Day: May 29, 2024

Consolidated Water Co. Ltd. (NASDAQ:CWCO) is a Cayman Islands-based water utility centered on the manufacturing of ingesting water via desalination and the remedy of wastewater. The corporate’s important goal markets are the Caribbean and the southwest US, areas identified for his or her water shortage and which could be vital long-term development drivers, as mentioned within the Veolia article.

FY23 was a really sturdy 12 months for CWCO, which achieved a 91.5% YoY improve in income and reached all-time excessive margins and profitability, a pattern confirmed by Q1 FY24 outcomes. The corporate additionally presents a stable steadiness sheet, with internet debt of $-43.7m as of March 2024, anticipated to lower in FY24 resulting from a decline in NWC, at present at $95m. Though administration’s technique is based totally on natural development, this money reserve can enhance new strategic acquisitions, such because the $4.2m

Ramey Environmental Compliance (REC) deal closed in November 2023, and assist a share buyback plan, as prompt by administration on the Q1 FY24 Convention name. CWCO’s enterprise mannequin has some essential points, primarily the danger of shedding its water gross sales license within the retail phase, whose renewal has been beneath negotiation since 2018. Regardless of these and different dangers mentioned within the article, I assign CWCO a purchase score, justified by its monetary energy and structural development tendencies in desalination and water remedy within the Caribbean and the southwest US.

Enterprise Overview

Consolidated Water’s operations are divided into 4 enterprise models:

(1) The Retail phase is engaged within the manufacturing of ingesting water, obtained from the desalination course of, and provided to residential, industrial, and authorities prospects within the Cayman Islands via a license granted instantly by the nation’s authorities. Income was secure between FY18 and FY23, accounting for 17% of complete income in FY23 (21.7% in Q1 FY24). Nonetheless, EBIT margin tended to be destructive, significantly after Covid-19, regardless of exhibiting indicators of restoration in Q1 FY24 with an EBIT margin of 11.24%, because of the return of tourism to 2019 ranges. Essentially the most vital threat dealing with this enterprise unit is the renewal of the license, which expired in 2018 and remains to be beneath negotiation. There’s a risk of much less favorable phrases or, within the excessive state of affairs, the license withdrawal.

(2) The Bulk phase can be concerned within the manufacturing of ingesting water via desalination. Nonetheless, on this case, it’s provided on to authorities owned distributors in each the Cayman Islands and The Bahamas. Income tendencies had been secure between FY18 and FY23, with a slight decline in FY20 and a return to development in subsequent years, pushed by the resurgence of tourism within the area. The phase has an working margin above 20%, making it the biggest contributor to CWCO’s EBIT, besides in FY23. The enterprise unit accounted for 19% of complete income in FY23 (21% in Q1 FY24). The first concern arises from the biggest buyer in The Bahamas, the Water and Sewerage Company of The Bahamas (WSC), which had accounts payable to CW-Bahamas totaling $26.9m, 80% of which had been delinquent as of December 2023. Regardless of this, WSC has by no means defaulted and plans to scale back its payables by the tip of FY24.

(3) Essentially the most attention-grabbing enterprise phase is Companies, the place, via subsidiaries PERC, Desalco, and REC, it builds and sells water manufacturing and water remedy vegetation, in addition to gives O&M and consulting providers for third-party corporations. Actions are centered on the southwestern area of the US, which has a rising demand for water. In FY23, gross sales grew by 239%, making it the highest phase when it comes to income, accounting for 54.3% of complete gross sales (44% in Q1 FY24), in addition to the primary part of EBIT. This development is attributable to the development of an $82m wastewater remedy plant in Arizona, scheduled for completion in Q2 FY24, and a $20m desalination plant within the Cayman Islands, of which $8m is attributable to FY23. On the O&M aspect, the acquisition of REC and new contracts obtained by PERC boosted the phase’s share of recurring income to $17.5m, up 36.9% in comparison with FY22. I additionally count on a stable efficiency from the enterprise unit in FY24 and FY25 because of the growth of a desalination plant in Hawaii, scheduled for building in Q3 FY25, value $204m, together with $150m associated to building and $54 million to O&M actions beneath a 24-year contract.

(4) The Manufacturing phase is engaged within the manufacturing of water-related merchandise and techniques relevant to industrial, municipal, and industrial water manufacturing, provide, and remedy. This enterprise unit is characterised by the best volatility when it comes to each income and working outcomes. In FY23, it contributed about 10% of complete income, attaining an EBIT margin of 12.5%, a transparent enchancment after destructive ends in FY21 and FY22. The phase carried out nicely in Q1 FY24, with a 57% YoY improve in income.

The proportion of gross sales generated within the US was 59% of complete income in FY23, up from 35% in FY22, pushed by the Companies phase, which primarily targets the southwest US as its important market.

Progress Drivers

The wastewater recycling and desalination markets are the first sectors the place Consolidated Water’s enterprise is concentrated and, in response to analysts’ estimates, will expertise appreciable development over the subsequent decade.

US federal and state laws is more and more centered on managing water provides, aiming to guard residents’ well being and preserve water assets. An instance is California, the place the State Water Board has applied

Direct Potable Reuse (DPR), a regulation that units particular standards for wastewater remedy to maximise the amount and high quality of reusable water. Though these initiatives are nonetheless of their early levels, they current vital alternatives for corporations like CWCO. Via its subsidiary PERC, CWCO is investing substantial monetary assets within the area. In keeping with Analysis and Markets evaluation, reported in CWCO’s April 2024 Investor presentation, the wastewater recycling market value $19B in 2023 and is projected to achieve $31.9B by 2028 with a 11% CAGR.

