Ecolab Inc. (ECL) Earnings Call Transcript & Summary

Great. Well, welcome, everyone, to the Credit Suisse 35th Annual Specialties and Basics Conference. We're going to do a session now with Ecolab. I'm John Roberts from Credit Suisse. I lead the U.S. Chemicals Group here. I hope you get a chance to see lots of companies while you're here. Scott Kirkland, Ecolab's SVP and CFO, will be doing the presentation for us. Scott's been with Ecolab since 2005. He's been the CFO since January. Ecolab, as you're probably familiar, I think of them in 2 main businesses, the cleaning and sanitization business and most things are cleaned with water. And then there's the water treatment business, which is about cleaning up water and being able to use water. And I think one of the key things that's often underappreciated is the energy savings that come with that. And Scott has heard me say, but for those of us old enough to remember the history of the company, it was Economics Laboratories before it was Ecolab. And what they -- even though they're a premium price business, everything they do is economic for the customer here. So this is all about saving money for the customer as well as making things cleaner and using less water. Scott, why don't I turn it over to you for your presentation.

Excellent. Thanks, John, and thanks to Credit Suisse for the invitation. Good morning to everybody. Excited to be here and more excited to really share with you Ecolab's growth story. Well, I'll start here with the cautionary statement, which I think you're all very familiar with. So with that, and assuming that, we'll move on to the fun stuff. Ecolab is the global leader in hygiene, food safety, water, climate technologies and services. We have strong macro trends that are in our favor, and what we do is vital to life. And we do that by helping our customers produce better outcomes, but also reduce, as John said, their total operating costs and environmental impact. We love the mission and we love our position. As you can see, the impact we have, both on society and environment is very significant. For example, last year, we saved more than 200 billion gallons of water. Just for perspective, that's enough to fill for the needs of over 700 million people which, in turn, helped our customers also reduce their carbon footprint, as you can see here with the 3.6 million metric tons of GHGs we help to avoid. We also have a very strong track record of delivering consistent strong top line growth, which translates into double-digit EPS in both good and challenging times. And each time we've come out of a crisis, whether it be the financial crisis or the euro crisis, we've come out stronger as a company. If we look at the 15 years before the pandemic, we delivered 11% compounded EPS growth and that's 12% over a 5-year period prior to the pandemic. The same will be true of the recent challenges the world has faced. The biggest impact of the pandemic, as an example, is our Institutional business, which represents about 20% of the company. So certainly, global lockdowns, customer fears impacted the restaurant traffic as well as the lodging stays, while the rest of our business really delivered good sales growth and strong earnings growth. Through this, we maintained our team, continued to invest in the business and new innovation and digital technologies, which ultimately has helped us take market share over the last couple of years and sets us up for a strong recovery. Of course, inflation is the new challenge that we're all facing, that the world is facing, but we've been accelerating pricing to unprecedented levels to really overcome this new challenge that the world is facing. I'll talk more about that in a minute. So certainly, the economic environment, the external environment has been dynamic, but our fundamental growth drivers and macro trends are very strong, new business, innovation, productivity and pricing, as I mentioned. We expect to deliver record pricing this year of over $1 billion, which will more than offset what we expect to be about $1 billion of inflationary costs we will face this year alone. We also have a long track record of achieving positive pricing. It's really based on the value we create to our customers. And we quantify this through the eROI, as shown here. And what that is, it's the return we provide to our customers based on their investments and our technology, our products and our services. As a result of that strong returns that we provide for our customers, we consistently deliver pricing in excess of our delivered product costs every year. We realized positive pricing even when the raw material costs go down, as you can see in this chart. And clearly, the inflation we've experienced, that the world -- inflation the world has experienced this year is unprecedented. We're also positioned to take advantage of a big opportunity and the great underlying business momentum we have that I mentioned. We have a $152 billion market that keeps growing, which I'll talk a little bit more about later. And we have macro trends that are in our favor, like infection prevention, water scarcity and climate change. And we have a great value proposition for our customers to go along with those macro trends, which is to deliver better outcomes at a total lowest -- lowest total cost while ultimately reducing the impact that they have on the environment. And our competitive advantage has only increased over the last couple of years. Our offering has become stronger in terms of infection prevention and water scarcity. Ultimately, what we do matters even more today for our customers than it did in the past. We are really well positioned to deliver double-digit EPS growth as the inflation normalizes. Importantly, we remain committed to these ambitious long-term growth objectives, which you see here, the 6% to 8% sales growth and the 15% EPS growth. At Ecolab, we've got a great business model. And as I've talked, we're aligned to the critical macro trends, which I'll go into a little bit more detail here. So obviously, our world continues to face challenges around water stress, public health, food shortages and climate change. There is expected to be a freshwater deficit between the supply and demand for freshwater of 56% by 2030. We are certainly seeing this today with the droughts in U.S. and in Europe. There will also be an estimate of 30% more people in the world by 2050. That's 2 billion more people putting even more stress on those natural resources. And that $2 billion -- 2 billion increase in people will also drive increased demand for food by about 35%. And as a result, the world will require 25% more energy by 2050. At