BMO Sees Limited Upside for SNC Though he continues to see SNC-Lavalin Group Inc. (SNC-T) “on a path to put its troubled past in the rear-view mirror,” BMO Nesbitt Burns analyst Devin Dodge now thinks there’s “limited remaining runway for a potential re-rating.”
“We believe there is little available cushion in the valuation to absorb any bumps in the road (e.g., further losses as problematic LSTK projects wind-down), yet the risk of unfavourable developments arising remains elevated. As a result, we believe the risk/reward for the shares is not favourable,” he said.
In a research report released Monday, Mr. Dodge warned “conservatism [is] warranted when selecting multiples, adding: “For the EDPM and Infrastructure Services divisions, we estimate margins are below the peer average once SNC’s corporate costs are burdened across the segments. Layering in muted M&A growth objectives, margin guidance that suggests limited expansion opportunities, and cash flow contributions being consumed by SNCL Projects, we believe these businesses warrant a multiple at the low end of the peer group range. We are more optimistic about the Nuclear division and believe it to be a low double-digit multiple business.”
“Unlike most stocks where valuation discussions focus primarily on earnings projections and the appropriate multiple, we believe there are several ‘SNC-specific’ items that need to be considered (e.g., near-term cash flow burn, non-controlling interests in JVs, settlement payments from federal charges, and legacy LSTK projects, etc.). In addition, most investors utilize EV/EBITDA as the primary valuation methodology for SNC but we believe care must be taken to neutralize the impact from lease accounting changes on equity values for E&C names. We estimate these ‘other considerations’ lower our NAV for SNC by more than $5 per share.”
Though he said potential upside from a “Blue Sky” scenario isn’t compelling, Mr. Dodge raised his target for SNC shares to $33 from $31 with a “market perform” rating to account for “more optimistic assumptions for cash usage at LSTK projects, Highway 407 valuation, and the multiple for Infrastructure Service.” The average is currently $39.
“Applying multiples to SNC’s divisions that are consistent with the most relevant comps, we estimate SNC’s shares could edge up into the mid-to-high $30s, or a bit more than 10 per cent above current levels,” he said. “However, we expect the closing of the multiple gap will be gradual and requires significantly improved and more stable financial performance. In our view, we believe the remaining re-rating opportunity isn’t sufficient to offset the downside risk should adverse developments emerge.”