Thursday’s analyst upgrades and downgrades

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

National Bank Financial analysts Travis Wood and Dan Payne think Canadian energy companies are poised to benefit from future strength in Western Canadian Select oil, predicting it could become “a dominant global heavy benchmark.”

“We no longer see WCS as the marginal global heavy barrel,” they said. “Although the U.S. refining complex will remain the primary consumer of Canadian oil, we think an operational TMX pipeline positions WCS as a global benchmark. This is likely to create short-term price swings across the heavy oil market as refineries digest the impact of a changing supply dynamic. In our view, this will have a more nuanced effect on oil pricing than is currently appreciated as we consider potential changes to the North American oil transmission and import dynamic across the PADDs.

“The majority of Canada’s 170 billion barrels of proven oil reserves are to be sourced from the oil sands and stands to help supply the global industrial and infrastructure expansions for as long as demand persists (reserve life implied 100 years). As refineries tackle contaminated or inconsistent supply sources during demand growth, we rank Canada as the best positioned global heavy oil supply source given a variety of factors, but notably from a: quality of supply, environmental, social, governance, geographic, safety and economic perspective ... checks all boxes.”

In a research report released Thursday, the analysts upgraded their commodity price assumptions for both 2023 as well as the long term. Their WTI estimate for 2023 rose by 3 per cent to US$80 per barrel (from US$77.50 previously) with their 2024 projection jumping 8 per cent to US$81 (from US$75). The firm’s long-term expectation rose to US$75 (from US$70).

“Since we last revised our commodity price assumptions back, crude prices have moved materially higher on the back of material OPEC+ production cuts extended through year-end as well as bullish inventory data finally calling attention to the true tightness present in global markets,” they said. “While there has been short-term volatility this past week related to signs of bearish gasoline demand amid a heavier refinery turnaround season in the U.S., the recent eruption of conflict in the Middle East, and its’ potential repercussions on global energy security have helped buoy prices along the forward curve. This upward movement in price over the past quarter necessitates us to update our price forecast to better align with strip.”

They added: “We remain constructive on both crude oil and natural gas supply/demand fundamentals over the short to medium term, while acknowledging the continued concerns surrounding a potential global recession, prolonged periods of inflation hampering demand and the potential for macro contagion.”

With their commodity price forecast adjustments, the analysts raised their total cash flow estimates for companies in their coverage universe by 4 per cent in 2023 and 14 per cent in 2024. That led them to increase their target price for shares by an average of 45 per cent.

They raised their targets for these stocks:

• Arc Resources Ltd. (ARX-T, “outperform”) to $25 from $23. The average on the Street is $24.03.
• Birchcliff Energy Ltd. (BIR-T, “outperform”) to $9.75 from $9.25. Average: $9.91.
• Canadian Natural Resources Ltd. (CNQ-T, “sector perform”) to $100 from $90. Average: $95.62.
• Crescent Point Energy Corp. (CPG-T, “outperform”) to $19 from $16. Average: $14.02.
• Crew Energy Inc. (CR-T, “sector perform”) to $7 from $6.50. Average: $7.92.
• Cenovus Energy Inc. (CVE-T, “outperform”) to $37 from $31. Average: $31.79.
• Enerplus Corp. (ERF-N/ERF-T, “outperform”) to US$25 from US$23. Average: US$25.64.
• Freehold Royalties Ltd. (FRU-T, “outperform”) to $20 from $19. Average: $19.08.
• Imperial Oil Ltd. (IMO-T, “sector perform”) to $110 from $82. Average: $83.50.
• Kelt Exploration Ltd. (KEL-T, “outperform”) to $9.25 from $8.50. Average: $8.79.
• Lucero Energy Corp. (LOU-X, “sector perform”) to $1 from 90 cents. Average: 90 cents.
• Meg Energy Corp. (MEG-T, “sector perform”) to $31 from $27. Average: $27.77.
• NuVista Energy Ltd. (NVA-T, “sector perform”) to $14.50 from $13.50. Average: $15.65.
• Ovintiv Inc. (OVV-N/OVV-T, “outperform”) to US$69 from US$59. Average: US$56.63.
• Peyto Exploration & Development Corp. (PEY-T, “outperform”) to $17.50 from $17. Average: $16.33.
• Paramount Resources Ltd. (POU-T, “outperform”) to $45 from $40. Average: $38.75.
• PrairieSky Royalty Ltd. (PSK-T, “sector perform”) to $28 from $26. Average: $26.20.
• Spartan Delta Corp. (SDE-T, “outperform”) to $7.25 from $6.75. Average: $6.21.
• Suncor Energy Inc. (SU-T, “outperform”) to $74 from $57. Average: $52.81.
• Tamarack Valley Energy Ltd. (TVE-T, “outperform”) to $7 from $6.25. Average: $5.83.
• Whitecap Resources Inc. (WCP-T, “outperform”) to $18.50 from $16.50. Average: $14.20.

