Ecolab Inc. (ECL) Earnings Call Transcript & Summary

Thank you. My name is Dave Begleiter of Deutsche Bank U.S. Chemical's team. Next up is the team from Ecolab, Scott Kirkland, CFO. Scott has been at Ecolab for about 18 years. He'll begin with the presentation followed by a Q&A session. So with that Scott, all yours.

Thank you, David. Appreciate everyone coming to spend some time with us. Happy to be here and talk about Ecolab's amazing growth story. But before I get started, I have to give you the obligatory cautionary statement, which I assume you're all very familiar with and so I won't belabor the point. But with that, let's move on to the fun stuff. I'll try to get the clicker going. There we go. Thank you. So for those new to Ecolab, Ecolab is the global leader in water, hygiene, infection prevention. We've had a proven strategy that we've used for 100 years to drive growth. Certainly, in the backdrop of a very challenging inflationary environment over the last couple of years, we have significant opportunity and in the near term focused on recovering and driving margin expansion. And we've shown over a long period of time, and demonstrated an ability to generate very strong financial performance, both top line and bottom line as well as strong free cash flows and continue to deliver strong returns for our shareholders. We do this by protecting -- by focusing on our purpose, which is to protect what's vital. And what that means is we focus on people health, which is protecting people from infections, which includes general public spaces as well as the entire food chain. We also focus on the world's most important risks, and we do that by helping our customers operate more efficiently while using as little water as possible. And then last but not least, driving business health. And through that impact on water and food and climate, we help our customers meet their sustainability promises, but do at the same time while improving their financial performance. And if you look at Ecolab's reach and capabilities across our global businesses, it's significant. We operate in over -- in 40 industries in over 170 countries, helping to have a very significant impact both on the society and a very important impact on the environment. And we do that by touching water at 1 million customer locations. And through those water savings that we deliver, we also impact 22% of the world's power, which I'll talk more about later. And as I said, we're also touching the food chain. We impact 36% of the world's food production, and we have prevented 1.4 billion of infections. And we do this while partnering with many of the world's largest and most trusted brands. So I'll start with institutional specialty on the left here. this is where we partner with hotels and restaurants to make sure that they have consistent standards across their global operations. Next, in our Industrial business, which is also the largest, it represents about half of the company. We're focused on water, helping our customers use less water in a wide variety of industries. And then in our Healthcare and Life Sciences business, helping hospitals and pharmaceutical customers have clean and sanitized environments as well as helping purify medications. So as you can see and you'll see from a geographical perspective as well, we believe we have both great balance in terms of the market we serve, but also geographically. And we have a very balanced business. In terms of the geography, the markets we serve, but we also have what we call the razor-blade model. And by that, I mean, 90% of our revenues -- more than 90% of our revenues come from consumable products, products that our customers use every day. But in addition, these products are also very critical to our own customers' operations. So as a result, we have a pretty predictable revenue stream. And through that business model and those important customer relationships, we've demonstrated a very long track record of driving strong consistent top line growth. which has translated into double-digit EPS growth as well. You'll see over the 15 years before the pandemic, we had compounded EPS growth of 11%. In the 5 years pre-pandemic, it was at 12%. Certainly, the last few years have been more challenging, and we're not immune from that. But each time we've come out of a global crisis over our long history, we have come out stronger. And we believe the most recent challenges the world has faced will be no different. As we look at the last few years, the biggest impact from the pandemic was on our institutional business, which represents about 20% of the company. So certainly with the pandemic hotel lodging stays, restaurant traffic were challenged at that time. During that time, the rest of our business performed quite well with strong sales growth and even stronger op income growth. But through the pandemic, we also maintained our team and continue to invest in the business, investing in innovation and digital technologies because it helped us take market share during that period, but it also helps us set up for what we believe will be a good recovery. And then, of course, inflation was the next challenge the world faced over the last couple of years and supplying our customers certainly came at a cost. But at the same time, we quickly accelerated pricing to levels now above our product cost inflation on a dollar basis. And you will see that here showing over the last several quarters, our organic sales growth, that accelerated pricing is very evident here as we're driving double-digit sales growth led by that accelerated pricing. And we've now gotten pricing to where it is ahead of our inflation and now we're beginning to recover our margins. And speaking of that positive pricing, we've had a very, very long history of driving positive pricing every year. And it's based on the value we create for our customers. And that value is quantified for our customers in what we call eROI, and what that is, is