Ecolab Inc (ECL) — Q1 2016 Earnings Call Transcript

Thank you. Hello, everyone, and welcome to Ecolab's first quarter conference call. With me today are Doug Baker, Ecolab's Chairman and CEO; and Dan Schmechel, our CFO. A discussion of results, along with our 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 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 Form 10-K 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, continued attractive new account gains and new product introductions drove good fixed currency sales growth in our Global Institutional, Industrial and Other segments during the first quarter, nearly offsetting a decline in Global Energy sales. New business and ongoing cost efficiency work led to the strong adjusted fixed currency operating margin expansion, more than offsetting the impact of soft economies, weak oil prices, and currency headwinds. These, along with fewer shares outstanding, drove the adjusted earnings per share increase before currency translation. While 2016 is proving to be a challenging year, we continue to focus on the same fundamental strategies that have successfully driven our strong growth record, providing the best products and service for our customers to give them the best results and lowest operating costs. They delivered again in the first quarter, and we expect them to deliver for the full year 2016. Looking to the second quarter, we expect our Global Institutional, Industrial and Other segments to continue to show solid acquisition adjusted fixed currency growth, outpacing their markets in soft international economies, as they leverage investments we have made to further improve sales and service force effectiveness and profitability, and more than offset lower results from our Global Energy business. We look for the second quarter earnings per share to be in the $1.03 to $1.11 per share range, with that range including approximately $0.08 per share or 7% of unfavorable currency translation and impact from the Venezuela deconsolidation, as we continue to aggressively drive business growth. For the full year, the Global Institutional, Industrial and Other segments are expected to continue to show solid fixed currency growth. Global Energy segment expectations have softened. Global Energy sales are expected to be on the lower end of our range, down upper single digits versus last year. While the dollar has weakened somewhat, at this early point in the year, we are maintaining our earnings per share forecast for 2016 to reflect the uncertain currency trends and business environment. Net, we continue to expect to outperform our markets in 2016, while also investing in the key drivers for future, sustainable above-average earnings growth. We expect our consolidated results to show improving comparisons in the second half and continue to look for adjusted diluted earnings per share in the $4.35 to $4.55 range. Moving to some highlights from the first quarter. And as discussed in our press release, reported first quarter earnings per share were $0.77. On an adjusted basis, excluding special gains and charges and discrete tax items from both years, first quarter 2016 adjusted earnings per share decreased 4% to $0.77, reflecting an $0.11 or 14% currency headwind. The adjusted earnings per share growth was driven by delivered product and other cost savings, cost efficiencies and the lower share count. Our consolidated fixed currency acquisition adjusted sales were modestly lower, as our Global Institutional, Industrial and Other segments grew 4%, but were offset by lower Global Energy sales. Regional sales growth was led by Latin America and Europe. Adjusted fixed currency operating margins showed strong growth, expanding 60 basis points. In 2016's difficult environment, we are focused on driving new business gains by helping customers to lower their costs. We are using our industry-leading product innovation and service strengths to help customers achieve the best results and lowest operating costs and, through these, aggressively drive new account gains across all of our segments. We expect second quarter adjusted earnings per share in the $1.03 to $1.11 range, reflecting a currency translation and Venezuela deconsolidation drag of approximately $0.08 or 7%. Consolidated results are expected to improve with the second half outperforming the first half. We look for our full year adjusted diluted earnings per share in the $4.35 to $4.55 per share range. In summary, despite a very challenging global economic and market environment, we expect to continue to deliver solid fundamental results in 2016. 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. And now, here's Doug Baker with some comments.

Thank you, Mike. Good afternoon, everybody. Look, we had a solid quarter. We're on track for a full year delivery within our forecasted range. All of our sectors are handily outperforming their markets and competition, and we continue to gain share in all of these areas. For the year, there are natural puts and takes. We look at our Institutional, Industrial and Other business segments. They have been above expectations at this point, driven by new business, innovation, cost savings, very good execution. This is driving improving top line and improved margin performance. Energy is heading to the lower side of our expectation in spite of share gains and savings initiatives, and this is really driven by an even tougher market than expected. This will pass. We continue to believe, though, that the upturn is really a 2017, not a 2016 story, i.e. the oil and gas market upturn. If we froze FX at today's rates, FX would be less of a negative than planned, would be roughly $0.28 versus $0.38 negative. But given the fluidity of the FX situation, Brazil political environment, you've got the British exit vote, China, etc., we think it's too early and unwise to bake this into our forecast. Importantly, our forecast also continues to include significant investments in systems, R&D, talent initiatives which are all in total greater than last year, which I would remind you was greater than the prior year, and is, I think, a very strong indication of our confidence in the future which is high and we believe for good reason. So, as we look at the future, we know that the temporary double headwinds of energy and FX will abate. We don't know exactly when, but they will pass. Even with them, we've been doing well and outperforming markets. We do know though that our plan and our position, we think, are spot on for the future. So, clean water, safe food, abundant energy and healthy environment is even more relevant going forward than it has been in the past 5 or 10 years. We have a stronger competitive advantage position now, we believe, given our recent new innovations and our focus on driving excellent outcomes at low cost because of reduction in footprints on CO2 and water. We also have very strong execution momentum. Our teams are on it. They're doing a great job. They're driving new business. We had another very strong new business quarter in the first quarter, and we have promising new business bets in businesses like life sciences and geographies like MEA, and there are plenty more. And finally, we got a culture in the team that knows how to deliver. For all these reasons, we feel very good about where we are, how we're going to get through the year, the position that we're going to be in to drive continued growth beyond. So, that's my opening. And with that, I'll turn it over to Mike, who will move on into Q&A.