Ecolab, we serve a really large and growing market, and it continues to expand through new products and services that we offer our customers. And frankly, we love sales growing fast, but we want our markets to grow even faster. This has helped us maintain a leading position in large, growing and fragmented markets. And we do have leading positions in almost every market that we serve. At the heart of this is our long-term relationships with fabulous customers. Our customers really are the best of the best of the industries that they serve. They require the best technology, innovation and most effective services delivered on a global scale. Many of these relationships with these customers expand decades, and we have become an integral part of their operations and ultimately success. Talking a little bit more about the market. If you look at the $152 billion market that we serve that you see here, almost half of it is with customers that we already have relationships with. We have a $56 billion opportunity to penetrate customers that we already have relationships with by selling products and programs that we already have. There's another $83 billion of unsold customer opportunity. But we get after both of those opportunities with the same innovative end-to-end solutions, combined with our leading sales and service team. It's certainly an attractive value proposition that we can offer to existing customers and new customers alike. I'll talk a bit more about how we leverage that opportunity to continue to drive strong and consistent growth. As we look at our model, we operate in a variety of industries, ranging from restaurants to industrial plants. But we leverage key know-how in hygiene, infection prevention and water technologies and use the same model -- same business model, same products and programs and digital platforms to solve customer problems across all of these end markets. And we also have a business that is highly consumable. 90% of what we sell is consumed as it's used. So as a result of those annuities, we have a pretty predictable revenue stream. And we leverage our chemistry, dispensing and advanced digital innovation and technologies across the company and across all those business segments I discussed. We take that best technology, combine it with the on-site expertise and really best-in-class industry know-how, produce better outcomes for our customers and predictive insights. Net, the value proposition helps our customers serve their customers better. We protect their brands while doing it in a way that reduces their overall cost and the impact that they have on the environment. This is a really strong competitive advantage, and the recurring nature of our business makes us a very sustainable high-growth company. And we typically represent a pretty small fraction of our customers' overall cost, yet we can have a really outsized impact on their operations as well as their brand reputation. We use our premium products technology backed by our leading on-site service teams. And our customers get great results by reducing their overall costs, reducing their overall energy usage, water consumption and impact their labor in a significant way. So this is one example of a customer. It's a large data center customer. Data centers are huge consumers of waters. And just for some perspective, one data center will use as much as 80 hospitals combined, just to put it in perspective. We help these customers get closer to their net zero ambitions by reducing the water consumption, as a result, energy consumption and carbon footprint. At the same time, we ensure the data center continue to operate while getting a big return on their investment in Ecolab, in this case, more than 60%. And speaking of sustainability, Ecolab has continued to be recognized by some of the most notable ESG rankings and raters. And the products and the solutions that we provide really put us at the heart of some of the biggest challenges that our customers face around water, food, climate and health. And really, that translates also into our own operations, which I'll talk a little bit more about our own internal operational goals around sustainability. Our 2030 operational goals, as you'll see here, include targets that we drive a net overall water impact by 40%. It also includes a 50% reduction in climate emissions by 2030. We also are supporting a diverse and inclusive workforce and ensuring our employees go home safe every day. We are outpacing our interim goals as well as our 2030 goals. And we remain committed each year by making sure that we have annual targets and embed those throughout the organization to make sure we stay on track to our 2030 goals. Let's review our customer outcome goals as well. So through our expertise and solutions, we are working every day to have an impact on our customers' impact. And honestly, this is where we can have the most material impact on sustainability, helping our customers reduce their impact by focusing on water, food, health and climate. And in 2021, we exceeded all of our customer impact goals across these four targets. So certainly, that puts us in a strong position for sustained growth, and we have a long history of strong financial performance. It starts with our long-standing and aggressive financial objectives, which we aim to drive high with our teams. And that approach has really yielded this multi-decade double-digit EPS growth. We have a strong cash generation model with 90% to 100% free cash flow conversion. And you'll see we have a target 2x net debt-to-EBITDA leverage ratio. We are a little above this target due to the most -- the recent acquisition of Purolite, but expect to return to those target levels, leverage ratios in the next couple of years. And we also have very clear capital deployment priorities, grow dividends in line with our earnings, continue to invest in the business, including attractive M&A opportunities and also repurchasing shares. In addition to the strong operating results and stock performance, we continue to remain committed to delivering attractive returns to our shareholders. We returned nearly $9 billion of cash to shareholders over the past decade, and we expect to continue to do so in the future. In summary, I'll wrap it up here. We love this business. We love the model. We've got a proven strategy to drive top line as well as earnings growth. We do what's right for our customers each and every day. We operate as the global leader in a very large and growing market, solving complex and fundamental needs of our customers, all of which results in our ability to drive superior shareholder value. With that, John, happy to answer any questions.

