H2O Innovation is undervalued, says Haywood

The share price may have skidded in recent months but investors can expect better results to come from H2O Innovation (H2O Innovation Stock Quote, Chart, News, Analysts, Financials TSXV:HEO), according to Haywood Capital Markets analyst Colin Healey, who reviewed the company’s quarterly financials in an update to clients on Thursday.

Quebec City-headquartered H2O Innovation provides customized water treatment systems based on membrane filtration technology for municipal, industrial, energy and natural resources customers, along with having a line of specialty products for the water industry.

The company reported its fiscal third quarter 2021 numbers on Thursday for the period ended March 31, 2021, which featured 8.6 per cent year-over-year revenue growth to $39.2 million and adjusted EBITDA of $4.5 million compared to $3.8 million a year earlier.

Company president and CEO Frédéric Dugré called it a strong financial performance with constant margin improvement. On the company’s path forward, Dugré wrote,

“As we continue to build our platform of complementary water treatment technologies and services through acquisitions and innovations, we multiply the synergies between these technologies and services which simultaneously fosters an exceptional business culture full of diverse talents,” Dugré said.

“The multiple synergies become our competitive advantage as they generate value for our customers and help the Corporation preserve long term business relationships, thus causing high recurring revenues. With a strong financial position showing a net debt-to-adjusted EBITDA ratio of 0.20, we have room to invest in organic growth opportunities and to realize strategic acquisitions, and therefore achieve our three-year plan,” he said.

Breaking down the quarter’s revenue, H2O saw revenue climb from $6.7 million a year ago to $10.1 million in its Water Technologies and Services (WTS) segment, while Specialty Products fell from $12.9 million to $11.8 million and Operations and Maintenance went from $16.4 million to $17.3 million.

H2O’s big M&A move over the quarter was the acquisition of the remaining 76 per cent of Madrid-based specialty products company Genesys Membrane Products, which H2O said increased the company’s EBITDA on a proforma basis by more than ten per cent. Meanwhile, the company finished the quarter with net debt of $3.3 million, improving from $10.5 million at the end of the 2020 fiscal year and the $14.1-million at the end of the second quarter, with cash and equivalents at the quarter’s end of $13.3 million.

Healey called the quarter solid, with HEO recording a slight beat of his forecast. The $39.2-million topline was better than Healey’s $38.0-million estimate as well as the consensus call for $38.2 million, while the $4.5-million EBITDA was also better than Healey’s $3.9-million estimate and the Street’s $3.9 million.

Commenting on the growth per sector, Healey said the company’s WTS business saw new project wins and was helped by a resumption of work following COVID-related delays.

“H2O continues to prioritize higher-margin WTS projects and those which offer cross-pillar synergies, meaning projects that have a potential to generate business for/within its other verticals,” Healey said.

“H2O’s financial position remains strong and is improving and we would expect to see further M&A activity in 2021 with a focus on growing the ‘specialty products’ and O&M businesses chasing that recurring revenue. These verticals are expected to lead growth for the company on a longer-term basis, despite the big year-over-year jump in WTS this quarter. Shares look attractive at current levels and strategy and execution continues to deliver revenue and margin growth,” he wrote.

Healey has slightly lifted his full fiscal 2021 (year end June 30) top and bottom line forecasts due to expected growth in H2O’s WTS vertical and is now calling for $148.5 million in revenue and $15.8 million adjusted EBITDA. For fiscal 2022, he is calling for $158.3 million in revenue and $17.0 million in EBITDA.

“H2O is on a very strong trajectory to meet its three-year strategic plan objectives of over 11 per cent adjusted EBITDA margins and revenue of between $175 million and $250 million by 2023,” Healey wrote.

On comps, the analyst estimated that HEO is currently trading at a 1.5x EV/Revenue multiple of his calendar 2021 estimate, which is under the industry peer group average of 2.4x.

“We believe H2O is undervalued given the resiliency of its business lines, large backlog and synergies it is achieving through M&A,” Healey wrote. “We believe strong financial performance over the next few quarters and further improving/stabilizing EBITDA margins will lead to share price appreciation.”

With the update, Healey maintained his “Buy” rating and $4.00 target price, which at the time of publication represented a projected one-year return of 63 per cent.

HEO had a great 2020, returning 106 per cent over the year, and while the stock started off 2021 by leaping ahead another 76 per cent by the end of January, it has pulled back since and is currently up 20.6 per cent year-to-date.