Ecolab

Ecolab reported solid second-quarter results as higher prices and volumes drove profit growth.

Why it matters: Ecolab shares were up nearly 5% at the time of writing on July 28 as the market reacted to management raising its third-quarter and full-year adjusted earnings per share guidance above FactSet consensus estimates. The higher guidance was driven by accelerating sales growth and the ability to quickly pass on cost inflation. This exemplifies our thesis that energy and commodity chemicals cost inflation due to the Middle East conflict-related supply shock would have little impact on Ecolab. Ecolab shares had sold off following the company's first-quarter earnings on weak second-quarter guidance due to cost inflation. But the accelerating sales growth in the second half of the year shows Ecolab's surcharge pricing can be quickly implemented during inflationary periods.

The bottom line: We raise our fair value estimate for wide-moat Ecolab to $305 from $300. The increase is driven by our outlook for higher pest elimination and life sciences growth versus our prior outlook. At current prices, we view Ecolab shares as fairly valued with the stock trading less than 10% below our updated fair value estimate. This puts shares in 3-star territory. As such, for investors who are not already in Ecolab, we recommend waiting for a pullback before considering an entry point. In early July, Ecolab closed the CoolIT systems acquisition. This, along with the 2025 Ovivo acquisition, will greatly expand Ecolab's exposure to data centers and semiconductor manufacturing.

We raise our Ecolab fair value estimate to $305 from $300 following the company's second-quarter earnings. The increase reflects higher growth assumptions in the pest elimination and life sciences businesses than in our prior outlook. Our cost of capital for Ecolab is roughly 7.5%.

In the near term, Ecolab should see profit growth and margin expansion in 2026. The water segment should benefit from growing demand for Ecolab's water-cooling and recycling technologies. The Ovivo and CoolIT acquisitions should drive Ecolab's high-tech water business to generate strong double-digit growth over the next few years. The institutional business should benefit from market share gains, driving volume growth. Ecolab should also benefit from price increases that exceed higher costs, driving further margin expansion. We expect Ecolab to raise prices to fully offset any cost inflation. The company has already implemented a trade surcharge, which should help it pass along higher costs more quickly. We view Ecolab as well-positioned to continue growing profits even if tariff-related inflation causes an economic slowdown.

Total revenue should grow at a mid-single-digit annual average rate over the next decade. We see faster growth in the water business from global high-tech end markets, including semiconductors and data centers. Elsewhere, we expect Ecolab to benefit from the secular trend of rising global fresh water costs, which in turn will lead customers to implement water management systems to conserve water. We forecast revenue will grow annually in the high-single-digit range for the water business. As Ecolab adds additional products and more digital services, we expect water segment profit margins to expand from 16.5% in 2025 to over 20% over the next decade.

In the institutional business, we expect Ecolab to continue to increase its share over time. The business will also benefit from increased consumer preference for fresh food and a rise in the number of healthcare and long-term care facilities. As food-service providers serve an increasing proportion of fresh food, this adds supply chain complexity from a cleaning and sanitation perspective, which allows Ecolab to further ingrain itself in its food-service customers' businesses. We forecast mid-single-digit revenue growth and margin expansion to the mid-20% range from the low-20s in 2025.

In the life sciences business, we expect Ecolab to grow revenue at a mid-single-digit rate over the next several years, as the business pushes to expand its presence by selling products and services to the healthcare and pharmaceutical end markets.

Revenue growth should drive margin expansion, and we forecast Ecolab's operating margins will expand to roughly 20% by 2027, in line with management's long-term goal.

In a downside scenario in which a global economic slowdown weighs on Ecolab's recovery, we assume the company experiences slower growth than in our base case. We also assume the company is unable to expand profit margins, which end up in the mid- to high-teens levels, short of management's 20% operating margin target. In this scenario, our fair value estimate would be $180

In an upside scenario, we assume Ecolab's revenue grows at a mid- to high-single-digit pace due to market share gains. We also assume the company can expand profit margins through larger price increases than in our base case, with long-term margins reaching the mid-20% range. In this scenario, our fair value estimate would be $430 per share.

We award a wide moat rating to Ecolab. We analyze the company’s competitive advantage through our framework for commodity processors. Moaty businesses in this space tend to benefit from switching costs, intangible assets, or cost advantage. We view switching costs as the key moat source that allows Ecolab to generate excess returns.

