2023-12-05 00:02:05 ET
Summary
- Ecolab has seen a solid price recovery in the past year due to strong earnings and guidance, but it is currently overvalued.
- The company offers water, hygiene, and infection control solutions across various industries, which contributes to its strategic industry diversification.
- Analysts rate ECL as a "buy" with a potential upside, but the premium price limits further gains unless future cash flows improve.
- The firm's balance sheet is currently stable providing an opportunity for growth.
- Assuming my DCF figures, Ecolab is currently overvalued resulting in a hold rating.
Ecolab Inc. ( ECL ) has seen a solid price recovery in the past year due to strong earnings and guidance coupled with high FCF. However, although I am impressed with the firm's operations, I do not believe that they deserve such a premium price tag resulting in a hold rating.
Business Overview
Ecolab Inc. is a multinational company that offers water, hygiene, and infection control solutions both domestically and abroad. The business splits its activities into three segments: Global Institutional & Specialty, which supplies specialty cleaning products to the foodservice, hospitality, and retail sectors; Global Industrial, which supports manufacturing; Global Healthcare & Life Sciences, which offers customized solutions to the healthcare, personal care, and pharmaceutical industries; and more. The Other division provides colloidal silica for manufacturing purposes and concentrates on pest removal services. Dealers, distributors, corporate account staff, and field salespeople all help distribute Ecolab's wide range of products.
Ecolab boasts a market capitalization of $54.86 billion and has delivered an 8% Return on Invested Capital. The stock's 52-week trading range has seen highs at $193.15 and lows at $140.13. Presently valued at $192.40 and a P/E GAAP ratio of 44.64, Ecolab's stock is currently trading close to its highs. Furthermore, the company's P/E GAAP ratio is above that of its industry counterparts, suggesting a relative overvaluation.
Ecolab P/E GAAP Compared to Peers (Seeking Alpha)
Ecolab also pays a dividend of 1.10% representing a 49.29% payout ratio. With minimal share repurchases due to the expensive price tag, I believe that paying a dividend as FCF improves and investing in its core business will allow shareholders to capture value as fundamentals attempt to play catch-up with price. With relatively stable cash flows for a chemical company, Ecolab can improve this dividend as cash flows increase if ROIC is strained by the size of the firm limiting growth opportunities in its core operations. With revenues and EPS continuing to grow, I believe the firm's cash flow situation should only improve resulting in dividend growth for the years to come.
Annual Shares Outstanding (Trading View) Statement of Cash Flows (Trading View) EPS Projections (Trading View) Revenue Estimates (Trading View) Share Performance (Seeking Alpha)
Performance Compared to the Broader Market
Over the past five years, Ecolab's performance, when adjusted for dividends, has lagged behind the S&P 500. Given its premium price, the fact that the S&P 500 has more than doubled the returns of Ecolab underscores the necessity for the company to deliver strong performance in the near future to justify its comparatively expensive valuation.
Ecolab Compared to the S&P 500 5Y (Created by author using Bar Charts)
Balance Sheet
When examining Ecolab's balance sheet, it is clear that the firm is adequately leveraged to endure macro and industry headwinds. With debt declining 12% in the last year and interest coverage of 9.02, Ecolab has more than enough cash flow to pay off debts and receive a competitive cost of debt due to its stable position. Also, with a high share price, Ecolab can raise cash through share issuance which is logical for the firm in the short term to capitalize on core business growth while competitors will have trouble achieving such capital. Lastly, with a Current Ratio of 1.3 and an Altman-Z-Score of 3.62, Ecolab can remain solvent in the medium term thus surviving headwinds.
Financial Position (Alpha Spread) Interest Coverage (Alpha Spread) Solvency Ratios (Alpha Spread)
Earnings
Ecolab also reported solid Q3 2023 earnings with EPS surpassing expectations by $0.02 at $1.54 and revenues only missing by $50 million at $3.96 billion showing a YoY growth of 7.9%. This performance demonstrates Ecolab's ability to hedge against headwinds such as volume declines in inflationary environments and maintain profitability. I believe that with inflation on the decline and a rate pivot coming in the next year, Ecolab will be able to outperform which is exemplified in estimates for the next few years showing strong EPS growth.
