Consolidated Water Co. Ltd. is a Cayman Islands-based water utility specializing in the production of drinking water through desalination and wastewater treatment.
The company targets regions with significant water scarcity, such as the Caribbean and the southwestern United States, which presents long-term growth opportunities.
FY23 was a record year for CWCO, achieving a 91.5% year-over-year increase in revenue and reaching all-time high margins and profitability, a trend that continued in Q1 FY24. With a solid balance sheet and strategic growth initiatives, CWCO appears well-positioned for future growth.
Business Segments
Consolidated Water’s operations are divided into four main business segments:
- Retail Segment: This segment produces drinking water through desalination and supplies it to residential, commercial, and government customers in the Cayman Islands. Despite stable revenue between FY18 and FY23, the EBIT margin has been negative, particularly post-COVID-19. However, Q1 FY24 showed signs of recovery with an EBIT margin of 11.24%. The primary risk is the renewal of the water sales license, which has been under negotiation since 2018.
- Bulk Segment: Also involved in desalination, this segment supplies water to government-owned distributors in the Cayman Islands and The Bahamas. It has maintained stable revenue and high operating margins above 20%, contributing significantly to CWCO’s EBIT. However, there are concerns regarding accounts receivable from the Water and Sewerage Corporation of The Bahamas (WSC), which has a significant portion of delinquent payments.
- Services Segment: This is the most dynamic segment, focusing on building and selling water production and treatment plants, as well as providing operations and maintenance (O&M) services. The segment saw a 239% increase in sales in FY23, driven by projects in Arizona and the Cayman Islands. Future growth is expected from a $204 million desalination plant project in Hawaii, scheduled for construction in Q3 FY25.
- Manufacturing Segment: This segment produces water-related products and systems for commercial, municipal, and industrial applications. It experienced volatility but showed improvement in FY23, contributing about 10% of total revenue with a 12.5% EBIT margin.
Growth Drivers
- Regulatory Support and Market Demand
The wastewater recycling and desalination markets are expected to grow significantly over the next decade. US federal and state legislation is increasingly focused on managing water supplies and promoting water conservation. California’s Direct Potable Reuse (DPR) regulation, for instance, sets criteria for wastewater treatment to maximize reusable water. Such initiatives present significant opportunities for companies like CWCO. The wastewater recycling market is projected to grow from $19 billion in 2023 to $31.9 billion by 2028, with an 11% CAGR.
- Water Scarcity and Desalination
Water scarcity in the western US necessitates the adoption of technologies like desalination. The US desalination market is projected to grow from $1.6 billion in 2022 to $2.6 billion by 2028, with an 8.3% CAGR. CWCO’s ongoing and planned projects in regions like Hawaii highlight the economic opportunities arising from these climate developments.
Financial Performance and Forecast
CWCO’s Q1 FY24 performance was robust, with a 20.8% year-over-year revenue increase to $39.7 million. The EBIT margin was 18.43%, slightly lower than FY23 but still reflecting strong profitability. Net income for Q1 FY24 was $6.5 million, maintaining a profit margin of 16.3%. Analysts predict a slowdown in revenue for FY24 but expect a return to growth in FY25, driven by the Hawaii project.
Balance Sheet and Cash Flow
As of March 2024, CWCO had a net debt of $-43.7 million, with $46.2 million in cash and equivalents against $2.5 million in debt. Significant net working capital of $95 million, primarily from trade receivables from WSC, is expected to be reduced following reassurances from the Bahamian government regarding payment timelines. This, along with expected cash inflows from projects in Arizona and the Cayman Islands, should further improve CWCO’s financial position.
Main Risks
- Retail Segment License Renewal: The risk of not renewing the water sales license in the Cayman Islands poses a significant challenge. If the license is renewed on less favorable terms or withdrawn, it could impact revenue and margins. However, the retail segment’s overall contribution to profitability is limited.
- Counterparty Risk: CWCO’s reliance on long-term contracts, particularly with WSC, presents a risk due to late payments. While WSC has never defaulted, late payments could cause short-term liquidity stress.
Valuation
A discounted cash flow (DCF) analysis estimates CWCO’s intrinsic value at $31.33 per share, approximately 12% above the current market price. This valuation incorporates a cost of equity of 8.04% and a WACC of 8.04%, with a long-term growth rate (g) of 2%.
Consolidated Water is well-positioned to continue its growth trajectory, driven by increasing demand for desalination and wastewater treatment, particularly in the southwestern US. With a strong balance sheet, robust cash flow, and strategic initiatives, CWCO presents a compelling investment opportunity.
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