Monday, June 18, 2007

Ecolab- Consistency Comes at a Price

Ecolab (ECL) is a model of consistency. The company develops and markets products and services for a wide array of markets including hospitality, foodservice, healthcare and general industry .This includes providing cleaning and sanitizing products and programs, as well as pest elimination, maintenance and repair services primarily to hotels and restaurants, healthcare and educational facilities, quick-service (fast-food and other convenience stores), grocery stores, commercial and institutional laundries, light industry, dairy plants and farms, food and beverage processors, and the car wash industry. Here is a recent newspaper view of Ecolab.

The company enjoys steady demand from the continuous efforts of business to comply with sanitary requirements particularly with regard to germs such as Salmonella. The company has been recognized for its ethical leadership and corporate social responsibility.

Despite what seems like a fairly mundane business, at least superficially, the business has shown excellent growth with revenues compounding at 16.1% over the last five years and e.p.s. at about 14.6% over the same period. About half of its sales are made outside of the US.

The company retains some 90% of their clients largely because of a business model that emphasizes high-touch service from their salespeople who work directly with their clients ' employees. The CFO of the company explains the repeat business with great simplicity and straightforwardness..."the moment you clean it up, it gets dirty again." The authenticity of what makes a simple business successful rings so clearly doesn't it?

Frequently, this provides the opportunity to cross-sell additional products and services. Internationally, the full scope of service and product offerings is not yet complete, and hence operating margins and working capital management tends to be somewhat less than the domestic business. But, this also represents a significant opportunity for improvement since margins trail by about 400 basis points on roughly half the business.

On a valuation basis, the stock is a little rich selling at about 30.2 times sustainable earnings per share. On a free cash flow basis, the stock seems a lot more palatable at 22.5 times FCF or a 4.4% FCF yield.

With an enterprise value of about $11.5 Billion, debt represents only about $800 million. EV/EBIT is about 18.3 times, again not terribly cheap. Return on invested capital is healthy at about 16.5% and revenues per dollar of invested capital have improved steadily over the last few years. Return on equity is about 23%, in-line with its historical averages. Operating working capital now represents only about 4% of revenues whereas it had been averaging around 9 to 10%. The cash cycle has improved quite dramatically to turn every 12 days, down from about 20. Capex now represents about 8% of revenues, in line with the past.

The current dividend yield is 1.25%. The five year dividend growth has been about 9.5%. In addition, the company has returned capital to shareholders through share buybacks. These have totaled about $173 million in the first quarter and about $283 million for all of last year.

Here is a look at the cash flow drivers

As well, here is a look at the valuation ratios and analytics courtesy of Reuters.

The most recent Wall Street Transcript included an interview with Dmitry Siulverstein who covers specialty chemical research at Longbow Research. (TWST subscription required)

As he says:

I like Ecolab - it's hard not to like the company. You have to be selective when you buy the stock because it never looks cheap, but to the extent you can buy it on a dip, even if it's a small dip, you will enjoy nice long-term gains with the stock. I think the biggest appeal of Ecolab is predictability. The company gives you a very narrow guidance for earnings for the year, and a $0.02 range for earnings in the quarter. Quarter-in and quarter-out, they deliver results at the top end of their guidance. This predictability and sustainability of results, combined with the company's excellent position in its market where they are continuing to gain market share and growing significantly above the growth rate of their industry, makes this somewhat of a growth name.

Ecolab is the biggest player in this industry, but despite their size and scale, they still represent less than 20% of the market.

Bottom-line, not a great deal of downside unless a recession really demolishes discretionary spending in the hospitality industry. International opportunity for improvements still exist. Not quite as cheap as I would like but clearly on my watch list for now.

Disclaimer: Neither I, my family or clients have a current position in Ecolab.


Post a Comment

<< Home

< ? Market Blogs £ >