Mr. Wood lowered his target for Vermilion Energy Inc. (VET-T, “outperform”) to $24 from $26. The average is $25.39.

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Seeing “a few near-term pressures that may require more time to abate” than previously anticipated, National Bank Financial analyst Ahmed Abdullah downgraded AirBoss of America Corp. (BOS-T) to “sector perform” from “outperform” on Thursday.

“AirBoss Rubber Solutions likely saw lighter than expected volumes in July with a limited bounce back in August and September as demand softened,” he said. “The UAW auto strike still presents a risk to AirBoss Engineered Products forecasts. AirBoss Defense Group continues to see depressed operating leverage due to the lack of big awards and before the benefit of the approximately $5-million annualized savings kicks in.”

Mr. Abdullah is now projecting third-quarter revenue of $108.7-million, falling from $113.3-million previously. His adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) estimate slid to $5.4-million from $9-million, and his earnings per share forecast fell to a loss of 5 cents from a gain of 5 per cent.

“ARS 3QE revenues at $49.8-million (down 5.0 per cent year-over-year) and Adj. EBITDA $6-million vs. $7-million (margin 12.0 per cent vs. 13.4 per cent),” he said. “Signs point to weaker demand levels (e.g., layoffs at major tire makers, U.S. Tire Manufacturers Association lowered its shipment forecasts for 2023). Our 3Q revs forecast for AEP points to $35-million (up 20.0 per cent year-over-year) as the revised agreements with customers continue to provide improved results, while Adj. EBITDA is expected to be $2.6-million vs. a loss of $6.2-million last year. The UAW auto strike kicked off on Sept. 14 with limited capacity (3 plants at first, expanded since), so 3Q will likely not see a material related impact. Depending on the duration & scale of the strike, 4Q might face a more meaningful impact (we’ve begun tempering our estimates for this and a softening economy). We expect $24.0-million (up 3.5 per cent year-over-year) of revs for ADG and a small Adj. EBITDA loss of $0.2-million similar to 2Q. ADG announced annualized restructuring savings of $5-million that would likely only begin to materialize in 4Q.”

With changes to his forecast, Mr. Abdullah dropped his target for the Newmarket, Ont.-based company’s shares to $6 from $8.50. The average on the Street is $6.08.

“With limited visibility as to when volumes might bounce back and with a weaker macro backdrop, we think BOS shares will remain under pressure before a turnaround can materialize,” he concluded.

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While he thinks the valuation multiple for Spin Master Corp.’s (TOY-T) US$950-million acquisition of U.S.-based toy maker Melissa & Doug “looks full at first glance” at 10.5 times 2022 adjusted EBITDA, Stifel analyst Martin Landry said the deal can be “justified by the strong brand notoriety and faster growth profile than the industry” and called the transaction “long awaited” by investors given its large cash balance.

“Melissa & Doug’s target market begins at infancy while Spin Master typically engages with children ages two and up,” he said. “Hence, the acquisition complements well Spin Master’s portfolio with approximately 70 per cent of M&D’s sales in segment where TOY is not present. We see potential revenues synergies from: (1) International expansion as only 10 per cent of M&D’s sales are generated outside North America vs. 40 per cent for Spin Master, (2) channel expansion with mass retailers as the majority of Melissa’s sales are done online or in specialty retail and (3) accelerating innovation and product development by leveraging Spin Master’s innovation capabilities.”

