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.
Business Overview
ECL’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 ECL’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, ECL 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 foodservice, 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
ECL 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.).
ECL 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, ECL 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, ECL 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. ECL 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 ECL’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.
Source: Simply Safe Dividends
With cleaning and sanitizing products representing a small cost of the customer’s overall operations, ECL 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 ECL 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 ECL 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 contract significantly (this would be a great buying opportunity). The company’s stretched balance sheet doesn’t help either.
Even if ECL’s business is somewhat more volatile than it was in the past, the company is still extremely durable. It is well diversified by product, geography, customer, and technology. About 90% of its sales are also recurring revenue streams in the form of consumable products (e.g. soaps, chemicals). ECL is here to stay for many years to come.
Dividend Analysis
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. ECL’s long-term dividend and fundamental data charts can all be seen by clicking here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
ECL’s dividend payment is extremely safe with a Safety Score of 98. Over the last four quarters, ECL’s dividend has consumed 36% of its earnings and 32% of its free cash flow. As seen below, these levels are remarkably consistent with the company’s historical payout ratios. This means that ECL’s dividend growth has been fueled by earnings growth. For such a stable business, ECL’s payout ratios are extremely safe and provide plenty of room for dividend growth.
Source: Simply Safe Dividends
Source: Simply Safe Dividends
ECL’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. ECL’s sales mix contains more industrial and energy exposure today as a result of its acquisitions of Nalco and Champion Technologies, but we believe its fundamentals are still likely to be much less cyclical than the broader economy in the event of another recession.
Source: Simply Safe Dividends
ECL’s business is not capital intensive, generates strong margins, and is very consistent (90% of sales are recurring consumables). For these reasons, the company has generated dependable and growing free cash flow over the last decade:
Source: Simply Safe Dividends
The one grip we have about ECL’s dividend safety is the company’s balance sheet. ECL financed its Nalco and Champion Technologies acquisitions with a lot of debt, which it is in the process of paying down. As seen below, ECL has $6.8 billion of debt compared to $185 million of cash on hand. However, the company’s consistent free cash flow generation is reliable and easily covers ECL’s interest expenses and dividend payments.
Source: Simply Safe Dividends
Overall, ECL’s dividend is 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.
Dividend Growth Score
Our 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.
ECL’s dividend Growth Score is 79, suggesting that the company’s dividend growth potential is excellent. The company has paid cash dividends on its common stock for 79 consecutive years. Most recently, ECL raised its dividend by 6% in December 2015 and has paid more dividends every calendar year since 1986, making it a member of the S&P Dividend Aristocrats Index.
As seen below, ECL’s dividend has compounded at a 14% annual rate over the company’s last 10 fiscal years.
Source: Simply Safe Dividends
ECL’s objective is to increase its dividend in line with earnings growth, which was lower in 2015 due to foreign exchange headwinds, weak energy markets, and sluggish global growth. However, the company continues to believe it can compound earnings at a 15% annual rate going forward.
While this isn’t a stock for investors living off dividends in retirement, its long-term growth prospects are outstanding.
Valuation
ECL trades at about 21x forward earnings and offers a dividend yield of 1.4%, which is somewhat higher than its five year average dividend yield of 1.1%. Throughout its history, ECL has always looked expensive, yet the stock has outperformed the market most years (consistent 15% earnings growth will do that).
Currency headwinds and weak energy markets are impacting ECL’s near-term earnings growth, but the company continues to believe it can achieve 15% annual earnings growth longer term. If true, the stock appears to be very reasonably priced today considering ECL’s quality and offers double-digit total return potential.
However, if energy and industrial markets weaken further, an even better buying opportunity could present itself.
Conclusion
ECL is a wonderful business with a bright future. The company’s massive service network, breadth of services, strong technology portfolio, recurring revenue, and long-lasting customer relationships will likely serve it well for many years to come. ECL is no doubt one of the best blue chip dividend stocks that long-term dividend growth investors should keep in mind.
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