, with production declines expected to commence later this decade. While consolidation of TotalEnergies Canada’s remaining 31.23-per-cent non-operated WI in Fort Hills appears to be a foregone conclusion at this point, most likely prior to year-end according to corporate guidance, we still believe that SU will need to explore other M&A opportunities in the absence of brownfield expansions at Firebag, MacKay River or Fort Hills to replace Base Mine volumes. Following the recent pickup in commodity prices, our perception is that any strategic transaction will now come with a richer implied valuation, particularly after the removal of a major piece from the oil sands chess board (ie Surmont). In summary, we believe that many of the near-term catalysts for the story have now played out and that other Canadian large caps offer superior near-term upside potential.” Mr. MacCulloch also made a series of target changes to stocks in his coverage universe. For large caps, his changes were: ARC Resources Ltd. ( ARX-T , “buy”) to $26 from $25. Average: $23.91. Canadian Natural Resources Ltd. ( CNQ-T , “buy”) to $96 from $95. Average: $92.35. Cenovus Energy Inc. ( CVE-T , “buy”) to $33.50 from $31. Average: $30.47. Imperial Oil Ltd. ( IMO-T , “hold”) to $83 from $76. Average: $80.71. Tourmaline Oil Corp. ( TOU-T , “buy”) to $79 from $77. Average: $81.19. For dividend-paying stocks, his changes are: Enerplus Corp. ( ERF-T , “buy”) to $23 from $21. Average: $23.97. Headwater Exploration Inc. ( HWX-T , “buy”) to $9 from $9.25. Average: $9.28. Peyto Exploration & Development Corp. ( PEY-T , “hold”) to $13.50 from $13. Average: $15.25. Tamarack Valley Energy Ltd. ( TVE-T , “buy”) to $5.75 from $5.50. Average: $5.83. Vermilion Energy Inc. ( VET-T , “hold”) to $23.50 from $22. Average: $25.04. Whitecap Resources Inc. ( WCP-T , “buy”) to $13.50 from $12.75. Average: $13.81. “Our top picks are CVE (integrated oil), ARX (large-cap natural gas), TVE (mid-cap oil), AAV (small-cap natural gas), TPZ (royalty) and SDE (special situation),” he said. ===== Emphasizing “generational gold/copper assets in good mining jurisdictions are hard to find,” RBC Dominion Securities analyst Michael Siperco initiated coverage of Seabridge Gold Inc. ( SA-N , SEA-T ) with an “outperform” rating on Monday, seeing its 100-per-cent-owned KSM gold/copper project in the Golden Triangle region of northern British Columbia as “a potentially attractive option for producers looking for long-term, consistent production potential.” “KSM hosts one of the largest undeveloped gold/copper resources globally across five deposits, with over 150moz of gold and over 50bn lbs of copper across all categories,” he said in a research report titled Moving Mountains in the Golden Triangle. “Finding, advancing, and building large-scale gold (or copper) projects is becoming harder, with less exploration and fewer large discoveries. In our view, KSM, with a resource that could see production for decades beyond the 33-year PFS life (only 25 per cent of the global resource included), has significant strategic value beyond the current studies as a mining district, similar to other large-scale gold/copper projects globally.” As it begins to accelerate the development of the project with a new, “streamlined” study, Mr. Siperco thinks the new catalyst for Seabridge shares will be finding a senior partner to bring it to a construction decision, saying “the right partner could be a game changer” and believing it “could further validate KSM and drive a re-rate” “Management is actively seeking a partner for the development of KSM,” he said. “While this process has been ongoing to varying degrees since the property was assembled +20 years ago, we think 1) the project has grown and changed since prior partnership attempts, 2) far more capital has been invested in the project/region, and 3) gold/copper prices have increased and caught up to the improvements made at KSM. We see the 2022/2023 financings with Sprott Resource Streaming and the Ontario Teachers Pension plan (total of $375-million) as validation of the potential to advance to construction, and an indication that now could be the right time for a partner to step in. “Potential partners in our view would be senior gold, copper or diversified miners with experience building large-scale open pit (or potentially block cave) operations, with KSM being flexible enough to accommodate partner preferences for timing and quantum of capital spending, and preference for copper vs. gold.” Mr. Siperco set a target of US$25 for the Toronto-based miner’s shares. The average target on the Street is US$46.75, according to Refinitiv data. ===== National Bank Financial analyst Richard Tse thinks the risk-reward proposition for Nuvei Corp. ( NVEI-Q , NVEI-T ) looks “very compelling” at its current share price. “If you’ve been following this name, you know very well the stock’s volatility since becoming a public company in 2020 with the most recent driver of that volatility coming from its last reported quarter when its decision to exit a customer relationship and the moderating of both its near-term and mid-term growth targets fuelled another pullback,” he said. “Regardless of what those drivers of volatility may be, the reality is that the number of occurrences fuels the lower (relative) valuation against its peers. “Yet, as we look at today’s valuation of 8.6 times (EV/EBITDA F23) against our growth estimates – total and organic - NVEI is looking very compelling.” Mr. Tse said a recent lunch with a group of executives from the Montreal-based payment processor brought greater clarity on in its decision to cut growth targets . “Our focus undoubtedly was to assess the risk to our numbers, particularly in the short term, the reasonableness of the assumptions around the short and mid-term outlook and additional commentary that the Company’s intentional exiting of a top 10 customer is not reflective