Summer Series: Fluence Corporation (ASX: FLC)

Bryce: [00:00:44] So it is time to get the information that you need to get ahead in your career. With The Financial Times, visit F.T. Dotcom forward slash new agenda to read carefully selected free articles and save 33 percent on an annual digital subscription. Equity Mates, I will say this about everything you do, but what I learnt in 20. At. Welcome to another episode of Equity Mates, a podcast where we help you learn to invest in 45 minutes or less. We break down the world of investing from beginning to dividend so that you can hopefully make some returns. My name is Bryce and as always, I'm joined by my equity buddy Ren. How's it going, bro? [00:01:31][46.8]

Alec: [00:01:31] I'm good, Bryce. How are [00:01:32][0.8]

Bryce: [00:01:32] you? I'm good. I'm good. Pumped to be again doing another shallow dive into a company that has been suggested by one of our community members for our summer series. As we take a bit of a break over the Christmas New Year period, we are looking at 10 companies and doing a bit of shallow dive, trying to understand what they're all about and have a bit of a crack at the valuation, just primarily to show people how we go about our business and I guess show that it's not as easy and or difficult. So today, Ren, our company that we are going to be deep diving into is called Fluence Fluence Corp. The ASX ticker is FLC. They are currently trading at 45 cents. [00:02:15][42.9]

Alec: [00:02:16] But before we go any further, yes, you're going to spruik shirts and Get Started Investing feed. [00:02:21][5.4]

Bryce: [00:02:22] Thank you for the housecleaning. Yes. Before I do go any further, thank you for the reminder. If you haven't yet bought any of our merchandise, we have Oggi T-shirts available, men's and women's sizes, only a few left giving you the opportunity. Now, before we change the design and do a bit of a reference. [00:02:37][15.8]

Alec: [00:02:38] Price hasn't taken this off since you got it. And it is looking absolutely. [00:02:41][3.5]

Bryce: [00:02:42] So if anyone wants to buy that, by all means, they can go to Equity Mates dot com forward slash shop to to purchase. It would be a great New Year's gift for anyone. Also Get Started Investing feed our latest podcast, 12 part series on all the fundamentals that you need to get started on your investing journey. If you've just joined the Equity Mates show, welcome. Thank you for joining. You will be surrounded by an awesome community of of investors. And if you would like some of your mates to join you, then please get them stuck into Get Started Investing feed, which will be in your podcast feeds. Now, simply search it and it should come up. So get up, get on board and looking forward to having you on the journey. Now back to Fluence. Yes. So as I said, trading at forty five cents. It's ASX ticker is FLC and it has a market cap of two hundred and forty two million. So sort of just above that small cap micro-cap volume. [00:03:38][55.9]

Alec: [00:03:39] Two hundred and eighty one million again. [00:03:40][1.5]

Bryce: [00:03:41] Yahoo! Not great, not [00:03:42][1.4]

Alec: [00:03:42] great on Yahoo Lufti going. [00:03:44][1.4]

Bryce: [00:03:44] Wow. So there we go. Yahoo finance. [00:03:46][1.6]

Alec: [00:03:46] This is from Google. Google has two hundred ninety one point eighty nine million. OK, well shouldn't be that hard. It's just share price times the number of shares outstanding. That's the Google and or Yahoo! Lift, you [00:03:58][11.3]

Bryce: [00:03:58] guys. That's exactly how you do it. Okay, well, we will go with I guess we'll have to go with the higher. What does Google have. Is that share price? I don't know if that's wrong. [00:04:06][8.0]

Alec: [00:04:06] Forty five. Yeah. [00:04:07][0.9]

Bryce: [00:04:07] Okay, so that's right. So it must just be to do with the number of shares on issue they've got differently [00:04:11][3.7]

Alec: [00:04:11] unless it's like fractions of a cent. But that shouldn't make a difference. Yeah. [00:04:17][5.1]

Bryce: [00:04:17] Anyway it's in the two hundred [00:04:18][1.1]

Alec: [00:04:20] ballpark [00:04:20][0.0]

Bryce: [00:04:21] shows again to show you how confusing this can be for people. Yeah. [00:04:23][2.6]

Alec: [00:04:24] Yeah, yeah. [00:04:24][0.2]

