Ecolab Inc. (ECL) Earnings Call Transcript & Summary

My name is Tim Mulrooney and I am a Research Analyst at William Blair that covers Ecolab. For a complete list of research disclosures or potential conflicts of interest, please visit our website at williamblair.com. Ecolab is the leading provider of chemical-based programs and solutions for institutional and industrial end-markets. Two years after the onset of COVID-19, many businesses have returned to pre-pandemic levels and organic growth has been very strong lately. On the other hand, you've got inflation and supply chain issues weighing on gross margin. And these are all near-term factors that investors must take into account. But the thing that we often come back to is the long-term value proposition that the company provides for its customer. I mean despite all the changes that we've seen over the last few years, this fact is something that hasn't changed and something I hope we can dig into a little more today. So we're pleased to have with us this morning, Chairman, President and CEO, Christophe Beck. This format is a formal presentation followed by a [ breakout ] session in the Maher room. And with that we'll get started.

Good morning Tim. Good morning, everyone. Good to be here in person, especially after 2 years of Zoom. It is good to be all back together. So I'm looking forward to sharing with you our growth story, an interesting story, 99 years of doing well by doing good. And I'll go more in details on that in the next few minutes. So before I get there, obviously, the traditional cautionary statement, especially talking about the future in a world that's just a little bit unpredictable lately and probably the next few years as well, but I'm going to try to be as clear and transparent to obviously what we see, how we look at things and what we're doing as well about the unpredictable world that we're living in. So when we think about the world that we're living in, we are kind of blessed as a company since 1923 to help address some of the world's biggest challenges that we have out there. That was true before COVID. This is even more true today because we help address some of the biggest issue addressing healthy environment, which means infection-free as much as you can, environment, wherever you live, play or heal. But it's also helping food producers and food manufacturers produce safe food in order to make sure as well that you do not get sick after what you've been eating or drinking anywhere around the world as well. It's also helping address water scarcity which is a topic that's becoming bigger by the day. A few years ago, we were expecting that by 2030, the world would be needing 40% more than what nature could replenish. Well, today, we're facing an even bigger gap where we will need 56% more water than what the nature can replenish as well. At the same time, while we're helping customers around the world as the world leading company in water management to operate as close to net zero water as you can as well. And with it as well, so contributing to a much lower greenhouse gas footprint in order to contribute to a cleaner climate as well. Interestingly enough, we grow by growing our impact. The bigger the impact or the lower the impact our customers are having on the planet, the faster we grow. And if you look at 2021, just a few facts as well. So to keep it in perspective. Well, if we look at the 4 pillars I just mentioned before, well, we've helped clean 60 billion hands, which was pretty handy during COVID, obviously. At the same time, we've helped as well feed 1.4 billion people around the world as we touch 1/3 of the world food production, which what we're doing as well. At the same time, we've helped our customers digging up water for the drinking needs of over 700 million people on our path to get to the 1 billion, which is the commitment I've made in 2015 by 2030. And at the same time, while we do it, we've had [ to avoid ] 3.6 million metric tons of greenhouse gases as well. So you can see that we deliver not only on our commitments, you will see we deliver against our customers' commitment and the more the impact grows, the faster we grow as well, as a company, which is one of the reasons why we've been growing very nicely for many, many years, looking at -- as we've all done, starting with 9/11 or the financial crisis in the '08, '09 or the euro crisis coming a few years later as well, we've been used to difficult times as a company in our history of 99 years. And every time we got stronger during those crisis and as you can see our EPS has been growing double digits during those times as well, whatever the timeframe you want to take. And the same is going to be true. During these times, so with COVID, that hopefully is behind us or soon behind us and inflation that came up off the COVID as well. We'll deal with that in a way that's making our company stronger for the long term. When you think about COVID, touching 20% of our company, hotels and restaurants like this one, we've maintained our whole team. We haven't let anyone go because we wanted to make sure we had this expertise and customer relationship for the years to come as well, many of our customers have been for 50 years, customers of ours as well. In terms of inflation, making sure as you will see that when we do pricing, we keep our customers and we can keep pricing as well at the same time which is why I feel good about where we're going. And if you are looking at the recovery that we've had so far, 2020 was a down year obviously, after many positive years before that and 2021 has been good year as well for the company and we we'll continue as well in the years to come and important is what to keep in mind that in 2020 you probably complete that on the chart here but written on our website as well. 80% of the company did really well during COVID, growing 3%, 18% in EPS and our restaurant and hotel business went down because they shut down, and we kept our whole team as well to be strong for the future