There are just 53 stocks on the list of Dividend Aristocrats; members of the S&P 500 Index that have raised their dividends for 25+ consecutive years.
Q3 hedge fund letters, conference, scoops etc
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In order to be a Dividend Aristocrat, a company must have clear competitive advantages that it can sustain over long periods of time. It must have a strong position in its industry, a highly profitable business model, and the ability to grow through innovation.
Ecolab (ECL) is a perfect example of all of these qualities. This article will discuss the various factors behind Ecolab’s rise to prominence.
Business Overview
Ecolab was created in 1923, when its founder Merritt J. Osborn invented a new cleaning product called “Absorbit”. This product cleaned carpets without the need for businesses to shut down operations to conduct carpet cleaning. Osborn created a company revolving around the product, called Economics Laboratory, or Ecolab.
Today, Ecolab is the industry leader and generates annual sales in excess of $14 billion.
Ecolab operates three major business segments: Global Industrial, Global Institutional, and Global Energy, each of roughly equal size. The business is diversified in terms of operating segments, and also geography. Over 40% of the company’s sales took place outside North America last year.
Source: Investor Presentation, page 4
The Global Industrial group provides water treatment, cleaning, and sanitation. Customers in this segment are primarily large firms in the food and beverage, manufacturing, chemical, and mining industries.
The Global Institutional business provides specialized cleaning and sanitation services, such as on-premise laundry, housekeeping, and food safety. Customers are primarily in the foodservice, hospitality, lodging, healthcare, and retail industries.
Lastly, the Global Energy segment includes the Nalco brand. Nalco provides chemical and water treatment services to the petroleum and petrochemical industries, specifically to oilfield services and refineries.
Growth Prospects
Ecolab has many positive growth catalysts. One of the company’s most important growth catalysts is acquisitions.
In 2016, Ecolab acquired UltraClenz, a developer of electronic hand hygiene systems and dispensers. It also acquired Anios, a European healthcare and hygiene business. These deals helped Ecolab expand its scale, particularly in the international markets.
In 2017, Ecolab announced the acquisition of Georgia Pacific’s paper chemicals business. The purchase will help boost Ecolab’s growing paper business, which helps paper manufactures improve their efficiency, product quality, and profitability.
More recently, Ecolab announced that it would be purchasing U.K. based Holchem Group Limited for US$56 million. Holchem Group Limited is a supplier of hygiene and cleaning products and services for the foodservice and hospitality industries.
Acquisitions such as these, along with organic investment, have fueled steady earnings growth for decades.
Source: Investor Presentation, page 6
Ecolab generates steady growth. In 2017, earnings-per-share grew 8% to $4.69. Growth returned with improving volume growth, and higher pricing, across all business segments.
2018 was also a strong year for the company. Through the first three-quarters of 2018, Ecolab has seen revenues increase more than 7% to $10.9 billion. Earnings-per-share have increased 12.4% over this same time period.
Ecolab has been able to accomplish this growth even in the face of higher raw material and transportation costs through sizable product price hikes. A reduced tax rate has also contributed to the company’s top and bottom line growth, although Ecolab’s management reduced the midpoint for earnings-per-share for 2018 to $5.25 from $5.40.
Competitive Advantages & Recession Performance
Ecolab’s many competitive advantages include scale, a strong reputation among its customers, and innovation.
Ecolab serves more than 1 million customer locations, spread across more than 170 countries. The company is not afraid to spend significant resources on research and development of new products and services.
Management refers to R&D spending as its “innovation pipeline”. Ecolab often spends more than a $1 billion on the innovation pipeline. The company’s number of patents in nearing 8,000.
Ecolab’s R&D investments and intellectual property help the company stay ahead of the competition.
Source: Investor Presentation, page 12
Ecolab’s R&D investments have created an incredibly strong business, one that can hold up very well even during economic downturns. For clear evidence of Ecolab’s competitive advantages, look no further than its performance during the Great Recession:
- 2006 earnings-per-share of $1.43
- 2007 earnings-per-share of $1.66 (16% increase)
- 2008 earnings-per-share of $1.86 (12% increase)
- 2009 earnings-per-share of $1.99 (7% increase)
- 2010 earnings-per-share of $2.23 (12% increase)
Ecolab’s growth during the Great Recession was truly remarkable. Not only did the company generate positive earnings growth in each year of the recession, but in three of those years, it achieved double-digit earnings growth. This growth came during arguably the worst economic downturn in the U.S., since the Great Depression. Ecolab’s recession performance makes abundantly clear that the company holds sustainable competitive advantages.
Valuation & Expected Returns
Based off of the current trading price of $149 and expected earnings-per-share of $5.25, Ecolab has a price-to-earnings ratio of 28.4. The company expects 8%-10% annual earnings growth in the coming years.
The stock has a five-year average price-to-earnings ratio of 26.2. We have a target price-to-earnings ratio of 20. If shares of Ecolab were to return to our target valuation by 2023, this would reduce total annual returns by 6.8%.
The stock is in danger of experiencing contraction of the valuation multiple, which would negatively impact total returns. A breakdown of potential returns is as follows:
- 9% earnings growth
- 1% dividend yield
- 6.8% valuation reversion
We expect that Ecolab will offer a total annual return of 3.3% through 2023. This is a fairly weak expected return, due to the high valuation. The stock’s current valuation is well above our target, and a decline toward fair value would be a significant headwind for investors buying at the current price.
Ecolab’s dividend is not likely to represent a large portion of total returns. This is because the current dividend yield is just 1.1%. This is about half the average dividend yield of the S&P 500 Index.
However, with a low yield comes extreme dividend safety. We analyze Ecolab’s current dividend safety in the following video:
Final Thoughts
Ecolab is a time-tested Dividend Aristocrat, with an excellent track record of profitability and growth. However, now is not the best time to buy the stock, due to its high valuation and low dividend yield.
Ecolab is not likely to be an attractive stock for investors interested solely in high levels of income. That said, it is a very strong stock for investors interested in a recession-resistant business, and dividend growth.
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Article by Nate Parsh, Sure Dividend
ValueWalk readers can click here to instantly access an exclusive $100 discount on Sure Dividend’s premium online course Invest Like The Best, which contains a case-study-based investigation of how 6 of the world’s best investors beat the market over time.