Bryce: [00:04:24] But Ren I like this company from the point of view of what they're doing. Yeah. They are trying to solve a real world issue and that is a water scarcity and the quality of water. What fluence do is there a leader in decentralised water and waste management solutions. So I guess decentralised water treatment is essentially where you use dispose of trait waste within small communities, I guess doesn't have to be small communities, but that's generally where the application lies. And so, yeah, they're on the challenge now of, I guess, helping world water scarcity. [00:05:01][36.8]

Alec: [00:05:02] Yeah. Big challenge. Yeah. So some context for just how big the challenge is. Seventy five percent of the world's population are currently experiencing water shortages. Wow. Yeah, massive. Wow. And eighty percent of the world's wastewater is released without treatment. So, you know, if you think about our sewage, it goes to a sewage treatment plant and it gets treated. Eighty percent of the world's wastewater is in and seventy five percent of the population are experiencing water shortages. These are massive issues. What Fluence do is they make sort of containerised solutions, like if you think about a wastewater treatment plant that you sort of bespoke design and engineer from scratch, it's millions and millions of dollars per million litres that go throw it. This is meant to be significantly cheaper. I couldn't find good pricing on how much cheaper I could find. Engineering estimates that I waste water treatment plant costs about a million bucks per million gallons a day. Gallons for me is whatever. Yeah, it's about a litre probably. But I don't know what the comparison is. But logic would dictate that a containerise prefabricated solution that they can just drop in is cheaper than. Hearing sound from scratch, so that's what they're trying to do. [00:06:17][74.6]

Bryce: [00:06:17] Yeah, have you seen the Bill Gates documentary on Netflix, the his latest one three part series? It's a look into the life of Bill Gates, essentially as he stands today. Incredibly interesting. It it really tries to highlight what is he actually doing now with his money from a philanthropic point of view. And also it goes into a bit of detail, all the start ups that he's funding. Yeah. And around his mission of all of this sort of stuff like secure polo, when he read about the impact of poor water treatment around the world, he set out to essentially create a toilet and a water treatment plant that was cheap enough that it could be rolled out at scale, took him years and years and years and, you know, so much money to come to a solution. And there's a funny scene where it's the first time that water comes out of the plant after starting, his poo essentially comes out as fresh water and he goes to take a sip of it in his face. But yeah, fascinating. But to your point, it just highlighted how incredibly expensive a problem it is to get these pre engineered, you know, drop ins that are cheap enough that you can do it at enormous scale. [00:07:25][68.0]

Alec: [00:07:26] So what you're saying is that this company has a competitor that's backed by Bill Gates or [00:07:30][4.2]

Bryce: [00:07:30] they're competing against Bill Gates. [00:07:31][1.2]

Alec: [00:07:34] Yes. Do know what that company's called? No. Maybe it's this company, Ren. [00:07:38][4.9]

Bryce: [00:07:39] After a bit of research, it's not really a competitor. So what he did was come up with the system using a bunch of engineering and looking at actually using worms as a way of composting. However, what they did was then granted five million dollars to London School of Hygiene and Tropical Medicine to perfect the technology. And then once that was perfected, they just went to a large manufacturer in China to start pumping out these toilets at three hundred and fifty bucks a pop. [00:08:03][23.7]

Alec: [00:08:03] They are a competitor of this company, I guess. [00:08:05][1.8]

Bryce: [00:08:05] So long story short. [00:08:06][0.8]

Alec: [00:08:06] Yeah. I mean, like if communities were going to demand this, that now they might now be able to get a cheaper one subsidised by Bill Gates. [00:08:13][6.9]

Bryce: [00:08:13] Yeah, yeah. However, this is toilet specific. I feel what Fluence does is more of a drop in water, larger water treatment solution. [00:08:21][7.7]

Alec: [00:08:22] Yeah, slightly different. Slightly. [00:08:23][1.3]

Bryce: [00:08:24] However, we digress. [00:08:25][1.6]

