Monday’s analyst upgrades and downgrades – May 15, 2018

Though he cautions patience may still be required, RBC Dominion Securities analyst Drew McReynolds upgraded his rating for Thomson Reuters Corp. (TRI-N, TRI-T), believing it now presents investors with an “attractive” entry point.

“We continue to believe the stock will have to endure a ‘digestion period’ following the F&R [Financial & Risk] transaction, with lingering uncertainties around the substantial issuer bid, reinvestment of proceeds, and earnings power,” said Mr. McReynolds, moving the stock to “outperform” from “sector perform.”

“Excluding one-time reinvestments and transitional stranded costs, the stock trades at 10.1 times [forward 12-month] enterprise value-to-EBITDA versus 12.7 times and 14.1 times for Wolters Kluwer and Reed Elsevier based on consensus, respectively. While a discount to peers is warranted given these uncertainties and lower organic growth, we believe the magnitude is unwarranted and current levels represent an attractive entry point for investors looking through this digestion period.”

The upgrade came in response to Friday’s release of in-line first-quarter financial reports, which sparked a 3.7-per-cent decline in share price.

Those results also prompted Canaccord Genuity analyst Aravinda Galappatthige to raise his rating for the stock to “buy” from “hold.” He believes the stock’s dip is an overreaction to a near-term spike in corporate costs.

In justifying his move, Mr. McReynolds pointed to a rise in organic revenue growth from its legal segment, noting: “Given a ‘drifting’ of the stock since the F&R announcement,we expect the newly committed $500-million for share repurchases pre-closing to provide a firmer floor under the stock. Post digestion period, potential catalysts include: (i) a return to 3–4-per-cent organic revenue growth for Legal; (ii) steady improvement in earnings visibility with the completion of the substantial issuer bid and reinvestment of $1–3-billion in F&R proceeds; and (iii) any meaningful progress within F&R (revenue growth, margins, asset crystallization) under Blackstone.”

“A degree of conservatism leaves room for positive surprises to our forecast. The organic revenue growth and margin performance of Legal and Tax & Accounting have been stable and predictable for a decade. While management is targeting mid-single-digit organic revenue growth, we have built a degree of conservatism into our forecast: (i) a modest increase in organic revenue growth from 2.2 per cent in 2018 to 2.5 per cent in 2019E and 3.2 per cent in 2020E; (ii) a year-over-year decline of 166 basis points in Legal EBITDA margins in 2018; (iii) adjusted EBITDA of $1.234-billion in 2018, which is at the low end of guidance; and (iv) F&R organic revenue growth of 1 per cent, implying little improvement.”

Mr. McReynolds maintained a target price for Thomson Reuters shares of US$44. The average target on the Street is currently $43.14, according to Bloomberg data.

Though he believes the stock is now trading at “attractive ‘normalized’ valuation,” Mr. Galappatthige did lower his target to US$43 from US$44, citing “uncertainty” around temporarily elevated corporate costs and higher interest rates.

“We think the principal factor that is affecting the stock is the magnitude of the corporate costs in 2018 and 2019 ($550-million per year),” said Mr. Galappatthige. “This includes a number of items including stranded costs ($150-million in 2018), Investments to reposition ($200-300-million) and, of course, core corporate costs ($140-million). This all comes out of adj. EBITDA in 2018/2019 leading to a substantial earnings re-set and the market may be unsure as to what extent it should rely on the expectation that the combined corporate costs would decline from $500-600-million in 2018/2019 to $190-million by 2020, as guided by management. This is exacerbated by the fact that 1) 2020 is still a bit further away and 2019 would reflect no ramp down; 2) the programs to lower corporate costs below $200-million is still being finalized and thus in early stages. Note that it is not just a matter of lapping one-time costs. Some of these incremental amounts relate to ongoing resources that are needed after the exit of F&R (e.g. access to data centres, servers, etc., real estate partitioning, investments in enhancing digital capabilities). These incremental costs have to be offset with savings that are derived on the basis of halving the size of the business, due to the exit of F&R.

“We take comfort in two considerations. First, these incremental corporate costs are not new, they were included in the $1.5-2.5-billion estimate given by management alongside the F&R deal announcement. Second, even if $190-million in 2020 itself is not achieved, considering the component of restructuring costs (hence one-time in nature) included in the $550-million and the genuine halving of the size of the business, there is good reason to expect the aggregate number to fall materially by 2020, at a minimum to $250-275-million.

