Friday’s analyst upgrades and downgrades

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

Anticipating outperformance from the Canadian energy services industry, ATB Capital Markets analysts Tim Monachello and Waqar Syed believe “significant upside remains for well-positioned companies.”

“Canadian energy services stocks have performed well both over the past 12 months and year-to-daye, with ATB’s custom energy services index up 47 per cent and 20 per cent over those periods, respectively,” they said. “Most notably, the strong performance of energy services stocks has come during a period of relatively tepid North American activity levels with the U.S. land rig count down 14 per cent over the past 12 months, and the Canadian rig count up just 1.5 per cent year-to-date from 2023 levels.

“While the dislocation of energy services stocks from activity levels is a notable divergence from historical trends, we believe it is a reflection of the resilience of energy services company margins and cash generation over the period, and the fact that most energy services companies have significantly deleveraged their balance sheets. Overall, we believe energy services companies are proving to be lower beta in a more range-bound E&P capital spending environment, and this stability of earnings along with increasing returns to shareholder is being rewarded by the market.”

In a research report released Friday previewing second-quarter earnings season, the analysts pointed to a pair of factors that driven outperformance for small and mid-cap stocks in the sector. They are:

1. Earnings expectations and performance

“Companies that have stable or improving earnings outlooks have outperformed ,” they said. “Across our Canadian SMid-cap energy services universe, the top performing four stocks (CEU, NOA, TOT and PHX) since January 2023 have been the ones with the most resilient consensus earnings outlooks. TCW is an outlier as its earnings outlook has been middling, though its shares have outperformed likely given its top-tier shareholder returns.”

2. Shareholder returns

“Companies that have deleveraged and are returning cash to shareholders are outperforming,” he said. “We note that the four of the top five performing energy services stocks in our Canadian SMid-cap energy services universe are also stocks that have reached their long-term leverage targets and are returning top-tier levels of cash to shareholders.”

While those trends likely to be “resilient performance drivers,” Mr. Monachello and Mr. Syed emphasized they “must also be put in the context of valuation, and investors must consider the exposures and company-specific elements that could underpin fundamental earnings performance over the coming years.”

“Looking forward, we highlight four potential drivers of fundamental earnings outperformance including 1) high exposure to Canada which we believe will be the strongest growth market over the medium term (TCW, PD); 2) exposure to gas production which continues to be a reliable source of growth and less volatile than exposure to natural gas prices and gas directed activity levels (EFX); 3) exposure to the trend of increasing service intensity per well (CEU, CET, PD, PHX), and 4) exposure to companies with unique growth opportunities that can drive outperformance vs macro and industry activity trends (CET),” they said.

The analysts made a series of target price adjustments to stocks in their coverage universe on Friday due largely to reduced U.S. field activity assumptions. They are:

• Akita Drilling Ltd. (AKA.A-T, “outperform”) to $3.25 from $3.75. The average on the Street is $3.75.
• Cathedral Energy Services Ltd. (CET-T, “outperform”) to $1.50 from $1.60. Average: $1.76.
• CES Energy Solutions Corp. (CEU-T, “outperform”) to $8.50 from $8.25. Average: $8.47.
• Enerflex Ltd. (EFX-T, “outperform”) to $12 from $12.50. Average: $10.56.
• PHX Energy Services Corp. (PHX-T, “outperform”) to $11.75 from $12.25. Average: $9.94.
• Questor Technology Inc. (QST-X, “sector perform”) to 65 cents from 60 cents. Average: 73 cents.