And I'm going to ask questions when there are no questions from the audience. But if you have a question, you can either step to the mic or raise your hand, ask it and I'll repeat it so that everybody can hear that. But Scott, start with an update on the surcharge and how that's going? And the pricing algorithm, how long to get back to full cost recovery and how long to get back to normal margins in the business?

Thanks, John. Yes, we entered Q2 with a surcharge. And even before the surcharge came into place, had very strong pricing acceleration on our, what we call, structural pricing, but implemented the pricing surcharge in Q2 as a specific reaction to the war in Ukraine and the impact and spike in energy prices there. And coming into Q2, had never done the surcharge on a global scale. Weren't certain how fast or quicker it would go, but quite frankly, have been very pleased by how quick. Systematically, we did not even have the capability to do it on a global scale, had done that very quickly through Q2 and accelerated that pricing through the end of the quarter, where our total pricing, including structural pricing as well as surcharge was exiting the quarter at double digits. And we expect to continue to accelerate that through the second half. The structural pricing itself, as I said, it was tied to the war in Ukraine based on oil and natural gas prices and a matrix to those. The bottom end of that was at $75 a barrel of oil. Certainly, oil has continued to be well above that level, and as a result, have continued to implement and realize the structural pricing. We will continue to accelerate that and the structural pricing. On a combined basis, we expect the structural pricing and surcharge to be in the low double digits for the year with accelerating through the fourth quarter.

And then to get to full cost recovery, you're ahead on a year-over-year basis, but you haven't cumulatively caught up yet, when you get to margins back?

Yes. And historically, as you saw in some of the charts, we've had a long history of pricing and typically have, where we see inflationary costs going up, in the first year, we're recovering the dollars, which as we exited Q2. We recovering the dollars on a run rate basis. And then as we recover the dollars, then it's recovering the margins, say, over the next 18 to 24 months. Again, sort of also dependent upon what's happening from an inflation standpoint whether costs are going up or down.

And then you showed the chart. You're one of the few companies, I can't remember you ever having a price decline in a year or -- at least in modern history or as a public company. This cost cycle is different, though, than any that we've had in history. So if we had substantial declines in raw material costs sometime in the next 1, 2, 3 years, do you think that pricing holding is still a valid argument?