it's the return that we deliver for our customers in what we call total value delivered relative to the cost that they spend on Ecolab products and services. And because of those strong returns that we've generated over long periods of time, we've realized price in excess of our product cost inflation and delivered positive pricing even in periods where we've seen product costs go down. Another great story over the last few years has been our SG&A productivity. As I've talked about, our continued investment in digital technology, but we've done this not only for our customers but also with our own operations, whether it's the field sales teams or the back office, we've continued to invest in digital technology, have generated great OI margin impact as a result of this, and we will continue this focus going forward. As you'll see that income momentum over the last few quarters here showing organic operating income growth and adjusted EPS growth. So we've had strong momentum over the last few quarters, as you'll see getting to 19% organic operating income growth in the first quarter. And then certainly, with FX and interest rate headwinds that we haven't been immune from, adjusted EPS growth has been a bit less. It was seen in the first quarter, up 7%. But as we continue to get pricing and as we see raw material costs stabilize, that we expect to get back to our double-digit EPS growth by the end of this year. As I mentioned, each time we've had a global crisis as a company, we've come out stronger, which is why we remain focused on our ambitious long-term objectives, which is top line growth of 6% to 8%, organic OI margin of 20% and adjusted EPS growth of 15%. So I want to spend a little bit more time framing what we do for our customers and the value that we deliver and then also talking about the opportunities that we have in front of us. So certainly, the world continues to face challenges around public health, food security, water stress, climate change. As evidence of that, it's expected that there will be 30% more people by 2030, that's 2 billion more people that are going to put even more stress on food demand and natural resources. And those natural resources is expected by 2030 that there's going to be a 56% deficit between the supply and the demand for fresh water. And we believe that has become only more evident over the last few years and we've seen continued global drought, including impacting both the U.S. and Europe. And then additionally, by 2050, due to the increase in that population, we expect there to be a need for 47% more energy. As we look at the markets that we serve, it's very large and a growing market and fragmented. The market continues to expand for us as we continue to add new solutions to help serve our customers better. And frankly, we believe in growing our sales fast but want to grow our markets even faster. So we never lose out on opportunity. And as you see on the bottom here, we have leading competitive positions in nearly every market that we serve. And we do that by deploying dedicated on-site experts in every market that we serve, whether it's power generation, food and beverage processing, hotels, restaurants, pharmaceuticals, you name it. We deploy these dedicated experts that work with our customers to really understand our operations and then take the technology and services that we have and deploy them so they can help operate more efficiently, delivering better outcomes at a lower total cost, while at the same time, reducing their usage of natural resources because we believe there's not a trade-off between generating lower total cost and doing it in a sustainable way. And those market experts also leverage global enterprise technology platforms, whether it be chemistry, engineering or digital expertise. And we have over 1,200 scientists who have been impactful in helping us deliver an innovation pipeline of more than $1 billion. And it's evidence that our vitality index of 30% and what that represents is that nearly 1/3 of our revenue comes from products launched in the last 5 years. And speaking of digital technologies, we've been building on this concept of what we call connected chemistry for decades. We've innovated to the point where our customers can understand and monitor and maintain water processes and water quality on a real-time basis. And with all of these systems being connected to our ECOLAB3D Cloud. And that, for example, allows us to look at a best-in-class power generation facility as an example, right? And look at the best-in-class power generation example, take those insights from that location and apply them at other locations around the world for particular customers. And that's just 1 example. And we do this at other customers where we're very focused on water. And at the core of this value proposition, as I said, delivering the best results at the lowest total cost. And it focuses on driving great returns for our customers. And that's in part because the cost -- our cost is relatively small, very small to the value we deliver. But that cost is also small relative to our customers' overall operations. And through this, we deliver better outcomes, look at operational drivers, environmental impacts, so reducing the need for water, energy and driving productivity savings. And combined, that's what we call total value delivered. And that's part of our eROI equation, which is showing our customers how much they get -- how much return they get by investing in our products, services and technologies. Looking at our market opportunities a little bit further in our Circle to Customer, Circle the Globe strategy, which I'll give a couple of examples on in a moment. We have a $152 billion market that continues to grow. And almost half of that is with customers that we already have. So that represents a $55 billion opportunity to penetrate customers that we already have and a more than $80 billion opportunity with unsold customers. But we get after both