Thursday’s analyst upgrades and downgrades

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

Despite a recent decline in commodity prices, Canaccord Genuity analyst Mike Mueller continues to see intriguing investment possibilities in the Canadian exploration and production sector heading into 2023.

“It is no secret that 2022 has marked an exceptional year for the sector, with the S&P/TSX Capped Energy Index up approximately 47 per cent year-to-date and up 53 per cent compared to the S&P/TSX 60 Composite Index,” he said. “This appears even more remarkable after noting that this comes on the back of 2021 where the energy index was up 82 per cent on the year.

“Given this backdrop, we believe that investors have an opportunity to generate alpha when looking outside the broad sector/large-cap names given our views that: most of the “easy wins” off the bottom of the pandemic lows have likely been realized; and valuations remain compelling, with our E&P coverage trading at 2.6 times 2023 estimated EV/DACF [enterprise value to debt-adjusted cash flow] relative to historic multiples of 4.6 times and despite balance sheets being in far better shape sector-wide.”

In a research report released Thursday, Mr. Mueller initiated coverage of I3 Energy (ITE-T) with a “buy” recommendation while resuming coverage of five other stocks.

For Calgary-based I3, an independent oil and gas company with assets and operations in the United Kingdom and Canada, he touted its “broad asset based with a focused strategy.”

“Since 2020, i3 has assembled a strong foothold in Canada, growing production from zero to more than 23,000 barrels of oil equivalent per day,” he said. “i3 was an aggressive consolidator through the downturn, completing $100-million of deals across Alberta in 2020/2021 at attractive multiples of 0.5-1.4 times NTM NOI [next 12-month net operating income]. i3 has now shifted its focus to developing these assets through the drill bit and selling production into stronger pricing, leading into its plan to allocate up to 30 per cent of FCF to its monthly dividend while reinvesting the balance into organic growth through development of its existing assets.”

Mr. Mueller said the company’s dividend “was, is and will be a focus” for investors.

“The rationale for i3 picking up its initial ‘starter pack’ of producing assets in 2020 was to enter the Canadian market, consolidate assets at the cycle-bottom, and position itself as a shareholder-friendly, dividend-focused company,” the analyst said. “While this has become increasingly common in the domestic E&P space, at the time this was relatively uncommon amongst its domestic small/mid-cap peers. i3 intends to distribute up to 30 per cent of annual FCF to shareholders via its monthly dividend, which currently sits at $0.0023/share, reflecting a yield of 8.2 per cent. Next year, the company has indicated plans to distribute £20.4-million ($40.3-million), or $0.034/share on an annualized basis, reflecting a yield of 10.2 per cent on Monday’s close.”

“With the company’s history as a London-based North Sea exploration company prior to its entry into the Canadian market in 2020, we believe i3 has flown under the radar of many Canadian investors. The rapid growth over the past (nearly) three years has been impressive, particularly looking back at the timing of its acquisitions, which have proven the company’s astute and measured strategy to be successful. We believe that as i3 continues to demonstrate operational acumen and garner more attention from the market, that a multiple re-rate will be justified.”

He set a target for I3 shares of 70 cents.

“We believe i3 offers investors an attractive yield at 8.2 per cent, with a strong balance sheet [0.2] times D/CF) and organic growth optionality across its Clearwater and Simonette Montney assets at an attractive 1.8 times 2023 estimated EV/DACF multiple,” he said. “In our view, the potential for a re-rate on i3′s shares is better than most, given the company is in the early innings of its development strategy.”

Mr. Mueller resumed coverage of these stocks:

* Birchcliff Energy Ltd. (BIR-T) with a “buy” rating and $14.75 target. The average is $14.35.

“With a significantly improved balance sheet and visibility to grow to 90,000 boe/d to maximize efficiencies through its 100-per-cent owned and operated Pouce Coupe gas plant, we believe Birchcliff is well positioned to capitalize on a strong outlook for natural gas, particularly given its exposure to NYMEX natural gas prices, which have seen relative strength given a stronger correlation to global gas prices (resulting from US LNG exports),” he said.

