Energy Recovery proposes to lease its VorTeq solution as a replacement for the standard missiles. The VorTeq is an energy exchanger, which of course is Energy Recovery’s signature technology and knowhow. Using the VorTeq instead of the standard missile allows the energy from water driven by the high pressure pumps to be transferred to the fracturing mixture without letting the fracturing mixture come in contact with fragile pump components. The point of energy exchange is made in a cylinder-shaped device composed of a few components, all machined from high performance tungsten carbide. Importantly, using the VorTeq instead of the conventional missile requires no other equipment modification.
While financial condition is not a great concern, we listened with some reservation to management’s discussion of its VorTeq solution for the fracturing service market. Company engineers were responsive to our concerns about the transfer of risk of damage from pumps owned by the service provider to the VorTeq, which will remain the property of Energy Recovery. They were steadfast in their confidence that their components would be better able to withstand contact from corrosive materials than comparatively more flimsy pumps used at the gas wellhead. However, we note that Energy Recovery plans to retain ownership of the VorTeq systems and will be responsible for maintenance. During the analyst event the Company was a bit vague on the manufacturing cost for VorTeq and had no estimates for the cost of such maintenance. Accordingly, we are concerned that the proposed lease price of $1.6 million per year that has been proposed may not be adequate to ensure a profit for Energy Recovery. We are concerned that in their zeal to create a marketable proposition, the Company will leave too much ‘on the table’ with its gas field services customers.
We continue to rate ERII at Hold. There are no strong near-term trends up or down for ERII shares. We cannot characterize the stock as either oversold or overbought. That said, we note the stock registered a particularly bullish formation in a point and figure chart in the third week in November. The ‘triple top breakout’ formation suggested new upward momentum in the stock to a price of $7.25. We believe that formation was fueled in part on information that was filtering to the market ahead of the analyst meeting. Subsequent to the event, the stock has weakened albeit under diminishing volume. We view Energy Recovery as a strong technology play, but look for reform in the sales and marketing functions before we can call it an all-round strong operation. Even as a technology play we have an interest in the stock and would add to positions in periods of trading weakness. There is a level of price support at $4.00. Should the stock fall below this level but still possess intact opportunities and product viability, we would be more aggressive buyers of ERII.