of its product offering that would risk other exits, all paired against our own industry diligence,” he said. For 2023, the analyst said Nuvei explained its moderating growth rate by pointing to three factors: “1) the intentional exiting of a top 10 customer; (2) the timing of onboarding new customer wins; and (3) Paya’s same-store sales were slightly below expectations.” “In general, the Company intimated it was overly optimistic on the above and it appeared the outlook reflects more conservatism,” said Mr. Tse. “What we Think: While (1) and (3) are obvious reasons why the full-year outlook would be moderated, we really did not appreciate the extent of how the new wins impact that outlook depending on the timing of those wins and how they ramp, not to mention that larger enterprise deals add complexity to the timing given potential scope changes. In our view, the latter appears reasonable and actually lines up with our own diligence that’s been pointing to larger enterprise wins at Nuvei. So, while the most recent quarter (FQ2′23) had year-over-year organic growth decelerating to approx. 9 per cent (vs. approx. our 15 per cent year-over-year in FQ2′22), we think the Company will see a reacceleration which would have us estimating F24 growth at approx. 18 per cent (14-per-cent organic).” Also believing its long-term estimates are more conservative than necessary and seeing Paya Holdings Inc. as “a unique channel for Nuvei and potentially a prescient move in the sector,” Mr. Tse maintained an “outperform” recommendation and US$27 target for the company’s shares. The average on the Street is US$35.05. “We believe the risk profile in this name is high relative to its peers given what we’ve noted at the beginning of this note; yet NVEI’s valuation already reflects much of that risk,” he said. “Based on reflection of what we heard over lunch late last week, we continue to think Nuvei has differentiated itself by focussing on outsized growth segments with an à la carte go-to-market while (more recently) expanding its TAM [total addressable market] into larger enterprise merchants. At 7.4x EV/EBITDA (CY24), that represents an approximate 3.0 times discount to its closest peers – a considerable discount.” ===== Stifel analyst Martin Landry thinks shareholders of Pet Valu Holding Ltd. ( PET-T ) are likely to “react positively” to the “muted” entry of U.S. online pet food retailer Chewy Inc. ( CHWY-N ) into the Canadian market last week, believing the uncertain impact of the move as an “overhang” to its stock. “This Canadian expansion is not a surprise and had been previously discussed by Chewy,” he said. “At first glance, Chewy appears to offer only a limited number of brands creating less of a competitive threat than previously expected. In addition, Chewy does not distribute premium and ultra premium brands, which is the main focus of Pet Valu. Hence, there is a limited overlap of products (only 7 dog food brands) between Pet Valu and Chewy. Given that there is no associated promotional campaign to support Chewy’s Canadian expansion, this looks like a soft launch. However, we would expect that over time, more brands will join the Chewy platform .” Mr. Landry said he does not see Chewy as a “major threat” to Pet Valu at this time, believing any gains in the Canadian market may take “several” years. Touting “appealing” industry characteristics, “strong” growth prospects and “solid business economics and competitive positioning,” he reiterated a “buy” recommendation and $38 target for Pet Valu shares. The average on the Street is currently $40. “Pet Valu is a growth story with a significant growth runway,” he said. “We believe that the company can double its store count over time to 1,200-plus, an increase of 60 per cent from current levels. According to our analysis, PET has the potential to grow its EPS sustainably at a CAGR [compound annual growth rate] of mid-to-high teens. Pet Valu’s balance sheet is healthy with leverage expected to remain below 2 times in 2023, providing the company with good flexibility to allocate capital. “Pet Valu has several positive attributes, which include: (1) more than 2.5 million members in its loyalty program, generating almost 80 per cent of all system sales in Q2/23, (2) high-performing private label brands, generating near 30 per cent of sales and margins 1,200 basis points higher than similarly priced national brands, (3) a rapid payback of three years on new corporate stores, (4) flexible store formats which enable increased penetration in rural areas, a significant differentiation vs. PetSmart.” ===== In other analyst actions: * CIBC World Markets’ Christopher Thompson initiated coverage of Logan Energy Corp. ( LGN-X ) with an “outperformer” rating and $1.50 target. The average target on the Street is $1.62. * HSBC initiated coverage of Lululemon Athletica Inc. ( LULU-Q ) with a “buy” rating and US$500 target, exceeding the US$435.13 average. * After hosting recent institutional meetings with Canadian Natural Resources Ltd. ( CNQ-T ) president Tim McKay, RBC’s Greg Pardy raised his target for its shares to $90 from $82 with an “outperform” rating. The average is $92.30. “Our bullish stance towards CNQ reflects its strong leadership team, shareholder alignment, long life-low decline portfolio, abundant free cash flow generation, robust balance sheet and best-in-class operating performance,” he said. “We are reaffirming an Outperform recommendation on CNQ and boosting our one-year price target by $8 to $90 per share given the potential for accelerating shareholder returns. CNQ is our favorite senior producer and is on both our Global Energy Best Ideas and Top 30 Global Ideas lists.” * Bernstein’s Nadine Sarwat lowered her targets for Canopy Growth Corp. ( WEED-T , “market perform”) to $1.49 from $2.10 and Cronos Group Inc. ( CRON-T, “market perform”) to $2.84 from $3.04. The averages are 94 cents and $3.25, respectively.