Daniel J. Schmechel - Chief Financial Officer
Ecolab Inc. (ECL) Goldman Sachs Basic Materials Conference May 22, 2013 10:35 AM ET
Okay, everybody, we're going to keep going with our next presenter, Ecolab. We're really happy to have a relatively new CFO of the company, Dan Schmechel, here to present Ecolab's case. Dan?
Daniel J. Schmechel
So thank you very much. This is my first trip to the Goldman Sachs conference. I've been on the job, I guess, since October, so a little bit more than 6 months. This is a really, really nice space. I feel like I'm in a really, really nice business school, okay? This is terrific. So nice to see you all. Thanks for your interest in Ecolab.
I'll start here with the cautionary statement, right, which basically says that anything I'm about ready to say about the future might not actually turn out that way and for a lot of reasons, all of which are as detailed in our recent 10-Q and other SEC filings.
And then getting on to the presentation. So I expect that most of you know something about Ecolab. We are the leading global supplier of services and technologies for food safety, for clean water and energy and related to hygiene. So we protect what is vital: safe food, clean water, abundant energy and healthy environments. And as we are so directly linked to protecting what is vital, of course we like our positioning very much.
The basis of our business model and really the core of our value proposition is fundamentally very simple. We help our customers protect their brands and serve their customers better and do it in a way that makes them more cost effective and also reduces their energy and water footprint.
It's a wonderful business model. More than 90% of our revenue comes from products, products which are supported at customer locations by incomparable field service. And more than 90% of our revenue is from recurring contract base.
As the result of the fact that so much of our revenue is on a recurring basis and we have that terrific customer relationships, we are known for our ability to do one thing very well, which is to deliver consistent sales growth and to translate that sales growth into consistent EPS growth. So you can see the numbers over a 10-year period. We've delivered something like 13% compound growth, 12% at 5 years, widely exceedingly the S&P 500 based on both of those benchmarks and really based on any other benchmark that you care to think about. And so delivering is a critical part of our culture.
And we deliver on our expectations. So this chart shows us we have met or exceeded our forecast in 84 of 85 quarters. So something like a 20-year record. Now this is our forecasted public range. This is not the analyst consensus. But frankly, delivering is something that we're very good at. I would say, in fact, that delivering is part of our corporate culture, too. We deliver for each other within the company, we deliver for our customers and we deliver for our shareholders.
So here's a depiction of what we look like. We think that with the recent acquisition of Champion, which was closed on April 10 of this year, we are very well positioned by region, by segment and by strategy. With Champion, now the Energy business, represents about 27% of our total portfolio by sales, which we think is appropriate, and we think it positions us very well for where the growth will be.
Now from a value proposition, this is a pretty simple business model. We lead with the industry's leading technology, and it is supported by really incomparable field-level execution and in-unit service support. So whether or not it's a hospital or it's a 5-star hotel or a food and beverage facility or a refinery, we are bringing industry-leading technology and supporting it with incomparable field service.
So it does begin at the product level with innovation. The core of our innovation strategy is to bring to the market products that help our customer manage their business more effectively to reduce their energy and water footprint and to deliver superior results to their customers.
We spend a lot of time on it. We've got dedicated teams doing active R&D throughout the world, principally in St. Paul, Minnesota, Naperville, Illinois, and Sugar Landin Texas. Innovation, of course, is also the key to and the most effective way to increase our own margin over time. So it's great for the customers, great for their customers, great for our margins.
But our -- the real secret of Ecolab is our field sales and service team. It's the heart of the company. More than 23,000 field sales and service associates globally. This means that more than half of our global workforce works every day focused on serving customer needs directly in sales or service capacities. And we're very good at it, okay? So we are commonly recognized as one of the top 10 companies to sell for.
We have a very strong competitive position, and yet we are only a 12% share. So we did something like $11.8 billion last year in sales in a $100 billion market.
We like the position very much, but, obviously, there's room to grow. There's room to grow in all of our markets. So this shows by segment the markets that we serve. Orienting to the chart, if you can't see it, the green is the total opportunity, and the blue is a part of the opportunity that we already own.
So we have sales and service people in 172 countries globally. We are united by a common culture and also by a common business model. And we're also united and delighted by the incredible opportunity that we see ahead of us.
