Delivering on a demanding target

Fluence Corporation 1 February 2019 Update
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Fluence Corporation

Delivering on a demanding target

Q4 and FY18 results

General industrials

1 February 2019

Price

A$0.36

Market cap

A$194m

US$/A$0.715

Estimated net cash (US$m) at end 2019

18

Shares in issue

538m

Free float

60%

Code

FLC

Primary exchange

ASX

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

16.9

(11.6)

(27.5)

Rel (local)

12.4

(11.9)

(24.9)

52-week high/low

A$0.6

A$0.3

Business description

Fluence is a global supplier of water and wastewater treatment solutions. Its decentralised products provide municipal customers with ‘plug and play’ solutions that are quicker to deploy and substantially cheaper than traditional alternatives.

Next event

Q1 FY19 trading update

April 19

Analysts

Dan Gardiner

+44 (0)20 3077 5700

Dario Carradori

+44 (0)20 3077 5700

Graeme Moyse

+44 (0)20 3077 5700

Fluence Corporation is a research client of Edison Investment Research Limited

An impressive Q4 (73% y-o-y organic revenue growth) saw Fluence deliver on its FY18 target. Demand for its higher-margin smart product solution (SPS) remains strong with revenues expected to ‘at least’ double y-o-y in FY19. Its target of EBITDA breakeven by Q419 is reaffirmed and our profit forecasts are largely unchanged. With $38m of net cash and growing evidence of execution, we believe investors can now focus on the long-term growth story.

Year end

Revenue (US$m)

EBITDA* (US$m)

EPS*
(c)

EV/revenue
(x)

EV/EBITDA
(x)

P/E
(x)

12/17

33.2

(23.6)

(7.0)

3.6

N/A

N/A

12/18e

105.6

(17.5)

(4.0)

1.1

N/A

N/A

12/19e

149.1

(1.8)

(0.7)

0.8

N/A

N/A

12/20e

186.5

11.8

1.8

0.6

10.2

14.1

Note: *EBITDA and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Q4: An impressive performance

An impressive Q4 performance saw Fluence report revenue of $43.7m, up 51% q-o-q and 73% y-o-y, delivering on its FY18 guidance. Meeting this target represents a huge achievement in our view. FY18 revenues rose $47m or 82% on a pro-forma basis (Fluence was created from the merger of Emefcy and RWL Water in Q317), driven by a doubling of higher-margin SPS (from $10m to $22m) and the first revenue from San Quintin ($13.5m). Headline gross profit was flattered by a $7.1m (non-cash) provision reversal in Q418 but underlying FY18 margin rose to 24% (ahead of our expectations). Cash outflow was larger than our expectations in both Q2 and Q3, but fell by $3m q-o-q in Q4. Improved collections saw the company end the year with $38m net cash ($10m above our expectations).

FY19 outlook: Profitability target reaffirmed

We see the strong momentum of Q4 maintained into FY19. The company expects SPS to at least double again (in line with our expectations) driven partly by the ramp in the ITEST contract in China. Further San Quintin revenue is also expected but predicting the timing of additional large, low-margin custom-engineered solutions (CES) remains difficult (see Time for better treatment?). We have trimmed our estimates but the impact on profits is offset by a reduction to opex so our profit forecasts are largely unchanged.

Valuation: 98% upside on a DCF basis

We believe Q4 results could act as a catalyst for the shares. With the ITEST deal illustrating the potential of Fluence’s technology, Q4 removes near-term forecast uncertainty and demonstrates the ability to meet demanding financial targets. An increasing focus on proprietary technologies should build a business with better margins and visibility (from Q120 long-term recurring revenue contracts should generate at least 20% of gross profit). A DCF approach that reflects the growth and margins of which we believe Fluence ultimately capable, suggests an A$0.71 per share valuation and 98% upside. It is likely to take time and good execution to realise this, but with profitability in sight and funding secured, we believe formerly sceptical investors can now focus on these longer-term prospects.

