Ecolab Inc.

Moat: 4/5

Understandability: 2/5

Balance Sheet Health: 4/5

Ecolab is a global leader in water, hygiene, and infection prevention solutions, serving a wide range of industries and locations and is focused on helping its clients operate safely and efficiently.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Ecolab provides water, hygiene, and infection prevention solutions. The company’s offerings are essential for various businesses across the globe, particularly in the areas of food and beverage, healthcare, and hospitality industries.

Business Overview and Competitive Landscape:

Ecolab is a large player in the world of water, hygiene, and infection prevention solutions, with a wide array of products that serve a diverse set of end users. Its main sectors can be summarized as follows:

  1. Global Industrial: This segment offers water treatment and process applications, cleaning and sanitation programs, and specialty chemicals for industrial customers, including energy, manufacturing, and other industrial end users.
  2. Global Institutional & Specialty: This segment provides products and programs for the hospitality, healthcare, foodservice, education, and retail sectors, including food and beverage, laundry and housekeeping, and pest elimination products and services.
  3. Global Healthcare & Life Sciences: This area includes infection control and medical device cleaning and disinfection for hospitals and other healthcare facilities, along with biotechnology manufacturing and pharmaceutical companies.

The company’s competitive landscape is complex, as the industries it operates in are very fragmented and each segment has specific competitors with different strategies. That said, a few key competitors worth knowing are: * Diversey: A major provider of cleaning and hygiene solutions, similar to Ecolab. * Kimberly-Clark Professional: Offers hygiene products and solutions. * Steris Corporation: Competes in sterilization, infection prevention, and healthcare technologies. * 3M: A well-diversified conglomerate with a wide variety of products, including those in the cleaning and safety spaces. * Waterlogic: Competes with water treatment solutions and systems for a wider range of commercial and residential customers.

Ecolab, while not a monopoly, has a significant market share in many of its key sectors. It has also managed to create a vast distribution network, and a strong recurring revenue base. Furthermore, Ecolab’s products, due to their essential nature, are embedded in the customer operations, creating strong relationships that are often maintained for long periods of time.

Financial Analysis Ecolab’s recent financial performance can be seen in its Form 10-Q for September 30, 2023 and the Form 10-K for the fiscal year ended December 31, 2022. Below is a brief summary.

Financials

  • Sales: Third quarter 2023 net sales grew 7% on a reported basis and 9% in constant currency year-over-year, reaching $3.7 billion. YTD through September 2023, sales grew by 10% YoY.
  • The company has been able to consistently grow sales over the past couple of years. Management noted that they expect strong sales growth in Q4, 2023 as well.
  • Operating Income: Third quarter adjusted operating income was $561 million, a 12% increase YoY in constant currency. The company’s operating margin has improved 100 basis points to 14.4% in Q3, 2023. For the nine months ended September 2023, the operating margin was 12.5%, a noticeable improvement from prior years.
  • Net Income: For the third quarter of 2023, adjusted EPS was $1.75, representing an 18% increase. YTD through September 2023, EPS is $3.93. The company is benefiting from operational improvements, and higher sales volumes.
  • Cash Flow: In Q3, 2023, operating cash flow was $453.4 million (negative compared to 1601.4 for first nine months of 2022), with a free cash flow of -$34.9 million for the quarter and ~$1.5B for the first nine months of 2023.
  • Ecolab expects to achieve free cash flow of $1.9 to $2.1 billion in 2023.
  • Debt and Leverage: Long-term debt is at $8.5B and total liabilities are at $14.1B. Debt/equity at 2.8x is reasonably leveraged and well within comfortable levels.
  • While high in absolute value, the company’s debt is typical for its industry and is not a major concern for long-term investors. Also, given the nature of their business, a big portion of debt is offset by a vast and valuable supply network and long term recurring revenues. The company has a high interest coverage ratio.
  • Guidance: Ecolab raised its earnings guidance for 2023 in their latest earnings call, to approximately $5.65 per share, from the previous $5.40. They continue to expect robust sales growth for Q4, 2023.
  • It’s worth noting, in late 2022, Ecolab raised prices to combat cost inflations. This has helped margins considerably in the past year and the company expects these improvements to continue into the future.

Moat Assessment:

Ecolab has a very strong moat rooted in 4 dimensions. (1) Switching costs: customers of Ecolab tend to be loyal due to the nature of the business. Switching requires companies to learn a different system, which may be problematic and risky. (2) Scale: Ecolab has built a massive worldwide distribution network and supply chain, making it difficult for smaller players to compete. (3) Intangible assets: Ecolab has amassed an incredible amount of know-how, experience, and data that is very hard to replicate. It also has a variety of patents. (4) High Barriers to Entry: Ecolab operates in industries that are highly regulated and where new entrants will find it incredibly hard to take market share from an already established company.

Based on the above, the moat score for Ecolab is 4 out of 5. The company does not enjoy absolute lock-in of its clients but a significant level of stickiness, thus lowering its moat to a narrow moat from a wide one, but still very strong.

Risks:

While Ecolab has a strong moat, a few risks could threaten its profitability and value:

  • Economic Recession: During an economic downturn, clients may reduce their usage of Ecolab products, which can translate into lower revenues for the company. This threat, however, is fairly minor since all the company’s products and services are essential for companies’ operations.
  • Commodity Costs: Significant increases in raw material costs or oil, like we see in recent years, could squeeze Ecolab’s margins and lead to pressure on profits.
  • Technological Disruption: A new disruptive technology that threatens Ecolab’s existing products could be a challenge, but given the nature of the industry it will be hard to see that in the next 5-10 years.
  • Competitor Actions: A new technology developed by a competitor could erode profitability if it cannot be replicated by Ecolab. * Customer Concentration: Although unlikely for Ecolab, a large percentage of its sales from a single or a few clients could become problematic if that client chose to defect or if they encountered financial difficulties.

Ecolab has a good track record of bouncing back from tough times. The company is able to pass inflation in commodity prices by raising prices itself, and can continue to see consistent sales growth through its global operations. Despite the above risks, the business appears to be highly resilient.

Understandability Rating: Ecolab’s business is complex and operates in a variety of industries. It has a lot of moving parts. I’d give the business an understandability rating of 2 out of 5, because while its core idea is easy to understand (selling water, hygiene, and infection prevention products and solutions), the various industries the company operates in and the large amount of services it provides make it somewhat complicated for an average investor to understand in great detail, requiring a good degree of specialized knowledge.

Balance Sheet Health Rating: The company has a reasonably strong balance sheet, with manageable leverage, a very strong free cash flow, and adequate liquidity. Because of this, the company’s balance sheet health is rated a 4 out of 5. The main problem comes from the absolute value of debt. But given the high earnings and cash flow, it should not be seen as a threat.