Buy H2O Innovation for 71 per cent upside: iA Capital Markets

Naji Baydoun of iA Capital Markets is waiting for the floodgate to open on H2O Innovation ((H2O Innovation Stock Quote, Chart, News, Analysts, Financials TSXV:HEO), maintaining a “Buy” rating and target price of $3.60/share for a projected return of 70.6 per cent in an update to clients on March 9.

Founded in 2000 and headquartered in Quebec City, H2O Innovation Inc. 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 iA Capital Markets recently hosted investor meetings with company management.

“HEO is one of a select handful of publicly traded, pure-play water companies in North America, and should continue to benefit from industry-specific tailwinds that support a strong growth outlook (i.e., water sector investment outlook, ageing infrastructure, regulatory pressures, etc.),” Baydoun said.

The company operates three complementary businesses in the water infrastructure and technology services industry globally, with an aim toward providing full life-cycle service offerings to clients in the water sector.

In particular, H2O hopes its business model and value proposition will help the company capture top-line and bottom-line synergies between its operations while enjoying high client retention.

“Over the past several years, HEO’s organic growth and acquisition initiatives have helped the Company significantly grow its revenue and improve its profitability, and strengthened its market offering to clients, thereby improving the Company’s competitive positioning in the water industry and leading to high client retention,” Baydoun said.

Proof of concept for the company can be found in its Piedmont business line, which develops corrosion resistant equipment for desalination plants in the industrial and municipal markets. Piedmont has secured 13 new orders for fibreglass-reinforced cartridge filter housings, stainless steel duplex couplings, and PiPerLink permeate connectors, for a total of $9.3 million.

“We are really excited to see the large number of projects and volume of business won by the dedication and hard work of the Piedmont team, especially considering the cross-business synergies with our Specialty Chemicals Group,” said Gregory Madden, Chief Strategy Officer of H2O Innovation in the company’s February 16 press release. “Desalination is an important segment for the water industry, and we are optimistic about its growth. We continue to develop innovative products to complement our current portfolio, bringing to market unique solutions focused on energy and operating cost savings, living our mission to simplify water.”

After closing its 2021 fiscal year with $144.3 million in revenue, the company’s 2022 performance is already 14.3 per cent up year-over-year over the previous fiscal year ($80 million in 2022 vs. $70 million) in 2022, leading Baydoun to a year-end projection of $169.4 million for a 17.4 per cent year-over-year increase.

Looking ahead to 2023, Baydoun expects modest year-over-year growth of 10.2 per cent to clock in at $186.6 million, while 2024 would see the company crack another milestone at $203.1 million, a potential year-over-year increase of 8.8 per cent.

Meanwhile, after finishing with $14.6 million in adjusted EBITDA in 2021 for an implied margin of 10.1 per cent, Baydoun forecasts the company’s adjusted EBITDA to grow to $16.3 million in 2022, albeit with a slight margin compression to 9.6 per cent before getting back into double digits in 2023 at $19.5 million for an implied margin of 10.5 per cent, then slightly expanding again to $21.4 million for an implied margin of 10.5 per cent in 2024.

From a valuation standpoint, Baydoun forecasts the company’s EV/EBITDA multiple to drop from the reported 15.1x in 2021 to a projected 13.2x in 2022, then to a projected 10.8x in 2023.

Overall, Baydoun believes there could be a real opportunity with H2O for investors, particularly with the potential for a 30 per cent total shareholder return underpin depending on multiples going into the 2024 fiscal year.

“Our refreshed valuation work and scenario analysis help to frame the upside potential in the shares based on various expectations through F2024, and we believe that at minimum, the low end of our expectations could fully materialize,” Baydoun said. “In our view, the approximately 19 per cent YTD share price decline is fundamentally unjustified and represents a buying opportunity for investors.”

H2O Innovation has had its fair share of ebbs and flows on the TSX Venture Exchange over the last three months, resulting in a 7.5 per cent loss in that time, and an 11.7 per cent loss since the start of 2022. The stock was riding at a 52-week high of $2.89/share on March 22, but has experienced a fair bit of movement since then, culminating in a 52-week low of $2.05/share on March 7.