Ecolab Inc. (ECL) Earnings Call Transcript & Summary

Okay. It looks like we're live here, everyone. Great. Thanks for joining us here for the next session of Baird's Global Consumer Technology & Services Conference. I'm Andy Wittmann. I'm the senior analyst at Baird that covers facility services. Delighted to have the team from Ecolab back again at our conference this year. They've been great supporters of the conference over the years, and to have them back is always a treat. The company's CFO, Dan Schmechel, is here to give an overview of the company. We're going to be doing this one in a slide deck format for everyone. You'd also join -- and some of you who have got one-on-ones may have also seen Mike Monahan or Andy Hedberg, also Nate Brochmann. Their IR team is with us today. So very pleased to have all of them with us. Dan, I'm going to turn it over to you and your slide deck. Thanks.

Okay. Perfect, Andy. Thank you very much, and good morning. So as soon as I see it, we will roll. Perfect. Okay. Thank you so much. Good. Well, good morning and good day to everybody. So pleased to be here and happy to share the great Ecolab story, including our recent experience, which I'm happy to share. And we look forward to some more conversations throughout the course of the day. I'll start here, right, with the cautionary statement, which says that anything I might say about the future might not actually turn out that way and for many, many reasons as detailed in our recent earnings release and SEC filings. As many of you know, Ecolab is the global leader in food safety, water, energy, hygiene technology and services. We provide and protect what is vital: safe food, clean water, healthy environments. And as we protect what is vital, of course, we like our positioning. We have a long track record of driving consistent top line growth and translating that into consistent EPS growth. So over 15 years, before COVID, we delivered 11% compounded EPS growth, 10% over 10 years, 12% over 5 years, well recognized for our transparency and predictability in delivering our growth and on the business results. So I want to spend a little bit of time talking about our more recent business performance, a really important slide which I think captures nicely our company's experience with the COVID-19 virus. So importantly, look, COVID has had an impact on all of our businesses, but the impact across the businesses has been very different. The biggest business, as we expected and as you expect, has been on our Institutional business. So for the Institutional business, global lockdowns, changes in consumer behavior, reduced customer demand for food consumption in restaurants and also for lodging stays, and you can see the impact on Institutional in comparison to the rest of the businesses there. While the Institutional business has been disproportionately hurt by this extraordinary pandemic, its fundamentals are certain, and it will return to sustained profitable growth. We've clearly seen an inflection point and anticipate that this will continue. As the chart shows, 2020 impact on our Institutional business, just like COVID's impact on the world, has been unlike anything that we've ever seen. It's a business that saw very limited impact, frankly, from prior recessions, but as is increasingly recognized across the global economy, a recovery from a financial recession, which we've all experienced, and recovery from a global natural disaster will have very different patterns. One of the remarkable things about COVID and its impact on economies and on individuals is that while the impact has been quite disparate, for large segments of customers and also for their end customers, they will emerge from this natural disaster, which has been COVID, with a lot of pent-up demand and with very, very strong balance sheets on both the individual and the corporate level and with a lot of interest into lending and providing financial resources behind the restart of the global economy. And so while the impact has been disproportionate, so also do we anticipate the recovery to be. Underscoring this, our business is recovering very well, as shown here. Very important to note that during COVID, we made the choice to continue to invest in our business for the recovery rather than cut investments. Always, we were guided by the principle that says we will prepare for the future and fuel the future, confident that the brighter future would arise. So we continued our R&D investment. We continued our increase in digital technology. We protected our sales team's pay to assure their continuity for their customer relationships and the upswing. We planned for actions to be taken and business to go after. And we took other actions that cost us in 2020 but are setting us up for success in 2021 and beyond, and we are seeing the benefit. We had record new account wins in 2020, and we have seen steady recovery from the lows of the second quarter of last year. So we entered 2021 in a position of strength with very strong underlying business trends, North America, China; very clearly improving, Europe; I would say at the inflection point, emerging markets. Clearly, a different story by market, but net will follow. We have growing share powered by record new business wins. We are accelerating our pricing efforts, recognizing also that one of the consequences of the recovery has been stronger raw material prices and other input prices. We expect strong growth in the second half and in the second quarter. And as I indicated earlier, we have spent our time expanding our competitive advantage, continuing to work on our innovation pipeline. And I'll share some recent developments with you shortly. We've continued to invest and accelerate, frankly, our digital rollouts. We have continued to focus and enhance our sales firepower, and we'll continue to invest in new growth engines. Spend a little bit of time on our positioning. So for those of you that know us well, this is a really great business model with macro trends that are very much in our favor and among them: a world that by 2050 will have 25% more people requiring more food calories and demanding a safer food supply chain, leading to increased pressure on water supply, especially as much of that population growth occurs in areas where water is already scarce and the climate change impact is felt most keenly; aging population in developed markets driving greater demand for medical treatment and always new food safety and infection challenges; increased customer expectations for information and assurance delivered digitally. I think if you consider these trends, especially taken together, you'll understand why our commitment to deliver safe food, clean water and healthy environments positions us so well for the future. Our value proposition is simple. It's all about helping our customers serve their customers better and protecting their brands and doing so in a way that improves their cost effectiveness and reduces their impact on the environment. So more than 90% of our revenue comes from product sales, the products being consumable. Our product sales are supported by very high levels of on-site support. Our great products, high-touch customer service and our industry-leading digital platform and the recurring nature of the business have made this a very sustainable, high-growth company for the long term. We're a truly global company. We have a great team taking care of customers in 172 countries. We operate very similar business models, and we're bound together by a common culture. Our position, as a result, is very strong. We