Clean Water Need Grows Ever More Urgent

Fortune magazine estimates the water desalination industry to be worth $30 billion and expects this figure to double by 2016. Another publication, Global Water Intelligence, suggests that we will need to triple global desalination capacity to meet the growing demand of potable water. Today, nearly 20% of the global population, or approximately 1.3 billion people, lack access to potable water. This number is expected to grow to one-third of the population by 2025. But even as demand increases, the water supply decreases. For example, the world’s two most populous countries, India and China, cultivate 15% of their grains using ground water – most of which is expected to dry out. Governments, keenly aware of the seriousness of the problem, are funding nearly $480 billion in water projects in the next two years. In this context, companies such as Energy Recovery, Inc. (NASDAQ:ERII), which offers highly efficient desalination solutions, will surely grow.

ERI recently posted Q3 revenues of $9.5 million with EPS of $0.01, beating the market’s expectations of a break even quarter. A year ago, revenues were $9.0 million with EPS of $0.01.

The company is seeing demand for projects stabilize with credit markets opening up. In fact, in the past five weeks demand was higher than at any time in the past year. In particular, there is high demand for ERII’s pressure exchanger PX-300 because of its efficiency. ERI’s devices, some of which operate at 98% efficiency and reduce energy consumption by up to 60%, are the best in the industry.

During the quarter, ERII was awarded numerous international projects. The company will be helping IDE Technologies to expand its desalination plant in Hadera, Israel, from 388,000 cubed meters per day to 462,000 cubed meters per day. ERI was also awarded a project in Australia which will be constructed by the Southern Seawater Alliance (SSWA) to provide 140,000 cubed meters of fresh water per day to the Perth region and another 200,000 cubed meters project in Tenes, Algeria.

The company’s technologies remain unmatched, and it recently launched a Quadribaric technology to further reduce costs of desalination by doubling the workload of devices “with greater efficiency than any energy recovery device on the market.” The Quadribaric technology features straighter flow paths to ensure higher efficiency and reduces cycle speed by reducing the mixing between the seawater concentrate and feed water.

The company projects revenues of $14.5 million to $16.5 million in Q4 with EPS of $0.03 to $0.04. Revenues for the year are expected to grow 25% over the previous year.

The stock is trading at $5.64 with a market capitalization of $283 million. It reached $9.75 levels a year ago, but it has been languishing ever since. The credit slowdown and the resulting project slowdown has caused some of this inertia. However, as the infrastructure buildup kicks in in 2010, I expect that the projects would move faster, and in the long term, this should be a rocket stock. Whether that long term is defined as 2-year or 5-year, I am not sure. But the water problem is so critical, that somewhere down the road, desalination is going to be an essential key to solving the equation. At that point, if ERI continues to preserve a competitive advantage, the company is extremely well-positioned to run up the stock.