Q4 and FY18 review: Execution on a demanding target

Following disappointing performance in FY17, some investors were sceptical that Fluence could meet an ambitious FY18 target that implied at least 80% pro-forma revenue growth and was heavily H2 weighted. An exceptional performance in Q4 quashed those fears. Revenue of $43.7m implied growth of 51% q-o-q and 73% y-o-y. Much of the sequential rise (c $13m) was driven by the ramp up of revenue from San Quintin but the company also began recognising revenue from the ITEST contract signed in Q3 (see our recent note, China contract catalyst?). While no further high-volume smart product contract wins were announced in Q4, the company did sign an $8.4m build-own-operate contract in Peru based on Nirobox. This should begin operating in Q319, bolstering the annual recurring revenue base by $3m. The successful completion of an Aspiral trial with the Yiyang City government saw an extension of its contract here and in our view bodes well for future deployment of Aspiral in Hunan province.

The growth delivered by Fluence in FY18 was primarily driven by a ramp up in custom contract revenue from PDVSA and San Quintin (we estimate $27.2m and $13.5m respectively) combined with a doubling of higher-margin SPS revenue (from $10m to $22m). The greater profitability of SPS (25–40%) helped lift pro-forma gross margins from 22% in FY17 to 24% in FY18 whereas good cost control reduced the current operating cost run-rate to below $10m a quarter.

Fluence’s funding position also improved substantially over FY18, particularly in the last few months. A capital raising in Q3 (net proceeds of $25m) and a $3m sequential reduction in cash operating outflows in Q4 saw the company end FY18 with $38m of net cash ($10m ahead of our forecast). It also secured a $50m non-recourse debt facility to provide project financing for projects (see Debt facility in place for custom projects). The current business plan now looks fully funded.

FY19 outlook: Growth, improving mix, EBITDA +ve Q4

Fluence’s momentum should continue in FY19. The company expects SPS to ‘at least’ double (in line with our expectations) driven in part by the ramp up in the ITEST contract in China. Further San Quintin revenue is expected (we forecast $33m) but the company admits that predicting the timing of additional large, low-margin CES contracts remains difficult (see Time for better treatment?) and securing these deals is no longer a strategic priority. A pre-emptive $5m cut to our CES revenue estimates trims group revenue forecasts by 3% and we also lower our gross margin assumption slightly. Our new $149m revenue forecast implies typical seasonality in H1 followed by a substantially stronger H2. The impact on the bottom line is entirely offset by lowering our operating cost forecast from $43m to $39m. With the mix improving, we now see gross margins trending up to 25% and the company exceeding the revenue threshold of $40m per quarter that will deliver EBITDA breakeven in Q419 (in line with re-iterated guidance). The company is guiding to a $10m operating cash outflow in Q1 where we had previously assumed a $5m cash outflow. Taking this into account and reviewing cash trends in FY18, we now conservatively forecast a total reduction in cash during FY19 of $19m.

Exhibit 1: Changes to forecasts

FY18e

FY19e

FY20e

Old

New

%

Old

New

%

Old

New

%

Revenue

107.3

105.6

(1.6)

154.0

149.1

(3.2)

194.4

186.5

(4.1)

Adj EBITDA

(13.4)

(17.5)

N/M

(2.0)

(1.8)

N/M

11.9

11.8

(0.6)

Adj EPS

(2.6)

(4.0)

N/M

(0.8)

(0.7)

N/M

1.8

1.8

(0.3)

Net cash

28.7

37.9

31.8

25.1

18.5

(26.3)

41.3

42.2

2.1

Source: Company data, Edison Research

The next phase

With FY18 numbers successfully delivered, funding secured and profitability in sight investors can now focus on Fluence’s longer-term prospects. Management appears to be paying increasing attention to improving the quality of the business. Growth from its proprietary standardised technologies (Nirobox, Aspiral and Subre) should substantially improve the revenue mix, lifting both margins and visibility. The best gauge of the longer-term potential of these technologies is the volume of contract wins. However, introducing a segmentation that shows these higher-quality revenue streams will also help investors track progress. The SCS segment will directly reflect sales of proprietary products whereas recurring revenue and aftermarket will report large custom build-own-operate contracts where there is a recurring revenue element. Based only on contracts signed already, Fluence estimates annualised recurring revenue will be close to $15m by Q120, c 10% of total sales. As these contracts are also relatively high margin they could account for 20% of gross profit. By growing this proportion Fluence believes it can substantially improve visibility for investors.