“We highlight CET, PD, and TOT as our top picks. CET is positioned as a high-return, low capital intensity directional driller with substantial Canadian exposure, exposure to increasing service intensity, and likely the most significant company specific growth opportunity in our coverage,” the analyst said. “CET trades at 1.1 times/0.4 times EV/EBITDAS with a 21 per cent/39 per cent FCF yield in 2024/2025. PD is the largest Canadian driller with a dominant position in BC which will likely be the area with the highest growth and most service intensive wells. In addition, PD is rapidly deleveraging with visibility to meaningfully accelerated returns to shareholders in 2025. PD trades at 4.1 times/3.3 times EV/EBITDAS with a 20-per-cent FCF yields in 2024/2025 respectively. TOT offers a diversified business featuring elevated Canadian exposure, a differentiated growth wedge through its Australian business, and exposure to natural gas production through its compression and processing business. a diversified business with. TOT has a clean balance sheet, a track record of strong FCF generation and prudent capital allocation, and offers top-tier shareholder returns. TOT trades at 2.5 times/1.9 times EV/EBITDAS with a 15 per cent/36 per cent FCF yield in 2024/2025.”

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In a separate report focused on North American energy services large caps, land drillers and completions, Mr. Monachello and Mr. Syed emphasized U.S. drilling and completion (D&C) activity has underperformed and expect guidance will be weak.

“On the other hand, the Canadian D&C activity is outperforming, while International is largely in-line,” they adde. “We lower our 2024/2025 U.S. land rig count forecast by 3 per cent/8 per cent, while raising our Canadian rig count forecast by 4 per cent/4 per cent. For the earnings season, we recommend companies with high Canada/International exposure, strong FCF and company-specific catalysts.

“Our key long recommendations for the earnings season are: (1) SLB: It has unduly underperformed, while its Mideast/Asia business is performing very strongly, and it remains on track to meet its 2021-2025e EBITDA growth targets, and will likely outperform them when the recently announced ChampionX merger is included. SLB should return $7-billion in cash to shareholders in 2024/2025. (2) NOV: We expect stock catalysts like FCF ($204-million) and ‘Excess’ FCF inflection ($384-milllion), strong quarter-over-quarter inbound order rebound, and solid cash return to shareholders. (3) PD-T: Expect 12-per-cent EBITDAS beat in Q2/24, as Canadian rig activity has been running 15 per cent higher year-over-year in Q2/24 and the super-triple rig market remains strong. PD-T should generate $117-million in FCF and should pay down debt. However, the U.S outlook remains weak for PD-T. (4) ESI-T: Expect solid performance out of the Canadian business, and in the. U.S., it is seeing market share gains owing to its California exposure, as California is the only market currently showing activity increases, but the key differentiator is forecast of solid FCF of $77-million in Q2/24 (19 per cent of market capitalization) and likelihood of strong debt pay down. “

Mr. Syed trimmed his target for Precision Drilling Corp. (PD-T) to $120 from $126, keeping an “outperform” rating. The average is currently $127.02.

“For PD-T our 2024 estimate is slightly cut (less than 1 per cent), as the benefit of the strength of the Canadian market is slightly outweighed by its exposure to the weak U.S, land rig market,” he said.

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National Bank Financial analyst Cameron Doerksen thinks NFI Group Inc. (NFI-T) is poised to continue to benefit from a “significant” changes in competitive dynamics in North America over the past year, expecting market share gains for the short and long term.

“With three of NFI’s competitors (Nova Bus, ENC, and Proterra) effectively exiting the U.S. heavyduty transit bus market in the last year, it has resulted in the U.S. market becoming a duopoly with NFI’s New Flyer subsidiary and privately held Gillig,” he said. “This has created an opportunity for NFI to further grow its 50 per cent installed base share in the U.S., especially given the significant barriers to entry that make it unlikely a new competitor will enter the market for at least several years.”

Mr. Doerksen also sees the Winnipeg-based manufacturer is a strong position for the shift to zero-emission buses (ZEBs).

“A major transformation is underway as transit agencies transition their bus fleets to ZEBs, supported largely by a significant increase in the availability of government funding, particularly in the U.S.,” he said NFI has already had success in winning ZEB orders and is well-positioned to continue to do so, which will be positive from an EBITDA perspective as higher priced ZEBs represent a larger percentage of deliveries. Additionally, contracting changes recommended by a government-industry task force in the U.S. will help fund the working capital requirements for NFI, which have become especially burdensome with more expensive ZEBs becoming a larger portion of total new bus orders.

