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H2O Innovation is a Buy, says Desjardins

Looking for a bankable name with plenty of macro-level tailwinds? Desjardins Capital Markets analyst Frederic Tremblay makes the case for Canadian cleantech company H2O Innovation (H2O Innovation Stock Quote, Charts, News, Analysts, Financials TSX:HEO) in a Thursday update to clients.

Tremblay’s report previews H2O’s upcoming quarter, with the analyst saying increasing global concerns about water security as well as an urgent need for water infrastructure upgrades across the United States support a very positive thesis on the company and stock. Tremblay reiterated a “Buy” rating on HEO and 12-month target of $3.50 per share, which at press time represented a projected return of 81.3 per cent.

Headquartered in Quebec City, H2O Innovations offers water treatment solutions including filtration, specialty products and operation and maintenance services. Due to report its fourth quarter fiscal 2022 on September 28, the company posted record revenues of $51.9 million in its fiscal Q3, good for a 33 per cent year-over-year increase. Growth has been both organic in nature as well as through M&A and the company has been picking up contract wins in the United States, which represents about 70 per cent of its business.

Tremblay said investors will want to own companies like H2O for their role in supporting critical infrastructure. 

“HEO is at the right place at the right time. Its wide array of proven water treatment systems, parts, chemicals and O&M services can help solve water-related challenges. Continued R&D and M&A (leverage is 1.5x EBITDA) also have the potential to further enhance the company’s positioning,” Tremblay said.

“Looking ahead, we believe that governments and investors should focus on companies capable of reducing global risks associated with water scarcity. In our opinion, HEO is one of those companies, based on its emphasis on the production of drinking water and industrial process water, the reclamation and reuse of water, the desalination of seawater and the treatment of wastewater,” he wrote.

“Well-supported by a record backlog of more than C$150m and persistently strong activity levels across its three segments (O&M services, Specialty Products, WTS), we expect HEO to capture incremental opportunities associated with sector tailwinds, past and future M&A (leverage is 1.5x EBITDA), product innovation, and an expanding team of salespeople and distributors,” Tremblay wrote.

For the upcoming fiscal Q4, the analyst is expecting a topline of $47.6 million, while the consensus call is $46.2 million, with Tremblay’s estimate representing a 35.3 per cent year-over-year increase. On earnings, he is expecting adjusted EBITDA of $4.4 million, with the Street forecasting $4.3 million. By segment, Tremblay is calling for $10.3 million in revenue from Water Technologies & Services, $13.3 million from Specialty Products and $24.0 million from O&M.

Tremblay pointed to the recent water crisis in Jackson, Mississippi, where residents were left without safe drinking water after the city’s main water treatment plant failed. The US Environmental Protection Agency is currently investigating. 

Tremblay said the Jackson water crisis appears as an example of some of the serious consequences coming from underinvestment in water infrastructure in the US and beyond. 

“It is worth noting that the US’s drinking water and wastewater infrastructure received deplorable grades of C- and D+, respectively, in a 2021 report prepared by the American Society of Civil Engineers (ASCE). We note that the Inflation Reduction Act includes US$4 billion of drought resilience funding and US$550 billion for domestic water programs,” he said.

Looking further afield, Tremblay said his growth model for HEO is based on the expectations related to new customer and contract wins, scope expansion with existing customers, pricing increases and acquisitions across its Operations and Maintenance segment, while its Specialty Products and Water Technologies and Services revenues are expected to benefit from strong demand and price increases.

By the numbers, Tremblay thinks HEO will end fiscal 2022 with revenue and EBITDA of  $180 million and $17.5 million, respectively. For 2023 the call is for $208 million in revenue and $22.1 million in EBITDA and for 2024 he is forecasting $220 million and $24.8 million, respectively.

H2O’s share price rose from $1.00 at the start of 2020 to upwards of $3.00 by early 2021 but the stock has pulled back over the past year and a half and is currently trading around the $2.00 mark.

On valuation, Tremblay said H2O is trading currently at 9x his 2023 EV/EBITDA estimate — which is essentially its trough multiple over the past two years, where the range has been 9x-15x — and the analyst said this is despite positive developments and a strong outlook. Tremblay’s $3.50 target is based on a 14x EBITDA multiple of his fiscal 2023 estimates.

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About The Author /

Jayson is a writer, researcher and educator with a PhD in political philosophy from the University of Ottawa. His interests range from bioethics and innovations in the health sciences to governance, social justice and the history of ideas.
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