At the heart of this opportunity is with our largest customer relationships. So we really have, in many cases, decades-long, very close customer relationships with industry-leading players, right? They have the highest expectations. They deliver the highest performance, and they have the highest growth opportunities within all of the markets that they compete in.
From a strategy perspective, this is a very simple story. I've been with Ecolab for 18 years, and we have always articulated it exactly this way and it is still a strategy that works: circle the customer, circle the globe. We are recognized and deep partners with our customers, servicing their requirements. And as they have expanded globally, we expand with them.
So just a couple of examples of this and how this actually plays out in various segments that we serve. So let's begin in a restaurant, okay?
Our core offering in a restaurant is the dishmachine. Now you might think there's nothing particularly remarkable or attractive about an opportunity based on the dishmachine, but the dishmachine is really the heart in many ways of the commercial kitchen. Most customers will have multiple cooktops, multiple fryers, lots of different food preparation opportunities and surfaces, but there's only one dishmachine, and if the dishmachine goes down, they're out of business, right, because there's no way that they could keep up manually with the requirements of keeping all of their dishes, glassware and flatware clean. And so owning that dishmachine relationship, which we do with very advanced monitoring technology as well as certainly industry-leading cleaning and sanitizing products, and supporting that with terrific in-unit service, we then have the opportunity to broaden that relationship into food safety audits, into Pest Elimination, into water filtration and into many other applications that are core to the successful operation of a restaurant.
Similar story really in a food & beverage processing plant, where our core and entry technology is clean-in-place, meaning these are quite technologically advanced systems that allow our customers to operate and also to keep their production lines sanitized with our products without having to dismantle their production equipment. So we're able to introduce our product into the customer's processing line and then to rinse it, to sanitize it and to get them back quickly into production.
Off of that platform, again we introduce a number of products, including, for example, food-grade lubricants, which keep production lines operating efficiently in a way that poses no threat to the food supply or to the product quality.
Hospital, very similar approach. I won't go through all of the examples, but you're beginning, I'm sure, to get the idea. The lead offering in a hospital is typically 2, 1 of which is instrument sterilization and the other is hand sanitizing.
And in a refinery, again same idea. We make a whole array of chemistries and water technologies that both protect the asset of the refinery operators and improve the quality of the product that comes out. Owning these relationships also gives us opportunities to, for example, market fuel additives and other services, again fundamentally supported and critically by very strong unit service at the refinery level.
So we have always been navigating by a very consistent and, I think, very prudent set of financial principals. The first is growth, okay? We target 15% EPS growth annually, which isn't to say that we deliver that kind of growth every year. But over time, we have delivered it, and we see every opportunity for delivering it going forward.
From a return perspective, so we've recently done 2 sizable acquisitions. We completed the acquisition of Nalco and now are busily completing the integration of it and, as I mentioned on April 10, closed on the acquisition of Champion, a Houston, Texas-based company that was very complementary to our Energy Services business, which we'll look at in a minute. But having done 2 big acquisitions, we've taken a bit of a dent in ROIC. We delivered returns on a book basis for years in excess of 20%. Our target is to get back to a 20% return on invested capital by 2020, which quite simply means that we'll be improving ROIC by about 100 basis points a year.
From a leverage perspective, we've announced publicly our intention to return to what I'll call an A range balance sheet from a metrics perspective and to do that by the end of 2015. By that, we mean, as indicated here, have focus on the total debt-to-EBITDA number of less than 2.
We've been very clear also in our use of cash flow. We have consistently increased our dividend as our net income has increased. As mentioned, we will return to A range metrics, which will involve paying down some of the debt that we've taken on to finance these acquisitions. There is -- continues to be room in our thinking about cash flow for what I'll describe as bolt-on acquisitions. So things that we will do to fill out specific geographies or products or even customer sets. And with what is left, we'll use for share repurchase. Importantly, when we did the Nalco -- announced the Nalco transaction, we also said that we intend to complete our previously announced billion-dollar share repurchase program, of which there's $280 million remaining, and it is still our intention to complete that.
So we think that we are incredibly well positioned to grow going forward. So this chart summarizes some of the macro trends that we see pitching directly in our favor, and let me focus on just a few of them, if I might.
