The F-35 Lightning II fighter aircraft.LOCKHEED MARTIN via THE NEW YORK TIMES
Inside the Market's roundup of some of today's key analyst actions
Russel Metals Inc. (RUS-T) is currently "fairly valued," according to Raymond James analyst Frederic Bastien.
Though he said he's a "big fan" of the company's management, Mr. Bastien said the sustainability of the recovery in steel is "in question" and the demand outlook for energy products is "muted." Accordingly, he downgraded his rating to "market perform" from "outperform" to reflect the stock's "big gains" thus far in 2016. Russel's share price has risen 47 per cent, compared to a 7-per-cent return for the TSX index as a whole.
Despite being more upbeat about its Metals Service Centers (MSC) when Raymond James marketed the firm to institutional investors in Toronto last week, Mr. Bastien said its management remained cautious about the outlook for its energy products division.
"Tighter inventories and U.S. mills' effective lobbying against imports have helped push scrap, sheet and plate prices up a respective 65 per cent, 48 per cent and 41 per cent from 4Q15's multi-year lows," said Mr. Bastien. "OCTG [oil country tubular goods] prices, meanwhile, have stopped falling and now hover closer to where they started 2016. While the price rebound is encouraging to us, we'd prefer to also count demand as a key contributor. The reality is few industrial sectors are enjoying growth these days, save for automotive and construction. This is reflected in the latest MSCI data, which shows April steel shipments from U.S. and Canadian service centres falling 6 per cent and 13 per cent, respectively. Accordingly we expect prices to correct sometime this summer or early fall, and settle to levels more in-line with fundamentals by year-end."
Pointing out the spending appetites for energy customers remain limited, Mr. Bastien added: "It is hard to envision how the firm's OCTG business in the U.S. will improve when: (i) there is still nine months of supply in the system, and (ii) the majors are struggling to pay their bills. Russel's gas-heavy client roster north of the border is in comparatively better shape financially, but prices aren't. With customers setting budgets for the fall and winter months amid $1/GJ AECO, we only see a modest pick-up over the next 12-15 months."
Suggesting "needle-moving" M&A opportunities are lacking in the service centre sector, Mr. Bastien lowered his 2016 and 2017 earnings per share projections to $1.10 and $1.55, respectively, from $1.15 and $1.65.
His target price for the stock remains $23. The analyst consensus price target is $21.25, according to Thomson Reuters.
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Resuming coverage of Peyto Exploration & Development Corp. (PEY-T) following its recent equity financing, BMO Nesbitt Burns Randy Ollenberger said its first-quarter results exceeded his expectations.
The Calgary-based energy company reported funds from operations of 88 cents, topping Mr. Ollenberger's 81-cent estimate and the consensus of 80 cents. He pointed to lower-than-projected operating costs and higher realized pricing as the key reasons for the result.
The company's quarterly production of 101,546 barrels of oil equivalent a day (boe/d) also met his expectations (101,400 boe/d). It reported a cash netback of $15.14 boe for the quarter, compared to Mr. Ollenberger's projection of $14.52 boe.
The equity financing of $172.5-million is expected to provide Peyto with financial flexibility.
In reaction to the deal and the results, Mr. Ollenberger raised his 2016 cash flow estimate to $3.15 per share from $2.85. His 2017 estimate rose to $4.22 from $3.26.
Maintaining his "outperform" rating, he raised his target price for the stock to $35 from $33. The analyst average is $35.74, according to Bloomberg.
"We continue to view Peyto as one of the top natural gas producers in North America given its industry-leading cost structure, strong hedging program, and enhanced balance sheet," said Mr. Ollenberger. "At current prices, Peyto shares are trading at a 2016E EV/EBITDA [enterprise value to EBITDA] multiple of 11.8 times versus a North American peer group median of 11.4x."
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Without accounting for the potential of U.S. trading actions faced by softwood producers, the Street's estimates are still too high for Acadian Timber Corp. (ADN-T), said CIBC World Markets analyst Hamir Patel.
Mr. Patel downgraded the stock to "sector underperformer" from "sector performer."
"With increased likelihood Canadian softwood lumber producers will face punitive anti-dumping (AD) and/or countervailing duties (CVDs) by February/March 2017, we believe there may be volume and/or pricing downside risk to our near-term estimates for softwood log sales out of Acadian's New Brunswick timberlands (approximately 73 per cent of 2015 EBITDA)," the analyst said. "Additionally, while we suspect the Maritimes will benefit from an exclusion from tariffs when we do eventually get another SLA (similar to the region's treatment under prior periods of managed trade), this is by no means certain."
