Ecolab Inc. (ECL) Earnings Call Transcript & Summary

Andrew Wittmann, I'm the senior research analyst that covers facility services. Here we're joined again this year by Ecolab and the company's Chief Financial Officer, Scott Kirkland. Karen Clark from Investor Relations is also joining us here today at the conference. So we appreciate that you guys joined us. Scott, you're going to take us through the presentation deck. We might have time for just a couple of questions in this room. If there's any questions on the webcast, we are also available to send an e-mail -- if you send it to [email protected]. I'll receive that on my iPad, and maybe I can throw that one in at the end as well. But Scott, why don't I turn it over to you for an overview of the company.

Awesome. Thank you, Andy. Appreciate the invitation. Thanks for everyone to be here. Excited to share with you Ecolab's growth story. Before I get started, I need to share with you the obligatory cautionary statement, particularly the forward-looking information, which I'm sure you are all very familiar with. So with that momentary pause, I will get on to the fun stuff. So those who are new to the Ecolab story, Ecolab is the global leader in water, hygiene and infection prevention. We've had a proven powerful strategy now for 100 years, 100 years anniversary in March of this year that we've used to drive growth. And we're coming out of a period of obviously high inflation. And as a result of that, we see a significant opportunity to expand margins coming out of this environment. But we've also demonstrated over a very long term, our ability to generate strong long-term financial performance and free cash flows as well as good returns for our shareholders. We do this by focusing on our purpose, and that is threefold. It starts with protecting people, protecting people from infections, people health, whether that's in a general public environment or the entire food chain. We also focus on planet health. And that's about protecting the planet's most important resource. We do that by helping our customers operate efficiently but using as little water as possible at the same time. And that translates into business health. Through that, we help our customers meet their sustainability commitments, but do that in a way that also improves their P&L. We have significant reach across our global businesses. We operate in over 170 countries. We operate in 40 industries. And through those businesses, we have a very significant impact, not only in society but the environment. And we do that through touching water at 1 million customer locations. And through the water savings that we achieve at these customers we're also impacting 22% of the world's power. In addition, we're impacting 36% of the world's food production, and we've helped prevent 1.4 billion infections. And we do this while partnering and protecting with some of the world's most trusted and largest brands, starting in our institutional specialty on the left here. We partner with hotels and restaurants to make sure that they have the same standards across their global operations. Our Industrial business, which represents about half of the company. Within the Industrial businesses, we're focused primarily on water, helping our customers in a wide variety of industries reduce their water consumption. And then in our Healthcare and Life Sciences business, We are focused on helping hospitals and pharmaceutical companies, clean and sanitize their environments as well as help purify medications. So we have both great balance in terms of geographical presence, but also in the markets we serve. In our model, is one of balance, but also a model of a razor-razor blade model. And we do that because more than 90% of our products are consumable -- 90% of our revenue is from consumable products, excuse me. And these products, not only consumable, but they're also critical to our customers' operations. And as a result, that makes for a pretty predictable revenue stream. Through those relationships that I discussed as well as that business model, we've had a long track record of driving strong consistent top line growth. That top line growth has translated into double-digit EPS growth over a long period of time. Over the 15 years before the pandemic, you'll see that we delivered 11% compounded EPS growth and over 5 years before the pandemic, 12% EPS growth on a compounded basis. The last few years have certainly been challenging, and we have not been immune to that, which I'll talk more about. But each time we've come out of a global crisis, we've come out stronger. And we believe that same will be true of the most recent challenges the world had faced. The biggest impact of the pandemic was on our institutional business, which represents about 20% of the company. The rest of the business during that period of time during the pandemic fared very well, driving good sales growth and even better op income growth. Through the pandemic, we maintained our team and continue to invest in the business. particularly in innovation and new digital technologies, which helped us gain market share during this period of time and help set us up for what we think will be a strong recovery. And of course, as we're all very well aware, inflation was the next challenge that the world faced and we were not immune from that either. And supplying our customers has come at a cost. But with that cost, we quickly accelerated our pricing to unprecedented levels to overcome that. You'll see that here in our organic sales growth over the last several quarters, driving double-digit sales growth since Q1 of 2022, clearly, strong growth led by accelerated pricing. And that pricing has now overcome that inflation on a dollar basis, and now we're starting to recover our margins as well. We've got a long history of positive pricing. I showed you there the accelerated organic growth. But over a long period of time, we've driven positive pricing. We do that by driving value within our customers. And we quantify that value