Evoqua Water Technologies: Avoid The Drop (NYSE:AQUA)

Late in 2021, I observed that water is tightly priced in the case of Evoqua Water Technologies Corp. (NYSE:AQUA). In that article I believed that the company has seen struggles amidst a demanding valuation from the start, with investors having embraced the water theme in recent years.

However, the overall valuation was far too demanding for me to get involved, as high multiples created a tough backdrop amidst rising interest rates in 2022.

A Recap

Evoqua went public at $18 per share in 2017, ending the first day of trading in the low-twenties. The company is a large provider of critical water treatment solutions, covering over 200,000 installations and many contracts. On the back of a strong IP portfolio, with thousands of granted or pending patents, purification levels can be achieved at higher levels.

Back in 2017, the 113 million shares valued equity of the business at $2.4 billion, for a $3.1 billion enterprise valuation after factoring in net debt. This was applied to a business which generated $1.1 billion in sales in 2016 on which a $5 million (GAAP) operating loss was reported.

Revenues were up 9% in the first nine months of the year 2017 (when the business went public), as sales were set to come in around $1.25 billion in 2017. With EBITDA north of $206 million, leverage ratios came in around 3 times, as realistic earnings multiples came in around 40 times earnings. What followed were a few years of modest growth and occasional repositioning of the portfolio.

I picked up coverage again in 2021 as shares rallied from $27 to $47 per share during the year. That momentum seen last year felt a bit misplaced, with 2021 sales up just 2% to $1.46 billion, with EBITDA up 5% to $251 million. With earnings only seen at $0.42 per share, that was even below the pro forma earnings seen at the time of the public offering nearly five years before.

With a $6 billion enterprise valuation late last year, a 4 times sales multiple, and 25 times EBITA multiples looked high already, yet it was the earnings multiples which were pretty much non-existing amidst a heavy “D&A” component, leaving me cautious as we entered 2022.

2022 – Solid Performance, Not The Shares

After shares traded at $47 per share last year, shares have fallen to $35, mostly the result of the valuation multiple compression on the back of higher interest rates. In the meantime, the business has seen solid growth as first quarter sales rose 14% to $366 million.

GAAP earnings were flat at $0.05 per share, with adjusted earnings reported at $0.12 per share, but this excludes a quite substantial adjustment related to stock-based compensation expenses. The company hiked the full year guidance, now seeing sales between $1.62 and $1.70 billion and EBITDA between $280 and $300 million.

Second quarter sales rose 23%, roughly half the result of organic growth, with GAAP earnings posted at $0.06 per share, as the company hiked the guidance in minimal fashion. In the meantime, the company announced a couple of bolt-on deals, with no financial details being announced, although the cash flow statement revealed some $200 million spent on deals in the first three quarters of the year.

These transactions supported resilient third quarter growth, with sales up 19% to $439 million, as half of the growth was driven by organic growth. In the seasonally strong quarter, the company posted GAAP earnings of $0.14 per share, three cents ahead of last year.

Even if earnings are still stuck below $0.50 per share, for the 5th year in a row since its IPO, valuations remain incredibly high.

And Now?

While Evoqua’s move lower so far this year has increased relative appeal here, the reality is that earnings multiples remain very much elevated, too elevated to get onboard.

I must say that I am impressed with the acceleration of organic growth, driven by secular trends like greater attention for the environment, scarcity of water, and need to recycle and get access to clean water. While some advocate that EBITDA multiples are quite reasonable, the D&A component is high here, and at some point it all works down to the EBIT as capital spending is needed to update these assets.

Hence, Evoqua remains an easy name or me to avoid, even as the long term growth opportunity is certainly here and margins have improved, albeit in minimal fashion.