lead the competition in nearly every market that we compete in, but we still have huge upside. So yes, we chase something like $135 billion market globally, and so we have something like a 9% share. At the heart of the opportunity is our relationship with great customers. Our customers are really the best and best in their industries, among them the global leaders requiring the best technology and most effective solutions delivered on a global scale. Look, we love to do business with industry-leading competitors in our customer group. They tend to be the most demanding of us, and it is also where our value-add shows up most consistently. Many of these customer relationships span decades, and we are an integral part of their operations, helping them to achieve success in their businesses. Sustainability is absolutely at our core. We serve our customers in very sustainable ways as sustainability is critical to us, and we recognize increasingly how critical it is to our customers. Our products minimize packaging, transportation cost, along with our service expertise, greatly reduce our customers' energy and water usage. It's an integrated approach that makes us a clear leader in our industry and a critical partner in reducing our customers' energy and water consumption. We also walk the talk with strong sustainability commitments that have received and continue to receive recognition from leading third parties. We're showing here just a few examples to highlight a very important fact. We play in very big markets and have a significant impact on our world, supporting our customers who provide the food, water and health care that the world needs. We'll continue to drive our growth using the very same value proposition here pictured a little differently, but it's the same across all of our businesses. And put simply, it is best results at lowest total cost. The pie chart representing a typical Ecolab value proposition which shows that really in all of our businesses, products and services are a very small part of the customer spend, and yet we help them to impact really all of the rest of their spend. So using our premium products backed by leading on-site service, customers get great results, reducing their biggest cost drivers, which yields substantial overall savings and really, very, very importantly, helps them do this in a way that reduces their energy and water consumption. Our value proposition is really anchored by a long track record of innovation. So we recently launched the first sink and surface cleaner and sanitizer that kills the COVID-19 virus in less than 15 seconds. The formula also kills norovirus, which is the #1 cause of foodborne illness. There is no competing product that does this work as effectively or more quickly. We can sanitize tables in a restaurant, hotel much quicker since the kill time is at least 4x faster than competitors. And unlike competing products, we do not need to require rinsing, and it reduces the labor content of getting this sanitized result. They also have less packaging. And with that, you get greatly improved guest safety. Another product example. So Synergex sanitizer and disinfectant continues to get better. After a successful 2015 introduction into the food and beverage industry, Synergex quickly became the industry-leading sanitizer and disinfectant. With the ability to provide food safety, product quality, product optimization, sustainability, worker safety, we saw the adoption in nearly all of our segments, so in dairy, cheese, food, beverage, brewer, protein, really across the whole F&B platform. And in 2020, Synergex received the first-ever food contact surface no-rinse biofilm claim, so biofilms which plagued the food and beverage industry and have for years because they provide a protective coating environment for harmful bacteria and pathogens to grow. We partnered with EPA and have developed a test method which proved that Synergex can remove 99.999% of film -- biofilm pathogens in a no-rinse application. Looking at a specific customer case study. This slide shows how we helped ADM reduce over 2 billion gallons of water, reduce its greenhouse gas emissions and energy use, saving them $28 million each year through their investment in Ecolab products and service that cost them a fraction of that. So it's great for the environment, great for people and also great for our customers' bottom line. Example chosen from a different market here, data centers. Our data center program is backed by advanced polymer technology. It improves solids capture, water separation and the waste streams, which improves water recovery and reduces solids disposal cost. Also importantly, this polymer works at lower temperature levels than others, also saving energy. We charge more, meaning we earn a higher margin, for this chemistry than the products it replaced. The equipment is supported most often with leased equipment to the customer, most often with 3DT monitoring, our 3D TRASAR technology, which allows real-time monitoring; and our enVision technology, which allows us to support our customers to optimize the dosing of the polymer delivered chemistry and also to improve water separation and cost savings for the customer. A little more about the financial management of the company. We remain and will always remain committed to delivering strong and attractive shareholder returns. In addition to delivering strong operating results, driving strong stock price performance, we also have returned nearly $9 billion in cash to shareholders over the past decade through share repurchase and dividends, and we expect to continue doing so. We have a very long history of strong financial performance. We target 15% EPS growth. Our returns on capital should improve by about 100 basis points a year. We have our balance sheet now where we intend to run it, which is a debt-to-EBITDA ratio of about 2x. And we have very, very clear cash priorities. We will continue to increase our dividend in line with earnings growth. We will continue to invest in the business and pursue attractive M&A opportunities. And we will continue to pursue share repurchase to offset the dilutive impact of share-based compensation programs and also to manage our balance sheet at levels that we think provide adequate stretch for our investors. So I would summarize this way. I hope it's clear we love this business and we work tirelessly to make sure that it lives up to its potential. We are the global leader with a still pretty small share in a large and growing market. We have a lot of upside opportunity at top line, which means bottom line, too. We serve fundamental, global and increasingly complex customer needs. The macro trends are very much with us. And so we think that our customers are going to need much more of what we have to offer in the future. This is an annuity type business. So once we sell to a customer, if we do a good job and we're good at what we do, we'll keep the business for a long period of time. So it is a great business in terms of return on capital, return on effort and predictability. And we have big opportunities for new growth, a lot of margin improvement opportunities even in the business that we've been in for a long time. And we have significant competitive advantages across our business platform. So we like very much our position. And finally and importantly for all of you, we believe we'll continue to be able to perform consistently at a very high level as we go forward and that we will continue to drive shareholder value. So Andy, that's our story. And I will turn it, please, back to you, sir.