Valuation: 98% upside on a DCF basis

At A$0.36 and assuming US$18m of net cash (end FY19e), Fluence’s current share price implies a US$120m EV and 10.2x FY20e EV/EBITDA. A DCF approach, based on P&L forecasts that are largely unchanged, reflects the growth and margins of which we believe Fluence ultimately capable and suggests an A$0.71 per share valuation and 98% upside. It will take time and further execution to realise this valuation. However, with profitability in sight and funding secured, we believe formerly sceptical investors can now focus on these longer-term prospects.

Exhibit 2: Financial summary

$m

2016

2017

2018e

2019e

2020e

31-Decemeber

IFRS

IFRS

IFRS

IFRS

IFRS

INCOME STATEMENT

Revenue

 

 

0.8

33.2

105.6

149.1

186.5

Cost of Sales

(2.0)

(27.2)

(80.3)

(112.0)

(132.9)

Gross Profit

(1.2)

6.0

25.3

37.0

53.6

EBITDA

 

 

(8.8)

(23.6)

(17.5)

(1.8)

11.8

Operating Profit (before amort. and except).

 

(9.1)

(24.3)

(20.1)

(4.4)

9.2

Amortisation of acquired intangibles

0.0

0.0

0.0

0.0

0.0

Exceptionals

0.1

(1.2)

(31.1)

0.0

0.0

Share-based payments

0.0

0.0

0.0

0.0

0.0

Reported operating profit

(9.1)

(25.4)

(51.2)

(4.4)

9.2

Net Interest

(0.0)

2.6

1.0

0.6

0.6

Joint ventures & associates (post tax)

0.0

0.0

0.0

0.0

0.0

Exceptionals

0.0

0.0

0.0

0.0

0.0

Profit Before Tax (norm)

 

 

(9.1)

(21.7)

(19.1)

(3.7)

9.8

Profit Before Tax (reported)

 

 

(9.1)

(22.9)

(50.2)

(3.7)

9.8

Reported tax

0.0

(0.7)

(0.1)

0.0

0.0

Profit After Tax (norm)

(9.1)

(22.4)

(19.2)

(3.7)

9.8

Profit After Tax (reported)

(9.1)

(23.6)

(50.4)

(3.7)

9.8

Minority interests

0

0

0

0

0

Discontinued operations

0

0

0

0

0

Net income (normalised)

(9.1)

(22.4)

(19.2)

(3.7)

9.8

Net income (reported)

(9.1)

(23.6)

(50.4)

(3.7)

9.8

Average Number of Shares Outstanding (m)

214

320

477

538

538

EPS - basic normalised ($)

 

 

(0.04)

(0.07)

(0.04)

(0.01)

0.02

EPS - diluted normalised ($)

 

 

(0.04)

(0.07)

(0.04)

(0.01)

0.02

EPS - basic reported ($)

 

 

(0.04)

(0.07)

(0.11)

(0.01)

0.02

Dividend per share ($)

0

0

0

0

0

Revenue growth (%)

4.7

(10.4)

39.5

36.1

22.7

Gross Margin (%)

(147.5)

18.0

23.9

24.8

28.7

EBITDA Margin (%)

(1,089.3)

(71.1)

(16.6)

(1.2)

6.3

Normalised Operating Margin

(1,126.1)

(73.1)

(19.0)

(2.9)

4.9

BALANCE SHEET

Fixed Assets

 

 

3.2

72.7

24.8

26.2

27.6

Intangible Assets

2.1

60.2

5.8

5.8

5.8

Tangible Assets

1.0

7.1

13.9

15.3

16.7

Investments & other

0.1

5.5

5.0

5.0

5.0

Current Assets

 

