Meet H2O Innovation, A Microcap Desalination Play Flying Under The Radar

• H2O Innovation Inc. HEOFF shares are down 13 percent year-to-date, and have declined steadily since June 26.
• Roth Capital Partners’ Gerry Sweeney maintained a Buy rating on the company, with a price target of C$2.
• The company reported a strong finish to FY15 and has record backlogs that set the tone for FY16, Sweeney said.

H2O reported its quarterly revenue at $11.7 mm, versus $7.9 mm in the previous year. Gross profit came in at $3.5 mm, representing 29.8 percent growth, versus the prior year’s figure of $2.1 mm, representing 26.8 percent growth.

Both the Projects group and Services contributed to the company’s revenues. “Revenue continues to be driven by overall backlog and demand for desalination for drinking water, water reuse and waste water treatment,” analyst Gerry Sweeney wrote.

Sweeney believes that H2O is well positioned to benefit from “an anticipated acceleration in spending on desalination projects.” Drought and general overuse have resulted in diminishing supplies of water.

This is boosting demand in the traditional water scarce regions of California, Texas and Florida as well as in many other regions including Washington, Oregon and the East Coast. There is demand not only from drinking water, but also from industrial and waste water applications.

“We continue to believe H2O is looking to buy additional services or equipment companies to leverage its growing distribution and enhance recurring revenue. It has also begun to slowly move in to the O&M arena to manage plants, which could also allow for increased sales of its own products,” Sweeney mentioned.

The company ended the year in June with $36.5 mm in backlog. By the end of August, this backlog had expanded to $44 mm. The analyst expects about 60 percent of the current backlog to be completed in F2016 “with additional revenue coming from shorter lead time projects.”

“Overall, the backlog provides visibility for the next 18 months of revenue. Couple the current backlog with recent bookings trends, increased sales presence and potential increase in overall membrane spending and the Project segment appears well positioned,” the Roth Capital Partners report stated.