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Energy Recovery Looks Out On Massive Global Water Shortage

Posted on Monday, Nov 8th 2010

A recent report from Global Water Intelligence pegs the contracted desalination capacity in 2009 at 68 million cubic meters/day. Capacity is expected to grow to 130 million cubic meters/day in 2016, taking the market value to $30 billion a year in the next six years. The top five markets for desalination technology are projected to be Saudi Arabia, the United Arab Emirates, the United States, China, and Israel. But, despite positive market projections, Energy Recovery Inc. (NASDAQ: ERII) has failed to deliver quarterly results that meet the market’s projections primarily due to the macroeconomic uncertainty and credit crunch impacting large scale infrastructure projects.

ERI’s Financials
Q3 revenues fell 27% over the year to $6.9 million, missing the market’s expectations of $11.4 million. They also suffered a bigger loss and reported a loss of $0.06 per share compared with the market’s projections of a loss of $0.02 per share.

For the current quarter, the company has projected revenues of $18 million–$20 million with expectations of margins ranging from a loss of $0.03 per share to a profit of $0.02 per share. The Street was looking for break even on revenues of $16.3 million for the quarter.

ERI’s Global Expansion
ERI has been focusing on expanding their global footprint. They recently announced implementation of their Pressure Exchanger energy recovery devices at the seawater reverse osmosis (SWRO) desalination plant in Limassol, the second-largest city in Cyprus, and Qingdao, China. The facility in Cyprus will provide 50,000 cubic meters of potable water to nearly 120,000 people a day.

I believe that China and India offer huge potential to ERI. ERI’s Qingdao project in China will provide 100,000 cubic meters of potable water per day to more than 500,000 people and will be the second large-scale potable water facility in China to include the pressure exchanger technology. China has over 1.3 billion people and accounts for a fifth of the world’s population. However, China has a mere 7% of freshwater resources available to it. McKinsey’s Charting Our Water Future report conducts a detailed study of water shortages in Brazil, South Africa, India, and China. These nations collectively account for 40% of the world’s population, 30% of the GDP, and 42% of the projected water demand in 2030.

Within China, McKinsey pegs a shortage of over 201 billion cubic meters of water by 2030. The report claims that nearly 21% of China’s available surface water is not fit even for agriculture. India too will see a widening “water gap” with demand of 1.5 trillion cubic meters by 2030 compared with projected supply supply of 740 billion cubic meters.

For India, a precarious situation is developing in Tibet, the source of a large portion of its current water supply. If China tries to control the faucet, there is a potential water war coming. (Read The Geopolitics Of The Tibetan Plateau.) Fortunately, India has a very long coastline. With desalination, India should be able to address the water shortage issues with systematic moves. I have dealt with this issue in Vision India 2010 in two projects: Gangotri and Mandakini.

At any rate, these troubling numbers only emphasize the need for innovative water technology to fill the widening gap. They also reaffirm my belief in ERI’s potential. However, as I said earlier, it is a long-haul stock.

ERI has made a strategic move to bring Bob Mao to the Board to gain high level leverage in China. He was most recently the CEO of 3Com, and presided over 3Com’s excellent turnaround and acquisition by HP. I know Bob Mao personally, and I consider this an excellent move. China is going to be a critical piece of ERI’s future growth, and I am sure Bob’s stature and connections will help them maneuver well in this market.

I would like to see a similar strategic heavy-hitter on the ERI board who can do the same with India.

The stock is trading at $3.67 with a market capitalization of $192 million. Earlier in September the stock touched a 52-week low of $3.08. The short-term gyrations notwithstanding, I am holding onto my ERI stocks.

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