Ecolab Inc (ECL) — Q3 2015 Earnings Call Transcript

Thank you. Hello, everyone, and welcome to Ecolab's third quarter conference call. With me today are Doug Baker, Ecolab's Chairman and CEO; and Dan Schmechel, our Chief Financial Officer. A discussion of our results along with the earnings release and the slides referencing the quarter's results and our outlook are available on Ecolab's website at ecolab.com/investor. Please take a moment to read the cautionary statements on these materials stating that this teleconference, the discussion and the slides include estimates of future performance. These are forward-looking statements and actual results could differ materially from those projected. Factors that could cause actual results to differ are described in the section of our most recent Forms 10-K and 10-Q, under Item 1A, Risk Factors, and in our posted materials. We also refer you to the supplemental diluted earnings per share information in the release. Starting with a brief overview of the quarter, strong new account gains and new product introductions drove solid mid-single-digit fixed currency sales growth in our Global Institutional, Industrial and Other segments during the third quarter, more than offsetting lower Global Energy sales. We leveraged that growth along with delivered product cost savings and our ongoing synergy and cost efficiency work to expand our adjusted operating margins, more than offsetting the impact of softening economies, weaker oil prices and increased currency headwinds. These, along with a lower tax rate and fewer shares outstanding, drove a solid 6% adjusted earnings per share increase. Looking ahead, we expect our Global Institutional, Industrial and Other segment to show continued superior fixed currency growth, outpacing their markets in softer international economies, as they leverage the internal work they have undertaken to further improve their sales and service effectiveness and profitability. We expect them to continue to more than offset lower results from our Energy business and produce the strongest quarter for fixed currency profit growth from our businesses this year. However, the fourth quarter will also face stronger external headwinds than previously forecast, including more unfavorable currency impacts and the effect on our operations from devaluing our Venezuelan bolivar business. As a result, we now look for the fourth quarter to show lower growth than previously expected, as the headwinds, including pension, impact earnings growth by 13 percentage points. For the full-year 2015, we continue to expect strong fixed currency profit growth in the mid-teens before the impact of unfavorable currencies, including the Venezuela devaluation and pension. We expect these will penalize growth by approximately 10 percentage points and yield a full-year adjusted earnings per share gain of 4% to 6%. Now on to a few highlights from the third quarter. Reported earnings per share were $0.86. On an adjusted basis, excluding special gains and charges and discrete tax items from both years, third quarter 2015 adjusted earnings per share increased 6% to a record $1.28, despite an $0.11 or a 9 percentage point headwind from currencies and pension. The adjusted earnings per share growth was driven by fixed currency sales gains, delivered product and other cost savings, synergies, new products and the lower tax rate and share count. Our fixed currency acquisition adjusted sales were flat, as good mid-single digit growth from our Global Institutional, Industrial and Other segment was offset by lower Global Energy sales. Regionally, we saw good growth in Latin America and Europe rose 4%. Adjusted fixed currency operating margins expanded 90 basis points. In this year's tough environment, we have focused on driving new business gains and lower costs. We are using our industry-leading product innovation and service strengths to help customers achieve better results and lower operating costs, and through these aggressively drive new account gains across all of our segments. Further, raw material cost savings along with synergies and our cost efficiency work are helping to offset these headwinds. Importantly, we also continue to make key investments in our future growth drivers. We are delivering a strong fundamental business performance in 2015. As shown in slide four, we have grown profits in the mid-teens this year before externally-driven factors. The fourth quarter, shown at the midpoint of our revised range, should represent the year's best performance on this basis, growing nearly 20%, despite the recent deterioration in the energy market. However, as noted earlier, the business environment has become more challenging in recent months, as several key foreign currencies and the energy market have continued to weaken. These and other recent impacts on our outlook are summarized in the waterfall chart on slide five. Starting with the consensus forecast of $4.51 that's followed our second quarter earnings release, the recent deterioration in the energy markets has resulted in an impact of about $0.04 per share, which should be nearly offset by the aggressive actions we have taken in driving delivered product cost savings, cost efficiencies and synergies, along with other actions to offset the impact. However, increasingly unfavorable currency trends, the impact on our adjusted earnings from devaluing our Venezuelan bolivar business, initial dilution from acquisitions, and a product recall will represent approximately $0.10 per share of increased headwinds to the full year. As a result, while earnings from the fundamental business should rise in the upper teens, we expect fourth quarter adjusted earnings per share to increase 0% to 8% to the $1.20 to $1.30 range, with currency including the Venezuela devaluation and pension representing a drag of approximately 13 percentage points to earnings per share growth. Full-year adjusted earnings are expected to rise 4% to 6% to the $4.35 to $4.45 per share range with the same impacts representing a 10 percentage point drag to results. In summary, our underlying business continues to perform in line with our high expectations. We remain confident in our business, our markets and our people, as well as our capacities to meet our aggressive growth objectives over the coming years, while also delivering attractive returns in 2015 and setting up for a stronger growth in 2016. And now here's Doug Baker with some comments.

