Inside the Market’s roundup of some of today’s key analyst actions
The increasing gap in the pace of growth between Canadian and U.S. railway companies is a "key story" in the sector's third quarter, according to RBC Dominion Securities analyst Walter Spracklin.
"We have noticed a divergence in growth rates between the Canadian and US rails with the Canadians benefitting from crude by rail, increased grain volumes and intermodal growth due to market share gains at the Canadian West Coast ports," said Mr. Spacklin. "On the other hand, the US rails have been affected by lower intermodal shipments reflecting trade concerns and excess truck capacity as well as weakness in coal resulting from low natural gas prices. While this divergence narrowed in Q3, we expect it to accelerate once again in Q4 and 2019 (mainly on the back of Crude, Ag and Intermodal)."
In a research report released Friday, Mr. Spracklin lowered his third-quarter estimates, pointing to lower-than-anticipated volumes. He blamed the weakness on “decreased intermodal volumes resulting from trade concerns and excess truck capacity.”
“In an environment of slowed global growth and increased trade war tensions between the U.S. and China, international freight volumes have suffered and adversely impacted carloads at all of the Class 1’s, especially the U.S. railroads,” said the analyst. “Additionally, in Q4/18, imports from China reached a record high as shippers tried to get their shipments to the US before the implementation of tariffs. The growth related to these pull-forward volumes negatively affected volumes in the first half of the year and implies that railroads are facing tough comps in the second half. Volumes have also been affected by lower coal carloads as domestic coal is weak reflecting low natural gas prices and export coal is down due to decreased export coal prices.”
Mr. Spracklin reaffirmed Canadian Pacific Railway Ltd. (CP-T, CP-N) as his favourite railroad.
" We believe that CP has many organic growth opportunities relative to peers and our view is that CP is likely to see on average roughly 300 basis points of growth better than the peer average, regardless of the economic backdrop," he said. " Combine that with solid operational execution, strong management and attractive shareholder returns, we continue to rank CP first among our North American rail coverage. Looking at CN, we continue to view CN as a solid long-term holding; however, we believe that the shares are fairly valued at these levels."
However, he lowered his third-quarter earnings per share estimate for CP to $4.60 from $4.70, pointing to lower crude and potash volumes. His 2019 and 2020 full-year estimates fell to $16.61 and $19.14, respectively from $16.71 and $19.24. The averages on the Street are $16.62 and $18.70. He also introduced a 2021 estimate of $21.
Keeping an “outperform” rating for CP shares, he increased his target to $378 from $356. The average target on the Street is $339.35.
At the same time, Mr. Spracklin lowered his earnings per share estimates for Canadian National Railway Co. (CNR-T, CNI-N) for the third-quarter to $1.65 from $1.73, which falls below the consensus on the Street of $1.68. His 2019 and 2020 full-year estimates fell by 8 cents to $6.20 and $6.85, respectively. Both fall below the consensus ($6.21 and $6.93.
He also introduced a 2021 estimate of $7.59, which he noted represents 11-per-cent year-over-year growth, "which is consistent with management's long-term guidance of low double-digit growth."
He maintained a “sector perform” rating for CN shares with a target of $137, rising from $128. The average on the Street is $129.29.
“Our target multiple represents a premium to the peer average due to CNR’s network advantage and diversified revenue mix,” he said. “While we believe that the shares are fully valued reflecting the high valuation, we continue to view CNR as a core long-term holding.”
Separately, Raymond James analyst Steve Hansen said Canadian railway traffic growth is "dissipating," leading him to lower his rating for CN to "market perform" from "outperform."
“While Canadian rail traffic continues to show modest quarter-to-date growth in the face of steep macro uncertainty, the pace of this growth has demonstrably slowed in recent weeks/months as key outsized tailwinds have dissipated — most notably crude-by-rail and potash," said the analyst. "Coupled with other near-term uncertainties surrounding grain (wet, delayed harvest), we have taken an initial swipe at our 2H19 traffic/earnings estimates, with our revised forecasts now calling for a relatively muted 2H cadence, but still modest EPS growth given the solid op. metrics observed. While we acknowledge these headwinds are likely short-term in nature, we’re mindful of the elevated risk associated with traffic turning negative (as in recent weeks) — particularly after a long and healthy upturn (difficult winters notwithstanding). In this context, while our LT outlook remains fundamentally positive, we believe the current lack of near-term visibility warrants caution, hence our decision to downgrade CN today to Market Perform (vs Outperform prior, target unchanged) given its weaker traffic pattern of late and more difficult forthcoming comparables. While we admittedly harbor similar concerns over CP’s 4Q outlook (potash in particular), we’re comfortable maintaining our Outperform rating (target unchanged) given the company’s healthier traffic pattern, recent contract wins, and advantaged EPS growth.”
He maintained a target of $135 for CN shares and $340 for shares of CP.
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Though it is “well-positioned” for 2020, Desjardins Securities analyst John Chu expects Aurora Cannabis Inc. (ACB-T) to face near-term headwinds.
Pointing to both seasonally weaker industry sales and and the rising costs associated with a ramp-up toward the mid-December legalization of edibles, Mr. Chu pushed back his expectation of positive EBITDA to early next year following Wednesday's release of lower-than-anticipated fourth-quarter results.
“We also believe that the potential for additional funding to grow the existing businesses and expand into the U.S. could be a near-term overhang on the stock,” he said.
“However, Aurora Sky and some of its other facilities are near full ramp-up, which should open up more sales opportunities both internationally, where demand outstrips supply, and domestically, as the retail structure across Canada ramps up (Ontario and Alberta have been adding new stores lately, which should boost industry sales near year-end and in CY20).”
