Description

The water infrastructure upcycle has a long tail and Consolidated Water (“CWCO”) is one of the few pure-play beneficiaries. We see the combination of a misunderstood business model (it’s an E&C + utility), consensus belief that earnings peaked in 2023, and lack of awareness of receivables (which makes the B/S stronger than it appears) as providing for a very attractive entry point. Based on a two-analyst consensus, CWCO appears fairly valued at 11x 2025 EBITDA. Our 2025/26 estimates are 40% higher than consensus, and coupled with $4/share of additional cash to be collected this year, the stock trades closer to 6.5x EBITDA. The CFO apparently agrees as he postponed his announced retirement by three years, we believe to see this renaissance play out.

With a market cap oscillating around $400M and limited sell-side coverage, Consolidated is the embodiment of an underfollowed small cap. A cursory look at the company’s results shows lumpy revenues over the last ten years, similar to other project-based engineering and construction (E&C) businesses. Success for these E&C companies is driven by a few large projects, so their stocks ebb and flow with the trajectory of contract awards. With its stock off 30% from recent highs, the market seems convinced CWCO is facing a protracted lull and that 2023 represented peak earnings.

Investment Thesis

We believe CWCO is on the cusp of booking several new projects that will drive a rebound in profits in FY25/26, negating the bear rhetoric that FY23 was the peak. With nearly 50% of the company’s profit generated from recurring sources, CWCO’s business is of higher quality versus the typical E&C business that is entirely project-based, and therefore deserving of a higher multiple. Finally, the company has overdue receivables that should convert imminently, driving net cash balances to nearly 30% of market cap. Our earnings estimates are 40% ahead of Street estimates. In summary, a positive earnings revision story coupled with accretive capital deployment can propel the stock towards our $40/share price target by mid-2025.

Brief Company Description

CWCO reports its results under four segments: Retail, Bulk, Services, and Manufacturing. These segments represented 17%, 19%, 54%, and 10% of FY23 revenues, and 26%, 17%, 50%, and 6% of FY23 gross profit, respectively. Retail comprises the company’s operation of three desalination plants on Grand Cayman, thus serving as the water utility for two of the three most populated areas on the island. In the Bulk segment, the company produces and supplies water to government-owned utilities in both the Cayman Islands and The Bahamas under long-term contracts that include inflationary adjustments. In Services, the company provides design, engineering, construction, and management services related to desalination, wastewater, and water reuse infrastructure. And lastly, under Manufacturing the company manufactures systems and products applicable to commercial, municipal, and industrial water production and treatment.

Water Infrastructure Upcycle Supportive of Record Earnings for FY25-FY26. Significant legislation passed over the last few years supports a robust outlook for water infrastructure spending. The Infrastructure and Jobs Act has $55B earmarked for water infrastructure, with matching requirements at the state level, and the Inflation Reduction Act has over $13B earmarked for water programs. The CHIPS Act, passed in 2022 to promote domestic semiconductor manufacturing capacity, should also provide a meaningful benefit given the significant water demands of large new manufacturing facilities. In California, recent regulatory changes aimed at making the state more drought-resilient pave the way for new investments in wastewater reuse; in fact, a water recycling plant operated by CWCO in Santa Monica could become one of the first facilities to implement direct potable reuse under these regulations.

While these are obviously large numbers, pinpointing the exact opportunity set for CWCO is a bit tricky.  Our channel checks on the company are quite supportive and we believe the company will win its fair share of a growing end market. On the most recent earnings call, management referenced three large opportunities they are currently bidding on. It is worth noting this management team has been rather conservative in the past when communicating potential contract wins so the mere mention of these opportunities should be taken as a positive.

CWCO breaks revenues down into four segments, with the Services segment representing the majority of the project-based work. Last June the company announced a $204M contract award for the design, construction, operation and maintenance of a seawater desalination plant in Oahu, HI. This will be the 24th seawater desal plant by the company, but its first in the U.S. While the operation/maintenance piece extends over a 20-year period (with 5-year extension opportunities), $150M is expected to be earned over the two-year construction period commencing in 2025. We expect the company will book $12M in planning and design work on this project in FY24, and another $44M next year (likely in 2H) as project construction begins.