Believing financial leverage moving forward is not a concern, Mr. Stifel raised his 2024 forecast for the Toronto-based toymaker by 9 per cent, which he called “a sizeable accretion, which should increase over time as the $25-$30 million cost synergies are realized.”

“TOY expects to generate cost synergies of approximately $25 to $30-million by 2026, primarily through the combination of back office operations (i.e. HR, Legal, Finance) and supply chain savings, which would bring the acquisition multiple down to 8.1 times,” he said. “There is an additional contingent earn out consideration of up to $150-million subject to achieving certain financial targets for 2024 and 2025, payable at multiples lower than the transaction multiple at closing, potentially reducing the blended multiple below 10.5 times.”

“For modeling purposes, we have assumed that the transaction closes on February 1st, 2024 and included the financial contribution from that date onward in our forecasts. The acquisition increases our 2024 revenue estimates by 20 per cent and our EPS estimates by 9 per cent given the debt servicing cost and the lost interest income, which Spin Master would have generated on its cash balance. We have not factored any cost synergies in our FY24 forecasts, leaving potential upside to our estimates.”

With those changes, Mr. Landry raised his target for Spin Master shares by $4 to $54, reiterating a “buy” recommendation. The average on the Street is $51.14.

“We view this acquisition favorably as (1) it diversifies Spin Master’s product portfolio, (2) is an accretive acquisition, with good synergy potential and (3) it increases bargaining power and relevance with retailers,” he concluded.

Elsewhere, others making target changes include:

* Canaccord Genuity’s Luke Hannan to $60 from $50 with a “buy” rating.

“We believe the transaction represents a prudent use of capital and fits well into the Spin Master portfolio,” said Mr. Hannan. “Melissa & Doug has long come up during our conversations with investors as a possible acquisition candidate for Spin Master, so we expect this morning’s announcement is unlikely to catch investors off guard. What did surprise us was how complementary Melissa & Doug is to Spin Master; 70 per cent of Melissa & Doug’s POS are in categories that are incremental to TOY, allowing them to reach an additional 11 million households. With the Melissa & Doug team only recently having invested more heavily in marketing, and mostly in the US, we see opportunity for Spin Master to expand this reach further, which should drive revenue upside. We expect additional upside to come from deeper penetration of the mass market channel, where Melissa & Doug is relatively underindexed compared to Spin Master.”

* National Bank Financial’s Adam Shine to $46 from $44 with an “outperform” recommendation.

“Founded in 1988, Melissa & Doug (M&D) is a trusted brand with parents and known for its creative & developmental toys for very young children,” said Mr. Shine. “It’s a highly recommended brand with strong consumer loyalty and has achieved sustained POS performance ahead of the overall toy market over the past five years. TOY sees immediate growth opportunities through mass market, e-commerce & international expansion (M&D’s sales more than 90 per cent to North America), as it aims to grow M&D’s core evergreen product portfolio, explore adjacent categories like baby & toddler, and expand in future into new areas like publishing.”

* RBC’s Sabahat Khan to $51 from $49 with an “outperform” rating.

* Cormark Securities’ David McFadgen to $61 from $54 with a “buy” rating.

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MTY Food Group Inc. (MTY-T) is “managing growth amid a more demanding consumer backdrop,” according to National Bank Financial analyst Vishal Shreedhar, who called its third-quarter “good given a beat on EBITDA, relative network stability and consumer resilience.”

Shares of the Montreal-based restaurant franchisor and operator slid 3.7 per cent on Wednesday despite reporting better-than-expected results. Sales rose to $1.467-billion from $1.105-billion in fiscal 2022, exceeding Mr. Shreedhar’s $1.458-billion estimate with a year-over-year gain of 55 per cent in the United States and 4 per cent domestically. Revenue rose to $298.1-million from $171.5-million, topping the Street’s expectation of $289.5-million, while normalized adjusted EBITDA grew to $72.9-million from $50.6-million, also beating the consensus projection of $70.1-million.

