H2O Innovation Inc. (TSX: HEO) is a Canada-based company. It is engaged in providing water treatment solutions based on membrane filtration technology for municipal, energy, and natural resources end-users. The company has three divisions that are water technologies & services(WTS), specialty products, and operation and maintenance services(O&M).

Key Highlights:

• Higher revenues: During Q3FY22, the company reported an increase in the total revenue to CAD 51.91 million as compared to the total revenue of CAD 39.15 million in Q3FY21. The WTS (water technologies & services) segment stated the sales of 11.89 million in Q3FY22 against CAD 10.09 million in Q3FY21, specialty products saw an uptick the revenue to CAD 15.90 million during the same period (Q3FY22) against CAD 11.81 million in pcp, and the O&M sales stood at CAD 24.11 million in Q3FY22 vs the sales of CAD 17.25 million in pcp.
  

• Increased consolidated backlog: The company saw an increase in the consolidated backlog to CAD 108.90 million in Q3FY22 as compared to the consolidated backlog of CAD 101.40 million in Q3FY21. The higher backlog depicts the rise in the projects in the pipeline and the probability of higher revenue to be reported in the coming quarters, giving strong support to the future estimates of the revenue figures. Recently the group got a contract renewed from City of Gulfport, Mississippi, valued at CAD 55.5 million, spreading over four years, which brings the O&M’s backlog to CAD 131.0 million on April 4, 2022.

Source: Company filings

• Higher adjusted EBITDA: During Q3FY22, the company reported an adjusted EBITDA of CAD 5.33 million, which is higher than the adjusted EBITDA of CAD 4.51 million in Q3FY21. The increase in the adjusted EBITDA was mainly driven by the higher amount of depreciation of property, plant, and equipment, increased amortization of intangible assets, and higher stock-based compensation during Q3FY22.

• Sequential improvement in the margins: During Q3FY22, the company reported strong revenue numbers which were slightly offset by the increase in the cost of goods sold, which helped the group to improve its profitability margins sequentially, which are presented below.

Source: Refinitiv, Analysis by Kalkine Group

Risks associated with investment

The company is vulnerable to price wars on account of rising competition which could erode its margins. Further, the group is facing other challenges such as constant changes in technology, rising costs, etc. 

Financial overview of Q3FY22 (Expressed in thousands of CAD)

Source: Company Filing 

• During Q3FY22, the company reported an increase in its total revenues to CAD 51.91 million as compared to CAD 39.15 million in Q3FY21. The higher sales from specialty products and the O&M segment in Q3FY22, helped the company to clock increased sales in the given period. Geographically, the USA region witnessed an increase of nearly 67.1% in sales during Q3FY22 against Q3FY21.

• The operating profits for Q3FY22 rose to CAD 1.92 million when compared to CAD 1.14 million in Q3FY21. The operating costs increased to CAD 12.20 million in the reported period (Q3FY22) against CAD 9.93 million in pcp, which resulted in a limited increase in operating profits in Q3FY22.

• For Q3FY22, the company reported a dip in the net earnings to CAD 1.33 million, against the net earnings of CAD 2.06 million in Q3FY21.
  

Valuation Methodology (Illustrative): EV to Sales based

Analysis by Kalkine Group

Stock Recommendation:

The group reported increased revenue of CAD 51.91 million in Q3FY22 against the revenue of CAD 39.15 million in Q3FY21, also the adjusted EBITDA rose to CAD 5.33 million in the same period (Q3FY22), when measured against the adjusted EBITDA of CAD 4.51 million in pcp. The HEO recently bagged the three new water and waste treatment projects, with a total value of CAD 7.9 million, which brings the WTS backlog to CAD 40.4 million as of May 25, 2022. On the valuation front, the stock is measured on the EV/ Sales based relative valuation multiple and the stock is currently trading at 1.0x as compared to the industry (utilities) median of 4.8x, suggesting the stock is still undervalued. We have considered Xebec Adsorption Inc., Enwave Corp., etc as the peer group for the comparison.         

Therefore, based on the above rationale, and valuation, we recommend a “Speculative Buy” rating on the stock of HEO at the last closing price of CAD 1.94 on June 07, 2022. Additionally, the markets are trading in a highly volatile zone currently due to certain macro-economic issues and geopolitical tensions prevailing. Therefore, it is prudent to follow a cautious approach while investing.

One-Year Technical Price Chart (as of June 7, 2022). Analysis by Kalkine Group

Note- The reference data has been partly sourced from REFINITV 

  Technical Analysis Summary

Disclaimer

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