the same way, which is driving innovative technologies, end-to-end solutions at both new and existing customers, combined, as I said, with this industry-leading on-site expert team. So I'll give you a couple of examples of that circle the customer strategy. And this particular one is for our food and beverage manufacturing facility, a very large customer. So it starts with the anchor technology in food and beverage plant, which, in this case, is our clean-in-place system. And what the CIP system does, it allows us to clean and sanitize a food production system without having to dismantle the entire production line. And then from there, on top of that anchor solution, we add other solutions for our customer, in this case, including water treatment, pest elimination as just a couple of examples. Here's a real-life case study for food and beverage customer, one of the world's largest who often is -- who is also very focused on driving sustainable solutions across their global operations. But many of their locations happen to be also in at-risk watersheds. But we were able to deliver the total value deliver savings to them of $1.2 million, which represent a more than 50% return on their investment in Ecolab by reducing their water and energy usage. Here's our CTC case for a pharmaceutical plant. And it starts the same way, which is putting together -- putting in place anchor technology, which in this case is to clean and sanitize the manufacturing site as well as the cleanroom. And then in addition, selling other solutions in this customer, which like the food and beverage example could be water treatment, pest elimination, but also in this case, adding our new technology around bioprocessing to help purify medications. Another real-life case study with a life sciences customer with this one, we're able to deliver total valued savings of $16 million, which, in addition to the water and energy savings with them, we were able to help them with productivity savings around audit readiness, validation and training. So I've talked a lot about what we do and our focus on sustainability. And frankly, almost everything we do is -- really puts us in a great position to be a leader in sustainability. Our customers come to us to help them with their sustainability goals. And what we do is sit down with them to understand what their commitments are, understand the gaps to their target, and then take the solutions that we have, which really put us at the center of many of the biggest challenges they have, particularly around sustainability, around water, around food, around climate and energy. As you look at what customers are doing around disclosures on sustainability, you can see here on the left, there's been a very rapid increase over the last several years in the number of climate reporting disclosures based on the carbon disclosure project. And water disclosure are also increasing. This is more greenhouse gas emissions but we see an opportunity here because we know that water has a big impact on greenhouse gas emissions. And so we believe there is a need to continue to have more smartwater strategies to help solve the greenhouse gas emissions. And we do that through our expertise and innovation helping our customers have a very big impact. And frankly, it's where we, as a company, can have the biggest impact on sustainability is our customers and the impact that they have on the environment. And we do that by focusing on water climate, food and health. And across these 4 categories -- because we monitor and we have our annual goals, and we have our long-term goals as well as our 2030 goals, which you'll see on top here. And across these 4 categories last year, we're ahead on 3 or 4 of these, and we are a bit behind on food, which was impacted by the recovery of the foodservice industry but we expect to be back on track across all 4 in 2023. I talked a bit about our strong financial performance and our ability to demonstrate long-term strong both, both from a top line and an earnings perspective. And we do that by aiming high. And I've talked about our ambitions around sales growth, 6% to 8%, OI margin of 20% and 15% EPS growth. And we aim high to drive our teams. But that approach has yielded as you saw before, a long-term double-digit EPS growth, which we expect to get back to this year. In addition, strong free cash flows, and we have a free cash version of 90% to 100% on an annual basis. And we also have, from a balance sheet perspective, a leverage target of 2x net debt to EBITDA -- adjusted EBITDA. And we're certainly a little bit higher than that at this point following the Purolite acquisition at the end of 2021, but expect to get back to that 2x net leverage in the next couple of years. And then lastly here, have been -- have long-term consistent capital allocation priorities, which includes firstly, growing our dividend in line with earnings, which we've done for over 30 years, continuing to invest in the business and also making very smart acquisitions. And then lastly, we have excess cash, we're purchasing shares. So we remain committed to driving great shareholder returns. So in addition to the earnings growth that I've talked about and the stock performance, we have returned almost $10 billion to our shareholders through dividends and share repurchases over the last decade. So I will just conclude here. And what I will say is we love our mission, and we love our position. We know what we do for our customers and the communities matter. And we do it in a way that not only improves their operations but do it in a sustainable way. And as I said, we believe we have a significant opportunity to expand margins coming out of this very high inflationary environment. And we will continue on our long legacy of driving very strong financial performance, free cash flows and returns for our shareholders. So with that, thank you for the opportunity to share today, David, and happy to take any questions at this point.