* Crew Energy Inc. (CR-T) with a “buy” rating and $9 target. Average: $8.78.

“With the company’s four-year plan expected to see CR nearly double production through 2026, all in step with the onset of LNG Canada’s Phase 1 facility (expected 2025), we believe Crew offers investors exposure to a growth-oriented, Montney operator in the heart of northeast B.C.,” he said.

* Peyto Exploration & Development Corp. (PEY-T) with a “hold” rating and $16.75 target. Average: $18.28.

“While we believe the outlook for Peyto remains robust and recognize that the company has built a resilient ‘integrated’ natural gas producer, we believe the stock will remain range-bound through early 2023 given (1) the current 3.5 times 2023 estimated EV/DACF [enterprise value to debt-adjusted cash flow] multiple is above the peer group average of 3.1 times; (2) debt levels of 1.1 times 2022 estimated D/CF [debt to cash flow] exceed our gas-weighted peer group average of 0.6 times (we find it difficult to justify a more meaningful multiple premium at this time); and (3) while the dividend yield is an eye-catcher, yielding 9.5 per cent, we do note that this reflects an all-in payout ratio of 79 per cent on our 2023 estimates, the highest across our coverage universe and well above the peer group average of 67 per cent (suggesting a limited ability to layer in additional increases based on the current outlook),” he said.

* Pine Cliff Energy Ltd. (PNE-T) with a “buy” rating and $2.10 target. Average: $2.17.

“With the company’s net cash position of $58-million at year-end and low base decline of 6 per cent, we expect PNE to have ample opportunity to allocate FCF above and beyond its 8.0-per-cent monthly dividend next year,” he said. “We believe this may come in the form of an increased base dividend, special dividends, and/or asset purchases.”

* Tamarack Valley Energy Ltd. (TVE-T) with a “buy” rating and $6 target. Average: $7.29.

“Tamarack offers investors exposure to one of the most economic oil plays in Western Canada and has provided a well-defined return of capital framework contingent on certain debt milestones. In our view, the company’s Clearwater exposure brings the potential to warrant a premium valuation on the stock, which has historically traded at a discount to its peer group,” he said.

=====

Altius Minerals Corp. (ALS-T) is “building a diversified/low-carbon portfolio from the ground up,” according to National Bank Financial analyst Shane Nagle.

Touting its “stable, long-life asset base, transitioning of the portfolio towards lower carbon intensive commodities and leveraging Altius’ in-house expertise to provide long-term exposure to future exploration success,” he initiated coverage of St. John’s-based company with an “outperform” recommendation.

Mr. Nagle called Altius’ Project Generation division a “key differentiator” in the royalty sector, seeing it utilize the company’s “geology and exploration expertise to grow a pipeline of future royalties by originating and adding value to mineral projects.”

“Upon the sale or transfer of these assets, Altius seeks to retain a royalty interest in the project and/or equity stake in the resulting company,” he said. “To date, the business has converted 57 projects to royalties and equities, and we see a number of opportunities to be monetized in the coming months including Lithium Royalty Corporation and additional junior gold royalties.”

“As attributable revenue from renewable energy replaces thermal coal, the company also generates stable revenue from high quality iron ore used in clean steel production, potash supporting sustainable food generation and battery metals including copper, nickel, cobalt and lithium.”

Mr. Nagle set a target of $26.50 per share. The current average on the Street is $25.25.

“ALS is trading at 1.00 times NAV [net asset value], broadly in line with junior precious metal royalty peers at 0.99 times and an 1.3-times discount to senior peers,” he said. “Altius has a strong liquidity position, low-risk growth profile, strong FCF and is trading at a discount to recent royalty/stream acquisitions within the sector. We expect current market conditions and continued deal flow to ultimately drive a re-rating for the junior royalty names.”

“While we see some risks to near-term commodity prices, long-term fundamentals remain supportive and the company has an established track record of investing throughout the commodity cycle while surfacing value from its portfolio at a time when market conditions support favorable valuations.”

