Saturday, July 14, 2007

Ecolab Followup-Transforming from Soap to Services

About a month ago, I wrote a post on Ecolab (ECL) describing it as a model of consistency. As I quoted Dmitry Siulverstein who covers specialty chemical research at Longbow Research:

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.

Last week’s edition of The Wall Street Transcript (TWST subscription required) had an interview with Doug Baker, the Chairman, President and CEO of Ecolab. I frequently use TWST interviews to get a deeper picture of the corporate strategy of the business.

Here are some excerpts from that interview that I think help to position the corporate strategy:

“We are the food safety and infection prevention experts. Our promise to our customers is that we will help them create cleaner, safer, healthier products and environments…Our primary drivers are a continued focus on innovative new products and programs backed by unbeatable service support. Today, 40% of our sales are products and programs introduced in the last five years, and those products are backed by more than 13,500 sales and service experts worldwide. We excel at sales and service execution because it's core to satisfying our customers and delivering on our promise to them.”

“We're expanding our pest elimination business, which has the leadership position in the US, and driving it globally…Health care, particularly acute care, is also an area of interest for us and is a place that we've been investing, both through acquisitions and through organic growth of our existing business. Kitchen equipment repair is another target area in the US. It is just as it sounds - fixing cooking and cooling equipment in restaurants. Interestingly, restaurants (our largest market segment) spend as much on kitchen equipment repair as they spend on everything else we sell them, so it's a "double-the-market" idea for us. It's also a fragmented industry that gives us a lot of opportunity to build on our leadership position. We're also helping our customers reduce the amount of water and energy it takes for them to get a clean, safe and healthy environment.”

Mr. Baker describes the primary drivers that have provided Ecolab its dominant position in the marketplace:

"It is a fragmented business. We are the leader in this industry. We have a 12% share of the $40 billion market opportunity. There were several key actions in the past that enabled us to attain this:"

"Development of solid product technology. This is where we took what have historically been liquid products and offered them in a much more convenient and easier to use solid (waterless) form. We can offer a solid product in place of a five-gallon pail of cleaning product, cutting the weight by seven-eighths, from 45 pounds to eight pounds and achieve superior cleaning results. It gave us huge advantages in terms of greater ease of product use, safety, storage, product usage control, lower transportation cost, and reduced customer disposal volume, all of which reduced overall customer costs and developed greater customer satisfaction."

"Development of our chain accounts business…Foreseeing the rapid growth in restaurant and lodging chains, particularly in the US foodservice market."

"The third would be our advanced sales and service concept. We don't just sell products - we couple them with high levels of individualized customer service…Our service capabilities in assisting our customers with solving critical cleaning and sanitizing problems - and protecting their brand names in a world increasingly concerned about food-borne illness."

Food contamination is a serious issue. An estimated 76 million cases of food-borne disease occur each year in the United States. The majority of these cases are mild and cause symptoms for only a day or two. Some cases are more serious, and CDC estimates that there are 325,000 hospitalizations and 5,000 deaths related to food-borne diseases each year.

A new report published in April of this year by the US Centers for Disease Control and Prevention reveals a 50 percent increase in E coli infections since 2004, and a huge 78 percent increase in Vibrio infections - caused by eating raw shellfish - over the past decade.

Food safety is becoming a much more serious issue. Here is a link which highlights the confusion that exists that relates to food safety monitoring and regulation. As the article describes:

“Under current law, food safety monitoring, inspection and labeling functions are spread across 15 agencies in the federal government, including the US Department of Agriculture (USDA) which oversees meat, poultry and egg products; the Food and Drug Administration (FDA) which oversees most other food products; and the US Commerce Department's National Marine Fisheries Service which inspects fish. The agencies collectively administer at least 30 laws."

The General Accounting Office (GAO) has called for legislators to radically amend the system, which the federal auditor said leaves the US food chain open to attack by terrorists.

It seems to me that strengthening of regulatory oversight as well as its unification will force many producers to enhance their food safety procedures, which should only mean continuing demand for Ecolab services.

Large opportunities exist in the healthcare markets as well. Here are some stats from a presentation made to a Credit Suisse conference earlier this year:

“What's interesting about the healthcare industry as shown here is that hospital-acquired infections are the Number 4 killer in the US. And that's more than auto accidents and murders combined. It's something that we think we can make a lot of headway in, improving in the US -- particularly when it involves something as basic as basic sanitation. So we're developing products for the healthcare area, to help them address that. It's a $3 billion market. We just entered it a couple years ago.”

With EBITDA/ interest paid of almost 17 times, this steady demand company is under-levered.

In my original post, I had neglected to mention the 29% ownership of Henkel, the massive German detergents, cosmetics, and adhesives company.

Ecolab's agreement with Henkel limits the German company to owning no more than 35 percent of Ecolab's stock between now and the end of 2010.

Per the most recent proxy statement:

“Henkel’s equity ownership in the Company is subject to an agreement (“Stockholder’s Agreement”) containing certain restrictions pertaining to, among other things, Henkel’s acquisition, transfer and voting rights of our Common Stock. Generally, the Stockholder’s Agreement terminates when Henkel owns less than 2% of our voting shares. Pursuant to the Stockholder’s Agreement, Henkel is precluded from acquiring more than 35% of our outstanding Common Stock or from acting, alone or in concert with others, to control or influence the Company. Henkel may sell its shares of our Common Stock under certain conditions specified in the Stockholder’s Agreement, subject to our right of first refusal. Any disposition by Henkel of any shares of our Common Stock would be effected in an orderly manner....including our right of first refusal."

Henkel could make a takeover bid after that point. Alternatively, Ecolab could purchase Henkel’s stake (at current prices, worth around $3.2 billion) Added to current long term debt of about $550 million, even at a 7.5% interest rate would result in EBITDA interest coverage of 2.8 times.

There is precedent. In October of 2004, Clorox Co. and Henkel KGaA agreed to a $2.8 billion stock swap and cash deal, in which Henkel sold back its 29 percent ownership stake in Clorox in return for $2.1 billion in cash, as well as a handful of Clorox businesses and a position in a Spanish joint venture valued at $745 million.

The company remains on my watch list but I am increasingly intrigued by this company that is transforming itself from soap to services.

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


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