Great. Thank you, Scott. That was excellent. You can join me here on the -- in the seats. So there's a lot of focus from investors on raw material costs. What are you seeing today on raw materials? And what's your expectation over the next couple of quarters?

Yes. Certainly, as we've seen the raw materials have increased significantly over the last couple of years. In the fourth quarter, year-on-year, it was up over 20%. We've continued to see it increase in the first quarter year-on-year. It's up about 9%, and this is realized cost increases for us. And what we've seen is, although year-on-year, it was increasing, starting to stabilize. But we've taken a view for the year as we've talked about our ability to get back to growing double digits that we expect -- just given the dynamics that we've seen in the last few years within those markets, we're expecting them to stay stubbornly high. And certainly, when we set our expectations for the year, that's what we've taken into consideration. But as at some point, when they come down to some level, there's nothing that precludes us from taking advantage of that as well and -- but maintaining the pricing that we've delivered over the last couple of years.

Got it. Now I am seeing things like caustic, polyethylene begin to move down. Where are you still seeing inflation? How long does it get to take to go through your overall cost of goods sold?

Yes, it's a good question, and we get that a lot. The caustic as earlier in Q4 and more recently, spot prices have abated a bit, is it was up 90% year-on-year in Q4. And as you said, it takes time once it happens in the commodity markets for us to realize it. One is we have relationships vendors as we do with our customers. And so there's time in that in terms of those conversations. And then as well, just naturally just to get through our supply chain. As you think about our -- how long we hold inventory and take. So I would say it depends, right? Certainly, we also buy over 10,000 raw materials, and so it's very hard to generalize. And so there's a lot of products to manage in there, but it could take a couple of quarters for -- if we -- if nothing stays -- if every -- all else equal, it could take a couple of quarters for it to hit our P&L.

Got it. And sequentially, are we seeing raws begin to flatten out at least sequentially?

Yes. In Q1, they were up year-on-year. But as we've said, it's -- year-on-year, they were still going up, but have started sequentially to stabilize on an absolute basis.

Right. And if you go back to beginning of '21, how much combined cost inflation have you seen in your business?

Well, as we talk about it, the year-on-year, it was over 20% in Q4, as I said. And so on a 2-year basis through the end of the year, it was over 40%.

Got it. And the good news is on pricing. Are you still raising prices as you sit here today?

Yes, we are. And still increasing pricing, although our pricing last year was on an annual basis, up 10% year-on-year. And so last year, we delivered $1.3 billion of pricing, which was amazing, and the teams did a fantastic job. And then in the first quarter, that pricing on a year-on-year basis increased to 13%. But we do think that's probably the peak of it. And so pricing will still be up year-on-year but that rate of pricing will go down through the balance of the year.

Got it. I know in Q1, we saw gross margins up for the first time I think in 7 quarters. I assume to see gross margins expand Q2 and beyond. How should we think about that price cost tailwind as you progress through the year?

Yes, it's a good question. Obviously, there's things that we control and there's things that we don't control. And on the pricing, as I said, year-on-year, that will start to -- the rate of increase will go down. On the gross margins, to get to that point, it was up 20 basis points certainly sooner than we thought, we assumed the gross margins would be really expanding in the second half, although 20 basis points is somewhat modest in the context of gross margins are down 6 points right, relative to 2019. And so it was a modest increase, but yet a good trend. I would expect that gross margin expansion to be more significant in the second half, less so in the overall first half. But again, there's an element that we don't control, and we'll still have very positive pricing throughout the year, but the raw materials -- and again, as we've seen in the last few years, certainly, in the commodity markets and the shorter term spot bases, you're seeing them going down. But at the same time, they can be fickle. And we've had that experience over the last few years, whether it's the impact from the war in Ukraine, whether it's the Texas freeze or a hurricane or OPEC actions. There's a lot that can happen. And I think we learned from that. And so to look at it very prudently.

And just how sticky is your pricing longer term?

