Saturday, February 1, 2014

Energy Recovery ( Nasdaq - ERII ) -- Goes With the Flow

Energy Recovery (ERII $4.25) is the leading provider of systems that convert industrial energy contained in moving liquids into electricity.  A wide variety of manufacturing facilities move fluids at high speeds, and then discharge them into a motionless storage tank when the processing is complete.  Energy Recovery's systems capture that pressure in transit with rotors that are nearly frictionless, turning it into electricity.  Other products made by the company are designed to capture steam that otherwise would be vented into the atmosphere.  The electricity that's generated is recycled back into the customer's operation, reducing costs.  Water desalinatination currently is Energy Recovery's principal market.  The company's patented ceramic rotors seldom need maintenance, which helps customers average a one year payback on their systems.  Energy Recovery holds an estimated 90% of the market.  Desalination plants apply electrical energy to remove salt from seawater.  Demand is rising due to shortages of drinking water that are developing around the world.  Part of that is ascribed to global warming.  A larger factor is modernization.  Water consumption tends to increase as economic development takes place.  The Middle East remains Energy Recovery's biggest market due to the particularly arid conditions there.  But orders are accelerating in China, India, and a number of smaller emerging countries.

The United States offers additional opportunity.  Energy Recovery landed its first order in California last year.  Another 18 desalination projects are in various planning stages.  Construction has been thwarted to date by environmental objections spearheaded by the Sierra Club.  Those challenges ostensibly were made to protect various animal species.  Many people suspect the real purpose was to prevent further economic development by limiting the available water supply.  California presently is enduring a major drought which could encourage the state's bureaucracy to be more accepting of desalination facilities in the future.

New markets could yield enormous leverage.  Energy Recovery is in trials with three major companies to implement its energy recycling technology.  The initial targets are natural gas processing plants.  The company's turbines convert the energy in high pressure fluid flows into electricity, cutting energy costs by approximately 25%.  Customers include Sinopac (China), Aramco (Saudi Arabia), and a major domestic producer.  The trial period has lasted longer than Energy Recovery originally anticipated.  The company reports that the performance in the field has been good and that the customers are happy with the results.  But design changes in plants that size require lots of proof.  None of the three customers has yet decided to deploy the technology on a broad scale.  If the industry adopts the technology volume could dwarf the desalination business.  The first three customers alone could exceed that.  They also have ancillary divisions that could reinforce demand.

Many other industries could implement the technology.  Energy Recovery currently is aiming at ammonia manufacturing.  A raft of additional chemical production facilities also are possible targets.

Desalination orders have been variable in the past.  That trend is likely to continue due to the large size of the projects.  We estimate sales generally were flat in 2013 at $42 million, although the December quarter itself probably reflected a robust series of shipments.  In 2014 we estimate desalination sales again will predominate, driving revenues up 31%-43% to $55-$60 million.  Earnings could reach $.08-$.12 a share.  If the diversification into the oil & gas and chemical industries is successful spectacular gains could be realized down the road.  Business could expand many times over.  Acquisitions of complementary products and marketing relationships could enhance performance.

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