for our customers in what we call EROI. And what that represents is the return our customers get by investing in the products and services we provide. And because of the strong returns that we provided to our customers, we realize pricing in excess of our delivered product costs, that's raw materials and logistics store customers in ex of that inflation. And we're delivering -- because of those returns we deliver to customers, we're delivering positive pricing even when raw material costs go down, and you'll see that over a several year period. Also during the last few years, one of the great stories has been our SG&A productivity. You'll see here over the last 4 years. For several years, we've been investing in digital technology, and that has accelerated over the last few years and through that leveraging of digital technology, not only for our customers' operations, but also our own operations, both within the field and within the back office. That leverage of that technology has helped generate strong SG&A leverage and as a result, strong operating income leverage, and we expect this will continue. Looking at that operating income growth and adjusted EPS growth, you'll see here over the last few quarters, we've driven a really strong [indiscernible] in both cases. Over the past few quarters, the operating income growth, organic operating income growth, which excludes FX has accelerated to in Q1 2023 was up 19%. And we dealt with headwinds as many have around FX and interest rates. And so EPS growth was less than that, but that also accelerated in Q1 getting to 7% year-over-year growth on an adjusted EPS basis, headed towards our commitment to get back to that double-digit EPS growth by the end of 2023. As I said, each time we've been impacted by a global crisis, we have come out stronger, which is why we continue to focus on our ambitious long-term financial objectives, which is 6% to 8% sales growth, 20% OI margin and 15% adjusted EPS growth. So now that I've set up the background at Ecolab, I want to spend a little bit more time framing the value we deliver for our customers and the opportunities that we have in front of us. Here we go. The world continues to face challenges around public health, food security, water stress and climate change. As an example, there's estimated to be 30% more people by 2050. That just to be clear, is 2 billion more people putting even more stress on food demand and natural resources. And as a result, we expect there to be a 56% gap, that's a 56% gap between the supply and the demand for fresh water by 2030. And this issue has only become more evident as we've seen global droughts around the world, including in the U.S. and Europe. And then additionally, because of the population increase, we expect there to need to be 47% more energy by 2050. Ecolab serves a very large, fragmented and growing market and it continues to expand. It expands as we add new solutions to serve our existing customers even better and gain new customers. Frankly, we believe in growing sales very fast but want to grow our market even faster, so we never lose on opportunities. And we have leading competitive positions as you'll see on the bottom here, in nearly every market we serve. And we do this by deploying on-site experts in each of those markets that we serve, whether it's power generation, food processing, data centers, restaurants, hotels, pharmaceuticals. We deploy those dedicated experts to those markets that we serve, and those teams work very closely with our customers to understand how they operate. And once we understand how they operate, we can deploy technology and services and that expertise to help them operate more efficiently and ultimately driving the value proposition of best results at lowest total cost. And at the same time, we're doing this without a trade-off, helping them use less natural resources. And those experts also leverage enterprise technology platforms. around chemistry, engineering and digital technologies. And we share those insights across all of these markets that we serve and across these experts. And we have over 1,200 scientists in the company that have helped to generate more than $1 billion of innovation pipeline. Those scientists and experts have helped also generate nearly 1/3 of our annual sales coming from products introduced over the last 5 years, which represents our vitality index of 30%. Speaking of digital technology, we've been building on this concept, what we call connected chemistry for decades. We've invited to the point where our customers can understand, monitor their water processes and water quality on a real-time basis with all of those systems connected to our Ecolab 3D cloud, which just, for example, allows us to look at a best-in-class power generation customer or plant, look at that data, take those insights and apply them to other locations around the world and do it in a scalable way. But we can also take those insights in doing that in other marketplaces using this technology to drive efficiencies, both for our customers but also for our field operations. At the core, our value proposition is this. It's delivering high returns for our customers. And we do this in part because our cost is relatively small to their operations and very small relative to the benefits that we achieved for them. And those benefits are here showing you in this business outcome, operational drivers and environmental impact, reducing the water, reducing the energy, the labor and other efficiencies that we can impact. We call that total value delivered which we calculate and discuss with our customers, which is part of the equation of the EROI, discussed before. And our goal is to achieve at least a 25% return on that total value deliver for our customers' investment. I want to talk a little bit more about our opportunity in the markets that we serve. You'll see here on the left, our unsold customers and on the right, the existing customers that we have opportunities to penetrate. So we have an opportunity to penetrate