ANALYSTS STEADFAST AMID SNC TURMOIL
Street believes undervalued stock offers golden buying opportunity
Anybody in the last two or three years that has had a buy recommendation out on SNC-Lavalin has got to be smoking something.
Every time MacNicol & Associates portfolio manager Ross Healy and his wife travel to Las Vegas, the couple follows one rule.
Each one of them has $50 to gamble with per day. Should they lose their $50, they take it as a sign that “the gods are not with you.”
Healy may be willing to take the odd gamble when working the slots and the stock market, but one place he won’t be making any bets is on shares of SNC-Lavalin Group Inc. — despite what the Street is telling him. If his clients were to ask to him to do it, he’d refuse.
“I’m afraid this is a toxic stock.” Healy said. “Anybody in the last two or three years that has had a buy recommendation out on SNC-Lavalin has got to be smoking something interesting and I’d like to know what it is.”
Whatever that something is, it appears there is plenty going around.
Over the past eight months, SNC-Lavalin’s shares have plunged from a June high of more than $61.54 to around $35.90, as the Montreal-based engineering firm has found itself trapped in a downward spiral of negative news.
But during that 40-per-cent decline, not a single one of the dozen or so analysts that follow the company, according to data collected by Bloomberg, has put the equivalent of a sell recommendation on the stock.
Their steadfastness is often attributed to the belief that the stock has been widely oversold and its resulting undervaluation is providing investors with a golden buying opportunity. But it’s also a reminder that no recommendation is foolproof.
Healy, with 54 years in investing, understands the valuation argument but remains confounded by how the Street can still have a positive outlook on a firm that’s “in the middle of a maelstrom.”
SNC’s trouble began in August, when the company was caught in a diplomatic breakdown between Canada and Saudi Arabia, where it has significant operations.
In October, the stock fell again when SNC announced it had been denied a remediation agreement for fraud and bribery charges stemming from a Libya project that will likely see it go to court.
Then, in late January, SNC warned it would miss its profit target for the year due to uncertainty over its Saudi operations and a new, unspecified major issue with a South American mining project.
One week later, it continued to make headlines for the wrong reasons, playing a feature role in a political scandal on Parliament Hill over allegations that the Prime Minister’s Office had attempted to interfere in SNC’s criminal case.
Another profit warning followed only two weeks later on Feb. 11, and the next day, it was reported that the company might face further fraud charges in connection to a Montreal bridge contract.
Through the turmoil, the analyst community has yet to turn its back on the stock.
At the beginning of June, all 13 analysts then covering the company had the equivalent of a buy recommendation on SNC, according to Bloomberg. Their target prices ran as high as $77.
Since then there have been downgrades and price target reductions. Currently, eight of 14 analysts who cover SNC, according to Bloomberg, still have buy ratings on the stock. Six have holds.
The average target price has slipped to $45.38, but perhaps surprisingly, no analyst has issued a sell recommendation on the stock.
The most bullish still see the stock returning above $50 within the next twelve months, given the embedded value.
Even Healy notes that with the shares trading at 1.5 times book value, SNC is now the cheapest it has been since 2000.
The bedrock of the analyst community’s valuation of SNC relies on the company’s stake in Highway 407, an Ontario toll road that skirts Toronto to the north.
SNC’s approximate 16-per-cent stake is worth about $28.50 per share, according to National Bank of Canada, meaning that the market is pricing the rest of the company — a globally-recognized engineering titan — at just $7 per share.
In a March 3 note, National Bank of Canada analyst Maxim Sytchev defended the stock, saying there’s still “clear value in much of the segmented businesses” while suggesting the shares had reached a floor.
“How much worse can it get when $30-$33 in SNC/share value is embedded in hard assets?” said Sytchev, who has a buy rating on the stock.
While only time will tell who’s right when it comes to SNC, a preponderance of buy recommendations is nothing new.
Sell ratings are becoming so rare that Schulich School of Business professor Ambrus Kecskes says he has begun to think of hold recommendations as an analyst’s way of hinting investors should sell.
The analyst consensus on SNC is emblematic of a larger issue, according to Kecskes, who researches analysts and their interactions in the market. Analysts tend to be biased toward the positive side and are sometimes hesitant to downgrade stocks.
“The recommendation numbers are pretty close to pure marketing,” said Kecskes. “You can almost bet you’re never going to see (a sell recommendation) unless these guys are going bankrupt.”
The reason Kecskes believes analysts are positively biased in general is because they are wary of damaging the relationships they have with the company they’re following. Some companies have been known to cut off the access analysts have to management teams if they issue sell ratings on their stock, he said.
Those who work for investment banks are at further risk of damaging their employer’s relationship with a company. Should the company be looking to refinance its debt, for example, skipping past the firm that has issued a sell rating is a choice that could cost that firm tens of millions of dollars in fees, Kecskes said.
Kecskes said this bias is particularly dangerous for retail investors who build their own portfolios.
“Retail investors, I think, are generally fooled by what’s going on,” Kecskes said. “The institutional investors are wise to this.”
Norman Levine, a portfolio manager with Portfolio Management Corp., said he has stopped paying attention to recommendations and target prices altogether.
With SNC in particular, it’s even more difficult for analysts to give an opinion on the stock because its movement has strayed so far from relying on fundamentals alone, Levine said. Any positive takeaway from the fundamentals, such as the company’s stake in Highway 407, is irrelevant, he said, given that the stock is now exposed to both political and judicial issues.
Its future is now “impossible” to predict, he said. In cases where stocks are shrouded by as much uncertainty as SNC, he believes analysts should refrain from giving any investment opinion.
“I can tell you with some certainty what most companies’ outlook is,” Levine said. “I can’t tell you with any certainty here.”
Healy is just as uncertain about the company’s future, though tumbling earnings forecasts convinced him long ago to stay away. It’s unclear to Healy whether the earnings downturn will continue even after the company’s judicial issues have been sorted.
If analyst projections are correct and the stock does rebound, his clients, most of whom are conservative-minded, aren’t going to thank him for taking a gamble, no matter the potential payoff, he said.
In the meantime, investors may want to consider deploying Healy’s Las Vegas logic. When he and his wife lose their $50 for the day, neither one is tempted to continue incurring losses.
“Let’s not lose the next $50,” Healy tells her. “Let’s go to a show.”