=====

Echelon Partners analyst Mike Stevens sees HS GovTech Solutions Inc. (HS-CN) poised to reach an “inflection point” and set to benefit from a several secular tailwinds.

Seeing it pairing a “timely textbook defence with an offensive attack eyeing a three-year 40-per-cent CAGR,” he initiated coverage of the software-as-a service-company, which serves the state, provincial and local government market on both sides of the border, with a “speculative buy” recommendation on Thursday.

“While the Company saw a tepid 5.7-per-cent compound annual growth rate (CAGR) during its early days as a public company from 2015-2018, current CEO Silas Garrison, who helped build HS GovTech’s cloud technology, stepped into the lead role in September 2018 while revamping operations to drive an 25-per-cent organic CAGR from 2018 to our year-end 2022 forecast,” he said. “Going forward, we project another level-up in organic growth to an 40-per-cent CAGR over the next three years to 2025. Concurrently, we expect the Company to realize considerable operating leverage following a period of substantial heavy lifting in staffing up for incoming growth. We forecast EBITDA margins moving from negative 63.0 per cent in 2022 to 15.4 per cent in 2025, with an EBITDA-positive turn exiting 2023.”

Mr. Stevens said HS GovTech’s business is “littered with defensive characteristics,” noting its revenue is generated from government customers that are “less sensitive to macro swings while the majority of revenues stem from long-term contracts (i.e., five-years-plus) with annual recurring revenues (ARR).”

“Additionally, the Company owns a sizeable customer base comprised of 150 or more contracts and a 90-per-cent-plus retention rate,” he said.

“Many state, provincial, and local governments are still using obsolete systems and processes to conduct business (e.g., paper forms, telephone ‘remote’ inspections, and postal cheques), while the COVID-19 pandemic has increased the urgency (and funding) across all stakeholders toward modernizing technology.”

Seeing it as a potential take-out candidate, Mr. Stevens, currently the lone analyst covering the stock, set a target of 80 cents per share, implying upside of 175 per cent.

“As HS GovTech executes against its qualified sales pipeline (approximately $25-million-plus) and moves closer to EBITDA-positive operations, we anticipate its current trough valuation multiples inching closer to industry peers,” he said. “The Company trades at 1.2 times/1.5 times 2023 EV to revenues/gross profit on our 57-per-cent forecasted growth, which compares to the industry giant Tyler Technologies (TYL-N) at 7.3 times/16.1 times on 8-per-cent growth. Notably, the Company’s leadership team previously founded and built a software company that was later purchased by Tyler. In a consolidated space surrounded by larger players, we expect take-out considerations to escalate alongside the Company’s scale.”

=====

In other analyst actions:

* JP Morgan’s Tien-tsin Huang lowered Telus International Inc. (TIXT-N, TIXT-T) to “neutral” from “overweight” with a $44 target, down from $45. The average target is US$32.93.

* KBW’s Jade J. Rahmani downgraded Tricon Residential Inc. (TCN-N, TCN-T) to “market perform” from “outperform” with a US$9 target, down from US$11 and below the US$10.97 average.

* TD Securities’ Daniel Chan reduced his target for BlackBerry Ltd. (BB-N, BB-T) to US$4.25 from US$4.75, below the US$5.56 average, with a “reduce” rating.

* CIBC’s Mark Jarvi trimmed his Boralex Inc. (BLX-T) target to $44 from $45 with an “outperformer” rating. The average is $46.23.

* Scotia Capital’s Justin Strong bumped his Innergex Renewable Energy Inc. (INE-T) target to $19.25 from $18 with a “sector perform” rating. The average is $20.48.

* Credit Suisse’s Andrew Kuske raised his target for Keyera Corp. (KEY-T) to $36 from $35, above the $33.45 average, with an “outperform” rating.

* Piper Sandler’s Charles Neivert cut his Lithium Americas Corp. (LAC-N, LAC-T) target to US$36 from US$38 with an “overweight” rating. The average is US$37.44.