Potential investors in water, hygiene, and infection prevention company Ecolab (ECL -0.09%) are faced with almost a series of philosophical questions about the stock right now. Let's take a look at what they are and whether Ecolab is a good value or not.
Ecolab's valuation
The bull/bear debate over the stock can be best defined by trying to ascertain what its valuation should be in the light of developments in the business in 2020. Frankly, there's a lot going on.
First, it's hard to argue that Ecolab is cheap in relation to its historical rating. As the chart below demonstrates the stock is trading toward the high end of its historical valuation ranges.
Data by YCharts
Has anything happened in 2020 to justify a re-rating? The bullish case has two strong arguments behind it.
The bullish case
First, the bulls will argue that the stock should be valued higher now that its upstream energy business has been separated as part of a merger and then a public listing of ChampionX. Ridding the core business of the upstream energy division will take out a highly cyclical part of Ecolab's revenue stream. In addition, the company is now focused on its core activity of providing cleaning, sanitation, washing, filtration, and treatment solutions to its corporate and institutional clients.
It's a very attractive market to be in as 90% of its revenue is recurring and Ecolab can grow as its customers grow globally. No one customer contributes more than 2% of its sales and Ecolab's customer list reads like a roll call of global corporations: McDonald's, Microsoft, Starbucks, Apple, Walmart, and Unilever are all included. In addition, growing regulatory compliance needs are likely to drive growth for many years to come.
As the leading player (10% market share) in a highly fragmented market, Ecolab also has an opportunity to generate growth by taking market share through a combination of organic and acquisition-led growth.
The hospitality sector is a significant end market for Ecolab. Image source: Getty Images.
The second argument naturally flows. Simply put, it's highly likely that the COVID-19 pandemic will create an increased awareness around public health issues and that should mean an increase in Ecolab's long-term growth potential. As such, Ecolab deserves a valuation re-rating.
The bearish case
The bears probably accept most of the bulls' arguments about the attractiveness of the core business, and the probability that COVID-19 will enhance awareness of clean environments. However, the bearish case highlights the risk that many of Ecolab's key customers, notably the hospitality sector, are struggling right now and their long-term growth prospects could be negatively impacted by the pandemic.
Restaurants, hotels, and entertainment facilities make up a major part of the company's revenue and Ecolab needs foot traffic to improve at their facilities. This was a point highlighted in the second-quarter earnings where a 36% year-over-year fall in its global institutional (restaurants, hotels, educational facilities) sales contributed to a 15% drop in overall sales.
Things are improving in those industries, but there is still a long way to go and there may well be some long-term demand destruction. In the company's latest investor presentation management mentioned that 85% of U.S. full-service restaurants are open but are only operating at 50% of prior capacity. Meanwhile, U.S. quick-service restaurants are still operating "well below year-ago levels" and "global lodging rooms sold has risen globally from April lows and is now ~40% of prior year levels."
It's a picture of a gradually improving market, but there's no guarantee that consumer behavior won't be structurally changed by the pandemic. For example, people might get used to shopping for groceries, particularly online, as opposed to eating in restaurants. Similarly, travel and vacation habits might change as individuals seek to avoid the possibility of exposure or infection amid the coronavirus pandemic.
Is Ecolab a buy?
On balance, Ecolab stock has excellent long-term opportunities but also a significant amount of near-term risk and uncertainty around it.
Ecolab does deserve a valuation re-rating after the events in 2020, but as you can see in the first chart above, it has already had a re-rating. Moreover, the valuation suggests that investors are already assuming the bullish case for the stock as outlined above.
All told, based on its current valuation the stock is probably worth avoiding right now, but it's definitely the sort of stock to look at buying on any significant weakness. Valuations still matter.
