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.

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.

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.