TSX Commentary

Gildan Activewear (GIL) – $22.47 – Q1 in Line, Retail Advances; Raising Target to $26
Sector Perform, Above Average Risk, Price Target: $26.00 (prev. $24.00)
GIL reported Q1/F10 earnings in line with RBC CM’s estimate. RBC CM is raising its target price to $26. GIL revealed that its significant retail men’s underwear program is with Wal-Mart under the Starter brand, to be rolled out to all US stores in Q2 F10. GIL notes further programs are under discussion in activewear and for back-to-school 2010. GIL also has a boys underwear program at Target under the Cherokee brand. Management sees retail gross margins achieving similar levels as wholesale eventually, but noted initial start-up and training costs in new programs. Q1 saw significant volume increase of 80% YoY in int’l deliveries and these represented 25% of all screenprint sales in Q1 (~$35M), driving much of the quarter’s unit volume increase.
Management commented int’l could grow to same unit potential as US wholesale market for GIL currently. Int’l is a relatively new market for GIL given it now has capacity to cater to it vs. in prior years. RBC CM sees int’l as driving up capacity utilization for GIL in F10. GIL’s US screenprint market share grew to 61% (and 64% in Jan F10) from 57% in Q4. RBC CM’s new F10/F11 EPS estimates are $1.43/$1.64, up from $1.39/$1.59. RBC CM states that any pricing increase in wholesale channel in F10 could further increase our estimates.

Veritas Research: ARC Energy Trust (AET.UN) – $20.33 – ARC Still Trading Above Revised Intrinsic Value Estimate
Sell, Intrinsic Value Estimate: $19.50 (Oil at $80.00/bbl)
Ante Creek acquisition highlights decent Q4: Fourth quarter production came in at 62,520 barrels of oil equivalent per day (boe/d), with cash flow per unit of $0.60. The $180 MM Ante Creek acquisition in December comes in at $14.30 per barrel of 2P reserves, but includes many fringe benefits such as an additional 30% interest in a gas plant, 163.5 net sections of undeveloped land and 30 identified horizontal drilling locations, with more to follow. On a corporate basis, ARC expects to produce 70,500 to 72,500 boe/d and spend $610 MM in capex in 2010. For 2010, ARC plans to spend $250 million to complete its 60 mmcf/d Dawson gas plant ($5.8 MM), to drill 35 wells of which 32 are horizontal, and to begin work on a second 60 mmcf/d gas plant. This activity will allow it to reach and maintain Dawson production at 115 mmcf/d to fill its increased capacity. An additional $47 MM will be allocated to its West Montney lands including Sunrise. ARC’s disclosed NAV value of $21.98 should be adjusted: In its reserves release, ARC estimates a year end “produce-out” NAV of $21.98 per unit (10% discounting). Vertias suggests recalculating, adjusting for taxes and the 13 million units issued in January. This results in an adjusted NAV of $17.83 (not excluding G&A). Underlying this number are assumed prices averaging $6.80 for AECO and $91 for Edmonton Light through 2015. ARC is trading at a 14% premium to this adjusted valuation. Following the issuance of 13 million units, ARC’s long term debt is now $606 MM with $710 MM of unused credit lines. Veritas’s valuation has increased, but ARC is still above it: Relative to ARC’s NAV calculations discussed above, Veritas uses lower pricing assumptions to arrive at its intrinsic value of $19.50 per unit, which assumes US$80 oil and mid-cycle gas prices of US$6 Henry Hub. Veritas’s valuation has increased with ARC’s additional tax pools ($2.2B at year end), its Ante Creek acquisitions and its January unit for debt maneuver, however Veritas continues to view ARC as overvalued, and maintains a Sell rating.

ARC Energy Trust (AET.UN): $20.33 – Montney Drives Impressive Reserves Growth and FD&A
Outperform, Average Risk, Price Target: $24.00 (prev. $23.00)
ARC’s Q4/09 results were ahead of our expectation and broadly in line with consensus. RBC CM has increased its price target to $24. ARC reported year-end reserves (2P) of 379 mmboe, +18% from last year. Growth was primarily driven by Montney reserve additions at Dawson and the Sunrise/Sunset blocks. FD&A costs (incl. FDC) were $11.55/boe, a result RBC CM expects will rank among the best in our coverage universe. While ARC’s reserves performance this year was excellent, the Upper Montney holds the potential to drive a similar level of growth for the next 3-4 years as booked recovery factors remain low, particularly on the Sunrise/Sunset and Septimus acreage where offset operators have had strong drilling results. While Dawson will clearly be the near-term growth driver for ARC, the 2010 capital budget includes several initiatives that could add material value over time, including: (i) Testing of other zones in NE BC, notably the Lower Montney at Sunrise/Sunset; (ii) The drilling of 17 horizontal Cardium wells at Pembina, which will test various geological settings and completion techniques and may lead to a substantially larger program in 2011; and (iii) Delineation of the substantial undeveloped land on the properties recently acquired at Ante Creek.