additional $55 billion in sales for the customers that we already have. Then we have another $83 billion of opportunities with customers that are currently unsold, but we get after both opportunities in the same way, which is driving innovative end-to-end solutions, but combined with our industry-leading sales and service experts. This is one example of how we circle the customer, and this is example of a food and beverage plant. And in most of our operations, it starts with an anchor technology, which in this case, in a food and beverage plant, is a clean-in-place system and what a clean-in-place system does or otherwise known as CIP, it allows for the efficient cleaning and sanitization of a production line without having to dismantle the entire thing. From there, we can add on additional solutions to technologies such as water treatment, from our industrial water business as well as pest elimination, as just a couple of examples. Here's a case study, a real-life case study for a large food and beverage customer, one of the world's largest and who is also very committed to sustainable operations across their entire business. Many of their locations happen to be in at-risk watersheds as well. And we were able to deliver over $1 million of savings to total value delivered and generate a return on their investment in Ecolab of more than 50% by reducing their water and energy usage. Here's another example of how we circle the customer in a pharmaceutical facility, but we start the same way, adding anchor technology in this case to clean -- the manufacturing site and make sure the clean room is sanitized and sterile as well. And then add further additions, which includes our latest bioprocessing technology, which helps purify drugs as well as what I mentioned before in the food and beverage example, water treatment, pest elimination as a couple more examples of that circle-the-customer strategy. Here's another case real-life case study, but this particular to a life science customer, a large pharmaceutical customer where we were able to deliver $16 million of total savings. In addition to the water and energy, as I talked about in the food and beverage example, we're also driving productivity savings. And in this particular example, it's through productivity, through audit readiness, validation and training as it relates to this pharmaceutical customer. So as you've seen, I probably talked about, everything we do really positions us as a sustainability company. It's core to who we are. It's in our DNA. Customers come to Ecolab to help them deliver on their sustainability goals, and we look at these sustainability commitments, partner with them to understand where they're at, what are their gaps to reach their future targets and then take our solutions, which place us in the middle of some of the biggest challenges that our customers face around water, climate, food and health. And as we look at the disclosures companies are making on the left you'll see the graph that, there's been a very rapid increase in the amount of climate reporting that companies have made around the carbon disclosure project. And while the water disclosures are also increasing, we think there's significant opportunity here, knowing that water is an important part of this equation. More smart water strategies are needed to address the climate impact. And given that a significant portion of water also affects greenhouse gas emissions, it's going to be an important part of the equation. Through our expertise and our focus on sustainability, we're working every day to help our customers have that positive impact. And frankly, it's where Ecolab can have the most material impact on sustainabilities, really helping our customers drive progress focused on water, climate, food and health. In 2022, out of our 4 categories, we exceeded our customer impact goals, which we have annually as well as long-term targets. We met 3 or 4 of these. We're the only one following short was food, which was impacted by the slower recovery in the foodservice market, but we expect to be back on pace of our long-term target by 2023. As I mentioned, we've demonstrated a really the ability to generate strong financial returns over a long term. You see here, it starts with our long-term standing but aggressive financial objectives. 6% to 8% sales growth, 20% OI margin and 15% each EPS growth. We certainly aim high to drive our teams. This approach has yielded a multi-decade, double-digit EPS growth. But we also have a very strong free cash flow generation model, generating free cash flow conversion of 90% to 100% annually. We also have a leverage target of 2x net debt to adjusted EBITDA. We are certainly a little bit above that now due to the Pure Lite acquisition that we completed in December of 2021, but expect to get back to that 2x level in the next couple of years. And we've had very clear, consistent capital allocation priorities for a long time. It starts with continuing to grow our dividend in line with EPS growth, continuing to invest in the business, which also includes attractive M&A opportunities, and then with excess cash, making share repurchases. And as you'll see here, over many years, we've remained committed to delivering attractive returns to shareholders. In addition to the strong operating performance and the share performance, we've also returned over $9 billion in cash to shareholders over the last decade through a combination of dividends and share repurchases. In closing, I'll say this. We love our mission, we love our position. We know we do matters for our customers. It matters for our communities. We help them do it in a way that's sustainable, but also profitable. And our margins, of course, coming out of this high inflationary environment are a key point of focus for us, and we work to continue our legacy of that strong financial performance and returns to our shareholders. So with that thank you for the chance. Do you have any questions for the time we have remaining, Andy, I will be happy to address.

