From DesjardinsH2O Innovation Inc. Frederic Tremblay, CFA • (514) 841-0283 • frederic.a.tremblay@desjardins.com Louis Jutras, CFA, Associate • (514) 985-3563 • louis.a.jutras@desjardins.com
Rating: Buy, Risk: Average, Target: C$3.50 HEO C$2.09, TSX First take on 1Q FY23 results—solid results and positive outlook
The Desjardins Takeaway: Slightly positive HEO reported results which were slightly ahead of expectations. We were pleased with organic growth of 25.0%, representing the fourth consecutive quarter of double-digit organic growth. Looking ahead, as discussed in our recent sector update, HEO looks well-positioned to meaningfully grow revenue and profitability. A conference call is scheduled for today at 10am EST (dial-in 888-396-8049).
Revenue exceeds expectations thanks to 25% organic growth and M&A. Revenue increased 46.3% yoy to C$56.1m, ahead of our forecast of C$52.0m and consensus of C$51.3m. The Specialty Products segment drove the beat vs our forecast. Organic growth of 25.0% reflects high demand for specialty products, new and expanded O&M contracts, and new capital equipment projects generating additional services and aftermarket sales. The C$7.8m contribution from acquisitions was above our forecast of C$6.2m.
Adjusted EBITDA was C$5.0m vs our forecast of C$4.6m (consensus C$4.8m). Adjusted EBITDA margin declined to 8.8% from last year’s 10.5%, mainly due to inflation (eg labour, raw materials) and a less favourable revenue mix. That said, margin was relatively resilient sequentially (vs 4Q’s 9.1%) and management is implementing mitigation measures such as price increases.
Financial position. We calculate net debt to adjusted EBITDA of 2.5x, up from 2.2x in 4Q due to seasonality trends in cash flow generation and increased working capital requirements to support growth. We view the current leverage as manageable, and we expect it to gradually move lower during FY23 when cash generation from investments made in recent quarters (eg capex, working capital, M&A) starts ramping up. Increased profitability should also contribute to leverage reduction efforts.
Positive outlook supported by record backlog, strong demand and internal efforts. Backlog rose to a new record of C$182.0m (C$163.0m in 4Q FY22, C$122.8m in 1Q FY22) as HEO continues to accumulate new wins and renewals in the O&M segment and new water treatment projects in the WTS segment. Management envisions a continuation of strong organic revenue growth and sees opportunities for margin expansion coming from price adjustments (to offset gross margin pressure from inflation on materials and wages) and business mix. We continue to appreciate HEO’s broad portfolio of highly complementary products and services (O&M services, specialty chemicals, consumables, equipment) that generate significant recurring revenue (>85% of total revenue as per management’s estimates). This, along with strong secular sector tailwinds (eg water scarcity challenges, aging infrastructure, drought, ESG focus) make HEO an attractive play amid global economic uncertainty, in our view.
NOVEMBER 10, 2022 1 This report was prepared by an analyst(s) employed by Desjardins Capital Markets and who is (are) not registered as a research analyst(s) under FINRA rules. Please see disclosure section on pages 2–4 for company-specific disclosures, analyst certification and legal disclaimers