Alec: [00:08:26] So I think before we get into the problem and the solution that Fluence are trying to address, it's probably worth explaining the company because there's a bit of a history there. So there was an ASX listed company called Salkeld Group that looked like it went into receivership in 2014 and was delisted from the ASX. Then in 2015, it looks like there was a reverse takeover where Israeli company MFC MSFC y essentially took over Servcorp, the company listed on the ASX on the back of that and so on the 2015 annual report, it's called Mphasis. Twenty six still called and Fasi. It set up sales offices around the world, started doing a bunch of stuff, strategic partnerships in China. Twenty seventeen. It acquired another company called Well Water Group, and that combined company became Fluence Corp. And that's the company that we're talking about today. So it's gone through a couple of iterations and I guess it sort of merges technology as it goes. But Fluence itself, as a company called Fluence, is really only since twenty seventeen. The problem that it's solving is, you know, as we touched on, pretty universal. Seventy five percent of the population experiencing water shortages. As you can imagine, a lot of that is in the developing world. And so its main areas of operation are China, the Middle East, the Caribbean, Latin America and Africa. In twenty seventeen for wastewater, it had two plants and now it's got eighty eight today, including sixty eight in China and for its desalination. So taking salt water and turning it into fresh water, it had eleven in twenty sixteen and that's now to twenty nine in twenty nineteen. So it's [00:10:11][104.4]

Bryce: [00:10:11] growing. Absolutely. And as climate change continues and we perhaps might see more and more areas affected by drought in developed countries, I could imagine that these sorts of technologies will become more and more important outside of perhaps the traditional use that they've been developed for 100 percent. [00:10:29][18.5]

Alec: [00:10:30] Yeah, I think there is no doubt that as a macro theme, water is extremely important. Yeah, but the question then becomes, how does that macro theme and this company specifically interact? Yeah, and as you work through some of the intricacies of it all, I think you can you can probably start to say some questions raised about this specific company. [00:10:54][24.5]

Bryce: [00:10:58] But they might. So I guess the main question that I had to understand because I didn't really have a lot of experience with this is the difference between a centralised water system and a decentralised water system, because that's their biggest thing here, is that they are a leader in decentralised water systems. Is this something you were aware of beforehand? [00:11:18][19.4]

Alec: [00:11:18] I mean, the I guess the best analogy is if you think about electricity generation, you have your big engineered plants, which would be, in this analogy, wastewater treatment plant or desalination plant, massive capital to build, massive time to build. You need the right amount of land. You need the whole lot of things. So compare that to an electricity generator that you put in a container or something. You can just drop somewhere. That's the same here. These are basically containerised, all of them. So you essentially can just find a clearing, drop this in plug and play. That's really the analogy. Rock and roll. [00:11:56][37.3]

Bryce: [00:11:56] Yeah. To that point, their systems are designed, pretty engineered, low cost, small, almost like an IKEA table. [00:12:05][9.1]

Alec: [00:12:06] Yes. Yes. [00:12:06][0.8]

Bryce: [00:12:07] Pick it up unpassed like [00:12:08][1.4]

Alec: [00:12:10] I'm sure that. Appreciate you calling it that. But now here's where the rubber hits the road. And here's where questions can start to be asked, because everything in the investor presentations, all of that stuff is around these containerise solutions. They offer cost advantage, Spatt to use advantage. And there's a whole lot of case studies where they're the right solution. However, if you start to pull apart their financial numbers, what you say is that in the last year they made revenue of one hundred and one million US dollars. The vast majority of that didn't actually come from those containerised Modula treatment options, the vast majority of its 70 million of the hundred and one million actually came from building like custom engineered plants. So that's not to say that the modular treatment device segment isn't growing. It's up to twenty two dollars million, which is up from the year before. But it is important to keep in mind that these companies still predominantly makes its money from the old way of doing things, engineering specific solutions for specific areas rather than its modular solution. So they've got [00:13:20][70.8]

Bryce: [00:13:21] two forms of revenue. Then they've got their custom engineered system, which they build for, I guess, individual customers, and then they've got their pre engineered side of things, which is a much smaller proportion of their revenue stream at the moment. But growing. [00:13:36][15.2]

Alec: [00:13:36] Yes, yeah. [00:13:37][0.5]

Bryce: [00:13:37] My question is then I wonder, it sounds like then they're just using their expertise from experience in building custom engineered solutions and trying to then get into the pre engineered sort of product space. [00:13:49][11.6]

Alec: [00:13:49] Yeah, yeah, yeah. I mean, in the same way that coke fridge or your fridge at home is different to supermarket custom engineered fridge. I imagine whilst they both treat water there, they are different in a number of ways. But yeah, like that's, that's essentially what they're trying to do. They think they've got a better way to do this. And I think the logic makes sense. It's just is this company delivering on that [00:14:13][23.2]

