Compelling long-term outlook for H2O Innovation, says iA Capital

Naji Baydoun of iA Capital Markets is keeping an eye on H2O Innovation (H2O Innovation Stock Quote, Chart, News, Analysts, Financials TSXV:HEO), maintaining a “Buy” rating and target price of $3.50/share for a projected return of 43.4 per cent in an update to clients on September 29.

Founded in 2000 and headquartered in Quebec City, H2O Innovation is a diversified water infrastructure and technology company that provides integrated water treatment solutions in Canada, the United States and internationally. The company operates three business segments, including Water Technologies and Services, Specialty Products and Operation and Maintenance Services.

Baydoun’s latest update comes after H2O reported its fourth quarter fiscal 2021 financial results, which Baydoun noted to be slightly weaker than expected.

H2O Innovation reported revenue of $35.2 million in the fourth quarter, coming in below both the iA projection of $37.5 million and the consensus estimate of $38.2 million, with Baydoun attributing the lower figures to an unfavourable impact from foreign exchange, along with lower-than-expected organic growth within the Specialty Products business, including logistical delays.

Meanwhile, the company’s reported EBITDA of $3.1 million in the quarter was below the iA estimate of $3.8 million and the consensus forecast of $4 million.

Baydoun notes that the company has done well with its Water Technologies and Services segment, steadily delivering on projects within its existing backlog while securing new contracts. 

From the Specialty Products perspective, Baydoun notes that the company recently secured $4 million in new contract awards for its Piedmont subsidiary, signed new distribution agreements in Latin America, combined its Genesys and PWT business lines and increased its manufacturing capacity in the United Kingdom after previously doing the same in Quebec.

“Not only have we delivered our best financial performance with significant profitability improvement, as seen with our adjusted EBITDA of $14.6 million for fiscal year 2021, but we achieved that while dealing with an unprecedented pandemic challenging all aspects of our lives,” said Frédéric Dugré, President and CEO of H2O Innovation in the company’s September 28 press release.

“We have had to reinvent ourselves and develop new ways to interact and lead our business. Through this all, we realized that water is truly essential and that our business model is sound, robust, and resilient. Through our different business lines, we continue to create sales synergies and customer retention. Hence, we have maintained a high-level of our recurring revenues by nature, allowing us to gain financial predictability and continuously improve our balance sheet,” Dugré said.

The company received a boost in September after announcing that its specialty chemical business line has been selected to provide antiscalant to the world’s largest seawater reverse osmosis desalination plant, the Taweelah plant operated by ACWA Power in the United Arab Emirates, which is designed to treat 240 MGD (909,000 m³/day).

With fourth quarter results now in, Baydoun revised his 2021 revenue projection to $144.3 million from $146.7 million, with the revision still marking an eight per cent year-over-year increase. Baydoun’s updated projections show similar incremental revenue growth over the next few years, with potential year-over-year increases of 4.3 per cent in 2022 ($150.5 million, previously $152.5 million), 7.6 per cent in 2023 ($161.9 million, previously $166.8 million), and 8.6 per cent in 2024 ($175.8 million, previously $181.6 million) in play.

Baydoun’s EBITDA projections have also dipped slightly, as he now projects $14.6 million in EBITDA for 2021 (previously $15.3 million), with projected increases to $15.5 million in 2022 (previously $15.7 million), $16.6 million in 2023 (previously $17.2 million), and $18.6 million in 2024 (previously $18.9 million) also in the forecast.

Baydoun projects the consensus EV/EBITDA multiple to drop to 14.3x in 2021 after reporting at 17.6x in 2020, followed by another potential decrease to 13.5x in 2022.

Despite H2O management noting that the company is currently experiencing some supply chain issues which could extend through the first half of 2022, Baydoun does not believe this will present a long-term issue.

“HEO offers investors high single-digit revenue growth, low double-digit FCF/share growth, and potential upside from additional bolt-on acquisitions and strategic M&A,” Baydoun said. “Following the recent share price pullback, the shares are now trading at a discounted valuation to peers; as the Company continues to execute on its growth strategy, we see the potential for this relative valuation gap to shrink over time.”

Overall, H2O Innovation’s stock price has risen 7.5 per cent for the year to date, though it is down 36.1 per cent since spiking to its high point for the year, $3.60/share, on January 26.