So think about population and consumption trends. So a world that will have 50% more people by 2050 and consuming 100% more food calories, right, and, at the same time, demanding a safer and more secure food supply chain. All of this will put increasing demands on water, especially in areas where water is already scarce, which is where the majority of the population growth will occur. We see an increasing and seemingly insatiable global demand for hydrocarbon-based energy, not growing at blockbuster rates but nonetheless creating an opportunity for us to grow our Energy service business considerably. We also see an aging population in developed markets, placing increasing strains on health care delivery systems. All of these markets we are very well positioned to serve. And so, I think maybe you all get the idea why we like our positioning so much around safe food, clean water, abundant energy and healthy environments.
Our 2013 objectives are very straightforward, I think. We will continue to build share with the largest players globally. We will continue to introduce new products and use innovation to both deliver great results for our customers and drive margin enhancement opportunities for us. As discussed, and we'll talk a little bit more about the Champion acquisition, but continuing to increase our footprint and -- globally and our position in the energy market. We've got a large and growing portfolio and capacity to serve growth in emerging markets. We are very committed to continuing to deliver first of all the margin improvement opportunities that we've committed to in Europe as part of our project renaissance and also to capture the synergies that we've publicly announced for the Nalco transaction and now for Champion.
And very important to me as the CFO is driving continued executional excellence at the functional level, including increasingly more moves to global shared service capabilities.
With respect to the top of the market growth, we will continue to build share with the largest players. It's where, frankly, most of the growth will come from and the bigger share of the global growth. And we will drive that both from new account acquisition and through penetration based on bringing new products to the market.
I mentioned up front that a very important element of our culture is delivering on our commitments. Another core element is growing to win, okay? We are always pushing the top line and believe that, that is the best way to make opportunities throughout the business. Especially when you consider this highly recurring portion of our business portfolio, it's not exactly an annuity business, but it gives for us the opportunity to continue to develop the relationship and bring more and more solutions to bear.
And innovation. So we'll talk about a few of these platforms, but the core of our innovation strategy is bringing to the market new products and technologies that allow our customers to serve their customers better, to deliver superior results and to do it always in a way that reduces their footprint in water and in energy.
So a couple of examples. And so this would be our Textile Care Division, not the core necessarily of the offering, but I think it will give you a very good idea. So this is an integrated laundry program that allows commercial laundries to deliver consistently superior results to their customers. So think roughly white towels if you're staying at a very nice hotel but to do it in a way that saves both their energy and their water. And this is sort of a classic tensile sell for Ecolab where what we represent from a total cost perspective to the operator is relatively small. What we help them manage and significantly reduce is a significantly larger part of their total cost structure, be it water, be it energy or in food service operations, particularly be it labor.
We continue to do this globally. Nalco has brought many new -- the Nalco acquisition has brought many new opportunities to do it. So we will continue to leverage this 3D TRASAR technology, which just -- let me describe it for you briefly. This is a sort of integrated monitoring system. So think about it in the application around a boiler and cooling tower system or HVAC system, where with trace elements the customer is able to see both the concentration and the effectiveness of our product at work, which allows them to manage very effectively the dosing and the chemistry in their systems to prevent things like scaling, corrosion and fouling. So it's both an asset protection play and also delivers superior products.
We have terrific solids technology. So this is -- these are products which are super concentrated and diluted and dispensed on location. We are -- that application, which was developed primarily for food service, we've also extended, for example, to health care, instrument processing. 3D TRASAR, by the way, which grew up in the Nalco Water business, has also been extended to the Nalco Energy business. We are finding applications also in our Food & Beverage business where, again, equipping the customer to really understand how our products are interacting and supporting their commercial processes are vitally important.
We are experts in a wide variety of antimicrobial applications, many of them food grade and food protection based, right? And this is finding wide application. For example, the very first, what I'll describe as R&D synergy coming out of the Nalco transaction was the application of our antimicrobial expertise to impairment [ph] tons [ph] for produce waters from producing oil and gas wells, which sit at the surface and are subject to all kinds of microbial activity unless they're treated.
A word on Energy. So this is an important slide. Let's take a look at the left-hand side to begin with. So this -- the idea here is relatively straightforward if you've been around the industry. Oil and gas wells, once discovered and put into production, are instantly in decline, okay? And this light blue bit at the bottom represents the anticipated production profile of oil and gas wells that are already in production, consistently declining. And this in the face of a world where we anticipate the demand for hydrocarbon energy will increase at something like 2% to 3% a year. What will make up the difference is the development of crude resources which are known but undeveloped, but then increasingly, the finding and discovery and development of crude oil and natural gas resources in environments which are both more difficult to access, more difficult to produce and more difficult to treat. This creates a terrific opportunity for us. So if you see down at the bottom left-hand side, this would be representative of what our Energy specialty products and the revenue opportunity that's available to us per barrel produced as more and more of this difficult-to-reach, difficult-to-treat crude oil comes to the market. This is how we are able to drive in our Energy Services business consistently and going forward low-teens growth in a market where the underlying production trend grows 2% to 3% per year.