“MTY continues to target net positive organic store openings; construction/ store permitting is improving, although the higher cost of debt is negatively impacting new openings,” said Mr. Shreedhar. “We model net-neutral organic store openings in Q4/23. If MTY can deliver organic growth (same-store sales and unit growth), this could place upward pressure on the multiple. Specifically, if MTY traded in line with the five-year average, it would add over $20 to the share price [Wednesday].

“MTY does not yet see significant cracks in the consumer backdrop; the focus is on improving the customer experience as pricing sensitivity is heightened. The competitive backdrop is indicated to be rational.”

Noting leverage is “elevated but expected to improve ... supported by strong cash generation and lower capex from Q4/F23 onwards,” Mr. Shreedhar raised his target for MTY shares by $1 to $71, keeping an “outperform” recommendation. The average is $71.29.

“We remain constructive on MTY given attractive valuation, expectations of improving operational performance (digital sales, menu innovation, marketing, data analytics), and medium-term supportive capital allocation outcomes such as acquisitions and potential NCIB,” he said. “That said, we also acknowledge heightened risk related to inflation, labour and general macroeconomic concerns.”

Elsewhere, others making target changes include:

* Scotia Capital’s George Doumet to $62 from $69.50 with a “sector perform” rating.

“With pricing reaching maturity at restaurants, it all comes down to traffic,” said Mr. Doumet. “The closure rate remained at low levels, but the road ahead could be challenging as high interest rates are weighing on financing decisions for new locations. While the valuation is not demanding from a historical context (shares trading at approximately 9 times vs. historical average closer to 11 times), the higher interest environment could weigh in on M&A - and we would need to see continued SSS (in the low single-digit range) and sustained flat net closures to get more constructive on the name.”

* Raymond James’ Michael Glen to $65 from $70 with a “market perform” rating.

“While we acknowledge that MTY’s valuation, which is sitting at 7.8 times forward EBITDA on a pro-forma basis (including M&A), is reasonable in the historical context, we would be more opportunistic in selecting an entry point on the shares,” he said. “As we assess and gauge investor interest in the name, we believe that there are three things that would benefit the stock: 1. A committed and communicated plan to repurchase shares consistently; 2. Communication of a capital investment program that will include explicit targets for net store openings and organic sales growth; and 3. Some combination of system sales, EBITDA and FCF guidance. On the first point, while MTY did renew its 5-per-cent NCIB late June, but given recent M&A activity and pf leverage just below 3x we do not expect any share repurchase activity to take place as the company prioritizes debt pay down. On the second point, we did see MTY post one of its better net store performances in 3Q with 5 net closures (which was similar to 4 net closures in 2Q) and we will look to assess sustainability of this trend. On the third point, we believe it would be helpful for investors to have a series of metrics where we can more readily measure operating performance.”

* Acumen Capital’s Nick Corcoran to $80 from $84 with a “buy” rating.

“We view the recent sell off as overdone,” he said. “MTY continues to demonstrate strong momentum in the business driven by recent acquisitions and initiatives to drive organic growth brand-by-brand.”

* TD Securities’ Derek Lessard to $65 from $70 with a “hold” rating.

“Overall, our HOLD recommendation is predicated on a more cautious stance in the face of tougher comps, wage inflation pressure, increasing competition (particularly in pizza), and the potential impact of the current macroeconomic environment on consumer spending,” he said. “That said, we believe that a few more quarters of strong execution (including evidence of sustainable net network improvement and success around Papa Murphy’s), lower leverage, and/or improving economic outlook would make us more constructive on the shares.”

* CIBC’s John Zamparo to $71 from $75 with an “outperformer” rating.

“We consider MTY’s sell-off post FQ3 unsubstantiated,” said Mr. Zamparo. “Industry headwinds exist, mostly from U.S. student loan repayments, more cautious consumers, and now the potential impact of weight-loss drugs, and restaurant stocks are down meaningfully of late. However, MTY is delivering quality growth (17-per-cent organic EBITDA growth in FQ3); M&A will contribute again at some point; and unit growth potentially turning positive remains a real catalyst to expand the shareholder base. Our EPS estimate for next year marginally increased to $4.19; we have reduced our target multiple one turn to 17 times to reflect current industry sentiment.”