 

24.4

131.9

155.7

147.7

166.2

Stocks

0.5

18.5

35.9

33.4

30.2

Debtors

0.7

26.7

69.4

83.6

81.6

Cash & cash equivalents

22.9

75.2

39.0

19.2

42.9

Other

0.3

11.5

11.4

11.4

11.4

Current Liabilities

 

 

(2.5)

(95.9)

(117.7)

(114.7)

(124.8)

Creditors

(1.4)

(27.8)

(47.9)

(47.8)

(60.5)

Tax and social security

0.0

(0.1)

(0.1)

(0.1)

(0.1)

Short term borrowings

0.0

(1.1)

(1.1)

(1.1)

(1.1)

Other

(1.1)

(66.9)

(68.6)

(65.8)

(63.2)

Long Term Liabilities

 

 

(1.0)

(5.1)

(11.0)

(11.0)

(11.0)

Long term borrowings

0.0

0.0

0.0

0.0

0.0

Other long term liabilities

(1.0)

(5.1)

(11.0)

(11.0)

(11.0)

Net Assets

 

 

24.1

103.6

51.8

48.1

57.9

Minority interests

0.0

0.2

0.1

0.1

0.1

Shareholders' equity

 

 

24.1

103.8

51.9

48.2

58.0

CASH FLOW

Op Cash Flow before WC and tax

(8.8)

(23.6)

(17.5)

(1.8)

11.8

Working capital

1.7

(4.8)

(31.8)

(13.9)

16.1

Exceptional & other

0.0

0.2

0.7

0.0

0.0

Tax

0.0

(0.9)

(0.3)

(0.4)

(0.4)

Net operating cash flow

 

 

(7.2)

(29.0)

(49.0)

(16.1)

27.5

Capex

(0.4)

(3.7)

(3.5)

(4.0)

(4.0)

Acquisitions/disposals

(1.0)

50.6

(1.8)

0.0

0.0

Net interest

0.0

0.5

2.7

0.2

0.2

Equity financing

22.9

31.3

23.3

0.0

0.0

Dividends

0.0

0.0

0.0

0.0

0.0

Other

(0.2)

1.1

(3.7)

0.0

0.0

Net Cash Flow

14.2

50.8

(31.9)

(19.8)

23.7

Opening net debt/(cash)

 

 

(8.5)

(22.9)

(74.0)

(37.9)

(18.5)

FX

0.2

2.1

(4.1)

0.4

0.0

Other non-cash movements

0.0

(1.8)

0.0

0.0

0.0

Closing net debt/(cash)

 

 

(22.9)

(74.0)

(37.9)

(18.5)

(42.2)

Source: Fluence Corporation accounts, Edison Investment Research. Note: these financials assume 103m additional shares from the capital raising taking place and net proceeds of $23m.

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This report has been commissioned by Fluence Corporation and prepared and issued by Edison, in consideration of a fee payable by Fluence Corporation. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the Edison analyst at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

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This report has been commissioned by Fluence Corporation and prepared and issued by Edison, in consideration of a fee payable by Fluence Corporation. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the Edison analyst at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2019 Edison Investment Research Limited (Edison). All rights reserved FTSE International Limited (“FTSE”) © FTSE 2019. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

Neither this document and associated email (together, the "Communication") constitutes or form part of any offer for sale or subscription of, or solicitation of any offer to buy or subscribe for, any securities, nor shall it or any part of it form the basis of, or be relied on in connection with, any contract or commitment whatsoever. Any decision to purchase shares in the Company in the proposed placing should be made solely on the basis of the information to be contained in the admission document to be published in connection therewith.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document (nor will such persons be able to purchase shares in the placing).

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

The Investment Research is a publication distributed in the United States by Edison Investment Research, Inc. Edison Investment Research, Inc. is registered as an investment adviser with the Securities and Exchange Commission. Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a) (11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

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Germany

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United Kingdom

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United States of America

Sydney +61 (0)2 8249 8342

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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