A word about Champion. I mentioned that we closed on this transaction on April 10. The market, of course, has responded quite well to it. We love it. We were not completely wild necessarily about the timing of it, coming closely on the heels of the Nalco transaction but simply couldn't pass it up because it made such great strategic sense.
So Nalco is a company based in Houston, Texas that offered a platform -- I'd like to think $1.3 billion in sales, offered a platform that was very largely complementary to the Energy -- our own Energy Services platform from a customer, from a geography and, in many ways, from a technology perspective as well.
So we are now really near the front but still very busy with the integration of this Champion transaction and really looking forward to what this is going to do for us both from what we can do for customers globally and how -- and the new technologies that we can bring to the marketplace and particularly strengthens our footprint in the emerging, now emerged, I would say, North America Energy platform around tight gas, tight oil and in shale formation.
Likewise, we're -- we continue to be very committed to building our platform in health care. So here, we see our role as vital in helping health care providers get their arms around a real problem in our country that doesn't get the same kind of -- gets some public attention but not, I think, what it should, which is the frequency of occurrence of hospital-acquired infections. Particularly as the population ages, we think that this will become a bigger and bigger deal. Our ability to offer cleaning and sanitizing solutions in health care environments as well as our ability to manage key account relationships, I think, will continue to make this a very exciting opportunity for us.
And in emerging markets, right, I mentioned it, we now, courtesy of Nalco and Champion, have what I regard as businesses of scale in the major emerging market opportunities of the world. Certainly, in all of the BRICs, we saw good growth from these markets last year and look forward to growth and increasing presence as we move forward.
I mentioned, and we'll just visit again, a bit about delivering on our synergies. So we've announced with Nalco the commitment to deliver $250 million of cost synergies. We were exactly on target for the first year, delivered $75 million and will deliver incrementally $60 million next year.
We -- in Europe, at the bottom, right, we committed to delivering continuous margin improvement. Frankly, we're a bit behind, I think, based primarily on the sluggish economies in Europe, which have held back top line performance a little bit. But nonetheless, we are driving 100 basis points a year of margin improvement in the Europe, did a little bit better than that last year. And let me tell you we got a long way to go, but I'm very confident that we're going to get there.
Also in this cost synergy box here, this is the synergy delivery that we are committed to deliver for Nalco that includes something like $25 million this year but building to a $150 million opportunity quite quickly.
We've also changed, beginning with our 2013 reporting, our global segment lineup, and I had some discussion on that earlier in meetings. I think that this is not only the right thing to do from a disclosure perspective but also is the right way to look at our business. So the idea is we will be reporting on and we are really managing our business as global business units, including Institutional, which includes our core Institutional business focusing primarily on hospitality, lodging customers; KAY, which focuses on quick-serve restaurants, the health care markets; Global Industrial business, which focuses on Food & Beverage, water, both light and heavy water opportunities, paper and textile care; Energy is energy; and another segment, which basically includes pure service plays, including our Pest Elimination business in the U.S. and Equipment Care business. Very importantly, this is going to be supported by a regional structure that includes functional excellence and how we'll continue to drive that.
So let me just say this in summing up Ecolab. We absolutely love this business, and we love the company. We work tirelessly to make sure that it achieves its full potential. Despite the fact that we have a very long track record of consistently delivering for customers, for shareholders and for each other, I stand here telling you my -- and I'm completely confident that we're just getting started. I've never been more excited about the platform for growth that we have than we have here today.
So it is a very consistent business model. It is anchored by great technology, but the heart of it is an absolutely unmatched and unrivaled capability to deliver in-unit service around the world. I think that our financial management has been very prudent, and I'm proud of it. I've been part of it for a long time. We have significant competitive advantage. And it's a company and a business model that we understand well, and we'll continue to execute well.
So with that, I would thank you for your attention and welcome any questions that you might have, time permitting.
