Can Investors Recover Faith In Energy Recovery?

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by Debra Fiakas CFA

Despite reporting the highest gross profit margin in Energy Recovery‘s (ERII:  Nasdaq) history, investors were sorely disappointed with financial results in the Company’s second quarter ending June 2017.  On the first day of trading following the earnings release the share price gapped downward and closed even lower under above average trading volume.  This is likely because there was some expectation that Energy Recovery could finally report a net profit in the quarter as sales of the Company’s flagship PX Pressure Exchanger to the desalination market had appeared to pick up in recent months.  Unfortunately the Company reported a net loss of $500,000 or $0.01 per share on $12.2 million in total sales.

During the earnings conference call management took some pains to defend its business model focused on successive product innovations based on the Company’s core pressure exchange technology.  The plan has been under execution for several years now with the first example in the VorTeq hydraulic fracturing system for use in pumping fleets at oil or gas wells.  The VorTeq was expected to gain rapid acceptance in the oil and gas industry that experiences high costs and frequent delays with conventional hydraulic facturing systems.  The VorTeq hydraulic pumping system is designed extend the life of pumps by re-routing the abrasive proppants away from the high-pressure pumps and allowing only pure water to touch the pump.

In October 2015, Schlumberger (SLB:  NYSE), a leader in the oil and gas servicing sector, licensed the technology VorTeq technology, but has yet to place units in the market.  Energy Recovery has had to make design changes to the VorTeq in order to deal with vibration problems that surfaced as Schlumberger and Energy Recovery tested a prototype system.  Energy Recovery has been working with a leading value designer Kemper Value and Fittings Corporation (division of Caterpillar; CAT:  NYSE) to develop a second generation manifold for the VorTeq. The company has also made improvements to the ceramic cartridge that is the key to proppant-water separation.  Full-scale testing of the improved VorTeq is scheduled for the month of October 2017.  Management still expects to meet milestones set down in this agreement with Schlumberger before the end of 2017.

The effort has given rise to yet another product featuring Energy Recovery’s pressure pumping technology that is called MTeq.  The oil and gas recovery involves is a messy business especially when using a process called ‘mud pumping’.  Drilling mud is circulated from a mud pit through the well borehole to lubricate the drill bit and clean-up cuttings.  Conventional pumping equipment is subject to extreme wear as drilling mud with debris and sand comes in contact with the pumps.  MTeq serves as a barrier between the mud pit and the hydraulic pumps, extending the life of the expensive pumping system.

Energy Recovery has as high hopes for the potential of the MTeq to revolutionize oil and gas well operations  –  the same kind of promotion that accompanied introduction of the VorTeq system. The apparent endorsement of the VorTeq by Schlumberger sent Energy Recovery’s stock to historic high prices in the year 2016.  The delay in reaching the market with the VorTeq has left investors a bit more cautious relative to the MTeq.

The shares sank even further in the final day of trading this week, plunging into oversold territory.  We believe a candlestick chart for ERII provides key insight into current sentiment toward this perennially struggling energy technology company.  The candlestick that formed up in trading today resembles a cross with no body and long upper and lower shadows.  This candlestick results when neither the bullish nor bearish view is able to dominate the day even as there is buying that drives the stock above the open as well as selling that drives the stock in the opposite direction below the open.  The stalemate suggests that the bearish view that had tried to take over immediately following the earnings report is well matched by continued interest in the Company.  The stock set a new 52-week low in the most recent day of trading and that must have been compelling for investors with a long-term view on Energy Recovery’s underlying pressure pump technology.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.


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