Inside the Market’s roundup of some of today’s key analyst actions
Canadian pressure pumpers have been "dealt a Mike Tyson-worth one-two combo," according to Raymond James analyst Andrew Bradford.
"The near-term headwinds in Canada are material and will have some lingering effects on frack pricing in the quarters that follow, making the group unattractive from a catalyst viewpoint, despite the recent selloff," he said in a research note. "However, deep value resides within the group, so we still recommend owning shares in the space, albeit with less ‘buy it now’ urgency. Investors should be aware that relatively small changes in field-level activity have material impacts in pricing and demand. We are seeing the negative side of this coin today, but we think investors should want to be positioned with exposure in advance of a demand uptick we expect will become more evident through 2019."
Mr. Bradford said it's been "a tough three weeks" in the sector since the Aug. 30 decision on the Trans Mountain pipeline, noting "something snapped inside the hearts of most oilfield execs."
"As we’ve previously noted, sentiment around Calgary is reaching depths likely not seen since the implementation of the National Energy Program in 1980," the analyst said. "From an analytical perspective, the decision is far from a death-knell for the project. With some political oomph, the issues raised are all addressable and could conceivably represent only (another) delay. But as they say, “a pipeline delayed is a pipeline denied”, especially as far as today’s market is concerned, and especially in today’s political climate.
"Meanwhile, competition for limited pipeline capacity today has widened both light and heavy crude price differentials, with the promise of only modest relief in sight from rail – and even then probably not until early 2019. So while we’ve repeatedly noted that producers have been underspending their cash flow, and still are even with the widened differentials, the dark clouds hanging over the sector have removed any sense of urgency on the part of E&Ps to spend that cash flow. The Trans Mountain decision and recently widened crude differentials have dealt a one -two combination to the Canadian fracturing space, resulting in an over-supplied market and consequent downward pricing pressure."
After lowering his financial projections for fiscal 2018, 2019 and 2020, Mr. Bradford downgrade his ratings for STEP Energy Services Ltd. (STEP-T) and Trican Well Service Ltd. (TCW-T) to “outperform” from “strong buy.” He maintained an “outperform” rating for Calfrac Well Services Ltd. (CFW-T).
His target for Calfrac shares is now $9, falling from $10.25. The average on the Street is $8.09.
“We believe Calfrac will weather the storm better than most. Calfrac’s fortuitous customer positioning means it will be less impacted immediately, though the demand and pricing environment will ultimately catch-up with it,” said Mr. Bradford. “CFW stock has been among the weaker within the pumping group, bringing it into a deeper value range – roughly on par with TCW multiple-wise (5.4 times 2018 estimated EBITDA). CFW’s North American EV per unit horsepower is about US$790, making it expensive in a Canadian context, inexpensive relative to replacement cost, and very inexpensive in a U.S.-competitor context. Debt is manageable, even with our reduced numbers –we forecast it in the 3.2 times to 4.0 times trailing EBITDA range over the next several quarter. U.S. exposure (greater-than 75 per cent of EBITDA), operating plus financial leverage, and the potential for repositioning in the investor mindset provide room for considerable upside for patient investors, despite the Canadian headwinds.”
Mr. Bradford now has a $4.50 target for Trican, down from $6.25. The average is $4.71.
“Trican has had a difficult 3Q and we envision 4Q being even tougher, making the stock tactically unattractive,” he said. “However, the stock has checked-back meaningfully into deep value territory. Trican has been the least bad-performing equity over the last 90 days within the dismally performing Pressure Pumping sub-group – cold comfort for shareholders primarily, and to a degree for us, with our prior Strong Buy rating. We are lowering our rating to OP2. While the valuation is still reasonably attractive – even based on multiples of our reduced estimates (down 33 per cent in 3Q, 59 per cent in 4Q, and 47 per cent for 2019) – we will not have line of sight to improved horsepower demand or pricing until 2Q19 at the earliest, effectively removing the primary catalysts for the stock.”
He lowered his STEP target to $15 from $18. The average is $15.78.
