Ecolab (ECL): A High Quality Dividend Aristocrat Held by Bill Gates

Ecolab (ECL) is arguably one of the most reliable businesses that money can buy, which is perhaps why the company is a large holding in Bill Gates’ dividend portfolio here.

 

Although Ecolab’s dividend yield is low (1.1%), the company’s long-term growth outlook is excellent and supported by its impressive moat (90% recurring revenue in the form of essential consumables; entrenched customer relationships; twice as large as its next biggest competitor; more than 25,000 customer-facing employees).

 

Dividend growth investors will also appreciate the fact that Ecolab is a member of the dividend aristocrats list here, highlighting the durability of its business and its shareholder-friendly culture.

 

Let’s take a closer look at this impressive dividend grower to see if it’s an investment opportunity worth considering today.

 

Business Overview

Ecolab 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 2016 the company helped customers wash more than 31 billion hands, process 42% of the world’s total milk, clean 113 million loads of linen, ensure the safety of 27% of the world’s processed food, and manage 1.1 trillion gallons of water. Overall, Ecolab is in more than 1 million customer locations in over 170 countries around the world.

 

Acquisitions have played a meaningful role in the company’s evolution in recent years.

 

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 Ecolab serve customers more comprehensively.

 

In 2013, Ecolab acquired Champion Technologies for $2 billion to significantly enhance its position in the upstream energy services market. The company also acquired Anios, a European healthcare and hygiene business, for $800 million in 2017.

 

By geography, ECL generated 58% of its 2016 revenue in North America, 23% in Europe, Middle East and Africa, 13% in Asia Pacific, and 6% in Latin America. The company has been expanding its footprint in emerging economies like China and India which have a higher growth potential compared to mature markets like the U.S.

 

Segments

Global Industrial (36% of 2016 sales): provides water treatment and process applications, and cleaning and sanitizing solutions primarily to large customers within the manufacturing, food and beverage processing, chemical, mining and primary metals, power generation, pulp and paper and commercial laundry industries.

 

Global Institutional (35% of sales): provides specialized cleaning and sanitizing products to the foodservice, hospitality, lodging, healthcare, government, education, and retail industries.

 

Global Energy (23% 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 (6% 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 7,700 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, Ecolab’s main competitive advantages are its dependable service quality and people. The company focuses on continuous customer-centric innovation and personalized service. At the end of the day, Ecolab is selling service and consistency (e.g. food needs to be kept safe, water needs to be kept clean, etc.).

 

Ecolab carries out its value proposition with its 48,000 employees, and over 25,000 of its staff are in customer-facing roles.

 

These employees visit more than a million customer sites in more than 170 countries each year to provide service. These frequent touchpoints reinforce the value of Ecolab’s unique products and systems being used by the customer.

 

On-site visits also enable additional growth opportunities for the company. More specifically, Ecolab’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 Ecolab (the company’s addressable market is $100 billion in size and highly fragmented; Ecolab is the largest player with less than 15% market share).

 

Once Ecolab establishes a relationship with a customer, it works to introduce new products and solutions from all of its business segments. For example, Ecolab 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 Ecolab’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. During 2016, for example, Ecolab acquired the assets of UltraClenz, a developer of electronic hand hygiene compliance monitoring systems and dispensers, and Laboratoires Anios, a leading European healthcare and hygiene business.

 

As the largest player in the market, Ecolab 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, Ecolab grows with them.

 

The very nature of Ecolab’s products further adds to the strength of its business model. Over 90% of Ecolab’s business is a recurring revenue stream (e.g. customers consume Ecolab’s sanitizers and need to reorder).

 

While this provides reliable cash flow and stable operating margins (see below), it also results in sticky customer relationships that often last for decades.

 

 

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.

 

While Amazon (AMZN) is disrupting many industries, Ecolab seems likely to remain insulated from this risk because its employees build such strong relationships with customers and gather information critical to serving their needs better through on-site visits.

 

Simply put, Ecolab has benefitted from consistent product innovation, ongoing cost efficiency, and leadership positions in the huge global markets for food, water, energy and healthcare, which provide plenty of long term growth potential.

 

In fact, the company estimates that the world will require 40% more water, 35% more food, and 30% more energy by 2030, and Ecolab’s solutions will almost certainly play a major role in helping the planet get there in an efficient manner.

 

Key Risks

Soft economies, challenging end markets, and currency headwinds are usually the biggest short-term concerns for huge global companies like Ecolab. For example, the company derives 48% of its revenues from international markets, which have been volatile recently thanks to falling oil prices and geopolitical issues.

 

Ecolab has also been on a shopping spree, which brings about its own company-specific risks.

 

For example, Ecolab has made at least one acquisition almost every year in the last decade, and the Nalco and Champion acquisitions resulted in a significant accumulation of debt on its balance sheet. The company has used much of its cash for servicing its debt rather than paying significantly higher dividends to its shareholders, and it needs these deals to play out as expected.

 

With acquisitions come the issues of integration and accounting for new variables that might not have mattered much to Ecolab in the past.

 

Ecolab’s acquisitions of Nalco (2011 – $8 billion) and Champion Technologies (2013 – $2 billion) meaningfully altered the company’s mix, for example. More specifically, they increased the company’s exposure to industrial production and energy markets, perhaps adding some volatility to an otherwise stable business model.

