H2O Innovation Inc (TSX: HEO) is a Canada-based company that provides 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 

• Stellar performance from O&M and Specialty Products segments: The company is generating almost 80% of its consolidated revenues from these two segments where the O&M segment contributed 46.8% in Q2 2022, while the Specialty products segment contributed 32.8% respectively. Organic growth of CAD 2.0 million, or 11.3%, and CAD 0.7 million from the purchase of JCO and EC effective December 15, 2021, boosted revenue from the O&M business pillar by CAD 2.1 million to CAD 19.6 million in Q2 2022, compared to the previous similar period. In comparison to pcp, revenues from the Specialty Products sector climbed by CAD 3.4 million to CAD 13.7 million in the same period, owing to the purchase of GMP.

Source: Company Filing

• Acquired two O&M companies based in New York state: The company recently announced two acquisitions in the Northeast US, bolstering its Operation & Maintenance business line. Both deals are projected to be immediately accretive to H2O Innovation's net profits and EBITDA from a financial standpoint. These purchases bring the Corporation one step closer to the EBITDA objective stated in the 3-year Strategic Plan on a Pro-forma basis.

Source: Company Presentation

• Improved Backlog: On December 31, 2021, the company's combined backlog of secured contracts between WTS and O&M was CAD 126.2 million, up from CAD 112.0 million on December 31, 2020. This combined backlog provides excellent visibility on revenues for the coming quarters of the fiscal year 2022 and beyond. Additionally, recently the company expanded four-year contract, valued at CAD 55.5 million, brings the Corporation’s O&M backlog to CAD 131.0 million.

• Expanding specialty chemical business: Recently, the company revealed that its specialty chemical business line is doubling the footprint at their Cheshire, UK facility to keep up with demand from the market. This UK facility doubled in size to 30,000 ft² with capacity to produce 1,000 tons/year of powder cleaners. The company is expecting an acceleration in powdered cleaner sales due to their lower water footprint which reduces freight costs and associated CO 2 emissions compared to equivalent liquid products.

Risks associated with investment 

The performance of the company might be impacted due to a change in technology, entry of new players with value-added products at a competitive price leading to price competition and margin erosion, etc.

Financial Overview of Q2 2022 (in thousands of CAD)

Source: Company Filing

• In Q2 2022, the company reported higher revenue at CAD 42.0 million against CAD 34.9 million in the previous corresponding period. The increase was driven by strong momentum across all the business pillars.

• In the reported period the company stated a higher operating profit at CAD 1.3 million against CAD 0.9 million in the previous corresponding period. However, it witnessed elevated SG&A expenses at CAD 7.5 million V/s CAD 5.8 million in pcp.

• The company’s net earnings stood at CAD 0.7million compared to CAD 0.2 million in pcp; this improvement was mainly due to higher operating profit and partially supported by lower income tax expense. 
  

Valuation Methodology (Illustrative): EV to Sales

Analysis by Kalkine Group 

Stock recommendation 

The company's robust Q2 2022 financial results demonstrated that it is implementing its 3-Year Strategic Plan, with topline growth of 20.1% and good net profitability, despite the COVID-19 pandemic's persisting negative effects, including labor costs, raw material price rises, and supply chain difficulties. The company is investing continuously in the business to increase sales, grow through disciplined acquisitions, and use digital tools to improve profitability, and it is on track to meet its FY2024 goals of 10.0% year-over-year organic revenue growth and an EBITDA margin of above 11.0%.

Moreover, the group is also witnessing healthy growth in its backlog, which provides excellent visibility on revenues for the coming quarters of the fiscal year 2022 and beyond. Therefore, based on the above rationale and valuation, we recommend a “Speculative Buy” rating at the last closing price of CAD 2.35 as on April 8, 2022. Moreover, 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 Price Chart (as on April 8, 2022). Source: REFINITIV, Analysis by Kalkine Group 

 Technical Analysis Summary

Disclaimer

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