Energy Recovery Inc (Nasdaq:ERII) Brings More Efficiency to Water Desalinization

Nov 17, 2008
Author: SCP Editor

November 17, 2008 – Energy Recovery Devices (Nasdaq:ERII) is a developer and manufacture of energy recovery devices used for the water desalinization markets. Its’ focus is sea water reverse osmosis (SWRO), where high pressure is used to drive sea water through filtering membranes to produce fresh water. ERII’s primary product, the PX Exchanger, optimizes the SWRO process by recapturing and recycling up to 98% of the energy used in the ‘high pressure reject stream’ reducing energy consumption by about 60% in the process. According to management, ERII’s technology is specified by more than 80 OEMs worldwide with more than 6,000 PX devices installed or contracted in plants worldwide saving customers an estimated 500MW of energy, or $352 million per year in operating costs. The stock closed on Friday at $5.95, holding a market cap of about $297 million, trading at 6.7x sales (ttm) and 48x earnings (ttm).

Last week ERII released financial results for its Q3:

·         Revenue of $9 million, exceeding its previously guided range of $6.8 to $7.2 million;

·         YTD revenue of $30.1 million an increase of 40% Y/Y over the first nine months reported last year;

·         Q3 net income of $623 thousand, or $0.01 per diluted share, compared to net income of $2.4 million, or $0.06 per share last year;

·         YTD net income of $3.4 million, or $0.07 per diluted share, compared to $3.1 million, or $0.08 per diluted share for the same period last year;

·         Q4 guidance of $20 to $22 million in revenue and $3.4 to $4.1 million in net income, and FY08 guidance of $50 to $52 million in revenue with $6.8 million to $7.5 million in net income.

Financial results still appear to be choppy but the trend it distinctly higher. Revenues in 2005 were $10.6 million, 2006, were $20 million, 2007 were $35.4 million and this year, as noted above, revenues are expected to be more than $50 million.

The stock came public in a difficult market. Its IPO was in July, 2008, where it sold 14,000,000 shares at $8.50 per share with Citi and Credit Suisse acting as lead underwriters and HSBC, Janney Montgomery and SEB Enskilda participating in the syndicate. Janney upgraded the stock to BUY from NEUTRAL last Thursday.

At the current price, and in the current market environment, we aren’t convinced the stock is cheap enough to begin accumulating yet, but we are tremendously bullish on the company and its market opportunity. Demand for fresh water will only continue to grow.

Current expectations are that the global efforts to reduce temperatures are not going to meet their targets, which will result in a dramatic shortage in current reserves. There is going to be a massive increase in demand for drinking water to meet global demand.

·         The UN Population Fund expects global consumption of water to double every 20 years.

·         The International Water Management Institute projects that by 2025, 33% of the population of the developing world will be facing severe water shortages.

The problem with desalinization, historically, is that it is expensive and energy inefficient. This is exactly why ERII is compelling to us. Its technology makes the process more energy efficient which is critical in terms of reducing expense and also in light of the fact that the global energy environment is becoming increasingly tight.

With desalinization becoming more economically viable, the markets are showing strong growth, and ERII is focused on expanding its business in the highest growth markets, including China, Algeria, Australia and India.

So we think the opportunity for ERII remains huge. Our primary concern right now is the choppiness in its quarter-over-quarter performance and what appear to be long sales cycles. Given than, it is difficult for us to justify the current multiples, but we would be inclined to begin accumulating the stock on any dips below $5. That being said, we are in early stages of our own diligence on the company and will be following up on this commentary going forward.

Important Disclosure.SCPEditor does not own ERII. The information and trades provided here and in the comments are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance.


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