and thank God, we kept that team as well for today because we wouldn't find those people to come back, obviously, to serve our businesses as we go forward. So today, inflation is the new game in town, started in Q2 last year. We're all familiar with it as well. This is something that we've been used to, not at that level, obviously, of inflation, but economies goes in cycles. We all know that as well and we know that we need to deal with it with productivity, with innovation, and with pricing, obviously and that is what we've done and I am going to cover that as well in a second. But interestingly enough, in Q2 last year, we realized that we would be facing and that number has been going up over a billion of inflationary cost in our raw materials and logistics, trucks delivery. Obviously, to our 3 million customers that we have around the world, that was 10% increase of our cost in '21. That's 25% that's expected as well, so for this year, impacting a third of our P&L, just for the ones who want to do the maths as well. But interestingly enough, the way we approach it as a company is always to say we want to get ahead dollar-for-dollar in terms of pricing ahead of the inflationary cost and the year after we get the margin back in ratio. This time it is a bit different because it's 2 years in a row of inflation that we're experiencing all around at a higher level as well. But as you can see, so in '21, we were almost there in terms of dollar-for-dollar. And in '22, we expect to be way ahead as well by the end of the year. And interestingly enough, in June, we should be ahead already. It was planned to be in Q1. The war started, obviously, at the end of February, impacted the energy cost. We started the energy surcharge at the end of March, early April in order to compensate for that. So the turn we were looking for in terms of margin in Q1, which was very well on track, ultimately, so will happen towards the end of the second quarter, all related to the invasion of Ukraine that started at the end of February, which we didn't expect, and no one expected as well. So we decided to launch that energy surcharge, something that we've never done, which is basically [indiscernible] for the 3 million customers we have in 40 industries we serve in 172 countries around the world, there will be an energy surcharge that's going to be impacting every customer around the world in different ways, by industry, by agreement that we have with customers as well. But we started the second quarter with obviously 100% of the new energy incremental cost and 0% of the surcharge since we started in April, something we didn't plan. So it took time to get that well done, making sure that, first, we could keep the customers while we did it. And second, that we can keep most of this pricing as well going forward, which has always been the rule in our model for the many years back as we see as well in the second. But at the end of the day, you end up with a second quarter which is a transition quarter where you get a month plus of surcharge and 3 months of incremental energy cost, which is why -- like where we are end of the quarter. But ultimately, we get good pricing, good surcharge, good momentum entering the second half of the year, and that's why I feel good for the second half of the year. So just a short summary of how we look at the future, speaking second quarter and the quarters to come as well in a total transparent way, as we've always done. It's not providing a guidance, but it's providing what we see and what we're doing about it. The key points here; the first one is, we have great growth momentum, as Tim just mentioned as well, that's going to continue in the quarters to come. Second, the gross margin pressure will peak during Q2, which means that you will see some sequential improvement in the quarters to come. It's not going to be ahead of last year in the quarters to come, but it's going to be better every single quarter, which is this turn, we were looking for in Q1 when the war came, happened in Q2, but really in a good position as we exit the quarter that we have good momentum, good pricing, good surcharge, good productivity in order to feed the second half in a very good way. And that's why on the call, I've been talking about, I'd be happy if we get to 95% of last year's EPS because of that surcharge 1 month versus 3 months of energy cost increase as well. Well, it takes a few weeks to get it well done, and that's why I'm saying. So 90% should be where we should get closer to of where we were in 2021 during the second quarter, while the exit rates are really in a good place for the second half of the year and ultimately so looking very well for the second half and for the future as well as I'm going to cover that with you as well. I'd like just to pause as well on the pricing question since it's the topic with inflation. So right now, in our company, pricing, which is what you see since 2005 on that chart has always been positive, which means that we get pricing, we keep pricing. And the same is going to be true in here, just the magnitude is a little bit different. As you can see on the last bar in here, it's going to be north of 10% in 2022. And the second thing that I want to show is that those dark bars that you see close to the blue bars is basically the inflation cost that we are getting, that every year we make sure the pricing is ahead of it even if it's at very high numbers as we're experiencing it in '22 with this 25%, what we're going to have. So pricing and surcharge ahead of it, and that's already the case in the month of June as we speak now. So that turn is happening right now. So which is why I firmly believe that we are on a very good track, not only because we have a great market ahead of us that is growing as well, $152 billion market. The trends are in our favor, in infection risk, water scarcity, climate change, obviously, we have a great value proposition for our customers, which is ultimately deliver better outcomes at a lower cost because