Daniel J. Schmechel
Dan, the financial model or profile for Ecolab used to be kind of, I mean, high-single-digit top line growth, maybe 50 basis points or so of margin expansion to leverage that to kind of low-double-digit net income growth and maybe a little bit of share repurchase to get to kind of a mid-teens level. And that's been sort of obscured by all the significant M&A that you've been doing in the last couple of years and getting into some different end markets. But as all of that normalizes and after you get all the cost synergies from that, is that still the same growth profile you see for Ecolab going forward?
Daniel J. Schmechel
Yes, I think the formula is going to remain about the same, okay? So we talk and we'll deliver over time something like 6% to 8% organic sales growth. One of the reasons why we're so excited about the Energy business, frankly, number one, fundamentally the business model we're familiar with. You bring great stuff to the market and you support the heck out of it at customer locations. We talk the same language. But it will grow faster. And so of -- that 6% to 8%, I think it's still the right range to think about. Probably Energy and over time water will be near the north end of that, right? And then the conventional Ecolab business is perhaps more in the 6% range. And that kind of top line growth, coupled also, though, with our increasing ability, scale, number one, but also to find leverage and platform in the business. So we've talked about delivering something like 50 to 75 margin points improvement per year, and I think that, that's something that we can deliver. Yes, we will continue to be active in share repurchase. We'll complete this program. I would think about it as offsetting primarily the dilutive impact of option exercise, plus some as discretionary free cash flow is available. We'll continue to make bolt-out -- bolt-on acquisitions to fill up the platform, right? And so I think that the story that you've seen historically is very much the story that you'll see going forward without more volatility, just with a bigger platform to grow on, okay? Good.
You mentioned about high-growth markets. Can you comment your strategy in China given the fact that the government has put a huge emphasis on the food chain and frankly the public has been fed up with a lot of food safety issues over the last 12 months?
Daniel J. Schmechel
Yes. So it's a large and complex market, as I'm sure you're very well aware. We think that as in every market, the focus on security of the food supply chain plays directly to our strengths, and we view that, frankly, as a growth accelerator in China. Typically, in every emerging market that we've entered, China being no exception, our Food & Beverage platform is the first to go in, right? I mean, first kind of calorie consumption and expectations on food quality and availability rise, and then the brands start to show up. So we have a large and strong Food & Beverage business in China. It is anchored more extensively by Global Brands okay, which care a heck of a lot, as you can appreciate, about not only their brand reputation but also their product quality. And it's a platform that we see expanding and, frankly, view favorably the increased focus and attention on security of food supply. All right?
I had 3 quick questions for you. First of all, can you remind how you finance or plan to finance the Champion acquisition? Second one was on the point about debt reduction. I was wondering, what debt do you have to reduce? And when do you expect that to commence? Now the third question I have for you was, do you expect to be downgraded by Moody's?
Daniel J. Schmechel
So thank you. I guess I'll take them in order, okay? So from a financing perspective, the consideration was 25% stocks, 75% cash. The cash component was right before the end of the year last year, we did a 5-year , $500 million term note; this year, we did some bank financing; and the balance of it we financed in the CP market. Intentionally, we want to keep a lot of that to be prepayable because this company has very strong cash flow fundamentals, and our ability to repay debt is important to me and to our treasury team. And so I guess simplistically, what we said and what was part of our conversation with the rating agencies was that it is our intent to return to A range metrics, what they do from a rating perspective, of course, is up to them, and to do that on a run rate basis by the end of 2015. So we thought and think still that it is a very smart financing arrangement and a good package that balances our ability to do acquisitions, to continue to support share repurchase, including a big block that we've committed to, and the ability to get our balance sheet back toward what I guess I would regard as more of like a run rate level of that in the overall balance sheet. I won't speak for Moody's. We got significantly, as I'm sure you've noted, different reactions from S&P and Moody's on the announcement of the transaction. As you can well appreciate, we did pre-discussion with both of them. And so my take is they're kind of watching and waiting to see what we do. And we will do exactly what we've said we'll do, which is we're going to integrate these acquisitions, we'll continue to deliver great shareholder return and we'll get our balance sheet back to the A range metrics on the time line that we committed to, to help them make up their own minds, okay? They haven't signaled one way or the other to me, okay?
I think we'll have to end it there. Thanks very much, Dan.
Daniel J. Schmechel
Okay. Thank you.
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