We have a Research Flash on Hammond Power Solutions Inc. (HPS.A - TSX).

Given the accelerating trends in Hammond’s growth markets, the Company’s pricing power, and its track record of growth through the last three quarters, we believe that the consensus for Q3 is understated. Last quarter, HPS posted a 25% beat on revenue and a 39% beat on EBITDA. Similarly, in Q1, revenue beat by 17% and EBITDA beat by 54%. In response, HPS.A traded up 25% and 22% to Q1 and Q2 results respectively. Q3 financials will be reported on October 27th after market close. We think there is 10-20% upside to consensus. Consensus is expecting:

• Revenue of $118.5M (+24% YoY, -14% QoQ). Q3 is not seasonally weak and has historically shown sequential growth

• Gross Margin of 26% compared to 27% in Q3 last year

• Adjusted EBITDA of $10.6M (9% margin) compared to $7.5M (8% margin) in Q3 last year and $12.9M (9% margin) last quarter

INVESTMENT THESIS

Gold Standard Product with Diversified Customer Base. HPS manufactures dry transformers which are an essential piece of equipment for transmitting and distributing electricity. Transformers change voltage levels, reduce energy loss in transmission and ensures safety. Hammond’s brand is the gold-standard for dry transformers and holds ~25% market share. This has given HPS pricing power, where it has passed inflationary pressures onto its customers, conducting six price increases since 2021, leading to margin expansion. HPS generates 61% of its revenue in the U.S., 34% in Canada, and 5% in India, with no customer representing more than 5% of sales.

Picks and Shovels of The Electrification Revolution. Hammond has various tailwinds supporting its accelerating growth including electric vehicle demand (charging stations), solar energy, energy storage, and infrastructure spending. Another factor supporting the accelerating growth is a long-term trend of dry-transformers taking market share from oil-transformers since they do not use fossil fuels, require less opex/maintenance, and are much safer. This is evident through the 58% revenue growth in H1/22 after a history of <10% growth, in addition to the backlog growing 124% in Q2.

Incentivized Management Team with Deep Industry Experience. CEO Bill Hammond has been with the Company since 1978 and held the CEO role since 2001. Mr. Hammond brings deep industry expertise and a track record of success, being the founder’s grandson. Mr. Hammond owns 10% of the Class A non-voting stock and 100% of the Class B voting stock.

VALUATION

Hammond currently trades at 3.8x 2022E EBITDA compared to large-cap electrical equipment manufacturers that trade at 12.5x EBITDA and Canadian industrials that trade at 7.2x EBITDA. We note that Hammond’s newfound revenue and EBITDA growth vastly outpace both groups. Over the last ten years, HPS has traded at 5.6x LTM EBITDA on average, with much lower growth metrics. The historical multiple of 5.6x would imply a target price of $25.00/share (51% upside); We think the business deserves an even higher multiple given that it is entering a growth cycle.