Jazz Air Income Fund (JAZ.UN): $4.09 – Q4/09 Results Light
Outperform, Above Average Risk
AFFO (distributable cash) came in below RBC CM estimate. AFFO of $26.7MM ($0.22/unit) vs. $37.4MM ($0.30/unit) last year, was below RBC CM’s estimate of $31MM ($0.25/unit). The shortfall is due to margin compression owing to lower than expected block hours flown and incentive payments. EBITDA of $33MM fell 30% vs. Q4/08 primarily due to the revisions to the CPA. This was the first full quarter under the revised Capacity Purchase Agreement which brought the controllable cost markup of 16.72% to 12.50%. EBITDA was below RBC CM’s estimate of $37.8MM, mainly due to the lower than expected Controllable Adjusted Actual Margin.

Paramount Energy Trust (PMT.UN): $4.94 – Reserves Update
Sector Perform, Above Average Risk, Price Target: $4.50
Overall, PMT’s reserves were a modest disappointment. PMT reported year-end reserves of 471.6 Bcfe (2P), a decrease of 3% from last year in aggregate and 12.5% on a per trust unit basis. Reserves were impacted by a 17.3 Bcf technical revision associated with undeveloped reserves in the East Central AB Viking play. Also, proved reserves were impacted by the reclassification of 12.6 Bcf at Legend to the probable category due to shut-ins related to the gas-over-bitumen issue. At current AECO forward prices, PMT expects cash flow of $185-$190 million in 2010 which, along with DRIP proceeds, should fund capital spending, distributions and debenture maturities.

Acadian Timber Corp. (ADN): $6.72 – Acadian Remains in a Holding Pattern, Waiting for Recovery in US Housing
Sector Perform, Average Risk, Price Target: $8.00
Acadian reported fourth quarter distributable cash of $1.3MM or $0.08 per unit, above RBC CM;s forecast of $0.01. Distributable cash was up from a loss of $0.3MM in the prior quarter, but remained below the $5.7MM earned a year ago. On January 1, 2010, Acadian converted to a corporation. As part of the conversion, Acadian acquired $95MM of tax assets and spruce seedling technology from CellFor. expects to be able to continue to pay investors a $0.20 annual dividend, in line with the prior cash distribution. The company’s target payout ratio remains 95%. Following the distribution cut last November, shares of Acadian Timber have remained near $6.50, +/- $0.25. In the absence of a material pick-up in the US housing market, we anticipate Acadian shares will remain range-bound. We suspected that the longer-term value in Acadian, together with Brookfield’s 45% interest, would support the share price.

RioCan REIT (REI.UN): $19.08 – After The Storm: Earnings Trough 1 Quarter Later Than Expected As Q4 Misses
Sector Perform, Average Risk, Price Target: $18.50 (prev. $19.75)
Q4/09 FFO/Unit Misses – Q4/09 FFO/unit of $0.28 was -30% from Q4/08’s $0.39 and well short of RBC CM’s $0.32 estimate. The reason for the lower than expected variances are: i) NOI miss of $1.8MM (~$0.01/unit), in part due to $1MM of higher bad debt expense and $0.6MM of provisions for GROC tenants; ii) transactional/fee income missed by $3.7MM (~$0.02/unit), mostly due to the deferral of a milestone/zoning payment to 2010; iii) G&A was $2.7MM (~$0.01/unit) above forecast, in part reflective of non-recurring SIFT/IFRS/severance costs of $1.7MM; and, iv) interest expense exceeded forecast by $1.5MM (~$0.01/unit), in part due to a $0.6MM charge on the early redemption of unsecureds. Thematically, 2009 was also marred by the complete evaporation of transactional income which had totaled $40MM/$45MM in 2008/2007. The 2009 payout ratio is not a pretty picture: Distributions totaled $318MM ($1.38/unit) while AFFO was $250MM ($1.09/unit) for an over-distribution of $68MM (127% payout). RBC CM believes AFFO/unit improvements are just around the corner, but still do not see “core” AFFO covering gross distributions within our 2-year forecast horizon. RioCan is steadfast in its “covenant with unitholders”, stating that market chatter surrounding a cut in dist’ns are “extremely exaggerated”.

