H2O Innovation is a Buy, says Desjardins

Desjardins analyst Frederic Tremblay is going with the flow with H2O Innovation (H2O Innovation Stock Quote, Chart, News, Analysts, Financials TSXV:HEO), maintaining a “Buy” rating and $3.50/share target price for a one-year return of 77.7 per cent in an update to clients on Monday.

Quebec City-based H2O Innovation designs and provides integrated water treatment solutions based on membrane filtration technology for municipal, industrial, energy and natural resources end-users, with operations in the Water Technologies and Services, Specialty Products and Operation and Maintenance Services segments.

Tremblay’s newest analysis serves as a preview to H2O Innovation’s upcoming third quarter financial results for the 2022 fiscal year, which Tremblay expects to be positive upon their release on Thursday.

“We believe that HEO’s growth continued to accelerate in 3Q, thanks to strong market demand and ongoing company-specific initiatives to increase volume and pricing,” Tremblay said.

Tremblay forecasts improvements in all three revenue streams, leading to a raised projection from $44.9 million to $47.7 million, which would represent a 13.7 per cent sequential increase and year-over-year growth of 21.9 per cent.

Meanwhile, Tremblay also slightly raised his adjusted EBITDA projection for the quarter from $4.4 million to $4.7 million, with the accompanying margin forecast rising from 9.8 per cent to 9.9 per cent.

The Operation and Maintenance segment is now projected to account for 50.3 per cent of Tremblay’s revenue mix at $24 million (previously $23.3 million for 51.8 per cent of the revenue mix), with the Specialty Products stream now coming in at $14.3 million for 30 per cent of the mix (previously $12.8 million and 28.5 per cent of the mix), and Water Technologies and Services accounting for the remaining $9.5 million (previously $8.8 million).

Looking ahead to Thursday’s call, Tremblay noted an expected update on the company’s Specialty Products, particularly upgrades at the specialty chemicals plants in the United Kingdom and California, new sales hires, new distribution agreements, cross-selling with other segments and product development.

In addition, he said he’ll be paying close attention to the evolution and composition of the backlog and the progress achieved on ongoing projects, as well as monitoring the company’s potential for M&A activity.

The company has been busy since the March 31 quarter end, having secured a four-year, $55.5 million contract renewal with its largest operation and maintenance client, the City of Gulfport in Mississippi, which also includes a scope expansion for solid waste collection and fleet management, along with annual consumer price index (CPI) adjustments. The agreement, which also comes with four two-year renewal options for Gulfport to exercise, brings the company’s total O&M backlog to approximately $131 million.

More recently, the company announced it had signed a binding letter of intent to acquire Leader Evaporator, which has been selling maple farming equipment and products for more than 130 years to maple syrup producers located mainly in the United States.

“This transaction is a perfect fit for H2O Innovation’s maple business line as we already foresee multiple  synergies,” said  Frédéric Dugré, President and Chief Executive Officer of H2O Innovation in an April 12 press release. “We envision partnering with Leader’s customers to continue building a business of significant value, one that honors the legacy of Leader, and thus, becoming one of the most important players in the maple industry.”

With the revised third quarter estimates in place, Tremblay accordingly raised his overall 2022 revenue projection from $169 million to $172 million thanks to an improved fourth quarter projection of $41.1 million, with the end result being an implied potential year-over-year increase of 19.4 per cent. Looking ahead to 2023, Tremblay again raised his revenue expectation from $189 million to $192 million, implying a potential year-over-year increase of 11.6 per cent.

On the margins, Tremblay raised his adjusted EBITDA projection from $16.8 million to $17.2 million for 2022 for an even 10 per cent margin implication. For 2023, Tremblay also shifted his adjusted EBITDA projection upward from $21 million to $21.3 million, implying a margin of 11.1 per cent.

From a valuation perspective, Tremblay forecasts the company’s EV/adjusted EBITDA multiple to dip from the reported 13.9x in 2021 to a projected 11.8x in 2022, then to a projected 9.5x in 2023.

Overall, Tremblay is forecasting a strong growth outlook for H2O, which he believes will be reinforced by the incoming quarterly results after underperforming to start 2022.

“Our view that strong demand for water and wastewater solutions should persist was reinforced by the recent updates provided by AQUA and XYL,” Tremblay said, particularly pointing out XYL management raising revenue guidance and maintaining its previous adjusted EBITDA margin guidance. “Hence, we will look for an update from HEO’s management on the outlook for water-related investment (eg US infrastructure, global desalination, water reuse opportunities), pricing environment and growth initiatives across the company’s three complementary business segments.”

Despite an early 2022 high of $2.77/share on January 7, H2O Innovation has taken a 24.5 per cent loss on its stock price for 2022, closing Friday at a 2022 low of $1.97/share.