Explain your interest in fellow Twin Cities’ denizen Ecolab.
MH: Ecolab is not well-known for a company of its size, but it is the largest player in the high-end cleaning and sanitation industry, owning more than 10% of a $45 billion global market serving the food, hospitality and healthcare industries. Its headquarters is two blocks away – I’m looking at their building right now. If you went into a restaurant kitchen, the dishwashers would probably run with Ecolab’s patented detergents and rinse additives. The pest control services would likely be provided by Ecolab. In hospitals, you’d see a wide range of Ecolab soaps, surface disinfectants and sterilization systems. In many cases they use a razor-andblade strategy, earning high margins on consumable products that are the only ones compatible with the installed Ecolab equipment.
Once their systems are in place, switching costs tend to be high. The company also reinforces its competitive advantage by investing heavily in sales and service. They have more than 14,000 sales and service reps worldwide, who have proven quite good at cross selling new products and services and at keeping customer retention rates in the 90% range. All of that goes a long way toward explaining why Ecolab’s operating margins are double those of its closest competitor, JohnsonDiversey.
How cyclical is the business?
MH: Not very. Restaurants and hotels are obviously impacted by an overall slow-down, but the amount of cleaning necessary at each doesn’t change that much.
That’s not to say Ecolab feels no cyclical effects, but they’re typically not severe.
What’s driving growth here?
MH: In many ways the thesis is similar to what I described for Graco (NYSE:GGG). In the U.S., we expect them to continue to increase sales of new products and services to an already large base of customers. Operating margins in Europe are not as strong as in the U.S., but are improving and are much higher since Ecolab took full control of the European joint venture. The Asian business is less established, but again, we expect them to translate what has been a very successful business model to that part of the world as well.
At just under $39, the shares don’t appear terribly cheap.
MH: The stock isn’t as cheap as it was in early March, but we don’t believe it by any means reflects our estimate of long-term earnings growth of around 14%, twice the rate we expect from S&P 500 companies overall. The current price is 18.5x our $2.10 per share forward earnings estimate, but given the quality and stability of the business and where the shares have typically traded, we believe full value is at 160% of the market multiple.
That translates into a share price today of around $46. If we’re right about growth, that fair value should then grow very nicely along with earnings.