Yes. As you said, John, we've had a long track record of positive pricing. And through each of these inflationary cycles, we've continued to have positive pricing subsequent to the inflation ramp up. And it's very much focused on our overall operating margins and continue to recover those.

Okay. And I assume that needs the surcharge to kind of come off because the surcharges are going to work automatically. So at some point, you're going to want that surcharge off so that your base price is your primary price, and it's not going to go down.

Yes. As we think about the net overall pricing, the surcharge is a component of that, again, based on a bottom end of that of $75 on that surcharge. And so dependent upon that. But at the same time, our pricing as we implement it, both surcharge and structural, we have conversations with our customers, so that they understand the impact, but also our pricing is value-based. And so we have value-based pricing. And what we've seen through this cycle is that we continue to demonstrate value that only increases our customers. As we think about the value we deliver on them, the impact on water and energy and labor savings, which, as you think about the environment we operate in, labor savings and labor constraints are a huge problem for our customers. And so that's part of what we're doing in the value we create, which also has an impact on the pricing that we're able to get and retain.

Can you give us an update on currency, foreign exchange? It's one of the other headwinds that Ecolab has to battle from time to time.

Yes, it is. Certainly, as we see the U.S. dollar relative to other currencies, Europe being the biggest impact for us, it was certainly a headwind in the first half, but is really doubling in the second half and expect it to be about $0.30 on the full year, and the euro being the largest impact of that as we see the gap between the U.S. dollar and the euro.

Your strategies, and you've summarized it before, circle the customer or double your sales, double the penetration to the existing customer base and circle the globe, add additional customers here. Is circling the customer much more profitable than circling the globe and that you don't have customer acquisition costs with that? So much better if you can sell more to the same customers.

Yes. Certainly, once we're at the location, the -- we're already there. We're working with the customer. And so the more that we can sell to the customer, there's an incremental benefit to that. Certainly, an implied benefit because you already have that service, you already have that base in the customer. So the more we penetrate our customers, certainly, there's -- it's different by business and different byproducts, but certainly an advantage to continue to penetrate within existing customers. But we also have a large opportunity with our new customer base and with our existing customers, have both, said, a highly consumable revenue model as well as a very sticky and a high-level retention with our existing customers.

Yes, the water business serves a lot of cyclical end markets, paper, refining, chemicals. Talk about the resiliency of Ecolab's water business in light of the cyclicality of those customer markets?

Yes. Well, some of the markets may be cyclical. Our business is not. And as we think about our business, whether you talked about paper, as an example, John, that is a business where we've continued to innovate. And as you think about there's different pieces of that, that have went up and down, but that we continue to focus on those markets that are growing. As you think about board and packaging as an example, innovation and value that we can drive in that, which continues to be a growing market. And the other piece, I would say, on water and these macro trends, these fundamental macro trends that we focus on, they're only getting bigger and more important for our customers. As we think about energy, climate, water and the commitments that our customers are making and the impact and how we can help them to deliver, those fundamental needs that they have are only getting bigger and the need for climate impact.

What differentiates Ecolab most from your competitors who's having the water business and the cleaning and sanitization business? What percent of the customers -- or how would you characterize your ability to do both for the same customers, customers that are doing water and doing the cleaning side?

Yes. Frankly, the more that we can do for the customers is the bigger impact. And the ability within our verticals to bring them together, it's very much an advantage for us and a strategy we have, as we look at food and beverage customers, looking at both what they need from a food safety, cleaning and sanitation as well as the water and bringing that expertise. And we do that both through our individual teams, but also a strong corporate account sales model, where there's one person that has the relationship with that customer and is able to bring all of the products and programs, innovation we bear and technologies to those individual customers.

While water is the kind of the biggest differentiator versus your other cleaning competitors, talk about your pest position and health care positions because, again, they're in the institutional or institutional specialty businesses, but your competitors really don't have your position in either pest or in the health care side?