Mr. Patel said he is not including the potential impact of AD and CVD into his estimates. However, he noted his 2017 EBITDA estimate of $21-million is 25 per cent lower than the consensus projection of the Street ($28-million).
"Assuming an unchanged quarterly dividend of 25 cents per share, our current forecast implies a 95-per-cent payout ratio in 2017 (right in line with the company's stated target over the cycle)," he said. "However, in a scenario where AD/CVDs on Acadian's sawmilling customers cause ADN's New Brunswick softwood log shipments to fare 8 per cent lower than our forecast for 2017 (with a related 4-per-cent reduction in pricing relative to our base case), we estimate total EBITDA would decline to $19.6-million with a payout ratio approaching 103 per cent. Although Acadian previously cut its quarterly payout to 5 cents per share in Q4/09 (when it reduced harvest levels during the Global Financial Crisis to maximize the value of its timberlands), with over $20-million of cash on its balance sheet, Acadian can manage the $17-million per year dividend outlay."
He maintained a price target of $17. Consensus is $20.
"Reflecting increased risks to pricing and harvest volumes of softwood logs in New Brunswick, we have increased our discount rate to 5.75 per cent (from 5.25 per cent previously)," said Mr. Patel. "While a potential 12-month window of subdued softwood performance in New Brunswick is not particularly material when assessing timberland with a 60- to 80-year rotation cycles, we are also factoring in the risk that the Maritimes may not enjoy duty-free access to the United States market under a future agreement of managed trade. While we understand our public market discount rate is higher than what may be utilized in the private timberland market, we believe a more conservative approach is warranted given the public market discount gap we have seen with publicly-traded U.S. timber REITs. U.S. timber REIT Rayonier estimated in February 2016 that North American timberland discount rates are in the 5%-6-per-cent range (real), but we have heard reports of even lower figures being utilized."
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Shareholders of Whitecap Resources Inc. (WCP-T) should see "a relatively good year," said Raymond James analyst Jeremy McCrea.
Emphasizing its "healthy" balance sheet and "a commitment to profitable above-average growth," Mr. McCrea initiated coverage of the stock with an "outperform" rating.
"While WCP's share price has seen considerable volatility over the past two years – related to dividend cuts, changes in capex spending, and acquisitions – one item that has remained constant is its top well economics and focus on return of capital in its core plays (Cardium and Viking)," he said. "Although WCP has not been shy of acquisitions (as proved by the acquisition of Husky's southwest Saskatchewan assets), forecasting future acquisition profitability is difficult. As a result, the focus of our initiation report is on its core plays and changes in completion design that should continue to keep Whitecap's well economics among the top economics in the Cardium and Viking."
Mr. McCrea said the Calgary-based company had "strong success" with its wells in the first-quarter, in particular in the Boundary Lake area. He said its drilling program brought "considerable cost savings, continuing the overall industry trend of declining capital costs." Whitecap also saw declines in transportation and operating costs.
"With a 15-per-cent decline in corporate realized pricing, WCP's field netbacks have seen a predictable decline at 19 per cent (excluding hedges)," the analyst said. "We note that cash flow in 2015 was supported by realized hedging gains but with hedges rolling off and with better expected commodity prices, the expected gains are set to decline. Overall, despite the fall in commodity prices, field margins (excluding hedges) are expected to decline only 4 per cent, from 68 per cent in 2014 to 58 per cent expected in 2017 thanks in large part to lower operating costs."
Mr. McCrea set a 6- to 12-month target for the stock of $12. Consensus is $12.13.
"Across our coverage we believe that if a company has significant running room and economic plays, than shareholders are better served through increased economic value add each year that could ultimately be paid out through share price appreciation," he said. "That being said, while WCP has been a consistent dividend payer, it has not stretched its balance sheet to do so and with rightsizing its dividend payout ratio to 25 per cent for 2017 (lower than any historical period), it strikes an appropriate balance between yield and growth investors. We suspect as commodity prices increase, additional funds flow will likely be deployed into debt repayment (for future acquisitions), further capex increases, and finally, an increase to its dividend."
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With its valuation at a 10-year high, RBC Dominion Securities analyst Robert Stallard said he's "taking a breather" from Lockheed Martin Corp. (LMT-N).
Mr. Stallard downgraded the Maryland-based global security and aerospace company to "sector perform" from "outperform."