Woodbridge Co. Ltd., the Thomson family holding company and controlling shareholder of Thomson Reuters, also owns The Globe and Mail.

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Believing it’s time to “get in on the ground floor,” Raymond James analyst Ken Avalos upgraded Crombie Real Estate Investment Trust (CRR.UN-T) to “outperform” from “market perform” following the release of in-line financial results.

“Crombie’s operations remain steady to strong, and with development completions beginning later this year, we think the Company’s NAV [net asset value] growth will be solid over the next few years,” said Mr. Avalos. “We believe Crombie is due for a re-rating given the visibility on deliveries and high quality of the locations (particularly on the West Coast). At a 22-per-cent discount to NAV, we believe the stock provides a solid entry point for investors with a bit of patience. We may be a bit early, but the 7-per-cent yield helps with the waiting.”

On Friday, the Nova Scotia-based REIT reported funds from operations for the first quarter of 30 cents per unit, an increase of 3 per cent year over year and meeting the Street’s expectations. Same-asset property net operating income grew a “robust” 2.7 per cent as occupancy rose 0.6 per cent to 95.6 per cent.

“With 8.6 million square feet of potential intensification and development in their portfolio, we have bumped up our NAV to better reflect potential beyond the active developments,” said Mr. Avalos. “For now, we have used a value of $15 per sf. (vs. $20– $25 for First Capital/RioCan). This equates to $130-million of new value incorporated into our NAV. The REIT added Penhorn Lands – Phase I in Halifax to the active pipeline, bringing it to five projects with a total cost of $315-million (5.5–13.0-per-cent yields). In total, Crombie has 22 major projects (greater-than $50-million cost) where development could include a mixed-use or residential component. Yields are projected to average out to 5.4% and the total projected cost is $3–$4.5-billion. Crombie also entered into a JV with Prince Developments on two projects, becoming a 50-per-cent partner in Le Duke (Montreal) and giving up a 50-per-cent interest in Bronte Village (Oakville). The projects will require $400-million to complete.”

Mr. Avalos set a price target of $14 for Crombie units, which is 73 cents less than the average on the Street.

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In reaction to “positive” first-quarter results, highlighted by U.S. revenue growth that continues to “impress,” Industrial Alliance Securities analyst Elias Foscolos raised his rating for Badger Daylighting Ltd. (BAD-T) to “strong buy” from “buy.”

“Badger’s Q1/18 results were positive given the negative sentiments leading up to the earnings release,” he said. “Overall economic growth and an Oil & Gas recovery has led to more company optimism moving forward leading to an increase in truck build rate to 160-200 hydrovac units in 2018. We have revised our target … which results in a potential one-year return of 31 per cent justifying our upgraded rating.”

On May 10, Badger, a Calgary-based provider of hydrovac, hydro-excavation, potholing and vacuum truck services, reported quarterly revenue of $121-million, meeting Mr. Foscolos’s estimate. Adjusted EBITDA of $24-million missed his expectation by $1-million.

Revenue from its U.S. operations, which accounted for 71 per cent overall, grew 29 per cent year over year to $86-million with 84 per cent stemming from hydrovac services.

“BAD has targeted to double its U.S. business from year-end 2016 values in the next three to five years,” the analyst said. “As hydrovac utilization increased in the quarter, we see more visibility for long-term U.S. growth opportunities and we believe the company is well equipped on this target.”

With the results, Mr. Foscolos raised his full-year adjusted earnings per share projection to $1.44 from $1.36. His 2019 estimate rose to $1.74 from $1.65.

His target price for the stock rose to $34.50 from $33. The average target is $32.54.

“On a year-over-year basis, BAD’s Q1/18 results showed substantial improvement with EBITDA margin and revenue improving,” said Mr. Foscolos. “This, coupled with increased truck build, provides a more confident outlook.”

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Magna International Inc. (MGA-N, MG-T) gained a pair of “outperform” recommendations from the Street on Monday.

BMO Nesbitt Burns analyst Peter Sklar upgraded the stock to “outperform” from “market perform” with a target of US$75, rising from US$64. The average is currently US$69.08.

“We now believe that recent strategic developments are highlighting Magna’s capabilities and the company’s momentum in becoming a meaningful player in new technology growth areas,” said Mr. Sklar. “As a result, we believe there will be a gradual re-rating of the company’s stock, which has already begun.”

”The risk to our thesis is if the auto cycle ends, or investors become concerned that the cycle is about to shift to a downturn as a result of ongoing Fed tightening.”