Thanks Mike. Good afternoon, everybody. So the story for the year remains quite consistent. Strong currency headwinds mute very good underlying performance. So looking through FX and pension, we forecast 15% EPS adjusted for the year and 18% for Q4, which we expect to be our strongest quarter. Unfortunately, Q4 has the stiffest currency headwinds too, totaling 11% including Venezuela, which is stronger than we had previously forecast. Energy markets were and are a huge factor for us this year, but they're not the central driver in our results. Low energy prices have caused value and price erosion in our WellChem business in particular and Energy services broadly, but that's largely been made up via lower raw materials across our platform. This is still the fact. FX is the main issue. The good news is when you look beyond FX, the business is quite healthy. The Institutional, Industrial, and Other segments combined are growing over 100 basis points faster than last year. The expanded fixed currency margin as well by 200 basis points in Q3, and a projected 130 basis points for the year. The Energy markets are worse than we or anyone else foresaw at the beginning of this year and our business results are softer than planned as a result. But with that said, the Energy business has held up well in the face of a very difficult market. Our OFC and Downstream businesses combined, which are now 90% of the business are forecast to be up modestly on the top line for the year and better on the bottom line reflecting synergies. WellChem is where we've seen the majority of our pain. They will be down some 40% for the year, reflecting the dramatic decline in NA drilling activity. Going into the year, they are expected to be about 18% of the business. They now represent under 10%. Now, we previously forecasted an improvement in Q4 versus Q3 in energy, and we still do, albeit not as large an improvement but still an improvement. So in total for the year, ES will be down high single-digits on the top line and modestly more on the bottom, so adjusting for Venezuela margins will only be off 10 basis points to 30 basis points for the year, so we've held there quite well. Lastly, let me make a few comments on our forward view. So consistent with our past practice, we'll be sharing our 2016 forecast in February during our Q4 release call. With that said, our early view is we believe our strong underlying business performance in our Institutional, Industrial, and Other segments will continue through next year and start to show through particularly in the second half of 2016. Our Energy business should show improvement as the year progresses too and will likely show flat to modest growth in total. Still, the Energy market and currency including Venezuela will be a comparison challenge that tapers as the year progresses. So Q1 should have similar – could have similar headwinds as Q4, but they should ease as the year goes on. Net, we believe our reported and adjusted results will improve in total as well. With that as an opening, let me open it now up to Q&A for Mike, Dan, and myself.

(11:20-11:29) reflect the new business wins particularly within Industrial and Institutional. I think they're well reflected in fixed currency growth numbers. My question is does 3Q and the outlook for 4Q, I guess, have embedded in at the right run rate of overhead that can be further leveraged into 2016? Or is there more to add there?

Mike, I apologize but we didn't hear the first part of your question. I don't know if you were still muted by the operator or what. So could you repeat it again? I apologize.

Oh, sure. Yeah, no problem. It was just a question about the corporate account efforts and some of the enterprise selling. I think the results, they speak for themselves. I think they're well reflected in the fixed currency growth numbers. And the question was around the overhead in 3Q, is that staffed according to how you've envisioned that in order to leverage into 2016 in those businesses?

Yeah. I'd say it's more reflective than not. I would say the only place where we continue to see, I would say, lower expense levels is Energy. And part of the story of Q4 on the bottom line is we'll see and realize full cost savings benefits from the actions that have been taken this year in Q4. So that will then move forward into 2016. On balance, I think the cost structure you see in the rest of the business is fairly indicative of what you'll see next year.

Okay. Fair enough. And my one follow-up for me is, maybe for Dan since we have him on the call, is it fair to assume that the full-year impact of the bolivar is $0.12, something like that, if we just annualize the 4Q impact?

Yeah, the number that we're coming up with this is about $0.13. So, yeah, it's almost closer to a direct annualization. That would be the impact of annualizing the devaluation. Okay?

