Buy H2O Innovation for a double, says Industrial Alliance

Strategic moves aimed at improving profitability are paying off for H2O Innovation (H2O Innovation Stock Quote, Chart, News TSXV:HEO), according to analyst Naji Baydoun of Industrial Alliance Securities.

Baydoun delivered an update to clients on June 12 where he reiterated his “Speculative Buy” rating and $2.00 target price for H2O, which at press time translated to a projected 12-month return of 110.5 per cent.

Quebec City-based H2O, which designs custom-built and integrated water treatment solutions based on membrane filtrations technology for municipal, industrial and natural resource end-users, recently held virtually a series of investor meetings, with Baydoun summarizing his takeaways in his client update.

The analyst reported that HEO is focused on its organic growth initiatives within its high-margin specialty products (SP) business along with its operation and maintenance (O&M) services business. Baydoun pointed to a number of the company’s initiatives which have had a positive impact on profitability in recent years, including strategically being more selective when pursuing new projects mandates, focusing on expanding its high-margin SP business and achieving targeted synergies from acquisitions.

“These initiatives have begun to pay off, as evidenced by HEO’s record Q3/F20 results,” wrote Baydoun. “We expect HEO to achieve ~8 per cent EBITDA margins in F2020 and beyond (versus ~6 per cent in F2019.”

On the M&A front, the analyst said, “HEO’s organic growth initiatives continue to support an overall healthy outlook, however, we do not rule out the potential for accretive tuck-in acquisitions.”

“Given HEO’s healthy balance sheet (Exhibit 3), we see further upside to our current forecasts if the Company can successfully execute on its M&A strategy (not included in estimates/valuation at this time),” he said.

Baydoun maintained that HEO is still trading at a relative valuation discount to its water-linked peers and added that even the current discount doesn’t fully reflect HEO’s highly recurring revenue profile and its improving profitability profile.

“As HEO continues to execute on its growth strategy, we see the potential for the relative valuation gap with peers to shrink over time,” he said.

Baydoun’s forecast calls for H2O to generate fiscal 2020 revenue and EBITDA of $131 million and $10.3 million, respectively, and for fiscal 2021 revenue and EBITDA of $136 million and $10.7 million, respectively.

Last week, H2O announced that its specialty chemicals subsidiary PWT had 95 per cent sales growth in the Middle East and Africa over the past year while broadening its distribution network with ten new distributors across the two regions.

“The PWT team has worked hard over the past few years to diversify its growth strategy, and to tap into other markets beyond North America and China. We can definitely say that their efforts are paying off today and that the addition of Genesys’ products and distributors will accentuate the momentum of our chemical business line,” said Frédéric Dugré, President and CEO of H2O Innovation, in a press release.

H2O’s share price finished 2019 up 5.3 per cent and is up four per cent in 2020.