Ecolab, an overvalued Dividend Aristocrat, recently announced its:

• 30th consecutive annual dividend increase; and
• 85th consecutive year in which a dividend has been paid.

This track record will appeal to investors who fixate on consecutive years of dividend increases.

Over various timeframes before 2010, Ecolab's (ECL) total investment return consistently exceeded that of the S&P 500 index. ECL’s total investment returns over the past several years, however, have fallen well short of returns generated by the S&P 500 Index.

Source: StockRover*

Despite ECL’s less than stellar performance in recent years, it is far more important to analyze a company on how we think it will perform going forward.

With ECL having released its FY2021 results and its FY2022 outlook on February 15, 2022, I take this opportunity to determine if ECL presents an attractive investment opportunity.

Overview

ECL delivers comprehensive science-based solutions, data-driven insights and world-class service to advance food safety, maintain clean and safe environments, optimize water and energy use, and improve operational efficiencies and sustainability for customers in the food, healthcare, hospitality and industrial markets in more than 170 countries.

Before FY2020, ECL completed more than 120 acquisitions in a little over 16 years. In addition, it has completed various divestitures in its ongoing efforts to position itself to improve long-term shareholder returns.

At its September 14, 2021 Investor Day, management indicated that ECL had identified a market opportunity of ~$147B; ECL has ample growth opportunities given that its FY2021 annual revenue was ~$12.7B.

Ecolab – Expanding Market Opportunities

Ecolab – Market Leader With Room To Grow

Purolite Acquisition

On December 1, 2021, ECL closed the $3.7B Purolite acquisition that had been announced on October 28, 2021; Purolite is ECL’s most significant recent acquisition.

It is a leading and fast-growing global provider of high-end ion exchange resins for the separation and purification of solutions for pharmaceutical and industrial applications.

At the time of acquisition, Purolite had operations in more than 30 countries and it generated FY2021 revenue of ~$0.4B.

Ecolab – Purolite Transaction Overview

Ecolab – Purolite Overview

Purolite now operates as a separate global business unit and its overall results roll up into ECL’s Life Sciences division.

With this acquisition, ECL significantly increases its opportunities in the high growth, high margin life sciences business, such as the purification of mRNA vaccines and monoclonal antibodies for cancer-treatment drugs.

Expectations are that the combination of ECL’s state-of-the-art capabilities in clean and safe processing with Purolite’s revolutionary resin technology will make customers’ end-products better, safer, healthier and more effective.

The acquisition also expands ECL’s capabilities in industries that are complementary to existing leading positions, such as:

• the polishing of advanced microelectronics;
• ultra-purification of water in nuclear power;
• food and beverage taste and product quality enhancement;
• high-end precious metals extraction, like lithium for EV batteries and in the production of hydrogen fuel cells.

Long-Term Objectives

ECL’s long-term objectives include:

• 6 – 8% annual organic growth;
• 2% annual acquisition growth;
• 15% annual EPS growth;
• 20% operating income margin;
• ~2x net debt/adjusted EBITDA;
• dividend growth in line with EPS growth;
• further acquisitions; and
• share repurchases

Following the recent Purolite acquisition, ECL’s Net Debt/Total Capital is 53.7%, its Net Debt/EBITDA is 3.4x, and its Net Debt/Adjusted EBITDA is 3.1X. Investors need to appreciate that the Purolite acquisition only closed in early December. It is not, therefore, surprising to see that ECL currently exceeds the ~2x net debt/adjusted EBITDA long-term objective.

Financials

Q4 and FY2021 Results

ECL’s Form – 8K and accompanying Investor Presentation released on February 15, 2022 reflect Q4 and FY2021 results and the FY2022 business outlook.

In Q4, ECL reported strong volume and pricing momentum. This, however, was largely offset by significant raw materials, logistics, and labour cost increases, which grew an estimated 20% YoY in Q4, leading to a ~10% overall impact on the total cost of sales. This rate is almost double the rate of increase in Q3.

ECL can’t continue to absorb these cost increases and on January 12, 2022, it announced that effective February 1, 2022 it would implement a 12% price increase across the board for all Life Sciences division offerings.