Yes. Hello, everyone. I wanted to talk, Doug, a little bit, obviously, you guys have always delivered the consistency and deliver what you say you will. With Energy continuing to kind of be a little bit of a drag in terms of thinking that it would be a third quarter or fourth quarter bottom, and it feels again like we're getting close to that. But where is your level of confidence lie in the other businesses as maybe the global economy gets a little bit weaker that they can continue to offset that if that were to get pushed out a little bit further in terms of where the real bottom ends up being?

Well, I'd say a couple of things. One, I think our institutional, industrial and other businesses are doing quite well. Many of our large businesses are accelerating second half versus first half. Have had great success in terms of new business productivity. I don't think – third quarter was not a great quarter from a GDP standpoint as far as I can tell anywhere. So I don't think we are currently performing in a good environment heading for a bad environment. I feel like we've been performing well in a lousy environment, which is likely to continue. So emerging markets turtled early this year if not late last year. U.S. economy has not been in any great shape, so I think the only positive surprise you could point to economically in the world would be Europe. And our Europe business is reflecting it. It was up 4% in the third quarter. And we expect continued strong growth in Europe. So I would say I'm confident that those businesses continue to perform well moving forward, because I don't think they've gotten any tailwind from the economy. In terms of Energy bottoming, it seems like it's 0 and 100 for anybody predicting the bottom of this Energy market. I would say we are seeing kind of sequentially the same business albeit a little stronger in Q4 versus Q3. What we are confident in is that the comps get easier the second half of next year than they've been, right? We're going against double-digit comps in the second half right now, last year in the Energy business. And so this eases and frankly makes it a bit easier as you move forward to show growth.

Okay. And then just one quick follow-up in terms of the raw material offset. Obviously that continues to flow through. Can you talk a little bit about the runway there in terms of what's still on the board in terms of the flow through and rates of renegotiations?

Yeah, I mean, a lot of that's going to depend on what your view is of oil. But I think this natural offset that we talked about at the beginning of last year has come through. And so what I'll say is if our view is oil stays exactly here for the next 14 months, you're going to have pressure from the Energy business in a comparison standpoint early in the year offset by favorable comparison on raw materials and then both axes cross and come together. If oil degrades further, raw materials will get lower, and we'll have the same formula that we've had so far this year. So I'll just tell you, I just don't think that's going to be the major driver of the results. It wasn't this year. I know it creates a lot of noise, even here where we've had somewhat we're on the lower end of our outlook that we talked about even in 2009, 2010 meeting – our investor meeting. We've seen improvement in raw material pricing that partially offset that. So this equation is in place. It will likely continue.

Hi. Good afternoon. This is actually Jermaine Brown filling in for David. Is double-digit or even low teens EPS growth possible for 2016? And if so, what are the different puts and takes to get to that?

We're not here to give a forecast. I think what we indicated is – net as we look I guess, as far as we're going to go is, we would expect reported results and adjusted results to be better than this year. But our commitment to 20% ROIC, 20% margin and 15% going EPS over a period of time remains intact, we think very real and deliverable.

Understood. And one more, if I can. Which, if any, of your expectations, excluding Energy, have changed since your September Investor Day?

All the change that impacted the forecast, I mean to be honest – look, we wish Energy was stronger, not weaker, but Energy is not the reason we're lowering our forecast, because it was nearly offset by other issues. The issue was really FX, including Venezuela, and that's the piece of the forecast that changed dramatically, and it changed post-Investor Day. So – all right?

Yeah, hi. Thanks. I guess just following up, Doug and Mike, both of you said you thought you're setting up for a stronger 2016, and I realize you're not giving guidance, but can you go through any of the major reasons you believe that? I mean, I guess like Energy comps get better by – get a lot easier, particularly in the second half of the year. The FX, based on where we are now, becomes less of a headwind. Is it those two factors that lead you to make that comment? Or is there anything else that we should think of?

Yeah, I would say it's several things, including those. So we're quite confident we're going to continue to perform well in our Industrial, Institutional and Other segments. The Energy business will be improved next year versus this. You can argue with us is it going to be modest growth, modest decline? It's not going to be – it's going to be better than this year for a variety of reasons. And then, yeah, FX headwinds are more likely than not to be less next year than they are this year. And I think that's fairly safe. Sooner or later, they're going to drive the economy down in the U.S., and that will fix FX.

Hey, folks. Good afternoon. Just following up on the Energy price question, can you talk about how much was competitive in terms of trying to get new accounts or new business within accounts rather than the peg to oil?

