Bullish On ERII

| About: Energy Recovery, (ERII)

After disappointing results for last quarter, Energy Recovery Inc (NASDAQ:ERII) beat the market’s expectations this quarter, and the company gave a positive outlook for the coming quarters. For an in-depth look at the global water crisis and business opportunities therein, read Dominique Trempont’s Water Shortages: Opportunities for Entrepreneurs.

Revenues of $22.0 million with EPS of $0.10 were higher than the Street’s expectations of $21.6 million with EPS of $0.08. Quarterly revenues grew 59% and EPS 67%. For the year, revenues of $52.1 million grew 47% and EPS of $0.18 grew 29%.

For the coming quarter, ERII is looking at revenues of $12-$13 million with EPS of $0.02-$0.03. For the full year, they gave a revenue outlook of $60-$65 million with EPS of $0.18-$0.22.

Even in the current economy, I would rate ERII as a good long-term hold. The water industry is enjoying high growth, with analyst estimates of an industry growth rate of 10-15% per year. Given that there are very few players in the industry, hardly any of whom focus on water desalination via seawater reverse osmosis, ERII should continue to grow nicely. Analysts estimate the reverse osmosis segment to grow 19-20% per year with large-scale projects growing nearly 40-55% per year.

ERII has managed to consistently bring down the cost of desalination. It is estimated that their technology helps reduce energy needs by 60% compared with traditional methods, which helps in winning them market share. It is also estimated that of the new large projects announced each year, nearly 65-70% are bagged by ERII. They already have a big pipeline for the coming years.

Add to that the demand created by current environmental conditions, such a state of drought emergency being declared in California, and ERII’s geographical expansion, and you have a potential long-term star.

However, there is no denying that the water industry faces certain risks. Water projects themselves could suffer as long as global credit markets remain tight. A recent report from the American Water Works Association indicated that there have been delays in water projects due to credit conditions. Further, as technological improvements are made in alternative energy sources, reverse osmosis might lose its criticality.

ERII raised $77 million in its IPO earlier last year. At the year end, the company had cash reserves of nearly $80 million. They could look at using some of this cash for vertical or horizontal integration. Vertically, they are already looking at players in the ceramic industry, and horizontally, they are focusing on the pump space. A merger could bring cost efficiencies and help diversify their revenue potential.

The stock is currently trading at $6.15 with a market capitalization of $307 million. At the current prices, even in the present conditions, I would rate ERII a good stock to hold, if not Buy. I am certainly holding on to my ERII holding. What more can I say?