The fundamental driver for the business is the sheer scale of the market for equipment maintenance in the resources industry. Economic research firm BIS shrapnel has estimated that annual maintenance expenditure in Australia’s resources industry will swell to $10 billion over the next five years. This is a flow on effect for the massive increase in new resources projects that have come on stream in recent years.

Whilst there is a well-established market of equipment suppliers and authorised maintenance repairers, Babylon has found a niche as an independent who can compete on the basis of technical capability and service support. Moreover, the company is well positioned as an alternative supplier to balance out, and keep the major suppliers “honest”, as well as providing overload capacity.

Just to be in the business, as a small, niche player, it is critical that the company excels in its technical capabilities, customer support and delivery performance. Further, Babylon is required to have the workshop space and labour resources to handle the workloads and projected growth to consistently meet client needs. These factors get Babylon into the business and has enabled it to secure work from a number of key customers. In fact, it has largely outgrown its current workshop with a larger space expected to be secured  to support further growth.

The company is growing nicely and building some good commercial relationships but long term potential in WA may be constrained by the dominant position in engine maintenance of the authorised Caterpillar distributors. There are opportunities to broaden the range of engines serviced to included other manufacturers but we think that there is potential to achieve a quantum leap in growth. This could occur through an acquisition of a similar business or with the development of a prime relationship with one or more of its key clients encompassing multiple sites around the country. Such an event would probably require a large expansion of its Perth workshop and maybe the development of another in the eastern states. In the absence of such an event, it looks like the company will continue to achieve strong growth over the next few years as it continues to build its market presence.

Babylon’s financial structure reflects its nature as an industrial company. It’s gross margin in the December 2018 half year was just under 35%. Although there was a small EBITDA loss of $48K, depreciation and interest costs blew the pre-tax loss out to $1.2 million. The company has invested heavily in equipment for hire and lease and tools and other equipment to support the maintenance business. Accordingly, increasing scale and utilisation rates are they keys to achieving sustainable profitability.

This capex investment is also reflected in the balance sheet where plant and equipment represent about 61% of the $12.3 million in total assets. The other main assets are receivables and cash. On the other side of the equation, borrowings amounted to $7 million against an equity base of $3.1 million. Whilst the apparent debt to equity ratio is high, $4.5 million of the borrowings are convertible loans.

Babylon has been impressive in what it has achieved in a short space of time, especially securing Tier 1 resources companies as clients. Having now established a solid base it needs to move to the next level to break through to profitability. Expanded workshop facilities will be important in this regard. The March quarter 2019 cash flow report pointed to continuing strong growth so a breakthrough to profitability could be achieved during FY 2020.

Notwithstanding that most of the borrowings are convertible loans, the debt to equity ratio is still high and will remain so until cash flows turn positive. So, I think the company may need additional capital during FY 2020 to support growth.

The challenge is to build scale and an earnings base which will support a markedly higher valuation which will both broaden its appeal and provide greater growth and funding options.

With a market cap of $6 million, Babylon will be of interest to growth investors who are prepared to take a long term view.

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