Well, getting new accounts typically wouldn't count against your pricing necessarily, because it's net new business for you as you go out. It would be protecting – it would be either protecting business, trading price for volume and/or cost-plus businesses. We haven't gone through and done a pure accounting of what percentage each of those things, and I would say, the biggest pressure is obviously in the North American portion of our Energy business, is where we have the most price pressure. And we obviously have sizable business outside of the U.S. where it's not been as acute early. Typically, though, that's a follower. And we expect we will continue to have modest price pressure moving forward as we go on. WellChem has been the single hardest hit component of that business, but all three segments of the business have been hit by price.

Good morning, or, yeah, I guess, good afternoon now. Couple of things. First of all, can you talk – you talked about sort of the growth you're getting in North America and the fact that your European businesses outside of Energy are picking up versus the sort of the target that we have out there of about 10-points improvement in Europe available, and you're certainly along that. Can you update us where you are on that pathway and sort of how you're thinking about the timing of getting the rest of that margin opportunity accessed in Europe?

Yeah. Europe, we'll end up roughly 200 basis points combined Q3, Q4, we're on average. For the year, we're going be right around 100 basis points. We may be a little south, but it's going be fairly modest if we're south, and a lot of that's just FX costs and some other things that we've got in that business, which we'll deal with over time. I think we're up over cumulative 500 basis points at this point in time, so we're going to end up the year about 7.5%. Started off south of 2.5% when we started this initiative. So we've made significant progress. We talked then that we expected to get this business into double digits. I would say that's still our view. A key driver, we said, had to become volume, and I think you're seeing that this year as we've started to see some top-line growth as well. And we talked early in the year that we would expect around 3% in that business for the year, and we still say that's what we expect to see, which is stronger than it's been in the past years. So I would say we remain bullish on our ability to get to double-digit OI margins in Europe, and we've made great progress.

So in terms of sizing the business, in 2014, based on a 6.30 bolivar per U.S. dollar exchange rate, sales in for the Venezuela business were just south of $200 million. And by piece, right, this is a business that is about 70% Energy and roughly 10% each for the Water, Paper and F&B business. So, it's not an enormous business in the context of Ecolab's business overall, but it's nonetheless sizable. And – so here's what's going on in Venezuela, if you're not following this. It's a country, obviously, in some chaos, crisis even. And it is hyper-inflationary, okay? And so the official exchange rate is and has remained 6.30 bolivar per U.S. dollar. However, for most importation, including for us, these rates have been moving towards 200 bolivar per dollar, so enormous change in the currency regimes that we're operating under. We have, through the year, taken first our Water and Paper business, then Food & Beverage, right, and Institutional, and now finally the Energy business from reporting at this 6.30 bolivar rate to 200 bolivars per dollar rate. We do it because we think that this makes the most sense from a business performance perspective.

Got it. And then not to make too much of this, because I recognize there's rounding there, but on the pricing, just to check, the pricing in the non-Energy business remains sort of in the 1% to 2% range and what's dragging it down to, around to zero, is some of the contracts that are tied to oil price. Is that right?

Yeah, the non-Energy businesses have pricing just north of 1%. And then we're flat in total, so I guess you can figure out that Energy being 30%, what Energy is.

Thanks. I'll just make it one. The Industrial production seems to have come down from the first half of the year in the third quarter. And your Industrial – I know it's not directly correlated, but your Industrial segment seems to have accelerated a little bit in growth if you do constant currency and take out the acquisition. Doug, what's behind that? What's giving that slight bit of acceleration? And do you anticipate that persisting?

Well, we've continued to gain share in those businesses. And so I mean, the main thing that's driving all of our businesses is our ability to gain share. Most of the – I wouldn't – the majority of our markets are flat to modestly up, but they're not – that's not the driver. It's been share gains. Energy being, of course, the exception where obviously you've got just market disruption right now as a consequence of the drop in oil price. If you look within our Industrial segment, you'll see pressure in the heavy industry part of that portfolio, be it mining, steel in some respects. China, in particular, you'll see real pressure in mining, steel and also paper because of a draw-down and lack of production overall. But with that said, we've been able to offset it. Water is doing quite well in accelerating, and in light water, our core Water business is healthier and getting better. It's 100 basis point to 150 basis point faster growing in the second half versus the first. And I like what they're doing, so we expect that business to continue to accelerate. I think we've found our sea legs there. So I would expect our Industrial business to continue to perform, even with some pressure on some segments.

Thank you. That wraps up our third quarter conference call. This conference call and the associated discussion slides will be available for replay on our website. Thank you for your time and participation today, and best wishes for the rest of the day. Thank you.