Thanks, Dan. Appreciate the overview. We do have some time for questions here. [Operator Instructions] I'll be monitoring my e-mail for those that come in.

But Dan, I thought the one thing you alluded to actually in your prepared remarks was about raw materials. Certainly, it's something that I think has been a lot on our clients' radar screen. And I was just hoping you could, one, first, just frame the amount of raw materials as a percentage of your revenue, the exposure you have to input costs. And then more broadly, if you could discuss the level of inflation that you're seeing today and expecting for the year.

Yes, sure. Okay. Let me just start maybe, Andy, with kind of a mechanical answer, and then I'll get more to the heart of what your question is. So we do not hire or employ fleets of economists to track an Ecolab view of the raws market. We tend to use standard industry available, IHS Markit, principally, indices to -- as we look forward. Okay? So when we started the year, our comment was that we anticipated a benign raw material market but we would be prepared for worse outcomes. And the benign part was really what the indices were saying. The "be prepared for worse incomes (sic) [ outcomes ]" sort of was rooted in this comment that I also made, which is an understanding that the recovery from the COVID virus impact is going to be distinctly different than the recovery from a financial recession. And what I mean by that is, look, behind our planning and our confidence and continuing to make investments in the business was the belief, turned out to be quite true, that there would be vaccine technology that was available, that it would be rolled out and that it would increasingly give consumers the assurance to get back about their normal lives, right? So there was a little bit of, what to say, like incongruity between this idea that raw materials were going to be benign and pent-up demand backed by very strong consumer and business balance sheets was going to power an economic recovery. And so we were doing our own internal forecasting around different raws scenarios that would be worse than we had necessarily anticipated based on the indices. So behind that, raws, something like 25% of Ecolab's total cost of sales we currently anticipate, round numbers, that something like -- there'll be maybe like across the whole scope of Ecolab raw materials 1% price inflation, maybe 1.5% across the raw material set. You know that we have said consistently in the past, we are -- we price for value, right? And it's not to say that there's perfect price elasticity in the model, but we've demonstrated the ability to get to something like a full recovery of the cost impact of raws runups in the first 12 months and restore the margin in the second 12 months, and we've demonstrated the ability to do it. And consequently, if I go all the way back to sort of the planning mindset as we thought about 2021, raws are worse than we anticipated, and our pricing plans consequently have gotten more robust. And so both things are working, and I think they're well aligned at this point.

