H2O Innovations has a 75 per cent upside, says iA Capital

Water industry trends are laying out a long runway of growth for Canadian cleantech company H2O Innovation (H2O Innovation Stock Quote, Charts, News, Analysts, Financials TSX:HEO), according to iA Capital Markets analyst Naji Baydoun, who delivered a report to clients on the company on Wednesday. Baydoun reiterated a “Strong Buy” rating on the stock, saying HEO is trading at a discount to its peer group.

H2O Innovation, which has business in water solutions, specialty products and water treatment operation & maintenance, had its AGM on Tuesday where it provided an update on its ongoing three-year strategic plan. 

Management said strong organic growth visibility up ahead were cause for a narrowing upwards of its guidance for the fiscal 2023 (ended June 30) year. H2O is expecting full-year revenue of between $220 and $250 million compared to its previous guidance of between $185 and $250 million, with an adjusted EBITDA margin projection of ten per cent (previously 11 per cent). 

Thematically, management cited population growth and water scarcity as factors likely to push up demand for water over time, while ageing infrastructure and regulatory changes should help drive investment in the sector. The company also aims to capitalize on the growing global demand for water reuse and desalinization.

“We still have ten main objectives, including two that were recently updated and three that were newly added. These new objectives will focus on organic growth opportunities and initiatives that will allow H2O Innovation to improve its adjusted EBITDA margins, optimize the cash conversion cycle and strategically address challenges associated with workforce recruitment and retention,” said President and CEO Frédéric Dugré in a press release.

Commenting on the AGM and strategic update, Baydoun noted management’s desire to deleverage its balance sheet in the current fiscal year, aiming to reduce net debt/EBITDA closer to about 2.0x from about 2.6x at the end of the first quarter 2023. 

“By utilizing FCF to invest in organic growth and pay down debt in F2023, the Company aims to position itself to execute on self- funded M&A next year and beyond (excluded from estimates/valuation),” Baydoun wrote.

“HEO offers investors: (1) double-digit organic revenue and Adj. EBITDA growth (>10 per cent/year, CAGR F2022-27E), (2) mid-double-digit FCF/share growth (~12-15 per cent/year, CAGR F2022-27E), (3) potential upside from additional bolt-on acquisitions and strategic M&A, and (4) a discounted valuation relative to peers,” he said.

Baydoun thinks H2O will generate full fiscal 2023 revenue and adjusted EBITDA of $219.7 million and $22.0 million, respectively, and 2024 revenue and adjusted EBITDA of $241.4 million and $25.3 million, respectively. With his “Strong Buy” rating, Baydoun maintained a 12-month target of $3.60 per share, which at press time represented a projected return of 74.8 per cent.