“STEP had a reasonably active 3Q, though like others, there are holes in the 4Q schedule,” he said. “It’s widely appreciated that STEP took dramatic measures to secure a new large format customer, but we believe competitive realities provide sufficient rationale, as we describe below. Similar to TCW, we have trouble pointi ng to any specific nearterm catalyst, though it does sound as though work programs in its Oklahoma-based US fracturing group are more promising than anticipated.”
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Elsewhere, in a research note on Canadian oilfield services companies, Canaccord Genuity analyst John Bereznicki said the domestic completion market appears to be "increasingly turbulent."
"We believe widening light oil and condensate differentials (driven by temporal and structural factors, in our view) are contributing to a more turbulent WCSB completion market than we had previously anticipated heading into Q4/18," he said. "We also believe some industry participants may be using current industry softness to jockey for market position, with Calfrac’s recent investor deck pointing to 'irrational pricing' behavior in the space. Despite these headwinds, we continue to look for at least a modest improvement in fundamentals next year and believe those with domestic completion exposure in our coverage universe remain generally well positioned to benefit should LNG Canada move forward with a positive FID.
"Given the inherent fixed-cost structure of the domestic pumpers, we believe even modest pricing reductions could have an outsized impact on operating cash flow. We thus believe it prudent to reduce our domestic EBITDA estimates for Trican and Calfrac through 2019. We are also lowering our EBITDA expectations for Source to reflect a reduction in spot proppant volumes and pricing."
With those declining earnings expectations, Mr. Bereznicki also lowered his target price for the three companies in his coverage universe for the sector, while maintaining "buy" ratings for them all.
His changes were:
Calfrac Well Services Ltd. (CFW-T) to $6 from $7. Consensus is $8.09.
Source Energy Services Ltd. (SHLE-T) to $8 from $8.75. Consensus is $8.91.
Trican Well Service Ltd. (TCW-T) to $3.25 from $4.25. Consensus is $4.71.
"While acknowledging our forecast visibility for the pumpers looks increasingly opaque as the Q3/18 earnings season approaches, we nonetheless believe the equities in our coverage universe generally reflect significant negative investor sentiment," he said. "Trican (a pure-play domestic pumper) is now trading at levels last seen in late 2016 when the company carried more than 3 times as much debt as it did at the end of Q2/18. We thus view Trican's recent share price weakness as likely overdone and believe the company should appeal to the patient value investor with a higher-than-average risk tolerance."
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Expecting its free cash flow to rise markedly on the back of its recent $320-million acquisition of Mount Bastion Oil & Gas Corp., Industrial Alliance Securities analyst Michael Charlton initiated coverage of Surge Energy Inc. (SGY-T) with a “buy” rating.
“Surge is well positioned to continue to grow organically with over 10 years of highly economic drilling locations at current prices, while offering investors three forms of upside: production growth of 5-7 per cent, a dividend yield of 4-5 per cent, and 9-10-per-cent free cash flow yield, for a combined total return per annum of 18-22 per cent, which we view as attractive and compelling reasons to own the stock,” he said.
Mr. Charlton said the MBOG acquisition, announced on Sept. 8, adds a "synergistic" new core area to Surge's portfolio, pointing to its "light and medium crude production with high working interest, averaging 80-per-cent and 90-per-cent operatorship across the assets and a substantial drilling interest."
He added: "Benefits of the transaction are numerous and include an estimated 11-per-cent bump to Surge's forecasted adjusted funds flow per share. Given the oil/liquids weighting of the MBOG production, it is also anticipated that the transaction will have a positive impact on Surge's realized prices and netbacks, with management estimating this acquisition will add an additional $85-million of net operating income in 2019 and exhibit capital efficiencies of less than $25,000 per flowing barrel. Given the low decline nature of the production acquired, management forecasts that Surge's overall corporate decline rate will fall to below 24 per cent."
Mr. Charlton also emphasized the company pays a sustainable monthly dividend, which it is looking to increase by 25 per cent with the closing of the MBOG deal.