ATS Automation Tooling Systems (ATA) – $7.38 – FQ3/10 Results Below Expectations, But Signs of Order Stabilization in ASG
Sector Perform, Above Average Risk, Price Target: $7.00
ATS posted total revenue of $138MM, down 38% y/y and below RBC CM’s $151MM forecast. The ASG business was particularly soft at $79MM (exp. $100MM), partially offset by strength in the solar division (revenue of $60MM vs $52MM exp.). Both divisions remained profitable, though consolidated EPS of $0.04 was below RBC CM’s $0.05 forecast and consensus $0.08. RBC CM has seen considerable slowdown in orders over the past several quarters, but FQ3 order intake did show some improvement over FQ2. FQ3 ASG bookings were down 41% y/y to $92MM, but up 30% q/q. RBC CM continues to believe that ATS management has handled the economic situation well over the past 12-18 months. In the face of plummeting demand in several key end-markets, they have managed costs, focused sales efforts and raised capital to enable them withstand the downturn, and emerge stronger on the other side. In the near-term, however, RBC CM continues to expect that financial performance will remain relatively soft, as indicated by low (though improving in FQ3) order and backlog levels. RBC CM sees ATA shares as reasonably valued, currently trading at ~1.2x book value, or ~9.7x EV/EBITDA (F2011E). Accordingly, RBC CM remains on the sidelines with respect to ATA shares. For investors with a 12+ month horizon (able to look beyond current market conditions) RBC CM would watch for weakness to accumulate positions.

Suncor Energy Inc. (SU) – $31.85 – Fire in the Sands – Part II
Sector Perform (prev. Outperform), Average Risk, Price Target: $46.00 (prev. $49.00)
Suncor Energy experienced another fire in its oil sands operations – this time at its 125,000 bbl/d Upgrader I. Details are limited at the moment, but Suncor estimates that it will take a couple of days to assess the fire damage along with remediation measures. Predicated upon four weeks of repairs, RBC CM has modestly trimmed its 2010 (base) synthetic oil production outlook by 3.4% to 284,000 bbl/d and increased its oil sands cash costs by 4% to $38/bbl. At current levels, Suncor is trading at a 2010E debt-adjusted cash flow multiple of 8.0x (roughly in line with RBC CM’s Canadian integrated peer group at 7.9x) and a P/NAV ratio of 0.72x (slightly below the average of its Canadian integrated peer group of 0.81x). In RBC CM’s opinion, Suncor’s longer-term outlook remains favourable, underpinned by its improved operating cost structure, enormous oil sands resource base and ability to generate mid-single-digit production growth. At the same time, RBC CM’s has become increasingly concerned about its execution performance, recognizing full well that two oil sands fires within such a compressed a timeframe could be purely coincidental. RBC CM has downgraded Suncor by one notch to Sector Perform, and has trimmed its one-year target price by 6% to $46 per share. It is never easy to downgrade a stock once most of the bad news appears to be reflected in its valuation, but Suncor may trade in a sideways range in coming months pending improved oil sands operating performance and execution in general. In RBC CM’s view, investors seeking to retain oil sands exposure should switch into Canadian Natural Resources (TSX: CNQ, $69.75; O-Avg) – RBC CM’s favourite stock within its coverage group.

Canfor Pulp Income Fund (CFX.UN) – $7.96 – Strong Fourth Quarter Funds Distribution Increase
Outperform, Above Average Risk
Distributable cash was $0.31 per unit, above RBC CM’s forecast of $0.21 and the consensus of $0.19. Distributable cash was almost double $0.16 in the prior quarter and many times better than $0.02 earned a year ago. EBITDA was $27MM, also above RBC CM’s forecast of $22.6MM and 8% higher than $25.0MM in Q309, reflecting higher pulp prices, higher energy sales and lower SG&A costs, partially offset by the 4% appreciation of the C$ in the quarter. The February distribution will be $0.12, up from $0.08 in January and December, which was itself an increase from $0.05 in November and $0.01 in the prior nine months. Cash from operations before working capital was $21.3MM for the quarter, $39.4MM for the year. Capex was kept low, at $2.9 in Q409 and just $17.3MM in 2009. Free cash flow was $18.4MM in Q409. Net debt to capital was a conservative 16% at year end. Prices for NBSK have recovered since hitting their April/May lows last year, with the February price increase announcement of US$30/mt taking North American prices to US$880/mt, up 39% or US$245/mt. RBC CM expects low global producer and consumer inventories and robust demand from China will support the implementation of the February increase, but remains cautious on the sustainability of further increases given continued weakness in fine paper demand.