Evercore ISI analyst Chris McNally initiated coverage of Magna with an “outperform” rating and US$80.

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After a reduction in his near-term earnings estimates, CIBC World Markets analyst Jon Morrison downgraded Total Energy Services Inc. (TOT-T) to “neutral” from “outperformer,” citing its valuation.

“To be clear, as we have long said, we believe Total is a very well-run company that is operated by one of the most conservative and fiscally disciplined management teams within the Canadian oilfield services sector,” said Mr. Morrison. “Throughout the company’s existence, the platform has maintained a conservative capital structure, remained keenly focused on generating true ROIC, and has never written down a dime of goodwill in the company’s history. With that said, we believe that some of the slippages that showed up in Q1 will have a follow-on impact in the coming period. Given that we do not believe it makes sense to increase our target multiple, our price target comes down, and we are downgrading the stock on the basis of expected risk-adjusted return versus the peer group.

“As such, our key message is that while we continue to believe there is a place for Total in a number of portfolios, at the margin, we would be dialing back our weights in the stock a touch. The company also announced a partnership with Pason this morning to employ some of the company’s drilling automation and optimization technologies on the Savanna rig fleet. While we view this as a positive sign that Total is focused on not falling behind in rig technology, we do not view it as revolutionary and we would argue that it is not a large competitive advantage in that the same opportunity is likely available for other North American contract drillers.”

Mr. Morrison lowered his 2018 EBITDA projection by 12 per cent, while his 2019 expectation fell 11 per cent.

That led him to drop his target price for the stock to $16 from $18.50. The average is $16.97.

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BMO Nesbitt Burns analyst Ryan Thompson raised his rating for First Majestic Silver Corp. (FR-T) to “market perform” from “underperform” after resuming coverage following a period of restriction.

“The acquisition of San Dimas has augmented our thesis on the stock as the acquisition appears to be accretive on cash flow and NPV metrics, as shown in Exhibit 13.

His target for the stock rose to $9 from $7.50. The average is $11.33.

“We rate shares Market Perform as valuation appears full at current levels. We would recommend FR to investors looking for above-average leverage to a rising silver price.”

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AltaCorp Capital analyst Tim Monachello initiated coverage of six oilfield services stocks on Monday.

Mr. Monachello gave four stocks “outperform” ratings:

Western Energy Services Corp. (WRG-T) with a $1.50 target, which is 2 cents below the consensus.

“We believe WRG has shown consistent operational improvements, featuring a resurgence in its Canadian drilling economics along with consistent market share gains over the recovery,” he said. “We also believe WRG’s high financial leverage and highly variable revenue exposure provide investors with a high-beta play to even a modest recovery in Canadian field activity. Notably though, this is inherently a high-risk proposition as WRG is also a high-beta play to any weakness in Canadian field activity. We believe this risk is largely mitigated by the fact that Canadian activity and pricing remain near trough levels, and global crude oil fundamentals are strengthening.”

Essential Energy Services Ltd. (ESN-T) with a 90-cent target, exceeding the average by 3 cents.

“Our basis for an Outperform recommendation is primarily predicated on ESN’s deep-value proposition based on our 2019 and 2020 cash flow estimates,” he said. “We recognize that deep-value in itself typically doesn’t serve as a catalyst for equities; however, we believe that assuming ESN delivers on market expectations it’s only a matter of time until fundamental value oriented investors, or opportunistic oilfield services players take notice of this anomaly. Along these lines, we expect that ESN’s ability to deliver on operational expectations will likely be the determining factors of share performance over the coming quarters. “

Source Energy Services Ltd. (SHLE-T) with a $10.20 target. The average is $9.36.

“Through its strategically developed network of dedicated mines & processing facilities in Wisconsin and distribution terminals in the heart of the WCSB, SHLE has captured an outsized proportion of rising Canadian proppant demand – propelling its Canadian market share to roughly 40-45 per cent,” he said. “We expect this dynamic will drive continued market share growth for SHLE over the coming quarters. Additionally, we believe SHLE’s fully integrated mine-to-wellsite logistics network, serviced largely by unit train deliveries to its fully owned terminal network, presents significant cost advantages over its competitors and positions it as likely the lowest cost provider of premium frac sand in Canada. We believe these features of SHLE’s business have created a significant ‘moat’ around its dominant Canadian market position. Tactically, we believe SHLE has been significantly oversold and its current price represents a prime opportunity for investors to gain access on the ‘ground floor’ to a company which we believe is poised to become a mainstay of the Canadian energy industry. “

High-Crush Partners LP (HCLP-N) with a US$17.20 target, topping the consensus of US$16.63.