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Bryce: [00:14:56] This podcast contains general information only. Please refer to the ideas on the website for further information to make sure this product is right for you. One is probably one that has a lot of money to spend and that's with your custom engineered. And then the other is probably a customer that doesn't have a lot of money to spend on this sort of stuff and I can imagine would be a hard sales pitch to get that at it at Mass. [00:15:17][21.3]

Alec: [00:15:18] Yeah, I mean, look, they're basically just selling to governments, rather as some like some resorts and stuff. It looks like a buying some of their prefabricated modular ones, which is a pretty good use case. Yeah. But like a lot of that, big sales are things like, you know, they're building a desalination plant for Egypt at the moment. I'm pretty sure they're building a wastewater treatment plant for the country escapes me. I'm pretty sure it's the Ivory Coast. So, yeah, like governments generally are responsible for wastewater treatment and water supply. So they're big customers, governments. And then the question is, at what level of government are you saying to local government, which is probably more the the cheaper, easier stuff or like the recycling to like Egypt, they're probably going to want something that's big. [00:16:01][43.2]

Bryce: [00:16:01] Yeah. Yeah. [00:16:02][0.4]

Alec: [00:16:02] Makes sense. Yeah. Anyway, so that was one red flag for me that despite all the talk about this prefabricated solution, they still make the vast majority of their revenue from these custom engineered stuff. The other question for me, we often talk about companies that under promise and over deliver being good companies. This company definitely is the inverse of that. Twenty eighteen. If you go through some of its investor presentations and stuff like that, it projected big increases in revenue and sustainable profitability by Q4. Twenty nineteen in its half year results in twenty nineteen, its revenue was down twenty seven and a half percent and its earnings were down sixty seven percent. So despite what it promised at the end of twenty eighteen, just six months later, it was far off that. So that was red flag number two for me. No. Three companies that do big engineering projects report a metric on backlog. The classic example of this is companies like Lockheed Martin, Raytheon, stuff like that. The pipeline. Yeah, because they enter multi-year contracts and so they they have that revenue pipeline essentially, and they only recognise a revenue in the year that they get paid. But it's good to know that a big pipeline means a big [00:17:19][76.8]

Bryce: [00:17:20] balance [00:17:20][0.0]

Alec: [00:17:20] sheet. Well, yeah, a big flow of future revenue. Yeah. So at the end of twenty eighteen, Fluence reported a backlog of two hundred and sixty seven million dollars worth of work. That's pretty strong buy. But the next half the backlog had increased to two hundred and seventy eight million dollars so increased by eleven million dollars. But at the same. Its revenue dropped twenty seven and a half percent, so there's many reasons why that could be the case, why the backlog increased and their revenue decreased. But that is something that I'd like to know the answer to. Why is it that if their revenue drops so much, why couldn't they convert more of that backlog into actual work in the half? [00:18:00][39.7]

Bryce: [00:18:01] I mean, it could be to do with the the length of time that it actually takes to deliver one hundred percent. [00:18:05][4.2]

Alec: [00:18:05] There's so many reasons that that could be, but definitely a question that I have. And then the last one is it's net tangible assets dropped from eight cents a share sorry, eight cents a share to five cents a share, which is close to halving. So it would be interesting to understand why that was the case as well. [00:18:21][15.8]

Bryce: [00:18:21] Net tangible [00:18:22][0.3]

Alec: [00:18:22] assets. Yes. What does it mean? Yeah. So net tangible assets are the total assets of a business, less any intangible assets. So things like goodwill or intellectual property. So we're talking about the physical assets of a business, its plant, its equipment, its stuff like that, minus its liabilities, so its debt and stuff like that. [00:18:46][23.6]

Bryce: [00:18:46] So either it's had to have an increase in debt or its assets have dropped in value. [00:18:51][4.7]

Alec: [00:18:52] Yes, yeah. You could say potentially what it's done is it's been it held a whole lot of stock and then it sold a whole lot of stock. And the stock it was holding, which has a value, decreased, but then that wasn't reflected in the revenue number nine. [00:19:06][14.6]

Bryce: [00:19:07] So a few red flags is what I'm hearing from you. Ren a few [00:19:10][2.8]

Alec: [00:19:10] questions, I think. [00:19:11][0.7]

Bryce: [00:19:11] Yeah, yeah. Unanswered question. [00:19:13][1.2]

Alec: [00:19:13] Yeah, yeah, yeah. [00:19:14][0.5]