Free Cash Flow (FCF)

FCF is the cash a company generates after accounting for cash outflows to support operations and maintain its capital assets. This measure of profitability excludes the non-cash expenses found on the Income Statement and includes spending on equipment and assets as well as changes in working capital from the Balance Sheet.

ECL’s FY2012 – FY2021 FCF (in millions of $) is $0.5955, $0.8975, $1.0217, $1.1846, $1.1829, $1.2227, $1.2282, $1.3154, $1.2528, and $1.4189.

I have calculated ECL’s FCF as follows:

Cash Provided by Operating Activities – continuing operations
Minus: Capital Expenditures
Minus: Capitalized software expenditures

Some sites use ECL’s Cash Provided by Operating Activities that includes Cash Provided by Operating Activities – Discontinued Operations. I purposely exclude any cash provided from discontinued operations because I consider this to be more conservative. As a result, my annual FCF results might differ from what some sites report.

Several years ago, ECL discontinued segregating capitalized software expenditures as a separate line item in the Consolidated Statement of Cash Flows; this line item was typically less than $40 million. In the grand scheme of things, these expenditures do not make a huge difference to the annual FCF calculation.

FY2022 Outlook

ECL’s strong sales growth, robust new business wins, innovation and increased pricing, are forecast to drive earnings growth and compensate for higher product costs.

Although healthy sales growth is anticipated in Q1, EPS is expected to be relatively similar to that reported in Q1 2021 because of continued high raw material and freight costs. Management also expects the COVID impacts to remain significant during the first half of FY2022 and inflation to remain high before progressively easing during the second half of the year.

The outlook for all of FY2022 is continued strong sales gains with adjusted diluted EPS growth in the low-teens.

Management forecasts the impact of the Purolite acquisition to be neutral to FY2022 adjusted diluted EPS; this includes $0.26/share of transaction-related amortization.

Credit Ratings

ECL has taken advantage of the low-interest-rate environment in the past couple of years.

• In August 2020, it issued $1.1B of 10-year and 30-year bonds at the lowest ever yields for an A- issuer in these tenors.
• In August 2021, ECL issued $0.7B of 34-year 2.75% bonds to redeem 2022 and 2023 maturities and exchange for long-term notes.

While ECL interest expense is ~8% lower from FY2020 because of lower average debt levels and lower average interest rates from debt refinancing transactions, the benefit was partially offset by new debt for the funding of the Purolite acquisition.

ECL’s current senior domestic unsecured credit ratings are:

• Moody’s: A3 upgraded from Baa1 in October 2021
• S&P Global: A- and stable
• Fitch: A- and stable

All 3 ratings are the lowest tier of the upper-medium-grade investment-grade category.

These ratings define ECL as having a strong capacity to meet its financial commitments. It is, however, somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories.

These ratings are satisfactory for my purposes.

Dividends and Share Repurchases

Dividend and Dividend Yield

On December 2, 2021, ECL announced a $0.03/share dividend increase in the quarterly dividend from $0.48 to $0.51. Using the current ~$180 share price, the dividend yield is ~1.1%.

Source: Portfolio Insight*

As noted earlier, this dividend increase represents Ecolab’s 30th consecutive annual dividend increase and the 85th consecutive year of dividend payments. These metrics might appeal to some investors. Basing investment decisions on these metrics, however, is a fundamentally flawed way to invest.

Source: Portfolio Insight*

Investors would be better served to look at an investment’s total potential return (capital gains and dividend income) rather than fixating on the dividend return.

Share Repurchases

In FY2012 – FY2020, ECL repurchased shares amounting to (in millions of $) $209.9, $307.6, $428.6, $755.1, $739.6, $600.3, $562.4, $353.7, and $146.2. The FY2021 Form 10-K is not yet available and I am unable to determine from the information currently available how much was deployed to repurchase shares in FY2021.

The weighted average number of outstanding shares (in millions of shares) in FY2012 – FY2021 is 298.9, 305.9, 305.9, 301.4, 296.7, 294, 292.8, 292.5, 290.3, and 289.1. While ECL repurchases shares annually, the weighted average number of outstanding shares has experienced minimal change because of new shares issued as part of the company’s compensation program.