In a note titled Competitive landscape changes positions NFI Group for much better financial performance, Mr. Doerksen emphasized its Alexander Dennis Limited division in the U.K. is facing more competition, but demand remains “healthy.”

“While end market demand and the competitive dynamics are clearly more favorable for NFI in North America, bus demand in the U.K. market may be in the early stages of an up-cycle as bus operators replace aging fleets and invest in electrification,” he said. “NFI’s Alexander Dennis (ADL) subsidiary is facing more competition in the U.K. given the lower barriers to entry relative to the U.S., but the company has maintained a strong market position in the region with an estimated 50-per-cent share.”

Citing an “increased confidence on improving financial performance over the next several years” and pointing to “visibility on a multi-year improvement in EBITDA and cash flows,” Mr. Doerksen raised his target for NFI shares by $2 to $21, keeping an “outperform” recommendation. The average on the Street is $16.90.

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Resuming coverage following its $345-million equity offering to be used to partially fund the acquisition of 13 Quebec retirement homes, Desjardins Securities analyst Lorne Kalmar predicts Chartwell Retirement Residences (CSH.UN-T) will “continue to opportunistically optimize and geographically rebalance its portfolio through additional acquisitions (likely single assets) and non-core dispositions.”

“We expect CSH’s newly announced acquisitions, together with the related financing, to be largely neutral to our 2024 FFOPU [funds from operations per unit] and 1 per cent accretive to our 2025 FFOPU,” he said. “Pro forma the Welltower JV wind-up and the announced transactions, Québec will represent CSH’s largest market by suite count (43 per cent vs 34 per cent as at 1Q24). The acquisitions, for which we estimate a 6.25-per-cent cap rate, will also generate incremental fee revenue and improve the overall quality of the portfolio, in our view.”

Mr. Kalmar said he’s now included in his forecast the completion of the sales of its Ballycliffe residence in Ajax, Ont., and Heritage Glen in Mississauga in the second half of 2024 , but he has not included any additional unannounced acquisitions for the remainder of the year.

“By levels of care, the exposure to various levels of care will not change materially pro forma the closing of the Welltower wind-up and acquisitions, as 84 per cent of total suites/beds will be ISL [independent supported living]; however the focus within this segment will shift slightly to apartment style (with full kitchens) from suite-style (without full kitchens) as the exposure to ISL apartments will increase to 37 per cent of total suites/beds vs 32 per cent in 1Q,” he said. “The exposure to other care-level segments is expected to remain largely unchanged as well, with AL representing 7 per cent of total suites/beds, followed by IL at 6 per cent and LTC at 3 per cent.

“Geographically, the exposure to the Québec market will increase materially from 34 per cent in 1Q to 43 per cent following the closing of the wind-up deal and acquisitions, while the share of total suites/beds in Ontario, BC and Alberta will decline to 40 per cent, 9 per cent and 8 per cent, respectively. With a heavy concentration in Ontario and Québec, CSH’s pro forma portfolio will continue to have a strong presence in the VECTOM markets (58 per cent of total suites/beds), with the balance in suburban markets in Ontario, Québec, Alberta and BC.”

While raising his 2025 FFO projections, Mr. Kalmar reiterated a $15.50 target and “buy” rating for Chartwell units. The average is $15.30.

Elsewhere, Scotia’s Himanshu Gupt raised his target by $1 to $15 with a “sector outperform” rating, reaffirming Chartwell as his “top pick” and keeping a bullish view on Seniors Housing.

Meanwhile, TD Cowen’s Jonathan Kelcher resumed coverage with a “buy” rating and $16 target.