That's really helpful context. The other thing that I just wanted to talk or have you touch on a little bit here was your Industrial segment. I thought this business really held up effectively, particularly on the profit margin side, really well through COVID. And I was just wondering if you could discuss some of the dynamics that were in play in that business and how and why margins improved so significantly as well as your outlook for the sustainability of those margins in that segment.

Yes, sure. So yes. Sort of maybe beginning at the top line and working down to margins. I said at the upside (sic) [ outset ] that all of our businesses were impacted by the economic, at least, impacts of COVID. Industrial, the same. I mean look, they hold through the year plus or minus low single digits through 2020, a little different by business by quarter. But by and large, I think by Ecolab standards, not completely impressive growth numbers, but against the background, I thought that they were completely impressive. So their continuing to find ways to get access to customers and solve customer solutions even as customer demand was being impacted was very impressive even on the top line. And they drove very significant profitability growth, to your point, delivering OI growth in the mid-teen range through most of the year. And that's not volume leverage when you're talking that kind of sales growth. What it is, is the benefit of pricing initiatives. So Industrial, look, they entered the COVID environment with some impact, some understood impact of margin enhancement. So they were really pushing at like a 2% pricing impact when they went into COVID. And then I will say this, that these are the businesses that Christophe, who is our new CEO, spent a significant amount of time running. And Christophe knows how to drive value and knows the importance of productivity. And so in a way, what you saw across the Industrial platform was a sales result that held up pretty well and a margin result that is the impact of pricing initiatives that they had well underway prior to COVID as well as aggressive cost savings that they had planned and activities that they had put in plan before COVID. And then like the rest of Ecolab businesses, it's not like we did nothing. Any expense that was discretionary, we were all over. Any investment that we thought was necessary to be in the best position to deliver a strong 2021 and 2022, we continue to make. So it was, in that way, sort of the reward of virtuous behavior prior to COVID that you see showing up in the P&L as they went through the year.

Do any of those focus on costs? I mean I know there's travel and entertainment across every company that we talk to, but those will probably come back. Is there anything sort of out in 2020 or in the last year or so that needs to come back besides that?

Well, on the compensation side, I would say for sure. Like across the businesses, our commitment was to keep the sales team on. Our compensation programs are highly skewed to growth, right? And so as we continue to return to positions of growth in this business, there will be rebuild of compensation across the -- across really all Ecolab businesses as they recover or those that are recovering significantly. Some performed brilliantly even during 2020. But it's comp programs and T&E that will come back. Okay?

Okay. That makes sense. We did have one from the audience here. The reopening seems to be going better and faster than expected, which really talked about significant year-over-year growth in the second quarter. Are you feeling better today about the second quarter than a few months ago? Why don't you touch -- take that one, Dan? Appreciate it.

Yes. Well, I won't -- I'm not going to comment on any comment that we made in our first quarter release, right, beyond saying that I would just refer you to it because we said exactly the same thing. Look, we're looking at the balance of the year with levels of confidence that, I would say, validate how we felt about the likely recovery from COVID even a year ago today. And look, it's not like we're brilliant. It's -- the fundamentals were clearly in place, and I think that they were widely seen across most of corporate players but also policymakers, too, which is the vaccine technology was safe and real, that it would be rolled out, sort of, in some ways, almost helter-skelter. Everybody, I'm sure, will tell your grandchildren about how you happen to get the vaccine, what vaccine you got, and it was not as anybody expected. I won't tell you how I got mine, but let's just say it took a little bit of ingenuity and creativity for me to get it earlier than had I maybe waited for my health care provider to call me and ask me to do it, and I think everybody did it. But we anticipated the vaccine. We anticipated that people would line up for it and anticipated that with very strong personal and corporate balance sheets and a lot of lending, that the recovery would be strong. We did a lot of downside modeling and how bad can it be. And you know well that we raised debt and we built up a cash portfolio just to protect against any outcome that would be of interest from a liquidity perspective. And then we patiently made the investments that we have to make in order to be in the right position, and that's the position that I think that we're in. Okay?

Okay. That sounds good, Dan. I think we're out of time here. I want to say thanks to you and the entire Ecolab team for the presentation here and conversation afterwards. I hope you have a great day at our conference. And to the investor clients, for your model, if you need contact information for anybody at Ecolab team, feel free to reach out to any of us here at Baird. We're always happy to help. Thank you very much, and have a great day.

Well, thank you, Andy, and thanks to everybody for your interest.

Take care.