 

However, even if Ecolab’s business is somewhat more volatile than it was in the past, the company is still extremely durable. Ecolab is well diversified by product, geography, customer, and technology, and about 90% of its sales are also recurring revenue streams in the form of consumable products (e.g. soaps, chemicals). Ecolab is likely here to stay for many years to come.

 

Ecolab’s Dividend Safety

We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.

 

Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.

 

Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.

 

 

We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.

 

Ecolab’s dividend payment appears to be extremely safe with a Dividend Safety Score of 98, which shouldn’t come as a big surprise since the company has paid uninterrupted dividends for decades.

 

The company’s strong dividend safety starts with management’s conservative payout policy. Over the last four quarters, for example, Ecolab’s dividend has only consumed 35% of its earnings and 38% of its free cash flow.

 

As seen below, these levels are remarkably consistent with the company’s historical payout ratios. This means that Ecolab’s dividend growth has been fueled by earnings growth. For such a stable business, Ecolab’s payout ratios are extremely safe and provide plenty of room for dividend growth.

 

 

Ecolab’s performance during the last recession also adds to the dividend’s safety profile. The company’s sales fell by just 4% in fiscal year 2009, and its free cash flow generation was about flat.

 

Customers still need to keep their food safe, facilities clean, and energy use efficient regardless of economic conditions. While Ecolab’s sales mix contains more industrial and energy exposure today as a result of its acquisitions of Nalco and Champion Technologies, the company’s fundamentals are still likely to be much less cyclical than the broader economy in the event of another recession.

 

 

Ecolab’s business is not capital intensive, generates strong margins, and is very predictable (90% of sales are recurring consumables). For these reasons, the company has generated dependable and growing free cash flow over the last decade, which has allowed the business to comfortably pay higher dividends while acquiring numerous businesses.

 

 

The only real negative factor against Ecolab’s dividend is its high debt load, which resulted from its acquisitions of Nalco, Champion Technologies, and Anios.

 

While the company plans to pay down some of its debt, Ecolab still has $7.5 billion of debt compared to $212 million of cash on hand. However, the company’s consistent free cash flow generation is reliable and easily covers the firm’s interest expenses and dividend payments. Ecolab also maintains an investment-grade credit rating.

 

 

Overall, Ecolab’s dividend looks very safe. The company’s payout ratios are relatively low, it generates strong and consistent free cash flow, and the business is fairly recession-resistant.

 

Ecolab’s Dividend Growth

Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.

 

Ecolab’s dividend Growth Score is 84, suggesting that the company’s dividend growth potential is excellent. The company has paid cash dividends on its common stock for 80 consecutive years, and its dividend growth has been impressive over the years.

 

As seen below, Ecolab’s dividend has compounded at a 13% annual rate over the last decade.

 

 

Ecolab last raised its dividend by 6% in December 2016 and has paid more dividends every calendar year since 1986, making it a member of the S&P Dividend Aristocrats Index.

 

Ecolab’s objective is to increase its dividend in line with earnings growth, which was lower in the last few years due to foreign exchange headwinds, weak energy markets, and sluggish global growth.

 

As a result, the pace of dividend growth slowed; however, given the improvements in energy and industrial markets, a more stabilized global economy, and Ecolab’s successfully integrated acquisitions, the company expects its full-year 2017 EPS to grow by 8% to 12%.

 

With a low payout ratio below 40% and potential to deliver double-digit earnings growth in the years ahead, Ecolab should comfortably increase its dividend in the high single-digit to low double-digit range going forward.

 

While this isn’t a stock for investors living off dividends in retirement, its long-term growth prospects are very strong.

 

Valuation

ECL’s stock trades at a forward P/E ratio of 27.7, which is a premium to both the S&P 500’s multiple of 17.6 and the materials sector’s forward P/E ratio of 18.3.

 

From a dividend yield perspective, ECL’s current 1.1% yield is about in line with its five-year average dividend yield of 1.1%.

 

Throughout its history, ECL has almost always looked expensive, yet the stock has outperformed the market most years. That’s largely because the company has been so successful at delivering consistent double-digit earnings growth, which continues to justify the stock’s premium multiple.

 

Investors certainly appear to be pricing in Ecolab’s quality and management’s expectations that the business can deliver double-digit annual earnings growth over the long-term.

 

Given ECL’s premium P/E multiple, the company needs to deliver on that guidance to generate reasonable total returns for shareholders going forward, and I would prefer to wait for a better entry point.

 

A pullback closer to $110 per share ($132 today) would create a more comfortable margin of safety and could happen if energy markets remain weak and industrial growth unexpectedly slows.

 

Conclusion

Ecolab appears to be a wonderful business with a bright future. The company’s massive service network, breadth of services, strong technology portfolio, large recurring revenue base, and long-lasting customer relationships will likely serve it well for many years to come.

 

High quality dividend aristocrats like these rarely trade at a discount, and Ecolab’s stock appears to be no exception. I prefer to remain patient for now, but this is certainly a great business to watch for long-term dividend growth investors.

 

Investors seeking greater income today can review some of the best high dividend stocks here instead.