I'll start with the pest, John. It's a great question. So our pest business, which is our other reporting segment, but it's a great business because it sells throughout all of our segments. And so this is a classic circle-to-customer play, where we look at the opportunities with our customers to drive sanitation and the impact on their overall operating costs. And we can do that with the pest business, whether it be in a hotel, a restaurant, an industrial plant, a food and beverage plant, that the pest business or a hospital, the pest business sells across all of those segments. And then so when we think about the health care business, again, there's both the infection prevention, the environmental cleaning and sanitizing business we do, leveraging technology and innovation that we have across all of our businesses as well as the impact and the customers we have within the surgical space of that health care business.

And just staying with health care. So it would seem like a natural for Ecolab and cleaning business in an infection prevention environment of a hospital. But it's not been one of the most consistent performers within the portfolio. So what drives the volatility in that business from time to time? And what do you need to do differently maybe to make it a more consistent performer?

Yes. Good question, John. It's something that we've talked about. So that business has not always performed at the same level that the rest of the businesses have and a business that we've taken a close look at. We've made investments in to continue to expand the offerings. I think one piece of that is in terms of the industry itself is thinking about moving from a fee-for-service to outcomes. As we talk about all of our customers, we focus on outcomes. It's not about the price and the invoice but it's the impact that we can have on their operations. And I think the sales cycle, the structure of the health care industry makes that a little bit more challenged, but we're continuing to make inroads there and are committed to it. Because ultimately, as you said, thinking about the hospital and hospital-acquired infections that where you can have the biggest impact from an infection prevention, cleaning and sanitizing, there's no place more that you can have a bigger impact than there. But it's then making sure that we help customers understand the outcomes they have in the business and move from the fee-for-service to this outcome-based model.

Maybe give us an update on Purolite, which was the last significant acquisition you've made?

Well, I would first say, it's a great business. We love the business. We bought it last year -- in December of last year. The sales sequentially were flat in the first half because of really not demand, but capacity, and we bought the business knowing that. It's a fast-growing business in a fast-growing market with very high margins. So a business that we love. We are adding capacity to the business as we speak, and we'll have capacity coming on board as we exit the end of the year. And so then we'll start to accelerate the growth in that business. And that business pairs very well with our -- as we think about our circle the customer strategy. And we have our legacy Life Sciences business that we had carved out of existing business as we often do as we find great markets -- great end markets where we can add value, high growth, high margin, and we carved that out, had made other investments, including an acquisition of another smaller company a couple of years ago. And that business, that legacy Life Sciences business was more of the environmental hygiene. Well, the Purolite is really part of the drug manufacturing process. And part of the Purolite is an industrial business, but the real focus on the business and the highest growth business and the highest margin business is the pharmaceutical and then the biopharmaceutical processing part of that business. And it pairs very well with our legacy Life Sciences business because we have relationships both in Purolite and Life Sciences with these global accounts and these global customers that were, again, the impact that we have on their operations and their brand is significant, especially relative to the tiny impact that we have on their overall cost that we have in their operations. But we're able to bring those relationships together between the legacy Life Sciences business and the Purolite to have that circle the customer strategy.

And I think Ecolab has an overtime strategy of 2% to 3% of sales from bolt-on acquisitions. Purolite was part of that. It was maybe a larger purchase price than some of the others. So should we expect another size -- Purolite size or multiple deals equal to Purolite over the next 12, 18 months? Or we're going to reduce the debt a little bit here in the near term and sort of reload for something beyond 2023?

Well, we're certainly, as you talked about, John, focused on deleveraging to give ourselves the flexibility. The acquisitions obviously do not come to you at the perfect time. So Purolite, we had done last year, and it was a great opportunity. And we're able to do that because we have the strong balance sheet and flexibility to do that and are very focused on, as I mentioned, delevering back down to those A-range metrics so that we continue to have the capacity whenever those opportunities arise and continue to look at those attractive M&A opportunities. We'll continue to do as we have the bolt-ons, but also look at transformational investments like we did with Purolite.

Give us in terms of your end markets, just kind of a run rate, where are we in full-service restaurants? Where are we on quick service? Some of the things that corrected downward. Have we fully recovered or not quite there yet? We know we don't have a lot of international travel still going on. We know we don't have a lot of business travel still is fully recovered.