you get less, when you use less natural resources. Well, that's exactly what customers and the environment is looking for, so right now as well. And we have competitive advantages that during these challenging times of the last 2 years, have just gotten stronger. We have a full team when most of the [ others ] have reduced their teams as well. Our offering has become stronger in terms of infection prevention, in terms of water scarcity, as mentioned before. What we do matters even more for our customers today and tomorrow that indeed even so pre-COVID as well, which is why, so we firmly believe that our future of really delivering double-digit EPS growth on the long term, so has been true in the past and it's true today as it's always been as well with our ambition to grow 6% to 8% organic. We're way ahead of that right now and driving an EPS close to the 15%, as mentioned. Now let's talk a little bit more about the future for the ones a little bit less familiar with our company. We serve a $152 billion market. We have 8% of that market. We've grown that market all the time by adding new end markets like life science, pharma being one example as well in here, we don't want to be 90% of the market we serve, we want to stay close to 10% of the market we serve. So we grow our opportunity as we grow within that opportunity as well. If you look at every end market that we serve, the blue is our share, the green is how much is available. We're the leader in most of those end markets. And at the same time, we have a huge opportunity that we can still capture as well, which is exactly the place that we want to be. And we serve 80% of the most trusted brands around the world, which is all growth opportunities for us as we expand our penetration within all of those customers as well around the world. So large market. Second, in terms of growth macro trends, there are 3 that I'd like to cover here quickly. The first one is what we call people health. We've experienced it, obviously, with the pandemic over the past 2, 3 years as well, the awareness has gone up, the risk of food safety outbreak has gone up as well. We're reading that as well in the newspaper, baby food, you've heard it over the past few weeks as well, hospital-acquired infections, 100,000 people are losing their lives every year in U.S. hospitals today because they get infections that didn't have when they joined the hospital ultimately. And last but not least, the shift as well on animal health because that's where everything starts. If the animals are sick, when they get into the food chain, well, it doesn't end up really well when it gets into your home, and that's what we deal with as well. All that brought together, we developed this concept of Ecolab Science Certified that for every industry and especially the hospitality industry, we can make sure that the programs maximize the safety of the environment that you're living in. This is something that increases penetration so for us within our customers and something that no one else has as well. This is a good macro trend, obviously, so for us. The second one is what I call planet health. When we talk especially about water, I mentioned that to you a bit before. So the gap between what the world needs and what the world can provide, 56% by 2030, well, that water that doesn't exist, well, we need to reuse it and recycle it, obviously, which is having as well an impact on carbon footprint because between 10% and 20% of the power that's being used in the world is to manage water, to heat it, to cool it, the transport it to treat it ultimately. So there's a direct link of using and recycling water and reducing carbon footprint as well, which is a good trend for us because our customers are demanding even more from it. And this third trend brings both together of people health and planet health, it's many of our customers have made commitments in terms of ESG as well of what they will be delivering by '25, by 2030, by 2050, whatever the deadlines are. And interestingly enough, each of those were thinking it's going to come at the cost, this green premium, which is not the way we look at it. It's basically to say, no, if you operate better, if you use less natural resources and reduce your environmental footprint, [indiscernible] is going to get better, you get the return, this is a good deal for you, it's a good deal for us, it is a good deal for the environment as well. So people health, planet health, business health; three big trends that are good while our goals going forward as well and last but not least, if you look at these $152 billion market that we serve in, while almost half of it is with customers that we already have. So we could quadruple the size of our company just by penetrating our current customers upto 100%, which is what you see so is the $56 billion on that chart in here. So how do we grow? How do we do that? Interestingly enough we serve 40 end-markets from data centers to hospitals to power plants to paper mills, [ car manufacturing ], you name it. Each of them has a dedicated division with dedicated expertise. But at the same time, we used the same platform around hygiene, infection prevention, water treatment, the same digital platform as well, the same cloud is used by every end markets that we have as well and we have the same business model that is 90% recurring products as well, so in good like in bad time, they need to use kind of more or less the same number of products as well, which is why it is very fairly stable in good -- any less good times as well. At same time we leverage enterprise technologies in terms of chemistry. It's being used from pharma, to hospitals, to hotels, which is the whole idea of Ecolab Science Certified. It's to say the safety you get in an operating room in a hospital that we all hope you never end up in, obviously, is being used in hotels and restaurants in order to make sure that you reduce the risk of getting COVID or whatever else that you can get as well. Dispensing technology, digital