Desjardins Following Wednesday’s release of “mixed” fourth-quarter results, H2O Innovation Inc. is likely to continue to face a significant drag on profitability from weaker demand for maple farming equipment, according to Desjardins Securities analyst Frederic Tremblay.
However, he thinks Quebec City-based company’s water solutions business is “well-positioned to capture incremental opportunities” within a rapidly growing market.
“While maple’s 4Q difficulties were disappointing, management is taking actions to mitigate the headwind in FY24 and position its maple operations for a recovery,” he said. “Meanwhile, HEO’s core category — water —continues to fire on all cylinders. Its record backlog, persistent organic growth levers, margin improvement efforts and potential acquisitions bode well for the future. We believe HEO’s depressed valuation offers a buying opportunity.”
Before the bell on Wednesday, H2O reported total revenue of $65-million, up 24.8 per cent year-over-year and exceeding Mr. Poirier’s $56.7-million estimate. Adjusted EBITDA of $3.1-million fell short of his $4-million forecast and fell 34.2per cent year-over-year.
“4Q FY23 results had pluses (water) and minuses (maple),” he said. “On the positive front, demand is persistently strong across HEO’s broad portfolio of water and wastewater treatment products and services, as shown by the 4Q revenue beat, double-digit organic growth and a record backlog. The strength of water-related businesses (85–90 per cent of total revenue) in 4Q was partly offset by the impact of weak maple syrup production in Quebec (down 60 per cent year-over-year in 2023) on demand for HEO’s maple farming equipment.
“HEO posted a seventh consecutive quarter of double-digit organic growth (16.1 per cent) .... Revenue exceeded our expectations in all three segments, with WTS and Specialty Products posting the largest beats. The challenges in the maple business contributed to a 34.2-per-cent year-over-year decrease in adjusted EBITDA to $3.1-million vs our $4.0-million forecast (consensus $4.5-million). We believe the difference vs our forecast is largely explained by the maple headwind being slightly larger than we had thought (we had assumed a $1.5-million hit).”
While noting the company is taking actions to counter the softness in the maple industry, inccluding price adjustments and cost structure, Mr. Poirier sees “rising tide” for water solutions.
“Backlog of $250-million is a new record and HEO looks well-positioned to capture other opportunities within the buoyant water/wastewater market in both industrial (reshoring, water reuse adoption) and municipal (upcoming deployment of stimulus money),” he said. “Following the 4Q profitability miss, we believe investors will closely monitor efforts to improve consolidated margins. We were therefore pleased to hear that margins embedded in the WTS backlog are superior to historical levels. Other tailwinds include price increases on certain specialty products, CPI adjustments in O&M and the insourcing of some product manufacturing. In terms of cost inflation (eg wages, materials), management sees more stability on the horizon.”
Seeing its financial position “supportive” of growth initiatives, he trimmed his target for its shares to $3.50 from $3.65, maintaining a “buy” recommendation. The average on the Street is $3.67.