Yes. The Institutional Specialty segment, which includes both the full service restaurants, lodging as well as our Specialty business, which includes the QSR and the food retail business. In total, the Institutional Specialty business through Q2 volumes are down about 10% versus 2019. If you look more specifically at the institutional -- global institutional business, restaurants and hotels largely, that business was down 14% on a volume basis, not total sales. These -- both of these are volume numbers, excuse me. So the volume was down. Sales are back to '19 levels, but that includes the pricing. The volumes in the Institutional business is down about 14% versus 2019 levels. But that's relative to a market using foot traffic as a proxy. The lodging being a smaller piece of that, but the foot traffic within the U.S. as a proxy is down more than 30% through Q2 and so versus us being down 14%. And the difference in there certainly represents market share that we've gained in the time as well as just within our customer operations, even though they may not have the same throughput, there's a certain footprint we have and what they need of our products just to be able to operate, whether that's a restaurant, a hotel or an industrial plant.

And then back on the raw material, what are the couple key raw materials investors should pay attention to that might be benchmarks or bellwethers for where your raws might trend?

The biggest basket, John, of our raw materials would be the oil-based commodities and ethylene and propylene are our feedstocks to those. So we're not directly buying those, but derivatives of those. And so that -- the oil-based commodities is about 30% of our overall product cost basket. And so not directly correlated, but certainly influenced by the price of oil, which we saw going up through early this year. And even as that's sort of stabilized and went down, it's also affected by the constraints in the market and the tight market. And so as I said, not directly correlated to oil. And then -- but on the flip side, our inorganic chemistries, which include caustic and chlorine, again, heavily energy intensive to produce and as a result of natural gas prices, those were going up disproportionately. And that basket is about 10% across those two of our -- over our total product cost. And because of the price increases in caustic and chlorine, those are really offsetting some of the stabilization or declines in more oil-based commodities.

Any logistic issues that -- so we know in the bulk commodity chemical businesses, there have been lots of logistical issues and they keep coming up. In terms of -- you have a very fragmented probably supplier base and you go to market via distribution as well. Are there any issues here in terms of inventories or logistical problems.

Certainly, through the end of last year, we saw constraints to the market to be able -- the ability to get the logistics to deliver products to the customers or move products around. But through that time, had built safety stocks as well as the ability and continuity of our supply chain to deliver products to our customers and frankly, has continued to be a bigger and bigger competitive advantage for us. And so I think through the constraints we saw last year as well as the weather events that we've seen over the last few years, we've continued to build continuity of supply within our operations to be able to get products to our end customers. And so certainly some inflationary impacts within that market as well, which is really captured within that delivered product costs, which is why we measure both looking at both raw materials and the cost to deliver product to our end customers is that total basket, which was up 30% between raw materials and the logistics in Q2.

We have a minute left. Any questions here from the floor. Chris, on the back.

With all the uncertainty in the world, can you talk...

The question is just incremental since the last earnings update in terms of either traffic and volume or anything on the price raw side.

Yes. I would say we expect the costs to sort of continue at this high level, although stabilized a bit, and we saw the run-up from Q4, up 20% to 25% in Q1 to 30% up in Q2 and have seen that stabilize a bit. Do not expect that to go down significantly or at least we're not planning so. Because in addition to the sort of the impact on oil, which is it went down a little bit, the natural gas prices have had an impact as well as just as a result of tight markets of supply. And so that cost, we expect to remain high, although not continue to increase at the same rate that we've seen over the last year, say. And then as it relates to sort of the markets. Certainly, we've seen a recovery over the last year from the pandemic and the food service industry and lodging start to increase. But I think that started to slow a bit in Q2. If you think about Europe in those markets, we've had a very strong Q2 in Europe, both on pricing and volumes. But obviously, given the challenges in Europe right now, would expect that to moderate.

Great. We're actually out of time. I want to thank Scott for a great presentation and Q&A. Andy Hedberg from Investor Relations is here as well. You can reach him at [email protected], or if you have questions, you can reach me at [email protected]. Thanks, all.

Thanks, John.