H2O Innovation is undervalued, says Haywood

Haywood Capital Markets analyst Colin Healey is riding the wave of positive momentum generated by H2O Innovation (H2O Innovation Stock Quote, Chart, News, Analysts, Financials TSXV:HEO), maintaining a “Buy” rating and target price of $4.00/share for a projected return of 74.7 per cent in an update to clients on Tuesday.

Quebec City-based H2O provides water treatment solutions using a membrane filtration system for utilities in Canada and internationally. The company’s three business segments are Water Technologies & Services, Specialty Products and Operation and Maintenance services (O&M).

Healey’s latest analysis comes after H2O announced it had secured an additional four contracts in its Water Technologies and Services segment.

“The project wins are positive news and highlight H2O’s solid positioning in the market with diverse and robust technology solutions to support and address two separate social issues being faced in the market,” Healey said.

The four contracts, valued at a combined $9.9 million, pushes H2O’s Water Technologies and Services backlog to $41.2 million, up from the $32.5 million reported on June 30.

One of its new contracts will be a water reuse system for a client in Escondido, Calif., which will be used primarily for agricultural irrigation. The project will incorporate an ultrafiltration system, which has a net filtrate production capacity of 2.5 MGD (9,460 m³/day), followed by reverse osmosis, which has a permeate capacity of 2.0 MGD (7,570 m³/day), to treat tertiary effluent from the recycled water supply to produce a higher purity product.

“In recent years, severe droughts have reached record levels in California and much of the Western US, which has led to water reuse becoming more critical than ever for a sustainable water supply,” Healey noted. “The US Infrastructure and Jobs Act earmarked $1 billion for water recycling programs over the next five years. With H2O positioning itself at the forefront of water reuse/recycling technology, we could see the company be a strong contender for further contract wins in this space over the next few years.”

In addition, the company secured two more First Nations contracts, which Healey notes the company could continue to do with 53 long-term drinking water advisories still in effect in 34 First Nations communities in Canada.

The Dene Tha’ First Nation in northern Alberta, where the company will design and supply a membrane bioreactor (“MBR”) system with an average day flow of 50,000 gallons per day, then provide operations training at site and a five-year extended service contract following commissioning.

Meanwhile, H2O will also design and supply a 457,000 gpd membrane treatment system for surface water for a First Nation community on the north shore of Gouin Reservoir in Quebec, which will supply pretreatment by multimedia filtration, with nanofiltration trains, and ultraviolet radiation for disinfection to improve drinking water quality, as well as a service contract for plant operation and remote monitoring.

“We believe in the importance of addressing the water issues of our First Nations communities,” said Frederic Dugré, President and Chief Executive Officer of H2O Innovation in the company’s October 5 press release. “H2O Innovation is proud to have completed more than 10 water and wastewater plants for First Nations communities that are still in service today. Our business model promoting customer care and strong customer retention through premium services, like remote monitoring and training, is a key driver for the success of our First Nations projects.”

Healey projects modest growth in H2O’s financial picture, as he forecasts revenue to reach $144.3 million in 2021 for a potential year-over-year increase of eight per cent, followed by a projected jump to $156.3 million in 2022 for a potential year-over-year increase of 8.3 per cent.

The gross margin percentages also trend upward, with Healey forecasting a move from the reported 26.9 per cent in 2020 to 27.7 per cent in 2021, then to 28.2 per cent in 2022.

Meanwhile, Healey also projects the company’s adjusted EBITDA to improve, as he forecasts a jump from the reported $12.5 million and 9.4 per cent margin in 2020 to $14.6 million with a 10.1 per cent margin in 2021, followed by another projected increase to $16.1 million and a 10.3 per cent margin in 2022.

“We believe H2O is undervalued given the resiliency of its business lines, large backlog and synergies it is achieving through M&A,” Healey said. “We expect the O&M backlog to fill out as long-term contracts start to renew, and acquisitive growth will further fuel top-line growth as H2O closes in on its three-year strategic plan objectives well ahead of schedule.”

“As H2O grows and diversifies its business, we continue to see it trading upwards towards the peer group multiple. Our 2.4x EV/2022 revenue multiple remains conservative within the peer group given our view on H2O’s growth strategy and potential and shares look attractive here. We believe strong financial performance over the next few quarters and further improving/stabilizing EBITDA margins will lead to share price appreciation. We see H2O as undervalued at these levels and as such are maintaining our target price of $4.00 and our Buy recommendation.”

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.