H2O Innovation has a 70 per cent upside, says Desjardins

The tide keeps rising for H2O Innovation (H2O Innovation Stock Quote, Charts, News, Analysts, Financials TSX:HEO), according to Desjardins Capital Markets analyst Frederic Tremblay, who provided a report to clients on Tuesday where he reiterated a “Buy” rating on the stock. Tremblay said H2O is trading at an attractive valuation and at a discount to its peer group.

Québéc City-based H2O Innovation, a water solutions company with water technology and services offerings along with specialty products and operation & maintenance contracts, had its AGM on Tuesday and provided an update on its ongoing three-year strategic plan, one which calls for both topline growth and gradual EBITDA margin expansion. 

H2O is now setting its fiscal 2023 (year end June 30) revenue target at $220-$250 million, compared to the previous guidance at $185-$250 million, with an adjusted EBITDA margin goal of ten per cent (previously 11 per cent). For fiscal 2024, H2O is called for revenue of $225-$300 million (previously $220-$300 million) with an EBITDA margin of greater than 10.5 per cent (previously 11 per cent), while for 2025, the call is for revenue of $280-$350 million and adjusted EBITDA margin above 11 per cent.

Commenting on the update, Tremblay wrote, “We view the update as a strong signal of management’s confidence in HEO’s ability to capture attractive organic and acquisitive opportunities over the plan’s three-year horizon. While the margin goals were lowered due to business mix and challenges (supply chain, inflation), they still imply healthy profitability levels.”

Tremblay hightlighted other comments from the AGM, noting management’s near-term focus on harvesting organic opportunities while working on optimizing the cash conversion cycle, which would help bring its net debt to EBITDA to 2x or less from a current 2.5x. That would put the company in a better position for future M&A, Tremblay said. 

The analyst also noted H2O’s announcement that it has qualifies for its first Blue Loan with National Bank of Canada. The augmentation of its existing revolving credit facility was increased to $65 million from $55 million, now with a lower interest rate.

Currently sporting a year-to-date loss of about 21 per cent, H2O is trading at about 9x fiscal 2024 EV/EBITDA, according to Tremblay, who said that’s at the lower end of the stock’s historical range of 9-15x and at a discount to its peer average at about 12.5x.

With his “Buy” rating, Tremblay has reiterated a 12-month target price of $3.50 per share, which at press time represented a projected return of 70 per cent.

“We estimate that HEO could be a $4+ stock if execution of the three-year plan is solid and if it closes the valuation gap with peers,” Tremblay wrote.