He set a target price of $4 per share, exceeding the average on the Street of $3.42.
“Management has a history of delivering production and cash flow per share growth over the past 2 years; this trend seems likely to continue with the company's most recent acquisition adding more fuel to the fire by increasing cash flow and dividends,” he said.
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In reaction to Thursday’s release of “mixed” fourth-quarter 2018 financial results, Desjardins Securities analyst Gary Ho lowered his target price for shares of Gluskin Sheff + Associates Inc. (GS-T) to reflect lower performance fee estimates.
"Base EBITDA was below our expectations and consensus, driven by an unexpected bonus accrual above its historical rate (second consecutive year)," he said. "GS had previously disclosed AUM and net inflows, so there were no surprises on that front."
Mr. Ho lowered his 2019 earnings per share projection by a dime to $1.35.
With a "hold" rating, his target price fell to $17.50 from $18. Consensus is $17.92.
"We believe the HNW market has the most attractive growth potential among wealth management segments over the next decade. That said, given the uncertainty around fees, risk of increased competition and higher expenses (and bonuses), we maintain our Hold recommendation."
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The departure of Mediagrif Interactive Technologies Inc.'s (MDF-T) chief executive officer Claude Roy could “open the door to a takeout,” according to Desjardins Securities analyst Maher Yaghi.
On Wednesday after market close, the Longueuil, Que.-based information technology company announced Mr. Roy's departure and the formation of a special committee to examine "various options" moving forward.
"We have updated our LBO [leveraged buyout] model, which we first published in June 2017, to assess what the stock might be worth to a buyer," said Mr. Yaghi. "In order to find a win-win scenario, one has to consider that over the last two years, MDF has not been able to turn around its organic growth rate, which has remained in the negative 4-per-cent to negative 2-per-cent range, even with investments in R&D. On the other hand, the company has a pristine balance sheet and healthy FCF generation.
"Our LBO model indicates that a 20-per-cent premium could generate sufficient return (IRR of 18 per cent) for private equity investors. Our assumptions include a leveraged transaction at 3.5 times EBITDA, debt costs of 4.0 per cent and an eventual divestiture after four years at 9 times FCF. Recall that in 2010, OMERS acquired the technology company Logibec, where Claude Roy was CEO and held 23 per cent of the company; the premium offered for Logibec was 17 per cent."
Maintaining a "hold" rating for the stock, Mr. Yaghi lowered his target by a loonie to $12, which sits below the average of $13.50.
"MDF trades at an attractive FCF yield of 10.7 per cent, and with FCF generation estimated at $16-million in FY19 combined with a low net debt to EBITDA of 0.7 times, this provides management with a good opportunity to generate value for shareholders," the analyst said. "At our estimated $12 takeover price, this would equate to an FCF yield of 9 per cent. It remains uncertain at this point which acquirer type would be interested in taking out MDF, but we believe the most likely scenario would involve a private equity group. More important is the question of what management would be willing to accept in a transaction—we do not have an answer to that question. We believe management will need to consider what the company could be worth today rather than focusing on what the stock price was when organic growth was comfortably in positive territory."
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Cannonball Research analyst Vasily Karasyov downgraded IMAX Corp. (IMAX-N) to “neutral” from “buy” with a US$25 target (unchanged). The average is US$28.58.
Mr. Karasyov said: “We think the estimates and valuation both look reasonable at this point. The former, in our view, reflect realistic expectations of IMAX box office recovery after a soft FY17 especially in the U.S. and China. Forward EV/EBITDA bounced back and is now around our target multiple of 9 times. As a result, IMAX is trading in line with our price target of $25. We think for the stock to go up from this level a re-rating would be necessary, but we don’t see a catalyst for it. We therefore believe the shares will trade close to the current range and we are downgrading IMAX.”
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In other analyst actions:
TD Securities initiated coverage of Uni-Select Inc. (UNS-T) with a “hold” rating and $24 target. The average is $25.92.
David Leeder