Roughly 80% of Ecolab's sales across all segments come from its installed base and consumables model, commonly known as the razor-and-blade model, which creates high switching costs. The other 20% of sales come from services, including pest control, regulatory and supply chain consulting, and manufacturing plant monitoring.

For the razor-and-blade model, the company provides proprietary cleaning equipment and devices to its clients and then sells a steady stream of the consumables required to keep the machines running. For example, for its restaurant customers in the institutional segment, Ecolab will provide a dishwasher that runs on its soap. The restaurant will only pay for the soap and can use the dishwasher for free as long as it meets minimum order requirements. While Ecolab’s consumables are priced higher than competitors, the company’s proprietary formulations can save customers energy, water, and labor expenses well above the additional cost of Ecolab’s products. In addition to the cost savings that its customers realize, Ecolab minimizes downtime for key pieces of its customers’ machinery, allowing its business processes to proceed without costly interruptions. Customers are motivated to avoid the costs associated with swapping to new equipment and retraining staff.

In addition to a continual emphasis on reducing water, energy, and labor expenses, Ecolab sells cleaning equipment that automatically keeps regulatory compliance records for its water treatment and manufacturing customers. This regulatory aspect allows Ecolab to act as a regulatory compliance consultant. This strengthens the company’s switching costs as customers would face increased regulatory compliance costs by choosing a competitor to replace Ecolab.

Ecolab uses a direct selling model with a salesforce that is segmented by specific customer industry and focuses on cross-selling products, which also contributes to switching costs. For a customer with multiple cleaning and sanitation needs, managing each order from each supplier has a fixed-cost component. Thanks to both the scope of its product offerings and its global scale, Ecolab serves as a one-stop shop for its customers. In turn, the customer is able to save time and money aggregating orders reorders across a variety of products and services by engaging solely with Ecolab. For example, a hotel customer that uses Ecolab’s products for dishwashing, laundry, cleaning, and pest control can enable automatic reorders and would not have to deal with machine maintenance. If the customers were to replace Ecolab with multiple suppliers, it would have to manage a far more complex and costly supply chain. This dynamic supports modest pricing power for Ecolab.

Ecolab is the largest player in the fragmented cleaning and sanitation industry, which allows it to service large global organizations that are outside the reach of local and regional players, such as McDonald's and Marriott. In addition to its global customers, Ecolab targets expanding restaurant or hotel chains. For brands such as Shake Shack, which are expanding to a national footprint, Ecolab is a preferred cleaning supplier as it can supply the same dishwashers, cleaning products, and quality to new locations across the US. The scale also allows restaurants and hotels with a global or national franchise model to ensure uniform cleaning standards and maintain the same cleaning process among large global companies and franchise brands.

Ecolab’s largest customers have traditionally been in the hospitality and food and beverage manufacturing industries, where the company is the global leader in cleaning and sanitation. However, Ecolab’s largest area of growth comes from its industrial water business, where the company sells water recycling technologies that can reduce its manufacturing customers’ water usage up to 50% while also reducing energy consumption, resulting in total cost savings far in excess of the additional cost of Ecolab’s products and services. Ecolab can then cross-sell its technology offerings, where the company installs sensors throughout a plant and then monitors plant operations. The sensors run predictive maintenance to help avoid expected plant shutdowns and reduce total plant downtime, resulting in a more profitable operation. This makes Ecolab deeply engrained in its manufacturing customers’ process, creating strong switching costs.

Even during the coronavirus-related downturn for many of Ecolab’s restaurant, lodging, and refinery customers, and subsequent cost inflation that temporarily weighed on profits, the company's returns on invested capital remained safely above its cost of capital. We think the company’s consistent excess returns are likely to continue for at least the next 20 years. Even in our bear case, which assumes a continued downturn across many of Ecolab’s end markets, we project the company to safely outearn its cost of capital and continue to generate positive economic profits.

Ecolab's focus on delivering savings on labor, energy, and water for customers makes the firm's products and services attractive even during economic slowdowns.

Ecolab's water business has growing exposure to artificial intelligence through its semiconductor manufacturing and data center customers. This should drive strong long-term growth for the company.

Rising fresh water costs will drive demand for industrial water management systems. Ecolab's water management systems will be able to save its customers water and energy costs, which will increase water business profits.

Sales growth could become more difficult, as Ecolab already sells to many of the largest restaurant and hotel chains.

As with many chemical companies, Ecolab's fluctuating raw material costs could weigh on the company's profitability.

Growth in demand for water management systems will attract competition to the market, which could result in slower growth for Ecolab.