The time is right for you to be investing in H2O Innovation (H2O Innovation Stock Quote, Chart, News TSXV:HEO), according to Industrial Alliance Securities analyst Naji Baydoun, who launched coverage of the stock on Monday with a “Speculative Buy” rating and $2.00 price target.
Baydoun said expected growth in global water infrastructure spending should put H2O on an annual revenue growth rate of between six and eight per cent over the next four years.
Founded in 2000, Quebec City-based H2O supplies integrated water treatment solutions in Canada, the US and internationally.
The company has three business segments, Projects & Aftermarket, Specialty Products and Operation & Maintenance Services.
H2O, which is expected to report its fiscal third quarter results on Wednesday, last reported on February 12 where its second quarter ended December 31, 2019, featured revenue of $33.3 million, up from $29.4 million a year earlier, and adjusted EBITDA of $2.3 million, up from $1.4 million a year earlier. The quarter featured input from H2O’s recent acquisition, Genesys, a UK-based specialty chemicals company dedicated to water treatment, bought for about $28 million last November.
For the Q2, Genesys contributed $1.6 million to H2O’s top line.
Baydoun argued in his report that industry fundamentals now support water infrastructure investment, as developed economies experience aging critical infrastructure, developing economies experience insufficient water availability, populations grow and the current low interest rate environment encourages investment.
Baydoun says, “HEO offers investors (1) solid high single-digit organic revenue growth (~6-8%/year, CAGR F2019-24E), driven by its order backlog (>$140 million); (2) improving profitability, driven by a changing portfolio mix (increasingly made up of higher-margin businesses); (3) a discounted valuation compared with peers; and (4) potential upside from additional bolt-on acquisitions and strategic M&A.”
On valuation, Baydoun estimates HEO currently trades at about 8x EV/EBITDA versus about 12x for its water-linked peers and he said there’s a potential for shares to experience a valuation rerating over time as the company continues to execute on its growth strategy.
Breaking down H2O’s business, the analyst pointed to over 80 per cent recurring revenues currently as compared to less than 50 per cent in 2015. Those recurring revenue streams include aftermarket services, specialty products and operation and maintenance, all of which stem from long-term sales contracts or service agreements, adding stability to the company’s overall portfolio, Baydoun argued.
The analyst also sees improving profitability from H2O, saying, “HEO has taken several steps to improve its margins, including (1) strategically being more selective when pursuing new business mandates (focusing on higher-margin opportunities), (2) focusing on expanding the high margin SP business (through new product additions and a larger distribution network), and (3) realizing both cost and revenue synergies from recent acquisitions.
Based on the growth outlook and improving profitability of HEO, we forecast high single-digit average annual AFFO/share growth through F2024.”
Baydoun is calling for fiscal 2020 revenue and EBITDA of $132 million and $9.1 million, respectively, and for fiscal 2021 revenue and EBITDA of $139 million and $10.4 million, respectively. At the time of publication, Baydoun’s $2.00 target represented a projected 12-month return of 129.9 per cent.