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Despite “further deterioration” in most commodity prices, Scotia Capital analyst Orest Wowkodaw expects North American miners to post “stronger” third-quarter financial results driven by a “meaningful improvement” in operating performance.

“Our estimates appear somewhat mixed relative to current consensus,” he admitted. “Although guidance risks remain skewed to the downside given the challenging operating environment, several miners cut expectations in Q2, and we see few obvious candidates to follow suit this quarter. We expect few company-specific catalysts.”

While his EBITDA estimates are 12 per cent below the consensus on average, Mr. Wowkodaw expect results to materially improve on a sequential and year-over-year basis as “the impact of lower commodity prices is expected to be more than offset by a meaningful improvement in operating performance.”

“Among the mid- to large-cap producers, we forecast CCO-T, CS-T, ERO-T, IVN-T, LUN-T, and TECK.B-T to meaningfully miss consensus EBITDA expectations,” he said. “We anticipate in-line results for CIA-T, FCX-N, FM-T, and HBM-T, and a beat for NEXA-N. On an EPS basis, we forecast below-consensus results for CCO-T, CS-T, HBM-T, LUN-T, and TECK.B-T, in-line results for CIA-T, ERO-T, and IVN-T, with modest beats for FCX-N, FM-T, and NEXA-N. ... FCX-N and TECK.B-T have the best track record of meeting expectations over the past four quarters; CS-T, ERO-T, and NEXA-T have the weakest.”

Alongside “minor” changes to his commodity price forecasts for the second half of 2023, Mr. Wowkodaw made four target changes to stocks in his coverage universe:

• Champion Iron Ltd. (CIA-T, “sector outperform”) to $6.50 from $7.25. The average is $7.40.
• Capstone Copper Corp. (CS-T, “sector outperform”) to $7.75 from $8. Average: $7.94.
• Ero Copper Corp. (ERO-T, “sector perform”) to $27 from $28. Average: $28.95.
• Ivanhoe Mines Ltd. (IVN-T, “sector outperform”) to $14 from $15. Average: $15.58.

“In our view, CIA-T, FCX-N, and HBM-T appear relatively well positioned heading into the Q3/23 reporting season,” he concluded. “Conversely, CS-T, LUN-T, and TECK.B-T appear somewhat poorly positioned relative to current expectations. We anticipate potential negative revisions to 2023 production guidance for CS-T, FM-T, and TECK.B-T. However, TECK.B-T remains a Top Pick as we anticipate the benefits of the impending business seperation to more than offset any near-term weakness related to the Q3 results. Similarly, we believe investors will look through any potential near-term disappointment for CCO-T.”

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In other analyst actions:

* In a third-quarter earnings preview for Canadian lifecos, Desjardins Securities’ Doug Young trimmed his targets for IA Financial Corp. Inc. (IAG-T, “hold”) to $94 from $95, Manulife Financial Corp. (MFC-T, “hold”) to $27 from $28 and Great-West Lifeco Inc. (GWO-T, “hold”) to $40 from $41. The averages are $100.13, $28.92 and $40.50, respectively.

“We are entering the third quarter under IFRS 17/9 and we still believe that understanding the results will be an educational exercise for at least the next few quarters,” said Mr. Young. “Similar to last quarter, we expect sequential trends (not absolute numbers) to be the main focus; however, a large variance between reported and core earnings has been a cause of concern over the last two quarters and if this continues, it will not be well-received by the investment community in our view. Based on what we know: (1) lower equity markets sequentially should be a negative for wealth businesses; (2) higher interest rates should be a positive for core earnings as we head into 2024; (3) trends in Asia should be a positive (for MFC and SLF); (4) FX movements had a positive impact; and (5) based on our math, the macro environment (equity markets, rates, spreads, yield curves), along with further CRE pressures, had a varying impact on reported earnings across the group, which could cause further sizeable variances between the reported and core numbers in our view. We tweaked our estimates (releasing our 2025 numbers) and target prices but kept our ratings unchanged. SLF [”buy” and unchanged $75 target] remains our top pick.”