Valuation

Price/EPS

In FY2012 – FY2019, ECL reported diluted EPS of $2.35, $3.16, $3.93, $3.32, $4.14, $5.12, $4.88, and $5.33; ECL reported negative earnings in FY2020 because of a $2.1725B Net Loss from Discontinued Operations.

I acquired ECL shares in February and March 2020 at an average purchase price of ~$183; these purchases were made based on FY2019 results released in mid-February that reflected diluted EPS of $5.33 of which $0.46 was from discontinued operations. In addition, ECL reported $5.82 in adjusted diluted EPS and FY2020 Adjusted EPS, excluding special gains and charges, was expected to be $6.33 – $6.53.

Using this data, the diluted PE was ~34.3 and the adjusted diluted PE was ~31.4. Based on the mid-point of management’s FY2020 adjusted diluted EPS outlook, my forward adjusted diluted PE was ~28.5.

ECL’s FY2020 results ended up being far worse than anticipated because of the divestiture of Ecolab’s Upstream Energy business.

ECL ended up reporting $3.33 in FY2020 diluted EPS from continuing operations and a $7.48 loss from discontinued operations, thus leading to a $4.15 loss attributable to ECL. On a GAAP basis, we cannot compute an FY2020 PE because ECL reported a loss. FY2020 adjusted diluted EPS from continuing operations, however, amounted to $4.02.

Despite a pullback to ~$180 from the ~$239 52-week high of early November 2021, ECL’s valuation is still high.

ECL’s FY2021 GAAP EPS is $3.91 and adjusted diluted EPS is $4.69. Using the current ~$180 share price, the diluted PE is ~46 and the adjusted diluted PE is ~38.4.

If ECL achieves 15% EPS growth, FY2022’s EPS should be ~$4.50 thus giving us a forward diluted PE of ~40.

The brokers that cover ECL will likely be revising their adjusted diluted EPS outlook over the coming days. For now, however, the following is the current forward valuation based on current estimates.

• FY2022 – 21 brokers: $5.34 mean and $5.14 – $6.15 range. The valuation using the mean is ~33.7.
• FY2023 – 21 brokers: $6.19 mean and $5.86 – $7.00 range. The valuation using the mean is ~29.1.
• FY2024 – 10 brokers: $6.92 mean and $6.49 – $7.80 range. The valuation using the mean is ~26.

The forward adjusted diluted PE levels are relatively similar to historical levels despite a $59 decline in the share price from the 52-week high. This shows the extent to which Ecolab was as overvalued Dividend Aristocrat in late December 2021.

Price/FCF per Share

Looking at ECL’s valuation on the basis of FCF we have the following:

ECL’s FY2012 – FY2021 FCF (in millions of $) is $0.5955, $0.8975, $1.0217, $1.1846, $1.1829, $1.2227, $1.2282, $1.3154, $1.2528, and $1.4189.

The weighted average number of outstanding shares (in millions of shares) in FY2012 – FY2021 is 298.9, 305.9, 305.9, 301.4, 296.7, 294, 292.8, 292.5, 290.3, and 289.1.

If we divide the annual FCF by the weighted average number of outstanding shares we get FY2012 – FY2021 FCF/per share of $1.99, $2.93, $3.34, $3.93, $3.99, $4.16, $4.19, $4.50, $4.32, and $4.91.

Since the annual FCF/share is less than diluted EPS in every year in which ECL did not report a loss, it stands that dividing ECL’s share price by FCF/share would result in loftier valuations.

Final Thoughts on Ecolab (ECL) – An Overvalued Dividend Aristocrat

My ECL exposure is relatively small and ECL did not make it into my top 30 holdings when I completed my early January 2022 analysis.

I was well aware ECL’s valuation was rich when I acquired shares in early 2020. The appeal, however, was ECL’s global leadership position in water, hygiene and infection prevention solutions and services. These are all areas with significant long-term growth opportunities; management estimates a $147B market opportunity yet ECL’s FY2021 annual revenue is only 12.7%!

ECL’s total investment return has been disappointing following my purchases. As a ‘buy-and-hold for a very long-term investor’, however, I am willing to patiently bide my time if I think a company has strong growth and profitability potential. I am not, however, prepared to acquire additional shares in this overvalued Dividend Aristocrat.