1Y Inflation (YCharts) Effective Interest Rates (FRED) Earnings Estimates (Seeking Alpha)
Analyst Consensus
Analysts currently rate Ecolab as a "buy" with a 1-year average price target of $196.48 demonstrating a potential 2.12% upside. This shows that although analysts are bullish on Ecolab's performance, they also realize the premium price Ecolab is currently trading at thus limiting upside unless future cash flows improve further.
Analyst Consensus (Trading View)
Valuation
Before Calculating the fair value of Ecolab, I decided to find an appropriate discount rate by calculating the firm's Cost of Equity using the Capital Asset Pricing Model. With a Beta of 0.9 and risk-free rate of 4.21% based on the 10-year treasury yield , I calculated a Cost of Equity of 8.23%. This is the return investors demand in return for the risk of holding Ecolab shares.
Cost of Equity (Created by author using Alpha Spread)
I then decided to use a 5-year Equity Model DCF based on net income to find a fair value. I decided to use a discount rate of 8.23% without a risk premium due to macro headwinds seeming to subside along with the firm's solid performance in recent reports. I also estimated revenues and margins to continue growing in line with analyst estimates. This resulted in a fair value of $122.42 demonstrating an overvaluation of 36%.
5Y Equity Model DCF Using Net Income (Created by author using Alpha Spread) Capital Structure (Created by author using Alpha Spread) DCF Financials (Created by author using Alpha Spread)
When viewing a sensitivity chart, it would take a discount rate of only 5% for Ecolab to be undervalued demonstrating the premium price of the stock but also the opportunity for value once interest rates drop making the risk-free rate decrease. Thus, I believe that once this opportunity arises and the price meets closer to fundamentals, Ecolab could be a value play sooner than we may think.
Sensitivity Analysis (Created by author using Alpha Spread)
Strategic Industry Diversification Improving Cyclicality
Additionally, I think that Ecolab's deliberate industry diversification is a crucial component that will enable the business to provide its water, hygiene, and energy technology to a broad range of industries. For example, Ecolab is a well-known supplier of sanitation and hygiene products to the food and beverage sector, which is essential to upholding the strictest regulations for food safety. The company's innovations help restaurants and food processing facilities maintain hygiene and adherence to strict requirements.
Ecolab is a key player in the healthcare industry as well, providing hospitals and other healthcare facilities with cutting-edge hygiene solutions. In this regard, the company's experience contributes to the general health and well-being of patients and medical professionals by keeping an atmosphere sanitary. In addition to these markets, Ecolab serves the hotel, manufacturing, and energy sectors as well, offering a varied portfolio that takes into account the particular difficulties that each industry faces. This strategy emphasizes Ecolab's dedication to sustainability and operational excellence across numerous industries, while also protecting it from economic swings in any one industry and positioning it as a versatile and necessary partner in a variety of markets.
With an increase in FCF as shown earlier in this article, I believe that Ecolab will continue this strategy through aggressive R&D or acquisitions which will open the firm's core business to new customers creating synergies and less fluctuation in cash flows. This will stimulate long-term growth and result in greater pricing power due to economies of scale.
Risks
Competition: Many companies in the competitive water, hygiene, and energy solutions market provide comparable goods and services. Ecolab's price, profitability, and market share may all be impacted by heightened competition.
Regulatory Compliance: Ecolab works in sectors where product efficacy, environmental norms, and safety are strictly regulated. Regulation changes might make it harder to comply with the law and raise operating expenses.
Conclusion
To summarize, I believe that Ecolab is currently a hold because even though the firm has solid future cash flows, a stable balance sheet, and dividends, Ecolab is currently overvalued relatively, and based on my DCF assumptions.
For further details see:
Ecolab: An Expensive Price Tag For The Current Environment