- CN metrics are recovering nicely after a harsh winter, while the 2018 capital expenditure envelope (C$3.4b) is expected to further improve network fluidity.
- Industry fundamentals remain robust despite concerns over a trade war.
- We expect increased momentum in the stock price and an expansion in valuation multiples.
CN is the second largest publicly traded North American railway and a backbone of the Canadian economy. It has a network of ~20,000 route miles spanning Canada and mid-America which connect North America to global markets on three coasts, and which offer product, geographic and customer diversity. The company employs ~25,000 people and handles more than C$250b of goods per year.
In tandem with overall economic performance, industry fundamentals remain robust despite concerns over a trade war. The economic indicators we monitor have continued to point to strong market conditions. US industrial production shows a strong correlation with carloads, and the outlook has been revised upward over the last twelve months (from 2.4% to 3.6% for 2018 and from 2.1% to 2.7% for 2019 on a year-over-year basis), supporting our bullish view on the economy.
At the company level, we highlight that CN's metrics are recovering nicely following a harsh winter and that its infrastructure investments are starting to pay off. Volume in the second quarter of fiscal year 2018 (2Q18) was up 7.6% year-over-year, beating our initial forecast of +0.9%, which has resulted in stronger operating metrics. We therefore recently revised our 2Q18 adjusted fully diluted EPS to C$1.41, up from C$1.31, and believe that CN's 2018 guidance (C$5.10–5.25) is poised for an upward revision in the coming months. Moreover, interim president & CEO JJ Ruest has done an outstanding job since his appointment in March 2018, in our view, and remains highly committed to making the necessary investments to restore fluidity on the network (capital expenditure envelope of C$3.4b in 2018 includes some 29 major infrastructure capacity projects). In view of his solid performance, we believe he will likely be promoted to the permanent CEO position, which should be well-received by the market.
Taking a closer look at CN's volume, we note that this is up in all commodities except automotive (which represents only 6% of total revenues). We expect volume growth to accelerate in the back half of the year, as CN will gradually be facing an easier comparison. Upcoming investment in port infrastructure (Prince Rupert, Vancouver and Montréal) should continue to fuel intermodal growth (25% of total revenues) in the long term and, despite the current concerns cited above, we foresee a bullish outlook for crude-by-rail, grain, metals & minerals (including frac sand) and coal. Given the strong volumes expected, combined with a lack of capacity in the truckload industry, we expect core pricing to strengthen above the 2.5–3.0% (year-over-year basis) targeted range. Recall that core pricing improved sequentially from 2.4% to 2.7% in 1Q18, with contract renewals averaging about +5% yoy.
Our target price of C$118 is derived from an average of three valuation methods, and we expect the stock to trade above historical averages in light of the company's strong fundamentals, impressive growth opportunities and robust balance sheet.
- Attractive profitable growth story with meaningful organic tailwinds such as an aging population, the age-at-home trend and product introductions. The dividend should also remain on a high-growth trajectory.
- Recently announced a large acquisition (Garaventa Lift), which will create a global leader in accessibility products.
- High insider ownership, with the CEO and CFO owning a combined 32% of the company.
Savaria designs, manufactures, distributes and installs accessibility equipment such as stair lifts, vertical and inclined wheelchair lifts, elevators for home and commercial use, and patient lifts. In addition, it converts and adapts minivans to be wheelchair-accessible. In 2017, Savaria entered the medical beds and therapeutic surfaces market through the acquisition of Span-America Medical Systems.
Acquired by Chairman and CEO Marcel Bourassa in 1989 for C$0.2m and publicly traded since 2002, Savaria has evolved into a market leader while creating significant shareholder value at the same time; the current market capitalization is above C$700m. With a combined ownership position in Savaria of 32%, Marcel Bourassa and his brother Jean-Marie Bourassa (Savaria's CFO) remain strongly aligned with other shareholders and are focused on taking Savaria to new heights. After lifting the annual revenue run rate to over C$250m (excluding Garaventa Lift) from C$60–70m and doubling EBITDA margin to 15–17% in the past five years, management's objective is to double revenue to C$500m by the end of 2021. We strongly believe that there are many exciting chapters left in this growth story, thanks to an aging population, seniors' desire to 'age at home', product introductions and contributions from acquisitions.
On July 10, 2018, Savaria announced an agreement to acquire Garaventa Lift, a manufacturer of wheelchair lifts and residential elevators headquartered in Switzerland, for C$98m. The transaction is scheduled to close in October. We view this game-changing acquisition positively as it transforms Savaria into a global leader by improving its competitive positioning on the North American West Coast, expanding its footprint into Europe and strengthening its Asian operations. Garaventa Lift generated revenue of C$108m (55–60% North America, 30–35% Europe, 5–10% rest of the world) and EBITDA of C$8.3m in 2017. We view the purchase price as reasonable given a compression from 11.8x trailing EBITDA to 8.0x forward EBITDA, after taking into account expected synergies of C$2m in the first year and C$2m in the second year.
Post Garaventa Lift, we estimate net debt/EBITDA at 1.1x, which is below management's maximum comfort level of 2.0x. Following Span-America Medical Systems in 2017 and Garaventa Lift in 2018, we believe Savaria could be ready for another large transaction in 2019.
The dividend has been on a sharp upward path, supported by Savaria's positive earnings trajectory. Following increases of 25% in 2015 and 30% in 2016, a 38% dividend raise was announced on September 11, 2017, to C$0.36 per share (2.2% dividend yield). We see further potential upside to the dividend in 2018 and beyond, based on Savaria's positive organic and acquisitive outlook.
Our C$22.00 target implies 16x EV/EBITDA on our 2019 estimates. This is at the higher end of where its peers are trading (9–17x) and is warranted, in our opinion, when considering Savaria's healthier growth profile, lower leverage and higher dividend yield. Savaria is one of the preferred names in our coverage universe.
|Company||Ticker||Price ($)||Market cap ($m)||Ratingfootnote 1||Target price ($)||Dividend yield (%)||Total expected return (%)||Sector|
|Manulife Financial Corporation||MFC||23.86||47,328||Buy-AAR||28.00||3.7%||21%||Life Insurance|
|Alimentation Couche-Tard Inc.||ATD.B||62.01||35,094||Buy-AAR||74.00||0.6%||20%||Consumer Staples|
|Sun Life Financial Inc.||SLF||53.71||32,635||Buy-AAR||60.00||3.5%||15%||Life Insurance|
|TELUS Corporation||T||48.16||28,684||Buy-AR||52.00||4.4%||12%||Telecom, Media & Tech|
|Algonquin Power & Utilities Corp||AQN||12.63||5,944||Buy-AR||15.75||5.4%||30%||Power & Utilities|
|Uni-Select Inc.||UNS||21.60||911||Top Pick-AR||33.00||1.7%||54%||Consumer Discretionary|
|Transat A.T. Inc.||TRZ||8.80||343||Buy-AR||15.00||–||70%||Transportation & Aerospace|
- Target price change: SLF to $60 (from $58).
- AR: Average Risk, AAR: Above-average Risk
Source: Desjardins Capital Markets, Bloomberg, FactSet