Well, as you saw on that 1 chart, we've never had -- in my almost 18 years and well before that, we've not had negative pricing. Certainly, this has been an unusual environment. We've not lived this in our careers or lifetimes, this type of inflationary environment. But it's very sticky. And the reason it's sticky is because of the value-based pricing. We don't take the pricing immediately when the costs go up because we're not a commodity chemical company because we're not taking the pricing when it goes down. Our pricing is based on value conversations, which the bigger the costs go up, then there's more homework to do, right, to quantify and have those conversations with the customers so that we make sure that when we take the pricing, we keep the pricing, and that is our expectation.

Right. So in '24, we can see substantial price cost tailwinds in theory in your business as raws come down further, pricing holds, raws keeps them moving higher?

Yes. Certainly, as raws come down, there's nothing that precludes us, as I said, from benefiting from that, right? Again, something that we don't control. We don't control that market. And so we want to be very prudent about that. But we also expect to continue to take pricing. And I think one of the things that we've learned through the last couple of years, where we've always done value-based pricing. But I think the diligence that we do on that is stepped up. It's at a new level now. And frankly, I think we've realized by doing that homework and being more diligent about it, how much value that we really deliver.

I want to ask you on your non-raw mat costs, wage and supply chain, what are you seeing right now?

Yes. Certainly, like everybody else, we're not immune from the inflation, but it's not as significant. It's certainly higher than it was historically, but not significant relative to the cost increases that we've seen in our delivered product costs, okay? But we've also, as you saw within the -- that SG&A chart, we're taking actions and driving great productivity in SG&A. And so although we do see a little bit higher costs from a labor perspective, like everybody, we've taken actions from productivity. And then frankly, invested in technology, as I said, we're doing it for -- with customers and helping customer operations, but we're also investing in technology to help our own operations. And some of the -- we've been on this journey for many years whether it's with field operations or the finance team, deploying global scalable ERPs. We've seen real value in doing that. And we expect our sort of relationship between SG&A and sales growth to change from what it was historically because of the digital technology. And frankly, I think it's necessary for a lot of companies because I would expect labor to continue to be a constraint for some time for people and to make sure that we can take the basic task and digitize those, make them systematic.

Right. Switching to demand. Can you walk us around the globe, your businesses and market geographies, the demand trends you're seeing right now and what do you expect to happen in the back half of the year?

Yes. Yes, certainly. Yes, I'll start with geographies, and there's probably 2 different stories there from a geographical perspective, Europe has certainly been challenged, and we expected it. As you know, coming out of Q3, we announced a restructuring program focused on Europe, and it was really to protect the income that we have in the Europe business. And it's been a -- the Europe business has been a great story, improving the OI margins in that business for many years, getting to double-digit OI margins and we really wanted to protect that business. So we took structural actions after Q3. They're still happening. It takes time if you ever operate in Europe, it takes some time because you have labor costs, there's supply chain, but taking actions there. But -- because we expected Europe to have a tough winter, as I think most people did. It was tough, but we expected it to be tougher. And so it was a little better than we even expected, which is part of the reason I think we delivered even better than we expected in Q1. And so that has certainly been down. In total, our volume were down, as you know, about 1% in Q4 and Q1, if you exclude Europe, it's slightly positive, right, marginally positive. And so Europe was certainly the biggest drag there from a geographical perspective. And then if I look at the businesses, I'd tell you, a lot of business is driving good volume growth still, given the challenging environment, institutional has modest volume growth despite the fact that we're not seeing tailwinds from a foodservice perspective. Foot traffic, as you think about North America, the best data point we have is still stubbornly flat. It has stalled out middle of last year but they're still growing, and that's because they're driving and taking market share. As we look at our industrial business, certainly impacted by industrial production. There's been some slowdown there. As we said, particularly in Europe. And then -- but the water business, even with the Europe impact is driving very good solid volume growth. And as I've talked about, the focus on water, and then I think the tailwinds and the macros that we see there, we're benefiting from that, but also a great business that has some what we call growth engines in there, data centers, microelectronics as an example, within the light water business that are helping to support that volume growth. And then on the flip side, within the industrial business, paper has certainly been challenged, a business that we really, really love. I think the focus on the paper business focusing more on board and packaging over the last several years looking at the mix of that business, long term, we think it's the right thing, but in the short term, certainly with paper and pulp production being a bit challenged, but we really like that business over the long term.