“Overall, we view the two newly announced portfolio acquisitions favourably. We believe both portfolio sellers were somewhat motivated (for different reasons), allowing CSH to achieve what we view as attractive pricing in the low-mid 6-per-cent cap rate range and an 30-per-cent discount to replacement cost on relatively new (5-6 year old) assets. We also view CSH as well positioned to continue adding to its portfolio as a buyer in what looks to be shaping up as a buyer’s market. With fundamentals expected to improve materially over the next 3-4 years, we believe bulking up the portfolio — in a neutral/slightly accretive to earnings fashion (similar to these transactions) — is a smart near-term capital allocation play. That said, our forecast does not include any unannounced acquisitions,” said Mr. Kelcher.

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In other analyst actions:

* CIBC’s Todd Coupland upgraded BlackBerry Ltd. (BB-N, BB-T) to “outperformer” from “neutral” with a US$3.50 target, exceeding the US$3.30 average on the Street, while Raymond James’ Steven Li cut his target to US$4.75 from US$5.50 with a “market perform” rating.

“Our upgrade is based on improved business plan execution, stronger-than-forecast FQ1 results, and a conservative but achievable FQ2 and F2025 guide,” said Mr. Coupland. “These factors support a favorable risk/reward at the current price. Our price target of $3.50 implies a return to target of approximately 60 per cent.

“Blackberry’s Q1/F25 results were 9 per cent better than FactSet estimates. Despite this upside, the guide for FQ2 and F2025 was unchanged. FactSet F2025 growth expectations are roughly aligned with management’s guide for a 5-per-cent year-over-year decline in Cyber and only 7-per-cent year-over-year growth in IoT at the midpoint. Our view is this outlook is conservative, achievable and positive for Blackberry’s share price. We also believe the progress towards better growth and positive EBITDA open options, including a possible divestiture of its Cyber unit. The next potential catalysts include: 1) FQ2 results on September 26 and 2) Investor Day planned for October 16. It is noteworthy that Blackberry stated it plans on providing segmented unit disclosure by the Investor Day.”

* In response to its up-to US$30-million royalty investment into Nokomis Energy LLC, Ventus Capital Markets’ Devin Schillling raised his target for Altius Renewable Royalties Corp. (ARR-T) to $14 from $13 with a “buy” rating. The average is $12.50.

“We view this announcement favourably given the royalty investment represents a new market segment for ARR (distributed solar) and provides further diversification to its royalty pool,” he said.

* JP Morgan’s Jeremy Tonet raised his Gibson Energy Inc. (GEI-T) target to $27 from $26 with an “overweight” recommendation. The average is $25.60.

* Stifel’s Stephen Soock hiked his K92 Mining Inc. (KNT-T) target to $13.75 from $11.50 with a “buy” rating. The average is $11.12

“We are updating our near-term expectations ahead of 2Q reporting and including Arakompa in our production profile,” he said. “For the quarter, we expect production to come in at 24.5koz AuEq and costs to normalize without the stockpile utilization (vs Q1). Exploration at Arakompa remains a priority with a third rig being mobilized. We have included a mineable base here of 856koz at 7.65 g/t, assuming it is processed through excess mill capacity at the Phase 2a and Phase 3 facilities starting 2028. Our investment thesis remains intact as we see sector-leading production growth and increased cash flow generation as Phase 3 and 4 come online in the next two years. Adding Arakompa increases our NAVPS by 13 per cent to $16.02 and we are increasing our target P/ NAV by 5bps to 0.65 times given the company’s recently finalized funding package with Trafigura.”

* In response to its 2024 Asia Investor Day, TD Cowen’s Mario Mendonca raised his Manulife Financial Corp. (MFC-T) target to $40 from $38 with a “buy” rating. The average is $37.47.

“The most important outlook offered by management was the increase to the core ROE target to 18 per cent-plus (2027E) from 15 per cent-plus. We estimate 2024 core ROE of under 16 per cent. We raised our long-term ROE outlook used to set target prices to 17 per cent, which remains below management’s target, and raised our target price to $40,” he said.