* Morgan Stanley’s Ioannis Masvoulas upgraded First Quantum Minerals Ltd. (FM-T) to “equal-weight” from “underweight” with a $31 target, down from $32.

* JP Morgan’s Patrick Jones downgraded Lundin Mining Corp. (LUN-T) to “underweight” from “neutral” with an $8 target, falling from $8.40 and below the $11.95 average on the Street.

* After Wednesday’s Investor Day, RBC’s Irene Nattel raised her Alimentation Couche-Tard Inc. (ATD-T) target to $94 from $87 with an “outperform” rating. Other changes include: BMO’s Tamy Chen to $81 from $78 also with an “outperform” rating and TD Securities’ Michael Van Aelst to $86 from $79 with a “buy” rating. The average is $82.80.

“ATD shares are up 25 per cent year-to-date, among the top performers in our coverage, as the stock tends not to experience the same selling pressure as the grocers during disinflationary periods, nor suffer the commodity pressure of the food processors,” said Mr. Van Aelst. “The shares have run up in anticipation of yesterday’s Investor Day and new five-year plan, but we see further upside (despite some normalization of fuel margins in F2024) as investors start to discount the strong outlook for organic EBITDA growth and FCF through F2028, which should also facilitate acquisition opportunities (balance-sheet capacity is currently $10-billion).”

* BMO’s Devin Dodge increased his target for AtkinsRéalis (ATRL-T), formerly known as SNC-Lavalin Group Inc., to $43 from $41 with an “outperform” rating. The average is $47.27.

* Updating his third-quarter forecast to account for “weak” wind generation, particularly in Quebec, as well as higher interest rate forecasts and “elevated volatility,” National Bank Financial’s Rupert Merer cut his targets for Boralex Inc. (BLX-T) to $39 from $43 and Innergex Renewable Energy Inc. (INE-T) to $16 from $18 with “outperform” ratings for both. The averages are $44.17 and $17.25, respectively.

* Following a multifamily rental (MFR) property tour and investor day in the Greater Vancouver Area, Raymond James’ Brad Sturges lowered his target for Canadian Apartment Properties REIT (CAR.UN-T) to $56 from $59.50, below the $56.74 average, with an “outperform” rating.

* Previewing the Oct. 24 release of its third-quarter results, ATB Capital Markets’ Chris Murray cut his Canadian National Railway Co. (CNR-T) target to $165 from $175 with a “sector perform” rating. The average is $160.62.

“Volumes remained weak in Q3/23 (down 4.7 per cent year-over-year) as destocking, softer industrial volumes, and a strike at the Port of Vancouver acted as headwinds,” he said. “Weakness in volumes was driven by intermodal, forest products, and petroleum and chemical volumes, with intermodal volumes expected to remain under pressure in Q4/23 and into 2024. CN’s operational turnaround appears intact, with a constructive outlook for bulk commodities expected to offset near-term volume pressure from consumer and industrial end-markets. We will look for an update on volume/yield expectations heading into 2024, particularly around intermodal and grain.”

* “Following another material quarter of catastrophe losses for the industry,” Raymond James’ Stephen Boland bumped his Definity Financial Corp. (DFY-T) target to $42 from $39 with an “outperform” rating. The average is $42.65.

“In light of the elevated cat losses Canadian insurers have experienced this year, we now expect harder market conditions in 2024 than previously anticipated. To reflect this dynamic, we are increasing our 2024 estimates and target price and maintain our Outperform rating,” he said.

* Stifel’s Cody Kwong initiated coverage of Logan Energy Corp. (LGN-X) with a “buy” rating and $1.50 target. The average is $1.61.

“As a part of the successful value maximization exercise at Spartan Delta, the principals have spun out a pure play Montney vehicle dubbed Logan Energy,” said Mr. Kwong. “This screens as a differentiated investment opportunity within our coverage universe given its focus on growth instead of the recently popular return of capital business plans that have emerged over the past few years. Between a hot M&A market within the Montney, Management’s proven track record of being commercial, armed with over $100-million of cash in the bank for organic and inorganic growth, and a brimming catalog of exciting drilling locations, we believe Logan Energy will be a name of focus for both investors and inventory-hungry peers.”