Ecolab Inc. (NYSE:ECL) has generated consistently strong earnings growth over the past two decades. Its robust and durable competitive advantages derive from its heavy R&D focus, innovative products, and sizable highly-trained sales force.
Ecolab delivers comprehensive solutions to promote safe food, maintain clean environments, optimize water and energy use and improve operational efficiencies for customers in the food, healthcare, energy, hospitality and industrial markets in more than 170 countries around the world
About 90 percent of its sales are recurring, which provides earnings support during economic downturns. As the largest player in highly fragmented industries, it has ample opportunities to grow its market share organically and via acquisitions.
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"ECL should benefit from global secular trends, such as the need for safe food, clean water, healthier environments, and energy," UBS analyst John Roberts wrote in a note to clients.
Over the past 20 years, Ecolab has generated consistently strong sales (13.6 percent CAGR) and EPS growth (13.1 percent CAGR). Over that period, a combination of organic revenue growth, investment in R&D and internal operations, and acquisitions has fueled the company's impressive operating performance.
Ecolab has met or exceeded management's EPS expectations in 85 of the last 86 quarters The company is targeting long-term EPS growth of 15 percent, which is conservative given the growth opportunities that lie ahead.
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Ecolab's business model combines a heavy R&D focus and innovative products which confer low total ownership costs with a highly-trained, 25,000-person sales force who provide analytical/monitoring services to their customers.
"The company competes on product quality and service rather than on price, and its sales people typically offer suggestions to customers on ways to reduce water, energy, maintenance, a! nd/or labor costs. Such cost savings often outweigh the price differential between ECL's products and the more commoditized offerings from competitors," Roberts noted.
Ecolab has a high degree of recurring sales. Ecolab is primarily a business-to-business services company, with about 25,000 of its 44,000 employees dealing directly with customers, providing advice and training for their products.
As a result, capital expenditures have generally been moderate at about 5 percent of sales. More than half of the capital outlays are for dispensing equipment typically leased to a customer, such as an ECL-designed dishwashing machine. These machines are the "razors" into which only Ecolab's chemicals (i.e. "razor blades") may be used. As a result, about 90 percent of ECL's revenues are recurring consumables.
"ECL's products generally represent a small portion of its customers' overall cost base, yet are critical components that are non-discretionary in nature," Roberts said.
The company has leadership positions in highly fragmented markets. The company holds the #1 or #2 position in nearly every market it operates. Nevertheless, its share of its addressable market of nearly $100 billion is only about 14 percent. The vast balance of its market is extremely fragmented, comprised of thousands of local competitors.
"On a pro-forma basis including run-rate sales for recent acquisitions Nalco and Champion, we estimate ECL's 2013 revenues will total more than $13bn," Roberts wrote.
The company's biggest strength is in its ability to weather the economic downturn. During challenging economic environments, Ecolab can focus on adding new customers, given its relatively low market share.
Under stronger economic conditions, the company can pursue deeper penetration of existing customers, who, on average, purchase only about 50 percent of its s product offerings. Further penetration of current customers also provides higher incremental profit margins.
"The company's legacy str! engths ha! ve been in chemicals and services to improve food safety and provide healthier environments (cleaner, pest free, etc.)," Roberts noted.
The Nalco acquisition in December 2011 added leadership in addressing the need for clean water as well as chemicals and services to facilitate oil and gas production/processing (also very water intensive). The energy capabilities were further enhanced with the recent Champion acquisition.
Investors have rewarded Ecolab's track record of consistently strong earnings growth as well as defensive qualities during economic downturns with a considerable premium valuation. The company's current forward P/E multiple of 25.5 times is about 20 percent above its 10-year average of 21.2 times.
"We believe this multiple is justified by ECL's strong earnings growth prospects and defensive characteristics during economic downturns.," Roberts added.
Buoyed by its strong operating results, the total return of Ecolab shares have far outpaced that of the S&P 500 over the past 20 years. Over that time, Ecolab's total return is nearly 1,800 percent versus the almost 300 percent total return of the S&P 500. Despite its lofty valuation, Ecolab offers attractive return potential over the next 12 months.
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