Bryce: [00:19:14] I like the comment you made around overpromising under delivering or vice versa. Under promising, over delivering. That's in some recent interviews we've done from a small cap perspective. That's certainly what they fund managers look for when it comes to a quality stock. So to I guess say that it's not I guess meeting the expectations of management is a good call up. [00:19:39][24.3]

Alec: [00:19:39] So in their half yearly update, they affirmed their guidance that they would hit sustainable profitability by Q4. Twenty nineteen. So if you're watching this stock and you're thinking about how they guide and do they deliver on their guidance, that might be a key one to look for. [00:19:54][15.4]

Bryce: [00:19:55] So that's going to be the end of December, [00:19:56][1.7]

Alec: [00:19:57] end of December year, because they are not profitable at the moment, which isn't in and of itself isn't a problem. But you would hope to see that change given they're guiding for it. So that's definitely one to keep an eye on. [00:20:10][12.8]

Bryce: [00:20:10] So Ren, let's move now to, I guess, the valuation of this stock. Again, it's going to be a little bit tricky because we've got a negative earnings per share. [00:20:20][9.5]

Alec: [00:20:20] Yes. [00:20:20][0.0]

Bryce: [00:20:21] Now, obviously not going to be able to get price to earnings ratio for it either. So how would we go about valuing this company if we can't really do a decent comparative estimation using pay or a discounted cash [00:20:34][13.4]

Alec: [00:20:35] flow to do a comparative one to compare it to other stocks? You could maybe do a price to sales. Yeah, and if we say what? Thirty two cents a share of revenue, the share price of forty five cents. So price of sales is pretty good. You would think about about one and a half out of my head a bit, a bit under one and a half, which is I imagine is pretty standard. It's probably right smack bang in the middle of its sector. So by that metric you could say not too cheap, not too expensive. You would want to hope that it has a path to profitability. You're right. Discounted cash flow becomes really difficult. If you really want to get in there, grind and do the work, you can start trying to forecast how it becomes profitable in the years ahead, what its sales pipeline looks like when all recognise that revenue, what it will do in terms of cost out and try and start projecting what the cash flow will look like. We didn't do that. And also doing the Roger Montgomery style of valuation becomes difficult because it's got a negative return on equity as well as its losses have deepened. So, look, I think in terms of trying to explain where the market has landed in terms of price, I think it is sort of anchored to its revenue. No, its sales, no. And we'll wait and see if it can create a path to profitability. [00:21:55][80.5]

Bryce: [00:21:56] So Morningstar have come in again with their fair value estimation at fifty two cents a share. So it's pretty much trading within that band. What is it now. Forty five. Forty five. Forty four. Forty five. So nothing too alarming coming from them either. So I guess it's an interesting company for me. Ren I like what they're trying to achieve in terms of your call out of, you know, the world leader in decentralised. Well, that's probably a bit more of a marketing play than anything if you look at how their revenue is constructed at the moment. But certainly in an area macro theme that I think is a important and B, if they do it right, well, positioning themselves pretty well. Yeah. [00:22:39][42.7]

Alec: [00:22:39] And look, if you wanted to make the bull case for them. You would say one, the macro theme is there, and two, they're getting more of those units out. Yeah, the fact that they've got one from two in twenty seventeen to eighty eight in twenty nineteen in terms of their wastewater treatment plants like that alone is a really good sign. Yeah. But yeah, I guess there are some questions that I would have before I put my own money into it. [00:23:01][22.0]

Bryce: [00:23:02] And where do you think this falls in your circle of confidence. [00:23:04][2.0]

Alec: [00:23:04] I think this is learnable, yeah. Yeah. Conceptually, nothing is out of the realm of possibility. Yeah. Wow. I mean, it's water like, you know, humans are 70 percent water [00:23:16][11.7]

Bryce: [00:23:18] by virtue of that fact. Then we should be hailing this. Yeah. Now, I agree. I think more than anything, it would be the interest in what they're doing that would bring it into my realm of competence. So but again, I had to understand what a decentralised was at the beginning. So. Yeah. Interesting company. [00:23:35][17.6]

Alec: [00:23:36] Yeah. Very well. [00:23:36][0.8]

Bryce: [00:23:37] We'll leave it there. Ren pick it up again next episode with another summer series. Shahla Deep Dive sounds good. [00:23:37][0.0]