technology is the same set of platforms that we use across all our businesses around the world. And all that comes together with our value proposition to customers to make sure they get the best outcome. It can be -- you get satisfaction in the hotel, can be the quality of the paper that's being produced, the quality of the drug that's being produced at the lower total cost because you use less natural resources, which is a typical sustainability play, obviously, with the terms that have changed because we bring together technology, on-site expertise, the 25,000 people serving 3 million customers around the world, you get this global know-how so that we can share between plants, between industries around the world and predictive analytics, knowing that things can happen down the road that we can address as well before that happen. And interestingly enough, usually, the investments of customers in what we do is less than 5% of their total cost. So it's a small investment, which is one of the reasons why pricing is something that we can drive, not easily, but continuously year after year because the impact is important, and the share of cost is very low. So the return is very interesting for customers as well. And one example is, for instance, data centers, we all use and have been using for the last few years of being on Zoom and using all electronic materials around us. It's one of the big data centers company, and I want to share that example here. One data center uses as much water as 80 hospitals combined, just to put it a little bit in perspective. Without water, there is no computer, there is no data center, there's no cloud, there's no zoom. It might be a good news for some, but it's a problem for those companies, obviously the uptime is an issue as such. We've helped them get closer to the net zero ambition. And as you can see, so we can reduce the water consumption, the energy consumption, the footprint in terms of carbon and at the same time, getting a 60% return of their investment. The savings they get versus what they invest with what we do, a 60% return. That's why when we talk about pricing, it's something that is easier to bring in the discussion than if it's just a negative proposition. This is a highly positive proposition because we help them reduce their cost by reducing the environmental footprint. Which brings me to why we are a sustainability leader. We've been a sustainability leader since 1923 when we started, obviously, with the same value proposition of better outcomes at a lower cost because you reduce the usage of natural resources. It was called differently. Now it's called sustainability or ESG, whatever is your term, obviously, for that. And for us, it's 2 parts. The first one is what we do in our own operations, in our plants, the way we use power and so on and second, what we do for our customers, and both need to be delivering against their targets. And interestingly enough, we just published last week, our sustainability report as a company that we have done so far a very long time now, and we've been delivering against our ambition and our targets, year in and year out. This is true for our own company. That's our own operation. As you can see in the circle. So down there we had 62% of our objective to be in 2030 and the red line shows where we should have been prorated with the time. So way ahead of all our commitments that we've made by 2030 as a company in water usage, in climate impact, in D&I and in safety, the 4 big pillars for ESG within our company. Second and last is what we're doing for our customers. as well in here in terms of water, climate, food and health, as you can see as well, measure it against the red line in here, the collective commitments that our customers have made and that we've aligned with in our road maps, we are ahead as well of what's been committed as well since whatever is the start date of baseline. So for those companies taking the water place, for instance, in here, 72% of our goal by 2030, which is to get enough water state for a billion people, which is the commitment I've made as mentioned before as well. So in a great place in terms of sustainable development, delivering year in and year out in our own operations with our customers in a way that improves as well the return for our customers, which is why we feel good about the financial strength as well of the business model we have, the performance that we deliver as well and being able to deliver on a long-term sustained basis, 6% to 8% organic growth, 15% EPS growth as well. High free cash flow conversion between 90% and 100%; so that's been the case for many years for us, a leverage close to 2x EBITDA and with very traditional free cash flow priorities on dividend on acquisitions. And last but not least, on share repurchases as well, which has helped us get back to shareholders close to $10 billion over the last 10 years as well, both in share repurchase and in dividends as well that's been growing every single year. We're a very long time in our company. So we like where we are. We like where we're going short term. When I think about how we exit the second quarter, good sales momentum, good pricing, good surcharge, good productivity, which leads us, obviously, so to a good future, starting with the second half and beyond as well. We serve a large market, with addressing big needs for customers and the communities around this as well, no one else can do what we can do as well. We have the best team in the industry to deliver against that as well. And when times get tougher as well, we adjust quickly as it's been practiced over the last 2.5 years, fortunately or unfortunately, well we could deal with that as well in a way that makes us stronger and that strengthens as well the relationship with our customers which has been one of our key strengths and will be a strength as well so far with future. So we like where we are and even more where we're going. So is that Tim I guess we just have a few minutes for a few questions.