Mr. Chu lowered his EBITDA and sales estimates for 2019 through 2021, citing "lower recreational sales given the $20-million lift from bulk wholesale sales in 4Q."
"S&M expenses should remain high for the next few quarters to prepare for the edibles launch, which should weigh on EBITDA," he said. "As such, we expect modestly positive EBITDA in 3Q FY20 (ending March)."
Maintaining a "buy" rating for Aurora shares, he trimmed his target to $14 from $16.50. The average on the Street is $12.24.
“Even with a more conservative forecast and a lower valuation multiple, we still see good upside in Aurora,” said Mr. Chu. “New retail stores and the launch of edibles should help set the stage for a robust CY20, and we expect Aurora to be one of the main beneficiaries.”
Elsewhere, Canaccord Genuity analyst Matt Bottomley maintained a “speculative buy” rating and $13.50 target.
He cautioned investors to expect sector-wide earnings volatility.
“Aurora noted that given the nascent stage of the industry and continued bottlenecks in Canada’s retail roll-out, quarter-over-quarter results could see volatility over the near term,” he said. “As a result, the company expects to see growth rates plateau in the coming quarters before re-accelerating heading into 2020. Although the company believes that inflecting into adjusted EBITDA territory is still a near-term event, the company appears less certain if it will be able to cross this threshold by the end of the calendar year.”
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Expressing concern about both its profitability and current valuation, Cowen analyst Vivien Azer initiated coverage of Acreage Holdings Inc. (ACRG-U-CN) with a “market perform” rating.
Ms. Azer said the marijuana company’s deal with Canopy Growth Corp. (WEED-T) brings tangible benefits prior to further sector consolidation, however she does not see meaningful upside on an organic basis.
The analyst thinks Acreage will need to spend its way to growth, which it says is a concern given its low margin profile and cash balance.
She set a target of $9 per share. The average is currently $18.
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Empire Company Ltd. (EMP-A-T) “has turned the page on its brush with disaster following the troubled integration of Safeway,” according to Desjardins Securities analyst Keith Howlett.
"The company has implemented a clear strategy and is improving its execution," he said. "Management is confident of obtaining at least $250-million of procurement cost savings (gross) in FY20. While the translation of Project Sunrise savings to EBITDA has been opaque, we expect the final tranche of savings to be more visible. Increasing EBITDA will, however, be even more difficult in FY21 and beyond."
On Thursday before the bell, the grocery store operator reported first-quarter adjusted earnings per share of 49 cents, meeting the Street’s expectation but falling a penny short of Mr. Howlett’s estimate. Same-store sales, excluding fuel, increased 2.9 per cent, exceeding internally measure inflation of 3 per cent.
In reaction to the results, Mr. Howlett raised his 2020 and 2021 EPS projections to $2.04 and $2.29, respectively, from $1.92 and $2.15, citing “higher translation of procurement savings and the impact of IFRS 16.”
With a “hold” rating (unchanged), Mr. Howlett hiked his target for Empire shares to $36 from $31. The average on the Street is $38.11.
“It appears that Empire is ‘back in the game,’ close to ‘fit and functional,’ and able to compete with Loblaw, Walmart, Metro, Costco and Save On, and to a lesser extent Amazon. The procurement savings from Project Sunrise should drive FY20 EBITDA from food to within sight of historical peak EBITDA (pre-IFRS 16). We assume that western Canadian operations are still less profitable than other regions of Canada but are no longer a threat to capsize the ship. There is improvement in Ontario. The debt rating agencies are increasingly positive. Significant risk remains in relation to the western Canada discount strategy and the Ocado online grocery solution.”
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In a separate note, Mr. Howlett trimmed his financial expectations and target price for Dollarama Inc. (DOL-T) after the discount retailer’s second-quarter results fell short of his projections.
"Same-store traffic and transaction size growth remains management’s priority," he said. "Samestore sales grew by 4.7 per cent in 2Q, driven by traffic growth of 0.9 per cent and basket size growth of 3.8 per cent. Gross margin declined 130 basis points. SGA expense rate increased in 2Q by 30 bps, but management maintained its FY20 SGA guidance of 14.25–14.75 per cent. We have lowered our FY20 and FY21 EPS forecasts.
"Dollarama appears to have used a number of tactics to revive same-store sales growth. This has included adding more items to the shelves, including (we believe) more wellknown nationally branded beverages and snacks, both for immediate consumption and to take home. It appears to us that prices of gift bags have been clustered at the $1.25 and $1.50 price points, reversing what had been a creep to higher price points. More impulse sales are the result of a single queue formation for cashing out that winds through confectionary offerings."
The analyst reduced his 2020 and 2021 EPS estimates to $1.77 and $2.16, respectively, from $1.84 and $2.23.
With a “hold” rating, his target dipped by a loonie to $48. The average on the Street is $50.71.
“We think it is positive that Dollarama has succeeded in increasing consumer trips by offering new (to Dollarama) and appealing products for sale, and increasing consumer engagement by faster rotation of promotional displays of products, on end caps and in other high-profile display areas. With little to no help from inflation, basket size is growing as are transactions,” said Mr. Howlett. “Units per basket are increasing. The cost is that gross margin has come under pressure from a decline in product margin, a shift to lower margin products and transitory logistics costs (through to the end of CY19). We have tempered our expectations for gross margin rate.”
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In other analyst actions:
JPMorgan analyst Seth Seifman cut Bombardier Inc. (BBD-B-T) to “neutral” from “overweight”
Raymond James analyst Steven Li initiated coverage of Universal Mcloud Corp. (MCLD-X) with an “outperform” rating and 65-cent target.
“Given the size of the TAM, the strong secular drivers and the attractive model, we believe mCloud is one of the IoT names to watch,” he said.
With files from Reuters
David Leeder