Dividend Aristocrats In Focus Part 8: Ecolab Inc. (ECL)

There are just 51 stocks on the list of Dividend Aristocrats, which are members of the S&P 500 Index, that have raised their dividends for 25+ consecutive years.

In order to be a Dividend Aristocrat, a company must have clear competitive advantages, that it can sustain over long periods of time. It must have a strong position in its industry, a highly profitable business model, and the ability to grow through innovation.

Ecolab (ECL) is a perfect example of all of these qualities.

Ecolab was created in 1923, when its founder Merritt J. Osborn invented a new cleaning product called “Absorbit”. This product cleaned carpets without the need for businesses to shut down operations to conduct carpet cleaning.

Osborn created a company revolving around the product, called Economics Laboratory, or Ecolab. Today, Ecolab generates annual sales in excess of $13 billion.

This article will discuss the various factors behind Ecolab’s rise to prominence.

Business Overview

Ecolab operates three major business segments: Global Industrial, Global Institutional, and Global Energy, each of roughly equal size.

The business is diversified in terms of operating segments, and also geography. Approximately 42% of the company’s sales took place outside North America last year.

Source: 2016 Annual Report, page 2

The Global Industrial group provides water treatment, cleaning, and sanitation. Customers in this segment are primarily large firms in the food and beverage, manufacturing, chemical, and mining industries.

The Global Institutional business provides specialized cleaning and sanitation services, such as on-premise laundry, housekeeping, and food safety. Customers are primarily in the foodservice, hospitality, lodging, healthcare, and retail industries.

Lastly, the Global Energy segment includes the Nalco brand. Nalco provides chemical and water treatment services to the petroleum and petrochemical industries, specifically to oilfield services and refineries.

Growth Prospects

Ecolab has many positive growth catalysts. One of the company’s most important growth catalysts is acquisitions.

In 2016, Ecolab acquired UltraClenz, a developer of electronic hand hygiene systems and dispensers. It also acquired Anios, a European healthcare and hygiene business. These deals helped Ecolab expand its scale, particularly in the international markets.

The company has continued to pursue growth through acquisition in 2017. For example, on September 29^th, Ecolab announced the acquisition of Georgia Pacific’s paper chemicals business.

The purchase will help boost Ecolab’s growing paper business, which helps paper manufactures improve their efficiency, product quality, and profitability.

Acquisitions such as these, along with organic investment, have fueled steady earnings growth for decades.

Source: 2017 Investor Day Presentation, page 2

2016 was a challenging year for Ecolab. Net sales fell 2% for the year. Global Energy segment sales declined by 17% for the year, driven by weak commodity prices, which resulted in lower demand from the company’s energy customers.

Still, earnings-per-share were flat for the year, thanks to cost controls and growth in the company’s other businesses. Global Institutional sales increased by 5% for 2016.

Results have improved to start 2017.

Net sales increased 3% over the first half, while earnings-per-share increased 14% in the first six months. The company reported sales growth across all three businesses, led by another 5% increase for the Global Institutional segment.

Ecolab expects to get back on track this year. For 2017, management forecasts adjusted earnings-per-share of $4.70 to $4.90, which would represent an increase of 8% to 12% from 2016. Growth is expected to come from improving volume growth, and higher pricing, across all business segments.

Competitive Advantages & Recession Performance

Ecolab’s many competitive advantages include scale, a strong reputation among its customers, and innovation.

Ecolab serves more than 1 million customer locations, spread across more than 170 countries. The company is not afraid to spend significant resources on research and development of new products and services.

Management refers to R&D spending as its “innovation pipeline”.

Source: 2017 Investor Day Presentation, page 34

2016 marked the third year in a row of more than $1 billion in spending on the innovation pipeline. The company ended 2016 with more than 7,700 patents.

Ecolab’s R&D investments and intellectual property help the company stay ahead of the competition.

For clear evidence of Ecolab’s competitive advantages, look no further than its performance during the Great Recession:

• 2006 earnings-per-share of $1.43
• 2007 earnings-per-share of $1.66 (16% increase)
• 2008 earnings-per-share of $1.86 (12% increase)
• 2009 earnings-per-share of $1.99 (7% increase)
• 2010 earnings-per-share of $2.23 (12% increase)

Ecolab’s growth during the Great Recession was truly remarkable. Not only did the company generate positive earnings growth in each year of the recession, but in three of those years, it achieved double-digit earnings growth.

This, during arguably the worst economic downturn in the U.S., since the Great Depression. Ecolab’s recession performance makes it abundantly clear, that the company holds sustainable competitive advantages.

Valuation & Expected Returns

In the past four reported quarters, Ecolab had adjusted earnings-per-share of $4.46. This means the stock trades for a trailing price-to-earnings ratio of 29.5.

This is a high valuation, even for a strong company like Ecolab. Consider that the S&P 500 has an average price-to-earnings ratio of 25.4.

With a price-to-earnings ratio near 30, Ecolab appears to be overvalued right now. The stock is in danger of experiencing contraction of the valuation multiple, which would negatively impact total returns.

Fortunately, the company can grow fast enough to still generate satisfactory returns for shareholders. A breakdown of potential returns is as follows:

• 8%-10% earnings growth
• 1% dividend yield

A projected earnings growth rate of 8%-10% is roughly in-line with management expectations. From this, total returns could reach 9%-11% per year, minus any potential effect from a declining price-to-earnings ratio.

Ecolab’s dividend is not likely to represent a large portion of total returns. This is because the current dividend yield is just 1.1%. This is about half the average dividend yield of the S&P 500 Index.

Final Thoughts

Ecolab is a time-tested Dividend Aristocrat, with an excellent track record of profitability and growth. However, now is not the best time to buy the stock, due to its high valuation and low dividend yield.

Ecolab is not likely to be an attractive stock for investors interested solely in high levels of income. That said, it is a very strong stock for investors interested in a recession-resistant business, and dividend growth.