28 May 2019
Reach Markets publish the notes from our analyst meetings with company management. They should be read in conjunction with the research we’ve completed. Reach Markets endeavour to provide self-directed investors a seat at our investment meetings. We publish these notes in a conversational format to get these out as quickly as possible for your consumption.
De.mem listed on the ASX in April 2017 having been established in Singapore in 2016. Over the past two years the company has grown strongly off a low base in the very large global water treatment market. With operations in Australia, Asia and planned expansion into Europe, the company is positioned to build global scale and achieve sustained high rates of growth over the next few years. I recently spoke with CEO, Andreas Kroell.
De.mem designs, manufactures and installs small to medium sized, decentralised water treatment systems. The systems use membrane filters based on technology initially developed and licenced from Singapore’s, Nanyang Technological University, which is ranked number 2 in the world in membrane research. These advanced membrane filters are low pressure and therefore provide significant operating cost advantages for users.
Decentralised water systems are used in small communities, mining camps and industrial facilities to manage and treat potable water, waste water and sewerage. Projects range in size from $100K to $5 million although the company’s sweet spot is between $1 million and $3 million.
A domestic filtration system has also been developed and will be launched during 2019 in Asia where urban water quality remains a major issue. Sales will be handled by local distributors and although unit values will be relatively low, the business has the potential to be a meaningful contributor to revenue and profitability without the lumpiness of project-based revenues.
Revenues are largely project based with about one third is recurring from Build, Own, Operate (“BOO”) or Operations & Maintenance (“O&M”) contracts, as well as the sale of consumables and replacement filters.
The company has operating offices throughout Australia, Singapore and Vietnam and manufacturing facilities in Singapore and Brisbane where all major system components, including filters, are produced. A planned acquisition of a complimentary business in Germany will extend the company’s operations to Europe.
Business case and market positioning
The global water treatment industry is massive and dominated by large engineering and water service companies who specialise in major infrastructure projects usually owned or sponsored by governments and municipal authorities. These projects are typically very large and take considerable time to deploy. However, the sub-market for smaller, decentralised systems is also large and growing rapidly. These projects are typically small-scale systems that can be installed and brought into operation relatively quickly. This sub-market is expected to generate turnover of about US$22 billion in 2021 having achieved compound annual growth in excess of 10% over the preceding 5 years.
The decentralised market is also highly fragmented with many regional operators designing systems based on standard off the shelf components. Water treatment is essentially an engineering solution so barriers to entry, at the small end, are not great but then there is also little differentiation between providers. De.mem, in contrast, does have product differentiation and competitive advantage with its proprietary range of membrane based products in an otherwise commoditised market.
Business drivers and growth opportunities
De.mem’s growth profile is based on securing project-based opportunities primarily in Australia and Asia, in combination with growing the more stable and recurring BOO and O&M business. This will be aided by an expanding product portfolio built on variants of its membrane filter technologies. The newly released domestic filtration system will also provide an alternate growth path with the potential to deliver volume rather than project-based sales. Acquisitions also look to be part of the profile where they can add geographic diversification and are complementary to De.mem’s capabilities and product profiles. The proposed acquisition in Germany is such a case. The unidentified business has an established operating history and is profitable with annual revenues of about A$2 million.
De.mem’s CY 2018 revenue is 262% higher than the previous year based on the company’s recently announced $10.5 million in revenue. This includes growth by acquisition, while the organic growth on a pro-forma basis is estimated at a solid 60-70% year-on-year. The proposed acquisition will boost revenue by around 15% in in the current year (ended 31 December), depending on timing, suggesting that the company will achieve revenue in excess of $15 million revenue in CY 2019. Medium term organic growth in excess of 10% pa seems to be achievable.
Revenues are growing rapidly off a low base. Whilst the company is generating losses, operating margins are increasing, the losses are narrowing and the cash burn is falling. Assuming the company can achieve about $15 million revenue in the current year, we think it will get close to or pass through the breakeven point during the latter part of CY 2019. With the benefit of the proposed German acquisition, and strong revenue growth, we think that a maiden full year profit will be achieved in CY 2020.
The company’s balance sheet indicates that the business is working capital, rather than fixed capital intensive. The balance sheet comprises mostly receivables, payables and cash balances. Cash balances at 30 June 2018 amounted to $2.1 million which was partially offset by borrowings of about $0.5 million. In January 2019, the company completed a rights issues to raise about $2 million. Some of the funds will be used to compete the proposed German acquisition with the balance boosting working capital.
My take on the company
Water treatment has long been an industry to generate considerable investor interest. Massive industry size, global opportunities, the emergence of decentralised systems and the linkage with rising living standards makes for an attractive investment proposition.
De.mem is certainly on the way to building scale and on its current trajectory suggests that a revenue base of $25 million to $50 million within a few years is readily achievable. A good product portfolio underpinned by advanced technology is the key driver. Importantly, the company appears to have sufficient funding to get to profitability.
The medium term challenge to accelerate growth and scale up towards $100 million or more annual revenue. As projects are working capital intensive and sales and marketing resources may need to be expanded, additional capital may be required in the medium term. Acquisitions would certainly provide a quantum leap and could very well feature in the growth strategy. The proposed German acquisition looks to be a good move in this regard.
The breakthrough to profit will be an important milestone along its growth path. Certainly a stock to watch.
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This document is provided by Gordon Capital Pty Ltd (Gordon Capital) and InterPrac Financial Planning Pty Ltd (InterPrac). The material in this document may contain general advice or recommendations which, while believed to be accurate at the time of publication, are not appropriate for all persons or accounts.
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