ERI Offers a Refreshing Investment in a Thirsty World

By LIAM DENNING
Coleridge's "The Rime of the Ancient Mariner" bewailed seeing "Water, water, every where, Nor any drop to drink."
If only he had packed a seawater reverse osmosis desalination unit, he would have been fine—although, admittedly, poetic rhythm would have suffered a tad.
We will need to claim ever more fresh water from the briny seas in the years to come. The United Nations expects the global population to expand by three billion people by 2050, many in developing regions without sustainable access to safe drinking water. Growing demand for food will add pressure, given that 70% of water consumed is for crop irrigation.
Treating seawater to remove salt, either by heating it or forcing it through membranes (reverse osmosis), is one way to cope. About 60 million cubic meters a day of desalination capacity exists world-wide, according to Global Water Intelligence. That's up more than 12% from 2008 but still represents only 1% of global consumption.

Energy Recovery Inc. offers an investment angle. ERI makes advanced pressure exchangers, which capture and recycle up to 98% of excess energy otherwise wasted in reverse osmosis desalination. Energy represents the single-biggest cost in desalination. ERI's patented technology captures more energy than older products and requires less maintenance.
ERI shares were listed in July 2008 at $8.50 a share. Its stock has been volatile and Friday closed at $6.57. Besides general market turmoil, frozen credit markets and lower oil prices–arid Middle Eastern countries are big buyers—have delayed big desalination projects. In April, a competitor of ERI, Calder AG, was acquired by Flowserve Corp. Calder's technology has much lower market share. But it is now part of an industrial group with a market capitalization of $5.9 billion, compared with ERI's $344 million.
Despite delays, though, the long-term growth story remains intact. ERI's proprietary technology and net cash position provide resilience. The consensus earnings estimate for 2011 is 25 cents a share, implying a heady multiple of 26.3 times. But Jefferies & Co. estimates each incremental one million cubic meters a day of desalination capacity built translates to a $17.5 million revenue opportunity for ERI assuming its current market share, or three cents a share of earnings.
Moreover, some 43% of ERI's revenue is spent on research and development, sales, marketing and administrative expenses. That should be leveraged across more end markets to improve margins. Last month's acquisition of smaller rival Pump Engineering LLC, expanding ERI's product range and addressable markets, was a step toward this.
Water stress, climate change, expensive energy, and infrastructure needs weigh on the global outlook like the proverbial albatross. ERI represents one way of investing in efforts to address the burden.
Write to Liam Denning at liam.denning@wsj.com