"A rising tide lifts all boats" is a quote attributed to President John F. Kennedy. It is ssociated with the idea that a good economy (and in particular government economic policy) will benefit all participants. With the Covid-19 pandemic, we have seen the results of the government creating a tidal wave of unprecedented monetary and fiscal stimulus for the economy, which lifted nearly all stock market boats to new highs - even the leaky ones.
Well, now the tide is running out. The government's fiscal taps have been turned off, and central banks around the world are raising interest rates. As Warren Buffett (Trades, Portfolio) famously quipped, "when the tide runs out, you see who is swimming naked." That's what we're beginning to see now. Lots of profitless tech companies and debt-laden zombie companies are now swimming naked (not a pretty sight) with their stock prices decimated.
But thinking further about Buffett's quip, when the tide runs out, you also see who is dressed appropriately. There are companies which may be experiencing temporary issues because of Covid disruption or the sudden rise of inflation, but are likely to bounce back given some time. So, I am on the lookout for companies which are in good shape and are standing tall in the low tide.
One such company is Ecolab (ECL, Financial), but while the business is great, the valuation might not make the cut.
About Ecolab
Ecolab is speciality chemical company and a world leader in cleaning and water treatment chemicals, systems and consulting. It brings a comprehensive and cost effective systems approach to managing the water, hygiene and energy use for its industrial and institutional customers.
The company's customer relationships are very sticky. Once an organization to organization relationship has formed, it's not easy or cost effective for the customer to move to another vendor easily. Typically what the customer spends on solutions provided by Ecolab are a small part of its cost structure, but it is critical. For example, a contamination of the customer's water systems could have very serious consequences. It's just not worth it to take the risk or hassle of changing vendors to save a few bucks. This stickiness gives the company pricing power as it is able to pass on costs to its customers without too much pushback.
The company is engaged in providing water, hygiene and infection prevention solutions and services globally. Ecolab was founded in 1923 and is headquartered in Minnesota. Specifically, the company develops and markets services for a broad range of industries that goes from hospitality to food service, as well as health care and several industrial markets.
The company currently operates in four business segments: Global Industrial, Global Institutional and Specialty, Global Healthcare and Life Sciences and Others. Below is a breakdown of the first three:
- Its Global Industrial segment provides water treatment and process applications as well as cleaning and sanitizing solutions, primarily to industrial customers within the manufacturing, food and beverage processing, transportation, chemical, primary metals and mining, power generation, global refining, petrochemical, pulp and paper industries.
- Its Global Institutional and Specialty segment provides specialized cleaning and sanitizing products to the foodservice, hospitality, lodging, government, education and retail industries.
- Its Global Healthcare and Life Sciences segment provides specialized cleaning and sanitizing products to the health care, personal care and pharmaceutical industries.
Ecolab is the largest supplier of cleaning and sanitation products in the world. The company's razor-and-blade business model creates customer switching costs as Ecolab's cleaning equipment requires customers to purchase its proprietary consumables. Ninety percent of sales volume comes from consumables, so revenue is recurring, and subscription-orientated.
In addition to a continual emphasis on reducing its customers' water, energy and labor expenses, Ecolab offers equipment that will automatically keep regulatory compliance records. This regulatory monitoring strengthens Ecolab's moat as customers would face increased compliance costs by choosing a competitor. Further, Ecolab focuses on cross-selling products, which also contributes to switching costs. For a customer with cleaning and sanitation needs, managing each order from a separate supplier costly and inconvenient. Through the breadth of its product offering, Ecolab serves as a one-stop shop, which saves its customers time and money aggregating orders and re-orders by engaging solely with Ecolab.
Valuation
Some of Ecolab's travel-related industry customers are still recovering from the pandemic, and the company's earnings are being impacted by inflation. It is working to pass on price increases to its customers, but there is a lag. The company has implemented an energy surcharge and is implementing structural price increases to overcome cost inflation. The company is aiming for 6% to 8% top line growth and about 15% bottom line growth in the long-term. However, this appears to be too optimistic as revenue per share and earnings per share growth in the recent past is not great.
| Growth Rank | (* per share data) | ||
| Rank: 4 /10 | 10-year | 5-year | 1-year |
| Revenue Growth % | 2.0 | -1.3 | 12.7 |
| EBITDA Growth % | 3.9 | -3.1 | 11.4 |
| Oprt. Income Growth % | 3.0 | -2.8 | 11.8 |
| EPS w/o NRI Growth % | 6.5 | -4.0 | 27.6 |
| FCF Growth % | 12.5 | 4.5 | -6.9 |
| Book Value Growth % | 2.3 | -0.5 | 12.7 |
GuruFocus' valuation box indicates that apart from GF Value, the stock remains expensive.
Since GF Value is based on past earnings multiples, past returns and estimates of future business performance, if a stock was very overvalued to begin with, it can sometimes make it look undervalued when it's really not. Thus, I take the GF Value rating of "significantly undervalued" for this stock with a grain of salt.
While the stock has come down over 30% from its highs, the overall impression I get is that there still is not much of a margin of safety if any. I think the stock was obviously very overvalued previously, but in my opinion it still remains overvalued in spite of the drawdown. There are better value opportunities in the market.
Currently, the stock has a forward price-earnings ratio of 32.47. For the company to justify its current price, it must grow its EPS by about 15% consistently. This has not been the case in recent years. While I am willing to pay up for quality, the premium being demanded by Mr. Market for this stock appears too excessive given its growth record in the last five to 10 years.
Conclusion
My overall conclusion is that there is not enough of a margin of safety for Ecolab at the present time. It is a great business fulfilling a critical need in the marketplace, and it has a wide moat with great long-term potential. For now, Ecolab will go on my watch list, which is a list of stock that I want to own but only at the right price.
