In This Week’s JMRD Market Observer
Canadian Banks – Q2/17 Earnings Preview – Low expectations provide a nice “setup”, though housing weighs on the longer term outlook
Diversified & Real Estate Income Equities
JMRD Basket Corner
Week at a Glance
Reads of the Week
Canadian Banks – Q2/17 Earnings Preview – Low expectations provide a nice “setup”, though housing
weighs on the longer term outlook
Banks begin reporting Q2/17 results on May 24, 2017. On average we are forecasting 14% EPS growth from the Big-6. Key sector themes heading into the quarter are:
- Mortgage market growth is in the spotlight. From 30% housing price appreciation in Toronto that resulted in regulatory action by the Province of Ontario to the ongoing Home Capital drama, there has been no shortage of market developments. Given rapid home price escalation and seasonality we believe Q2/17 mortgage market growth could be robust, perhaps too much so. Outlook commentary from the banks will hopefully address a variety of investor concerns, such as the importance of alternative lenders in the larger mortgage landscape, the impact of a potential failure of one of its participants, as well as the growth outlook for mortgages given market disruptions and regulatory actions that have been taken in recent months.
- Canadian credit quality continues to defy expectations. Will the market care? During Q1/17 banks reported PCLs that were 11% below our forecasts, on average. With credit card trust data pointing to continued Y/Y improvement during the quarter and stable employment levels, we are cautiously optimistic that the trend can continue. In fact, we have become more concerned about emerging signs of credit quality deterioration in the U.S. (rising credit card delinquencies, subprime auto loss rates), that could be relevant to both TD and BMO this quarter.
- Capital ratios expected to flatten. We are forecasting average Big-6 CET 1 ratios to stay flat at 11%, with elevated buyback activity by BNS/RY/TD constraining capital growth this quarter. On a stock-specific basis, if there’s one bank that needs to deliver a positive capital surprise its CM (see discussion on page 8).
- Banks lagging the index since reporting Q1/17 provides a nice “setup”. Banks have lagged the S&P/TSX by ~700bps since reporting Q1/17 results. A contrarian (i.e. positive positioning in this case) would typically be advisable based on historical patterns. We are positive on BNS (steady results, efficiency-driven growth, shielded from Trump trade fade) and CM (track record of EPS beats, potential capital surprise). However, for the sector to find broader support we believe the stocks need to become cheaper (i.e. current forward PE of 11.8x is “average”) and the market needs to see some resolution on the Home Capital situation that has stoked credit/funding risk contagion fears in the mortgage market.
Diversified & Real Estate Income Equities: Q1 2017 Earnings Recap
With calendar Q1 reporting behind us we highlight which equities in our diversified coverage list:
1) Had the best/worst earnings momentum in the quarter
2) Offer the most compelling yield opportunities
3) Provide the most attractive relative valuation
4) The best positioned to outperform going forward
We revise target prices for the following Outperform-rated equities:
Boyd Group: Target to $100 (from $95);
Crius Energy: Target to $12 (from $11.50);
Enercare: Target to $24 (from $25);
Exchange Income: Target to $45 (from $50);
New Flyer: Target to $62 (from $60).
The most compelling opportunities for income-oriented investors include:
Crius Energy: 7.4% yield / 74% 2018e DCPU payout.
AHIP: 8.0% yield / 73% 2018e AFFO payout.
Exchange Income: 6.1% yield / 50% 2018e DCPS payout
Alaris Royalty: 8.2% yield / 76% 2018e DCPS payout.
WPT Industrial: 5.7% yield / 77% 2018e AFFO payout.
Equities providing attractive forward relative valuations include:
Crius Energy: 5.2x EV/EBITDA & 7.4x P/CF (sharp discount to comps & TSX income peers).
Exchange Income: 6.3x EV/EBITDA & 7.9x P/CF (too low given organic + M&A growth profile).
Alaris: 8.9x EV/EBITDA & 9.2x P/CF (royalty structure & portfolio progress warrants higher).
