BQE Water: A Capital-Light Compounder with Expanding Margins and Long-Term Recurring Revenues
BQE Water is a high-quality Canadian microcap that offers a potential multi-bagger investment opportunity over the next 20 years.
Introduction
A theme has unwittingly begun to emerge on this blog. All three of the businesses that I have written about thus far - Cipher Pharmaceuticals, Moberg Pharma AB, and now, BQE Water (“BQE”) - are “capital-light compounders”. In other words, they are businesses that employ relatively little tangible capital within their businesses that also have the ability to earn increasing and potentially unlimited returns on invested capital by increasing their earnings with very little or no need for incremental reinvestments of capital.
To understand what makes this type of business so special, let us recall that the objective of investing is to give up consumption now in order to consume more later (the notion of “consumption” takes into account the reality of inflation).
Typically, when you make an investment in a business, you are giving up some portion of your capacity for consumption now because the capital you invest is no longer available to you for spending. Furthermore, in the case of most businesses, in order to further increase your ability to consume later on, you must continue to give up some of your capacity for consumption now by making additional reinvestments of capital, whether this is done by you personally or by management on your behalf through reinvestment of the business’s earnings. So, for the ordinary business, in order to continue to increase your future capacity for consumption, you must continually give up some portion of your capacity for consumption now through reinvestments of capital.
By contrast, in the case of the capital-light compounder business, after you have made your initial investment, the business no longer requires you to continue foregoing consumption now because the business can increase its earnings and your future capacity for consumption without additional reinvestments of capital. That being the case, management (provided they are competent) begins to return the cash being thrown off by the business to you via share buy-backs or dividends, thereby increasing your capacity for consumption both now (through the returns of capital) and in the future (through the business’s increasing earnings). That is what makes this type of business so special - you are wealthier (in terms of your capacity for consumption) both now and in the future.
The archetype of this business model is a royalty. The owner of a royalty typically makes a single upfront investment, after which time they reap very high margin, potentially increasing cash flows without the need to make incremental reinvestments of capital, which are made (if needed) by the licensee. That is why Cipher and Moberg fit the capital-light compounder business model so well - part of their earnings are derived from royalties that have the potential to grow without Cipher or Moberg needing to lay out any additional money.
The only downside of these businesses is that they typically do not offer the opportunity to redeploy additional capital at the same high rates of return, which is why the capital is returned to shareholders. But then again, you can’t have it all (most of the time).
BQE is a business that also fits this profile to some degree, although BQE’s business model does not include earnings from royalties. Rather, BQE is able to grow its high-margin free cash flows without reinvestments of capital due to its operation of water treatment plants, which earn a “tolling fee” based on the amount and quality of clean water that is discharged by the plant.
The only constraint on BQE’s ability to operate additional water treatment plants is the human capital required to operate them. According to management, a plant producing up to $1.5 million in revenue per year only requires five people to operate it. Additionally, the operation of an additional water treatment plant does not require an incremental reinvestment of capital because the cost of constructing the plant is paid for by BQE’s client, the mine operator, and the major cost (in addition to reagent costs and energy consumption) of operating the plant is employee expenses, which is an operating expense and not an investment of capital in fixed assets.
Furthermore, each plant provides operating leverage because the cost of operating the plant is fixed at the cost of the five employees required to man the plant, whereas the plant’s economic output in terms of the fees earned on the volume of water treated can increase without a significant corresponding increase in the plant’s operational expenses, although operating costs may increase in the form of reagent and energy consumption expenses.
Hence, BQE’s business fits the profile of the capital-light compounder business model because the operation of an additional water treatment plant does not require an incremental reinvestment of capital and each plant provides operating leverage through the treatment of higher volumes of water on which a tolling fee is charged without a corresponding significant increase in operational expenses.
With that conceptual framework in mind, let’s proceed to a more detailed examination of BQE business. All figures are in CAD unless otherwise specified. As always, this write-up is not a recommendation to buy or financial advice. You must do your own due diligence and satisfy yourself of the facts presented here. All investment decisions are your own. Thank you for reading and happy hunting.