“We believe HCLP’s common units represent a deep discount to fair value today which presents an attractive level for value and yield oriented investors to build positions at a point where HCLP’s quarterly results are poised for a period of consistent strength,” he said.

He gave “sector perform” ratings to the following:

High Arctic Energy Services Inc. (HWO-T) with a target price of $4.50. The average is $5.19.

“We expect the months and quarters ahead to be pivotal for High Arctic,” he said. “We recognize that HWO’s future success largely hinges on the outcome of 3 potential catalysts; 1) final approvals for an expansion of the ‘PNG LNG’ facility in Papua New Guinea; 2) HWO’s ongoing pursuit of North American acquisition based expansion opportunities; and 3) HWO’s negotiations with its largest customer in PNG (Oil Search Ltd.; OSH-ASX; ‘OSL’) surrounding a potential partnership. While we believe a ‘best case scenario’ could yield a bright future for HWO’s business and investors alike, as practitioners of fundamental analysis we must acknowledge that significant risk resides in an investment in High Arctic until there is more certainty around these undetermined outcomes; as such, we recommend a ‘wait-and-see’ approach with respect to building positions in High Arctic.”

Total Energy Services Inc. (TOT-T) with a $12.75 target. The average is $16.97.

“Through Total’s demonstrably disciplined and opportunistic capital allocation strategy it has amassed a long track record of above average returns on capital, and also built one of the most diverse Canadian oilfield services companies along the way,” he said. “For these admirable features of its business Total has cultivated a concentrated base of longterm investors, and its stock has generally traded at premium multiples to its peers. Still, the illiquid nature of an investment in Total presents challenges for investors looking to build or exit a position. Further, TOT stock sold-off considerably less than many of its peers through the downturn and as a result we believe the upside for Total shares today is relatively limited.”

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Avante Corp Inc.’s (XX-X) new chief executive officer Craig Campbell “rejuvenates [a] solid platform play,” said Beacon Securities analyst Gabriel Leung.

He initiated coverage of Toronto-based security, monitoring, system integration and technology company with a “buy” rating.

“While Avante has arguably been a relatively muted investment over the past few years, we believe the recent appointment of Craig Campbell as CEO could help kickstart efforts to optimize the company’s existing security business, while augmenting growth with accretive acquisitions,” said Mr. Leung. “Mr. Campbell is a 16-per-cent shareholder.

“Prior to joining Avante, Mr. Campbell was founder and CEO of Total Security Management. TMS grew to become Canada’s largest privately-held security firm with almost 3,000 employees and was ultimately sold to GardaWorld. Mr. Campbell then went on to found and become CEO of Resilience Capital, a Torontobased investment company that invests in stable profitable operating companies with a focus on the security industry.”

Mr. Leung set a 65-cent target for the company’s shares, which is a dime higher than the average among analysts covering the stock.

“We view the Canadian security services industry (which is Avante Corp’s current geographic focus) as being a steady growth opportunity,” he said. “According to IBISWorld, the Canadian market is valued at ~$3.7B growing at a 0.6-per-cent CAGR [compound annual growth rate] through 2022. We also view this industry as being a relatively recession resilient business with low capex requirements thus helping to drive strong EBITDA to FCF conversion.

“We believe this industry is highly fragmented, comprised of both larger, national players, and smaller, regional competitors, which offers Avante Corp the opportunity to become both an acquirer or acquire.”

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In other analyst actions:

Goldman Sachs analyst Matthew Reustle downgraded Canadian National Railway Co. (CNI-N, CNR-T) to “neutral” from “buy” with a target of US$79, which sits below the average of US$80.57.

National Bank Financial analyst Patrick Kenny upgraded Emera Inc. (EMA-T) to “sector perform” from “underperform” with a target of $43. The average is $48.41.

Macquarie analyst Michael Glen upgraded Cara Operations Ltd. (CARA-T) to “neutral” from “underperform” with a $27 target, up from $24. The average is $31.13.

National Bank Financial analyst Jaeme Gloyn upgraded Element Fleet Management Corp. (EFN-T) to “sector perform” from “underperform” with a $5.50 target, rising from $4. The average is $6.53.

GMP analyst Stephen Boland downgraded Sprott Inc. (SII-T) to “reduce” from “hold” and reduced his target for the stock to $2.75 from $3. The average target is $2.90.