Our top picks at current prices are:
Parkland Fuel: Bullish on accretion from CST/Chevron transformational acq’ns closing H2.
Enercare: Disappointing Q1, but no fundamental change to our positive investment outlook.
Tricon Capital: Sum-of-parts NAV valuation suggests shares are undervalued.
Alaris Royalty: Pullback creates an opportunity as portfolio made some positive strides Q1.
Crius Energy: earnings momentum, valuation and dividend growth profile still encouraging.
Exchange Income: H2/17 setting up well, as short term pain long term gain ’18 strategy evolves.
American Hotels, Boyd Group, Crown Capital, Morneau Shepell, New Flyer, SmartREIT and WPT Industrial all well-positioned to move higher.
Boyd Group, Enercare, Parkland Fuels and New Flyer are held in JMRD’s All-Cap Growth Basket.
JMRD Basket Corner
Pembina Pipelines (PPL) – Investor Day highlights – Veresen fits like a glove: Pembina held its annual Investor Day in Toronto, kicking things off by showcasing how well Veresen’s assets fit with its own – namely the Alliance Pipeline traveling through the heart of Pembina’s existing gas processing and corresponding NGL infrastructure network, while adding an industry leading Montney Midstream footprint. See the full research note (Note: Veresen is owned in the DIG Basket and Pembina announced plans earlier this month to acquire Veresen, with the transaction expected to close in October.)
All-Cap Growth Basket
Premium Brands (PBH) – Q1 2017 results a beat: Revenues increased to $478.2 million (NBF: $476 mln) driven by organic growth of 3.4% and a $95.2 million M&A contribution. EBITDA of $38.4 million was ahead of our $32 mln estimate (Street: $34 mln). EPS was $0.51 (NBF: $0.40). See the full article
Savaria (SIS) – SIS to acquire (close end Q2/17) Span for US$80 million: We are resuming coverage of SIS following the closing of a $38.4 million subscription receipt offering. Proceeds, along with cash on hand and available credit, will be used to acquire Span-America Medical Systems (NASDAQ: SPAN) for US$80 million (10x EBITDA). SPAN is a manufacturer and marketer of therapeutic support surfaces, pressure management products and related products, mainly for the medical market. See the full article
Shopify (SHOP) – Shopify announced a $500M USD on Thursday. That offering would result in 6% dilution. At an assumed US$90/share raise, gross proceeds would be ~$500 mln. Given Shopify’s $400 mln of cash on the balance sheet at the end of Q1 and positive free cash flow, the proposed equity raise comes as a bit of a surprise. And while the use of proceeds is to broadly invest for growth, we can’t help but think it signals acquisitions – and potentially even a large transaction even if what we’ve seen thus far from the Company are small tuck-in technology transactions. All in, while the transaction is dilutive in the near-term with added risk (via cost of capital and potential M&A), we believe that risk is offset by increased flexibility to drive growth. See the full article
U.S. Growth Basket
Applied Materials (AMAT) – The maker of semiconductor-manufacturing gear posted another strong quarterly report late Thursday, along with a forecast that easily topped Wall Street’s expectations. Revenue surged 45% year over year, to $3.5 billion, and operating income more than doubled, to $940 million. Their operating margin of 27% for the quarter ended April 30 was the company’s highest in at least seven years, according to data from Capital IQ.
Facebook (FB) – Happy Anniversary
- A great read on what happens When your financial plan gets thrown out the window
Reads of the Week
Monday May 22nd – Canadian markets closed – Victoria Day
Tuesday May 23rd – Canadian Wholesale Sales, U.S. Home Sales
Wednesday May 24th – Bank of Canada Interest Rate Decision, FOMC Meeting Minutes
Thursday May 25th – U.S. Wholesale Inventories
Friday May 26th – Michigan Consumer Sentiment, U.S. GDP
Monday May 22nd – None
Tuesday May 23rd – None
Wednesday May 24th – None
Thursday May 25th – Canadian Imperial Bank of Commerce
Friday May 26th – None
Have a good long weekend!