Yes. We've got -- we do have some time, you're welcome to have a seat and get more comfortable, stand up there, whatever is easiest. Get if there's any questions from the audience or on the webcast, we're taking questions on [email protected].

But I guess, I'd kind of pick up and start where you're left off, I was talking a bit about the margins. I thought the slide that you had in there showing how you cut SG&A through efficiencies as a percentage of revenue from what was it, 28% -- 28% to 26% last year. You made the comment, you still think that there's a little bit more to do there. So I was wondering what other opportunities you see on the SG&A line to start out with before we move on to talking about the gross margin, I think even there's greater opportunity.

Yes, it's a great question, Andy. What I would say is this, we've been investing in digital for a long time, and that's certainly accelerated into the pandemic, in part because of the necessity and historically have grown our sales and service teams sort of in line with sales, but leverage the digital tools to drive efficiency, both in our customer operations but also in our own operations. And that has been a huge enabler. But we're also doing the same in our functional and back office locations, deploying ERPs globally, scale ERPs and technologies where we can continue to drive leverage in SG&A. And I don't think that journey is over and expect that trajectory to continue.

Got it. Is there a target that we should be thinking about?

No, not a specific target. And again, it's sort of also dependent upon business where certain businesses, smaller businesses we're continuing to invest in and invest in sort of earlier stages. But I think as we've talked about, our OI margin expansion, historically, target has been that 50 to 75 basis points. And I think with that, it's near to the higher end of that.

Got it. Okay. Is there -- so 50 to 75 basis points is the historical range higher, probably near term. That's for AOI margin, so including SG&A and gross margin or is that just...

Yes.

Okay. So I would postulate to see if I'm right here, that of the 50 to 75 that you expect probably more than half of it would probably be coming from gross margins in the next 12 to 18 months, is that fair?

Certainly, that's a fair point. And as I talk about the 50 to 75, just to clarify, that's really on a longer-term basis. That's been like our long-term objectives, we have sort of a long-term equation of that 50 to 75 basis points in but certainly over the next couple of years as we're coming out of this very high inflationary market where we saw deliver product costs, which is the raw materials and logistics to clarify at over 20% in Q4, and we're still going up 9%, although starting to stabilize year-on-year still going up and where we've caught up, as you saw that pricing chart, where we've caught up on a dollar basis, overcome the dollars, and it's been part of a long-term model we have because we do not just price based on spot price for our customers. It's based on value delivered. And so as raw materials go up, we have to demonstrate value to capture that pricing. And that's what we've done and as we have historically over the first year captured the dollars and now going forward, now it's time to recapture the margins and certainly over the next couple of years as we hold on to that pricing, continue to price and then see some reduction in those raw material costs. That's where we'll see additional margin expansion, which I expect more of that to start in the second half than in the first.

