National Bank Expecting momentum for increased infrastructure spending south of the border to likely be “resilient for longer,” National Bank Financial analyst Maxim Sytchev raised his recommendation Stella-Jones Inc. to “outperform” from “sector perform” on Tuesday, predicting “pole momentum should persist.”
“We were admittedly early to downgrade shares in January this year as they have rallied 33 per cent year-to-date (versus a decline of 1 per cent for the TSX) and 95 per cent since our bullish July 13th, 2022 note (Deep dive on value?) which highlighted the company’s inherent undervaluation when shares were trading at 8.0 times NTM [next 12-month] EV/EBITDA and general expectations were subdued,” he said. “Now the shares are trading at 9.1 times on our new 2025 estimated EBITDA and that excludes any contribution that might arise from the U.S. Infrastructure Bill spending (which is expected to flow through at greater momentum in 2024-25, as per commentary from SJ’s peer Koppers who held its own investor day recently ... - reiterating previously strong growth and highlighted resilient pricing that minimizes our forecasting risk).
“After the incorporation of 2025 guide in our estimates as well as tracking the upside in volume growth from the Bipartisan infrastructure bill (the U.S is racing to fortify its grid infrastructure against extreme weather supporting resilient volume and pricing growth beyond normal maintenance levels), we are likely to see further positive earnings revisions for SJ, pulling shares up in tandem. As such, we are upgrading SJ.”
In a research note released before the bell, Mr. Sytchev increased his financial projections for the Montreal-based manufacturer of pressure treated wood products to better reflect the company’s guidance. He’s now expecting 2023 and 2024 revenue of $3.294-billion and $3.544-billion, respectively, up from $3.269-billion and $3.463-billion previously. His adjusted diluted earnings per share estimates jumped to $4.74 and $5 from $4.64 and $4.86.
“We are imputing 6-per-cent CAGR [compound annual growth rate] from 2022 onwards at 16-per-cent EBITDA margin, in line with guidance (with poles vertical at 15-per-cent CAGR),” he said. “Lumber is another lagging sub-vertical at negative 5-per-cent CAGR (guide of $600-$650-million by 2025; NBF estimate at $637-million). The above dynamics results in 2025 EPS estimate of $5.50 per share (a 16-per-cent increase from 2023E). These numbers do not include any potential M&A although that materiality is lessened by consolidated nature of poles/ties verticals, unless management pushes into adjacencies; hopes for actual extra spending that should drive up volumes (Poles 15-per-cent CAGR guide is pricing-driven) is minimal in our forecasts.”
Also introducing his 2025 projections, Mr. Sytchev raised his target for Stella-Jones shares to $83 from $73. The average target on the Street is $78.14.
Mr. Sytchev’s rating change for Stella-Jones coincided with the release of a research report on his Industrial Products coverage universe in which he reiterating his preference for “quality, clean balance sheets, and exposure to GDP-agnostic thematic tailwinds” given the inversion in the U.S. treasury yield curve.
“While the curve is still well into inverted territory, we wanted to take a highlevel look on what happens once an ‘un-inversion’ dynamic occurs; since 1976, this ‘normalization’ occurred 4 times, the last time in early June 2007,” he said. “Key findings: industrials do not provide a good hiding place (except ag + automation); copper did not fare well while gold did (+ staples).”
Mr. Sytchev maintained his thematic positioning from equities, emphasizing the lingering “macro uncertainty.”
“Automation, reshoring, and historic infrastructure investment are structural trends still in their early innings,” he said. “The effects of these tailwinds are most pronounced in the U.S., and STN remains our top pick in the E&C space given its 50-per-cent-plus topline exposure to this market in addition to the company’s expertise in the water and environmental services vertical. Among equipment distributors, we remain bullish on RBA (attractive valuation + volume growth on normalizing equipment supply) and TIH (net cash balance sheet + strong management team), which should at least partially shelter investors amid a broader market dislocation. Food (in)security is a growing political, social, and economic concern for governments around the world in the midst of rising global geopolitical tension. As such, we also reiterate our positive stance on AFN, especially given a highly attractive 6.5 times EV/2024 estimated EBITDA multiple ... Lastly, CIGI’s modest valuation (10.0 times EV/2024E EBITDA), highly flexible operating cost structure, and growing high-margin recurring IM revenue make the company a compelling pick for risk-tolerant, value-oriented investors with a 24-month time horizon. Recent discussions with management have further reinforced our confidence in the above names. We have also elected to upgrade Stella Jones shares (see corresponding note) as the same themes around re-shoring productive capacity towards the U.S. and only now-inflecting engineering backlogs suggest that the positive utility demand trends driving the Poles business are likely to stay; an undemanding 12.9 times 2024 estimated P/E valuation also helps protect the downside.”
