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H2O Innovations is a Buy, says iA Capital

Canadian cleantech company H2O Innovation (H2O Innovation Stock Quote, Charts, News, Analysts, Financials TSX:HEO) has stayed flat over the past 12 months, but iA Capital Markets analyst Naji Baydoun sees better times ahead for the stock. In an update to clients on Monday, Baydoun reiterated both his “Buy” recommendation and $3.60 target price, which at the time of publication represented a projected one-year return of 47.5 per cent.

Quebec City’s H2O Innovation announced on Monday a renewal and expansion of a contract with its largest Operation and Maintenance (O&M) contract with the City of Gulfport, Mississippi. The contract is worth $13.9 million a year for the water solutions company and includes a scope expansion for solid waste collection and fleet management along with annual CPI adjustments for a total four-year contract valued at $55.5 million with the option for extensions. 

“We are thrilled to continue our relationship with this very important client who has been working with us since 2011. The continued success of this project reflects the hard work and dedication of our employees who live our company values and strive every day to deliver award winning services to our customers,” said Frédéric Dugré, President and CEO of H2O Innovation, in a press release.

H2O Innovation has three business lines in Water Technologies and Services (WTS), Specialty Products (SP) and Operation & Maintenance (O&M), with the latter currently sporting a backlog of $131.0 million.

Fresh off graduating to the TSX senior board, HEO had hit a high of $3.60 per share back in January, 2021, but a pullback dropped the stock to the $2.50 mark where it has mostly stayed over since. Year-to-date, HEO is currently down about seven per cent.

On the announced contract win, Baydoun said it was expected and noted the CPI escalator, which will protect H2O from any inflation-related cost impacts. The analyst said the record backlog of $131.0 million is above expectations and will be reflected in his financial estimates ahead of the next quarterly update from the company.

“Importantly, we note that the City of Gulfport will have the option to extend the contract with several renewal options that could potentially lengthen the total contract term to 12 years (thereby providing additional runway for HEO’s O&M business),” Baydoun wrote. “The City of Gulfport has been a client of HEO since 2011, which we believe should provide confidence in the Company’s ability to retain the client over time.”

“We continue to expect HEO’s ongoing organic growth and recent acquisition initiatives to drive double-digit revenue and EBITDA growth with additional upside from accretive M&A activity. Overall, based on: (1) our sum-of-the-parts valuation, and (2) scenario-analysis underpinned by HEO’s F2023-24 targets, we continue to see the potential for the shares to deliver >20 per cent annualized total shareholder returns (TSR) to investors,” he said.

H2O last reported earnings in mid-February where its fiscal second quarter 2022 (ended December 31, 2021) featured year-over-year revenue growth of 20.1 per cent to $42.0 million and adjusted EBITDA of $3.8 million, up a hair from $3.6 million a year earlier.

In its quarterly commentary, management said that COVID-19 and its associated labour impacts, raw material cost increases and supply chain issues have all been a challenge for the company but that it remains on track to hit its three-year strategic plan of ten per cent year-over-year revenue growth and EBITDA margin above 11.0 per cent by fiscal 2024.

H2O’s revenue mix has been stable over the past year, with the fiscal Q2 showing WTS delivering $8.5 million for 20.4 per cent of revenue, SP delivering $13.8 million for 32.8 per cent of revenue and O&M hitting $19.7 million for 46.8 per cent of total revenue. WTS saw a 23 per cent year-over-year growth in revenue, while O&M had organic growth of 11.3 per cent.

For his part, Baydoun is currently calling for HEO to generate full fiscal 2022 revenue and adjusted EBITDA of $169.4 million and $16.3 million, respectively, followed by 2023 revenue and EBITDA of $186.6 million and $16.3 million, respectively, and 2024 revenue and EBITDA of $203.1 million and 21.4 million, respectively. On valuation, Baydoun has estimated HEO to be trading (as of March 9, 2022) at greater than 11.0x F2023E EV/EBITDA, which represented about a 2.0x discount to its larger, more liquid and more diversified publicly traded water-linked peers at about 13.0x FY2E EV/EBITDA.

“HEO offers investors (1) low double-digit organic revenue and Adj. EBITDA growth (~10 per cent+/year, CAGR F2021-26E); (2) mid-double-digit FCF/share growth (~12-15 per cent/year, CAGR F2022-26E); (3) potential upside from additional bolt-on acquisitions and strategic M&A; and (4) a discounted valuation relative to peers,” Baydoun wrote.

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