Ecolab (ECL): A High Quality Dividend Aristocrat With Great Growth Potential by Simply Safe Dividends

Ecolab (ECL) is one of the most reliable businesses that money can buy. Although its dividend yield is low (1.4%), the company’s long-term growth outlook is outstanding and supported by ECL’s moat (90% recurring revenue in the form of essential consumables; entrenched customer relationships; twice as large as its next biggest competitor; 25,000 customer-facing employees).

We look for these types of business for our Long-term Dividend Growth portfolio and believe that weak energy markets, currency headwinds, and sluggish global growth could be providing a buying opportunity.

Ecolab (ECL) – Business Overview

Ecolab’s sells a wide range of sanitizers, cleaners, lubricants, cleaning systems, dispensers, water treatment products, and on-site services that are used by customers in virtually every industry (e.g. restaurants, hotels, hospitals, laundromats, manufacturing plants, oil wells, etc.) to keep their food safe, maintain clean environments, and optimize water and energy use.

To give you an idea of Ecolab’s scope of business, during 2014 the company helped customers wash more than 31 billion hands, clean dairy operations to help process 330 billion glasses of milk, process 1.2 billion loads of laundry, manager water on 100 offshore oil platforms, wash more than 146 billion plates, and manage 14 trillion liters of water. Overall, ECL is in more than 1 million customer locations in 172 countries around the world.

The company merged with Nalco in 2011 in an $8 billion deal to become the global leader in water, hygiene, and energy technologies and services. This deal increased the company’s exposure to industrial markets, which are big users of water treatment products, and helped ECL serve customers more comprehensively. In 2013, ECL acquired Champion Technologies for $2 billion to significantly enhance its position in the upstream energy services market.

By geography, Ecolab generated 56% of its 2014 revenue in North America, 24% in Europe, Middle East and Africa, 12% in Asia Pacific, and 8% in Latin America.

Segments

Global Industrial (35% of 2014 sales): provides water treatment and process applications, and cleaning and sanitizing solutions primarily to large customers within the manufacturing, food and beverage processing, chemical, metals and mining, power generation, pulp and paper, and laundry industries.

Global Institutional (30% of sales): provides specialized cleaning and sanitizing products to the food-service, hospitality, lodging, healthcare, government, education, and retail industries.

Global Energy (30% of sales): serves the process chemical and water treatment needs of the global petroleum and petrochemical industries in both upstream and downstream applications. The biggest piece of the business is oil fuel chemicals that treat reservoirs (e.g. kill bacteria, prevent corrosion, clean water).

Other (5% of sales): provides pest elimination and kitchen equipment repair and maintenance.

Business Analysis

Ecolab is a unique business. The company has a large portfolio of valuable and protected technologies (over 6,700 patents) that allow it to sell its solutions at 10-20% price premiums compared to competitors’ offerings. While the initial cost is higher, the savings that these products deliver over time (e.g. less waste, more energy efficient, more reliable) make them cheaper.

However, ECL’s main competitive advantages are its dependable service quality and people. At the end of the day, ECL is selling service and consistency (e.g. food needs to be kept safe, water needs to be kept clean, etc.).

Ecolab has around 47,000 employees, and a whopping 25,000 are customer-facing. These employees visit more than a million customer sites in 172 countries each year to provide service. These frequent touchpoints reinforce the value of ECL’s unique products and systems being used by the customer.

On-site visits also enable numerous growth opportunities for the company. ECL’s service-driven business model allows it to pursue a unique growth strategy that it calls, “Circle the Customer – Circle the Globe.” Essentially, Ecolab realizes that its customers are spending about $6 on addressable products for every $1 they spend with ECL (the company’s addressable market is $100 billion in size and highly fragmented; ECL is the largest player with 14% market share share).

Once ECL establishes a relationship with a customer, it works to introduce new products and solutions from all of its business segments. For example, ECL might first win business with a restaurant with its dishwashing technology. From there, the company can try to sell products needed to clean the restaurant, help with water filtration, eliminate pests, keep food safe, repair kitchen equipment, and much more. Hotels are similar – their food services are very similar to a restaurant, and they have substantial room cleaning and laundry operations that can all use ECL’s products.

With such a large service network in place, Ecolab is able to develop or acquire new products that can be scaled across its global operations or cross-sold into related markets very efficiently. As the largest player in the market, ECL also benefits because the largest customers in the market require a supplier that can meet their needs on a national or global level. They do not want to work with 100+ suppliers and systems around the world. Ecolab is uniquely positioned to handle their scale and complexity thanks to its breadth of products and global service team. As those big customers grow their businesses and expand into new regions, ECL grows with them.

The very nature of Ecolab’s products further adds to the strength of its business model. Over 90% of ECL’s business is a recurring revenue stream (e.g. customers consume ECL’s sanitizers and need to reorder). While this provides reliable cash flow and stable operating margins (see below), it also results in customer relationships that often last for decades.

Ecolab

Source: Simply Safe Dividends

With cleaning and sanitizing products representing a small cost of the customer’s overall operations, Ecolab should retain the business as long as they don’t screw anything up. Furthermore, ECL’s employees build stronger relationships with customers and gather information critical to serving their needs better through their on-site visits.

Overall, ECL’s leadership in the huge global markets for food, water, energy and healthcare provide plenty of long term growth potential. The company seeks to grow earnings by 15% per year and improve its return on invested capital to 20% over time.

Key Risks

ECL’s acquisitions of Nalco (2011 – $8 billion) and Champion Technologies (2013 – $2 billion) meaningfully altered the company’s mix. More specifically, they increased the company’s exposure to industrial production and energy markets.

Some investors worried that Ecolab added unnecessary volatility to its otherwise stable business model. Management had to cut guidance twice in 2015 (extremely rare for ECL), perhaps adding some legitimacy to these concerns.

With energy markets reeling and global growth remaining sluggish, these fears could be put to the test in 2016. The stock continues trading at a relatively high earnings multiple, suggesting that investors expect Ecolab to power through just about any macro environment like it always has with little fundamental risk.

However, if depressed oil prices and sluggish industrial activity disrupt ECL’s results, the stock could meaningfully correct. During the third quarter of 2015, ECL’s Global Energy segment saw its sales fall by 12% in the third quarter of 2015. Time will tell how the next few quarters turn out with even lower oil prices, but if the company reports a material earnings miss, its valuation multiple could

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