I think just for maybe people that aren't aware of this, I wanted to just do a little bit of quick math to show how the price cost dynamics could play out from here. So if historically, you've said that your delivered product costs are about 1/4 of your revenues.

Yes.

And you said the inflation was 2 quarters ago, 20%, only 9% last quarter. So if you think about that 4:1 multiplier between the costs and the revenues, you basically you needed like 2% price to -- or 3% price to cover the delivered product cost inflation that you saw in the first quarter. Right basically?

Yes.

And you had -- and pricing was, what, like 13%?

It was yet was at 13%, which we expect to be the peak of that pricing as we've now capture the dollars.

Yes. But I mean that's showing that as inflation slows down and if pricing can stay -- it's not going to be 13%, but stay in the high single digits. It's a pretty clear ramp that if you're going to favorably compare and your gross margin should be expanding in the coming few quarters fairly materially above even maybe that 50 to 75. [indiscernible] words in your mouth.

50 to 75 was a longer-term target. But yes, and you see margin expansion and gross margins beyond that. That is sort of normalized going forward, a goal. But certainly, over the next several quarters as and when we see raw materials a bit whenever that is, I don't have a crystal ball, we would expect more margin expansion and certainly a focus of us, but it comes down to getting that pricing, capturing it and keeping it, but it has to be a value-based equation. Yes.

And is there anything notable that you just point out in delivered product costs that we should be thinking about in the macro today? Obviously, they've been coming down, but is there should we be looking oil prices or caustic some of the big inputs, labor even, I mean, to the extent that, that matters. What are some of the puts and takes there?

Yes, it's a complicated answer because, as you know, Andy, I've probably heard it before, is we buy over 10,000 raw materials, right? And so we buy a lot of raw materials. We're not buying at spot prices. like our customer relationships, we have relationships with our vendors. And so we're not taking increases immediately and at the same extent that commodity prices are going up and so on the back end as well. And then there's just the lag, time lag of getting in our system, getting through the inventory, so it takes a few quarters before it actually hit our P&L. But nothing would preclude us from realizing that as raw materials do come down.

Great. I thought it would be in the time that we have remaining, helpful to talk about some of the specific end markets in a little bit more detail. It seems like judging from your last earnings conference call and even from our earlier meetings today that there's actually some pretty good or at least okay demand in most of your business, but there are a couple of things that are probably holding your volumes back. I'm thinking I'm going to think macro I think volumes the pricing thing is so different than normal today. So could you -- that's the word I was looking for. Could you talk about what some of the bright spots are in some of the areas that are a little bit more challenging as well?

Yes, certainly. Yes. As I think about bright spots, top of mind, the water business, which has despite the fact that industrial production has been challenged in some places, as you probably know, Europe, holistically for us as the volumes have been tough given the macro environment there, given industrial production. Frankly, it was better than we expected to come over the winter. And I think most people expected it to be a lot worse they feared a lot better, but still it's certainly a on our overall volumes. If you look at our volumes were slightly negative in Q1. If you normalize for just Europe totality, we're slightly modestly positive. And so there's Europe, just from a geographical perspective, has been challenging. But then -- and if you look at our industrial business, certainly, that's been impacted by Europe. But within that, the water business has done very well, and the volumes are going 2%, 2.5% despite the fact that they're still dealing with the challenges in the macro environment in Europe and some great bright spots in there within our light business within the data centers, microelectronics businesses have been a very great bright spot pest business, which is in our other segment, but is a very important business to us as well, has done fabulous the institutional and specialty business despite the fact that within institutional, the market isn't exactly helping that foot traffic is still down and has sort of stalled out early last year. We're still getting modest growth there because we're driving market share and penetration using our tools and technologies like our Ecolab Science Certified program and then Industrial starting to roll out our water for climate program. And the focus on water savings and energy savings and sustainability impact is a big tailwind for us in that business.

Okay. Any other questions from the audience? Okay. you do have questions, we're going to be heading to the Rockefeller Room for the breakout session. But until then, please join me in thanking Scott for the presentation.

Thank you.

We'll leave it there.