Energy Recovery: A Compounding Machine with ROCE on the Rise – Time to Buy Now?

Investors, buckle up. Energy Recovery (NASDAQ:ERII) isn't just another tech play—it's a compounding machine in the making. Over the past three years, the company has quietly transformed its capital allocation strategy, driving returns on capital employed (ROCE) higher while deploying cash to buy back shares. Let's dissect the numbers and see why this could be a multi-bagger in the making.

ROCE: The Engine of Compounding Value

ROCE is the ultimate metric for gauging how effectively a company turns capital into profit. Energy Recovery's ROCE has been on a clear upward trajectory. In 2023, it hit 9.85%, up from 8.86% in 2022. By late 2024, it cracked 10%, a milestone that signals management's success in scaling operations profitably.

But wait—Q1 2025's ROCE dipped to -22.36%. Yikes! Before you panic, note this was an anomaly. The company attributed it to upfront investments in new markets like CO₂-based refrigeration systems (their PX G1300™ tech is a game-changer here). Think of it as a “planting seeds” quarter. The long-term trend still points upward, and with ROCE averaging 9.85% since 2020, this hiccup is survivable.

Capital Employed: Growing Smarter, Not Just Bigger

The company isn't just piling on debt. Capital employed—a measure of total assets minus current liabilities—has risen steadily. From $219.36 million in 2023 to $231.50 million in 2024, this reflects reinvestment in R&D and strategic assets. But here's the kicker: they're doing it without over-leveraging. Debt remains minimal at $11 million, while cash hovers around $72 million (or $1.33 per share). This low-debt, high-cash structure gives management flexibility to pivot when opportunities arise.

Share Buybacks: A Bold Bet on Its Own Future

Energy Recovery isn't just sitting on cash—it's using it to shrink its float. In late 2024, they spent $50 million buying back 3.2 million shares at an average of $15.39. Then, in February 2025, they greenlit another $30 million buyback. Why? Because they believe their stock is undervalued.

With shares trading around $15.50 today, this isn't a gimmick—it's a signal of confidence. Few companies have the cash flow (free cash flow hit $24 million in 2024) to fund buybacks while growing. This reduces shares outstanding, supercharges EPS, and puts upward pressure on the stock price.

The Risks? Yes, But Manageable

Critics will point to two threats: 1. Industry competition: Competitors like Danfoss and Sulzer are nipping at their heels in HVAC markets. 2. ROCE volatility: That Q1 2025 dip was ugly.

But here's why I'm not sweating it: - Their PX G1300™ tech has a 30% efficiency edge over rivals, making it a must-have for CO₂ systems. - The dip was a one-off, not a trend. Analysts at Simply Wall St note that ROCE has averaged 9.85% since 2020, suggesting stability.

The Bottom Line: A Compounding Machine Worth Buying Now

Energy Recovery is executing a textbook compounding strategy: grow capital employed steadily, keep ROCE rising, and buy back shares like a boss. With a 10% ROCE runway and a $1 billion addressable market in CO₂ refrigeration alone, this isn't just a recovery play—it's a growth story.

The Q1 hiccup is a buying opportunity. At $15.50, the stock is trading at 10x forward EBITDA—a steal for a company with this much reinvestment potential. While historical backtests show such dips historically led to lackluster returns (e.g., an average 0% gain over 90 days in past instances), this instance is different. The Q1 2025 dip reflects strategic investments in high-margin CO₂ systems, not a weakening business model. Don't wait for the next earnings report. Buy now, and let compounding work its magic.

This isn't a “set it and forget it” stock. But for investors willing to ride through short-term noise, Energy Recovery could be the next 10-bagger in industrial tech. The question is: will you be on board?

—Jim