Okay. And destocking has that pretty much played out through your businesses? Or we're still seeing some impacts...?

Well, within that volume, yes, you may be seeing some of that, David. But I think generally, the volume that we're seeing largely is, like I said, on the industrial production, what we're seeing in Europe certainly is part of that as customers in the short term, manage working capital like in Europe, where they have challenges. You'll see a lot of that. But for the most part, I think those trends are sort of consistent with what we're seeing in our customers' markets.

Got it. And what are you seeing in China? Is recovery still as muted as it appears?

Yes, China, it's as you know, a pretty small business for us, but seeing some of that recovery there, right, as they started to open up post lockdown. But at the same time, the industrial business is the biggest piece of that. And so that has challenged at times.

You have some major secular drivers in your business. Can you talk about those at a high level for us, overall cleaning and sanitizing post the pandemic and how important that is for you, you have these programs, Ecolab Science Certified to drive that awareness, how is that progressing? And then the whole water dynamic as well, another huge opportunity for Ecolab.

Yes, yes. Those are big, great innovation programs. And as I talked about, the institutional business driving good volume growth despite the fact that the market is still challenged, and we saw that over the last few years and during the pandemic, foot traffic in full-service restaurants in North America is still down 30%. And our volume is down 15%, but we know from that, that we've gained share of that. And that's in part because of programs like Ecolab Science Certified because although we're not -- the amount of sanitizer sales certainly have come down to the peak of the pandemic, which is not a surprise. It still elevated for it was pre-pandemic. So I think there still is a heightened hygiene awareness, which I think, as you said, is going to be a tailwind long term. And then in the water business, which we have seen because yes certainly despite the fact that it's been a challenging market for a lot of companies over the last few years and as you have seen in one of my slides, companies are accelerating their focus on sustainability and reporting and studying targets, and not always knowing how to get there. And we can have a big impact on helping in that given out focus and expertise on water.

Very good. As we quickly move down, just in the overall Healthcare & Life Sciences business, you've done some repositioning there can we discuss that and the potential of that segment going forward?

Yes. Yes. So it's -- the segment has really 2 very different businesses. Health care, of course, in hospitals, right, in acute care centers and then our life science is focused on pharmaceutical customers. Health care being a bit bigger but has been challenged, and we've been pretty vocal about that, a business that at times has done okay, but it's been inconsistent and in the short term has been challenged. Certainly, hospitals and those customers have had difficult times. And so we haven't been immune for that, but a business that we are taking a hard look at. We took restructuring actions in Europe and then sequentially in Q1 as part of our expanded program included -- included that health care, North America and institutional. And so looking at that business to make sure that we can fix that business, but always taking a best owner's mindset. And then on the flip side, you have the high-growth, high-margin business in life sciences, which includes both our legacy life sciences business, which in that case example I had, you have the historical, which is the legacy Life Sciences business, which is like the F&B as you think about it for a life sciences customer, I'm helping to sterilize the manufacturing environment. But then we acquired Purolite, which is an amazing asset 1.5 years ago, which is focused on drug manufacturing and help purify medications. And so those 2 combined, it's a little bit less than the health care business, but a high-growth great margin business.

And last question, how is Purolite doing? It's been 1.5 years and it was a big acquisition for you guys. How is that doing?

Yes. Yes, well, we bought it with the -- knowing that it was maxed out in capacity. So we bought it. And so it's been a little bit more a year into it. And so we've finished -- we started to add capacity there, and that is starting to ramp up now. And so as we've got to know the business better, we like it even more. And that Purolite business, it's in the life sciences, but 60% of it is really in industrial water business, but it's a great operating unit that we've kept together. And so in that piece of the business, I think the more we've looked at that, the more excited we get as well of the opportunities to cross-sell as part of our CTC strategy with our industrial water business. And then the remaining 40% is focused on pharmaceutical customers, including sort of traditional pharmaceutical as well as bioprocessing. And certainly, within the bioprocessing space, very exciting, but at the current time, we're sort of maxed out in the capacity, but investing in that capacity so that we can grow because there's great demand for it.

Excellent. Scott, thank you for your time, and thank you all for attending. Thank you.

Thank you. Have a great day. Thank you.