However, the water shortage skilled within the western US in recent times will necessitate the adoption of recent applied sciences equivalent to desalination, which is already extensively utilized in international locations like Saudi Arabia and the UAE. Analysis and Markets examine signifies vital development within the sector, estimated the US market dimension at $1.6B in 2022, projected to rise to $2.6B by 2028, with an anticipated 8.3% CAGR. As evidenced by the commissioning of a desalination plant in Hawaii, such local weather developments might current an financial alternative for CWCO.

Q1 2024 Snapshot & Forecast

After a powerful FY23, CWCO delivered strong financial efficiency in Q1 FY24, with income development throughout three of its 4 enterprise models. In Q1 FY24, the corporate achieved $39.7m in income, up 20.8% YoY. It ended the quarter with an EBIT margin of 18.43%, decrease in comparison with 20.63% in FY23, however with EBIT up 61.5% in comparison with Q1 FY23. Moreover, internet revenue of $6.5m, equal to a 16.3% revenue margin, is consistent with what reported in FY23. Analysts estimate a slowdown in income in FY24, however it’s anticipated to stay greater than historic efficiency. FY25 ought to witness a return to development, attributable to the development of the Hawaii plant. The identical pattern is predicted for EBIT margin and revenue margin, that are anticipated to remain at traditionally excessive ranges however decrease in comparison with FY23. These assumptions lead to a projected FY24(E) PE ratio of 23.1x, anticipated to say no to 19.7x in FY25(E), however nonetheless greater than the 14.7x recorded in FY23.

A powerful steadiness sheet boosts development

Consolidated Water had internet debt of $-43.7m as of March 2024, resulting from $46.2m in money and money equivalents, in comparison with simply $2.5m in debt and leases. Nonetheless, essentially the most notable growth considerations internet working capital of $95m, of which $26.9m is attributable to commerce receivables from SWC, 80% of which was delinquent as of December 2023. After a number of consultations with SWC and the Bahamian authorities, administration obtained reassurances on the timing of the cost. Reporting what CFO David Sasnett specified within the Q1 2024 Convention Name:

Throughout conferences with the Water and Sewage Company in March 2024 and with representatives of the Bahamas authorities in April 2024, we had been knowledgeable that the Bahamas authorities intends to scale back CW Bahamas accounts receivable to under $20m by June 30 after which to under $10m by the tip of this 12 months.

Such developments, together with $8m in anticipated contract property from the Arizona undertaking and $9m from the Cayman Islands undertaking, ought to lead to money inflows of round $30m in FY24, additional bettering the monetary place.

These outcomes have been achieved via a powerful OCF between FY18 and FY23, coupled with low CAPEX because of the firm’s natural development technique. Lately, CWCO executed solely small strategic acquisitions, equivalent to REC, bought for $4.1m, focusing on development in core sectors and geographic areas of curiosity, significantly the southwestern US. This enterprise mannequin has facilitated the speedy integration of acquisitions whereas creating new funding alternatives and buyer relationships.

Predominant Dangers

(1) For my part, the best threat dealing with CWCO pertains to the retail phase, which is regulated by a contract that expired in FY18 and has not but been renewed. Though negotiations are ongoing between administration and the Authorities of the Cayman Islands, it appears possible that the scenario will evolve in certainly one of two potential eventualities. Within the first state of affairs, the contract shall be renewed on much less favorable phrases than the present ones, a circumstance that might have a destructive however minor affect on the corporate’s margins and little impact on income. In distinction, the second state of affairs, involving the withdrawal of the concession, would lead to a 10-20% discount in complete income. Nonetheless, contemplating the phase’s low affect on CWCO’s total working outcomes, such an final result would have a restricted impact on profitability.

(2) Consolidated Water is affected by counterparty threat, as a lot of its income relies on long-term contracts, some extending past 10 years. Notably, there’s a focus of gross sales from WSC, which accounted for 17% of complete income in FY23. These concerns are significantly vital resulting from late funds by WSC. Though these late funds could not trigger insolvency points, they may result in short-term liquidity stress for CW-Bahamas.

About 40% of income is generated within the Cayman Islands and The Bahamas, each of that are characterised by a excessive threat of hurricanes.

Discounted Money Movement

I performed a DCF evaluation to evaluate CWCO’s intrinsic worth, returning a valuation of $31.33 per share, about 12% above the present market worth.

Beta = 0.52x was obtained from utility (water) unlevered beta offered by Aswath Damodaran.

MRP (6.87%) and Danger-Free fee (4.46%) had been obtained utilizing 2024 Fernandez’s information, weighted by the geographic breakdown of the corporate’s income. It resulted in a value of fairness of 8.04%.

WACC = 8.04% and g = 2%.

Conclusion

Consolidated Water is a small-cap firm with all of the credentials wanted to proceed the expansion trajectory initiated in FY22 and strengthened in FY23. This development is boosted by elevated demand for brand new desalination and wastewater remedy vegetation, in addition to entry into promising geographic markets such because the southwest US. Because of its technique, which is based totally on natural development and small acquisitions, the corporate displays regular and stable OCF technology and low CAPEX, together with a internet money place of about one-tenth of its market cap. In FY24, higher administration of internet working capital and a lower in commerce receivables from WSC, ought to permit a further $30m in money inflows. These funds may very well be used each to additional enhance enterprise development and to offer greater remuneration to shareholders, together with share buybacks. Contemplating what mentioned within the article and the outcomes of the DCF evaluation, I assign Consolidated Water a purchase score.