That was great. Thank you very much. Yes, we have a few minutes left here, but we also have the breakout opportunity that will join us in a moment, so I'm going to take this opportunity for myself and avoid eye contact with Andy while I ask you this question. So the -- you gave guidance this morning updating your thoughts for peaking in the second quarter, but does it change how you're thinking about what you guided for the full year? I think your previous guidance was low-teens EPS growth for the full year. We see it peaking in the second quarter and then getting better. Is it just shifting that slightly to the back half of the year? Or are you thinking now maybe EPS growth for the full year would be more low double digit, high single digit?

So a few things here. First, we're not providing firm guidance for the reasons I mentioned before as well, I want to be open as we've always been, with what we see, what we're doing about it and what's the net about it. It's kind of early to tell exactly. It's gotten harder, not easier, in the meantime. But generally, what matters to me is that the trends are all in the right direction that returned a corner on margin, that the trends on pricing surcharge and business growth are heading in the right direction. In Q2, it's a matter of weeks to get 3 million customers aligned around the world that was a hell of an undertaking. So generally, the picture for the second half and the future remains unchanged, but we will know more in the weeks to come.

That's very helpful and probably saved you getting asked that question 10x today. The pricing of 10% was a little bit surprising even to me, who follows the company very closely. I think I have 6% or 7% in my model. Now 10%, how much of that is structural versus surcharge? I'm going to guess and say 6% structural and 10% or -- and 4% or so is kind of that surcharge that you've since implemented over the last 30 days?

So it's going to be north of 10%. As I've shared and as you've shared as well, so right now, it's hard to get the perfect split because in all transparency, many customers have decided to move the surcharge into pricing for practical reasons because to have a surcharge on an invoice is something that the system could not absorb for instance. And I said, I can put that in pricing because it's going to be easier for us to reconcile PLs with invoices and things like that. So the line has become blurred. But the sum of both is what matters to me because at the end of the day, it's how much dollars we're getting, obviously. So directionally, what you said is more right down the road, but it's not the perfect picture. So the 6% to 7% structural pricing, as we call it, and then the rest being the energy surcharge, which offset this incremental energy cost is roughly right, the way you described it.

I'm just thinking because the surcharge you eventually will give back but structural, you probably won't -- that's right. Right. And my colleague here, Eric, just showed me a chart of WTI, which is in backwardation 3 years from now, we're talking $75, $85 oil instead of $120 and you're not giving back the structural pricing, you tend to never get back, right? So that -- all signs point to at this point, what the market is predicting that you get back to those 43%, 44% gross margin levels over the next couple of years if the market does play out as the charts are trending? Is there -- what do you think is the biggest risk to that not happening?

Not happening. I don't think there is a big risk here because of 2 reasons. First, we've demonstrated that for 20 years. And second, the way we price is with the ROI. So it's really this return question. I get more because the customer gets more longer term, obviously, the increased short term is not directly related -- but longer term, it is. When you have a 60% return, if it's between 55% and 65%, the customer is in a good place. That's why we never give back the pricing. And for the energy surcharge and the price of oil who knows where we're going to be. Some are talking about 200s. And a couple of years ago, we were in negative territory. So the margin is pretty big. But the good thing with the surcharge is that we have a mechanism to adjust wherever it's going, which is where I want it to be because that's something I can't control, the price of oil.

That's great. Thank you so much, Christophe.

Thank you so much. Thanks for attending.