Beyond Hawaii, the majority of our above consensus revenue and EBITDA estimates comes from assuming CWCO wins 2-3 more projects in the next twelve months. We assume these projects contribute $20mm to 2025 revenue and $60mm to 2026 revenue.

Recurring Business is Underappreciated and Continues to Grow. CWCO is valued like a lumpy E&C business, but 50% of profits are derived from the combination of the Retail and Bulk segments and the O&M business (included within the Services segment). In Retail and Bulk, CWCO essentially operates a water utility in the Cayman Islands and the Bahamas, with highly predictable revenues under long term agreements. In the O&M business, the company operates and maintains water treatment and desalination plants under multi-year contracts. All in, we estimate these businesses earn margins in excess of 20% with minimal capex requirements. E&Cs are currently trading around 8-12x 2025 EBITDA while water utilities are in the 12-15x range.

Reported Cash Balance Understates Balance Sheet Strength, Net Cash Should More than Double to $7/share. As of its most recent financial report, CWCO’s net cash balance was approximately $44M, nearly $3/share. Already impressive compared to the average small cap company, the picture gets even better in light of several other near-term cash sources. We estimate CWCO’s net cash position will soon exceed $100M, or $7/share, after accounting for the following:

First, the company recently announced it reached a settlement in the previously disclosed dispute between one of its subsidiaries and the Mexican government. The company has held on its books twenty hectares of land that was purchased for the construction of a planned desalination plant in Rosarito, a project first announced in 2016.  Following the Mexican government’s cancellation of this project in mid-2020, CWCO’s local business partner initiated a legal battle in an attempt to seek damages resulting from the cancellation. This effectively locked up a significant portion of the company’s capital, with any land sale pending the dispute’s resolution. As part of the settlement, the company closed the sale of this land on June 10th for approximately $36M (versus a cost basis of $24M). This represents a significant victory for the company and its shareholders, eliminating a major headache and distraction while also providing a significant liquidity boost.

Second, we estimate a $24mm benefit from working capital normalization, with roughly a $15M reduction in receivables due from the company’s primary Bahamas customer and $9M due from the Grand Cayman Water Authority related to its Red Gate plant.

Third, approximately $8mm that was held as retained billings on its Arizona Liberty project should be returned in the near-term.

With only minimal near-term capex needs and healthy operating cash flow from the Retail, Bulk, and O&M businesses, the company is in a great position to win new projects (given its greater bonding capacity), and continue pursuing its M&A strategy (the PERC acquisition being the epitome of success), all without impeding capital return.

Valuation:

In 12 months, we think CWCO could be worth $40/share (60% upside) driven by project award announcements, increasing 2025/26 estimates coupled with growing cash balances (and potential accretive M&A).

Valuation is a bit tricky given there is no great comp set.  If our estimates are in the ballpark, CWCO is trading at 6.5x 2025 EBITDA. Using an 11x multiple gets us to $40/share. Given the business mix (50% recurring) and our projections that 2026 will show healthy growth over 2025, a much higher multiple is possible. If you want to dream up a blue-sky scenario, ERII serves similar end markets with no recurring revenue and trades at 18x EBITDA.

Risks

• Cayman Islands license renegotiation: CWCO’s exclusive license to serve retail customers in the Cayman Islands expired in 2018, and it has continued to offer its services while renegotiating terms with government authorities. As Consolidated is the sole water utility in the region, we believe it will ultimately be successful in obtaining a new license, but the restructured terms may significantly reduce the income and cash flows they have historically earned from this license.
• Cash collection from Bahamas customer: CWCO has a large receivable balance due from its primary Bahamas customer, Water & Sewerage Corp. (“WSC”), the majority of which was delinquent as of March 31^st. WSC has delayed its payments in the past, but in all previous cases of delinquency, it eventually paid all amounts due, including interest, in full. Given Consolidated had not accrued an allowance for potential credit losses from this customer as of March 31^st, full collection of these receivables remains uncertain. We note that Moody’s latest long term foreign currency debt rating for the Commonwealth of the Bahamas was Ba1 with a stable outlook.

Catalyst

1. Project awards

2. Forward estimate revisions