Mr. Sytchev made a series of target price changes:
* Ag Growth International Inc. ( “outperform”) to $73 from $74. The average is $76.85.
Analyst: “There have been a lot of discussions about the ag cycle duration, especially as interest rates have jumped, putting pressure on equipment affordability. Company’s execution however has been materially stronger than expected due to mix and cost containment (hence AFN’s guide for 18-per-cent EBITDA margin in 2023E from 16.7 per cent in Q1/23). We are monitoring dry weather conditions in U.S. and Canada (explains 16-per-cent downdraft in shares in Sept) but company’s much more diversified revenue generation and better execution still gives us confidence in structural re-rating. Our positive thesis on AFN is fully predicated on self-help/virtuous cycle dynamic of margin improvement, working capital efficiency, debt repayment = higher ROIC dynamic = higher trading multiple (over time). Rapidly growing product transfer initiatives and international markets of India and Brazil (24 per cent of top line for both and expected to grow by double-digits) are therefore bound to take over the baton. AFN remains one of our top picks as deleveraging and ROIC improvements should both contribute to multiple rerating.”
* AtkinsRalis ( “outperform”) to $53 from $46. Average: $47.27.
Analyst: “The timing of AtkinsRalis’ (formerly SNC) name change coincides well with its turnaround profile that remains attractive despite shares up 88 per cent year-to-date vs. flat for the TSX; that being said, “easy” money is likely behind us as FCF/Engineering execution is the primary focus for investors. Despite the YTD gains, shares have only recently crested the same absolute levels from the past 10 years, while the likes of WSP / STN have gone up by a factor of 6.7 times and 6.1 times, respectively, over the same timeframe (TSX up 56 per cent). FCF generation still will be our anchor for performance (on an annual basis, this year of course should be better than 2022A but at this point it’s hard to say whether positive OCF is realistic even though H2/23 is expected to be positive). Based on our numbers, the biggest positive lever for SNC’s valuation is engineering margins improvement and corresponding multiple expansion. The business outlook in Engineering/Nuclear remains robust, something that we hear from the majority of our engineering consulting cohort.”
* Stelco Holdings Inc. ( “sector perform”) to $43 from $45. Average: $45.08.
Analyst: “After experiencing upside at the beginning of 2023, HRC pricing continues to compress downward, hovering around $700/st vs. above $800/st at the end of Q2/23 and an intermittent peak of $1,200 in Q1/23. HRC directionality is all that matters when it comes to calling STLC shares. The Auto OEM strikes make HRC pricing a headwind for Stelco as revenue is highly levered to auto customers who are anticipated to scale back production till a resolution is reached. Overall, we are not convinced that being long a hyper-cyclical now is the right place to be (even a well executing one). We remain on the sidelines given STLC’s inherently cyclical exposure at a time of significant macro uncertainty. "
* Stantec Inc. (“outperform”) to $105 from $96. Average: $97.55.
Analyst: “STN’s Water expertise and U.S. skew will continue to benefit the co in H2/23E. 38-per-cent year-to-date share price increase vs. flat for TSX is putting a hurdle ahead of Q3/23 as shares have had a tendency to sell off post prints. We would be using any downdraft opportunity to add as the market will be focusing on next strategic plan to be unveiled in early Dec 2023. M&A provides another capital deployment optionality over the forecast horizon with leverage now sitting below 1.8 times. Speaking with management, margin expansion momentum will be driven by higher demand for Environmental Services (20 per cent of revenue) and being more selective when it comes to projects, apart from wage pressures largely being behind us (4-per-cent to 4.5-per-cent increases expected in 2023).”
* WSP Global Inc. ( “outperform”) to $212 from $205. Average: $205.29.
Analyst: “WSP remains a core holding in our coverage universe (despite shares up 22 per cent year-to-date vs 12 per cent for the S&P). With record backlog intake and only 18 per cent of IIJA funds having been allocated (US$220-billion out of a total US1.2-trillion as of mid-May, as per the White House), we believe WSP’s prospects for the next several years remain bright. We also fully expect the company to be opportunistic when it comes to more M&A; M&A of last year (almost 8,000 personnel) has started to contribute to company’s momentum (9-per-cent organic growth year-to-date should be maintained as Q2 and Q3 are generally the strongest). With guidance having been raised post Q2/23 we do not expect any material updates re numbers.”