"Our rating change on Lockheed Martin is prompted by the strong performance of the stock (up 11 per cent year to date, up 11 per cent versus S&P500), and the consequent expansion in its valuation multiple (17.3x 2017 estimate P/E)," he said. "This puts Lockheed at the highest valuation that we have seen in 10 years - and the only time that the valuation was higher was when the DoD budget was growing at a double digit rate in 2002-03, and the US military was heavily engaged in Afghanistan. At this point we would be stepping back, and looking for better opportunities to deploy fresh capital into the stock."
Mr. Stallard said the "elevated" valuation could be a reflection of the improved outlook for the company's F-35, noting "we have started to (finally) see a material pick up in deliveries."
"We have the program expanding from 20 per cent of Lockheed's sales in 2015 to 30 per cent in 2018," he said. "As we get into the 2020 time frame, Lockheed should also be moving out of LRIP [low-rate initial production] into full rate production, which should also help operating margins."
"In the more immediate term, Lockheed potentially has less flexibility on cash deployment than it has enjoyed of late. After a payment holiday, we expect cash contributions to the pension of $1.5-billion in 2018 - though the dividend from the IS&GS [ Information Systems & Global Solutions] transaction and increased operating cashflows should help. With its dividend representing nearly 60 per cent of 2016 estimated EPS, Lockheed also has less headroom for growing the DPS at a mid-teens rate whilst also aggressively buying back stock."
Mr. Stallard maintained his target of $222 (U.S.) for the stock. Consensus is $243.60.
With a similar rationale, Mr. Stallard downgraded Northrop Grumman Corp. (NOC-N) to "sector perform" from "outperform."
"Our discussions with investors regarding defense and Northrop Grumman have increasingly gravitated towards valuation as being the major area of contention," said Mr. Stallard. "We would say that it is now the majority view that the fundamental outlook for defense has materially improved, and that we are now back into a revenue growth pattern. We think margins are likely to remain steady for most defense contractors, coupled with consistent cash generation and sensible cash deployment. So far so good – but what should investors pay for this? Northrup Grumman and its peers have enjoyed a period of very strong multiple expansion in recent years, and this has pushed the valuations for some defense names to levels not seen since the early years of George W Bush's first term – post 9/11, and during a period of very strong growth in US defense spending. As we have long shown, there has been a pretty good multiyear correlation between the DoD spending outlook and the forward P/E valuation for the defense sector. However, the recent period of multiple expansion has pushed valuations considerably higher than the historical correlation would suggest is fair for a mid-single digit growth outlook."
He added: "It could be argued that the multiple expansions that Northrop has enjoyed is partly due to its LRS-B win. What is now known as the B-21 is set to be a major franchise program for Northrop for decades to come. However, the program remains classified - and this has obliged the company to give less information than investors would like including company-wide backlog by quarter. The suspicion remains that the B-21 will be margin dilutive, and there is not much Northrop can say to prove or dis-prove this notion."
He maintained his $222 (U.S.) target for the stock. Consensus is $217.47.
"With an improving defense environment, and the B-21 ramp still ahead, we think the long term outlook for Northrop Grumman remains positive," said Mr. Stallard. "However, with the valuation having pushed up to nearly 18x 2017E P/E, we would be looking for a better entry point before deploying fresh capital into the stock."
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In other analyst actions:
Cardinal Energy Ltd (CJ-T) was rated new "Buy" at TD Securities by equity analyst Aaron Bilkoski. The 12-month target price is $10.50 (Canadian) per share.
Inter Pipeline Ltd (IPL-T) was downgraded to "sector perform" from "outperform" at Alta Corp Capital by equity analyst Dirk Lever. The 12-month target price is $27 (Canadian) per share.
L Brands Inc (LB-N) was downgraded to "neutral" from "outperform" at Robert Baird by equity analyst Mark Altschwager. The 12-month target price is $66 (U.S.) per share. It was downgraded to "neutral" from "buy" at MKM Partners by equity analyst Roxanne Meyer with a 12-month target price of $60 per share.
Lockheed Martin Corp ) was downgraded to "sector perform" from "outperform" at RBC Capital by equity analyst Robert Stallard. The target price is $244 (U.S.) per share.
Square Inc (SQ-N) was rated new "neutral" at Piper Jaffray by equity analyst Jason S Deleeuw. The 12-month target price is $10 (U.S.) per share.
Time Inc (TIME-N) was raised to "outperform" from "neutral" at Macquarie by equity analyst Timothy Nollen. The 12-month target price is $17 (U.S.) per share.
With files from Bloomberg News