Thanks, Doug. That concludes our formal remarks. Operator, would you please begin the question-and-answer period?

I guess, the first question. Oil has rebounded a lot off the lows. It doesn't sound like, from you or others, that that's going to be enough to really impact the trend in the Energy business. But how should we think about raw materials? It seems like that's probably somewhat more of a headwind by the second half of the year, assuming prices hold. And is it fair to say that the Energy business isn't seeing any real benefit yet from the move off the bottom? Thanks.

I think the recent move in oil price, I think, look, the best predictions I read forecasted that oil would move up in anticipation of increased demand for the summer. It was likely going to weaken over the summer because really what needs to drive the fundamental price of oil is a rebalancing of supply and demand. And nobody really believed that was going to happen until towards the end of this year. And until that happens, you're not going to really, we believe, have sustained improvement in oil price or increase – maybe we shouldn't call it improvement – increase in oil price. In terms of raw materials, I guess our forecast has always had two views; one, that raws likely move before we see the impacts of higher oil prices in our energy services business. That's in our forecast. So, in the back half, we have some uptick in raws included, not monstrous because we still have favorability in the first half, but that abates and goes away as we think the energy market starts correcting and healing. So that's our view right now. I don't think you're going to see material increase in activity, which is what's really needed to drive our energy services volume until at the earliest very late this year, but most likely we aren't going to see the impact until 2017.

Okay. Great. And then the follow-up. You cited that energy is maybe a little bit weaker, but have you seen anything else change much in the last quarter? And I guess, I'm just thinking through the thought process of not flowing through the FX. I understand there's a lot of uncertainty, but a lot of data has pointed to weaker global growth. Are you seeing that impacting the businesses or are you staying conservative at this point? Thank you.

I think if you look in our total business mix, we called out mining is under a lot of pressure, which isn't a real surprise given everything else you read. And this is really the water technologies that we sell into the world's mining operations. I mean, that business is down double digits. So, you'll see spotty things. China, particularly on the heavy industrial side, is soft. So, our business reflects what you're going to read day-to-day about the global economy. But overall, the model, as it has always proven, is fairly resilient. And so, we have puts and takes. We also have pretty strong business performance from Institutional in North America, in particular. There are oil dividends, which we've talked about, which are certainly lower raw materials which you see flowing through our II&O segments, which is one of the reasons gross profit is up. The other reason, obviously, is innovation. So, I mean, I don't think the other surprises are really outliers nor will they dictate, I think, the year. And even the energy market softness, I would say it's worse than we anticipated. I would still think Energy is likely going to come in with the range we talked about. It's just going to be at the bottom end of it.

Yeah. Good. Hello, everyone. So, Doug, just kind of following up on that with the energy question, like, do you feel that, like at this point, while we might have the lingering behavioral impacts and obviously still some pricing pressure as you help out your customers, but do you feel like at this point that you kind of, that we're in the later innings of getting your arms around kind of that we're getting close to a true bottom in that?

Yeah. I mean, we're certainly in the later innings. I'm not unwise enough to pretend to know if the bottom is 30 days ago or 90 days in front of us or 6 months in front of us. But certainly, we're in the later innings. And I think the data I pay most attention to is where are we on the supply/demand curve. There's virtually no inventory storage capabilities globally for oil, so this thing reacts wildly to very small changes in supply and demand. And that is still projected to start coming in very near balance at the end of the year, and I believe ultimately that's going to be the data that dictates when this thing completely turns. So we're, what are we, 18 months into this? And we're saying probably have six to nine months to go, so certainly we're in the later innings.

Okay. Great. And then, with the other businesses, too, like particularly on the Institutional side, on a relative basis, I definitely get the relative strength compared to the industry trends. But with the end markets still kind of being a little bit sluggish, I was wondering what it's going to take to get that Institutional business more in that sustained 6%-plus growth range that I know that we're hopeful for. Like, do we need the end markets to do that? Or are there certain initiatives in place that do that by themselves even in the sluggish end market environment? Thanks.

Yeah. I would say in Institutional Nate, I mean, the Institutional business itself or even the sector, Institutional business was north of 6% last year. It was 5% in this quarter, but expected to be 6%-plus for the year. And that was really a quarter phenomenon. That business is operating in the 6% to 8% band that we've talked about, and I think the team has done a good job and the team will tell you and I'll tell you they still have a lot of opportunity to get after growth opportunities and margin opportunities, particularly outside of North America, which they're focusing on. So that business is running as well as it's run in terms of its financial performance for many, many years.

Good afternoon. Two quick ones. Can you flesh out a little bit the comments about Latin America? And secondly, can you give us an update on how you're thinking about the M&A pipeline, particularly any chances to increase your footprint in the emerging markets?

I'll do it. The expanded footprint in emerging markets, we've operated now obviously for a while, and we talked about 160 before the merger, and we're 170-plus post merger. However, we didn't have equal capabilities in all these markets. And in particular, we made a breakout investment move in MEA about 18 months ago. And this cost us margin obviously last year and even a little bit early this year, but it has driven improved results. Previously, we really ran MEA as part of Europe. Our history, whenever we make these break-out organizational moves, we did it with food, retail, breaking it out from KAY QSR. We did it many years ago with healthcare outside of what was then called EPP, which is our janitorial business. There are plenty other examples here. Both participants benefit, improved focus, and I think you're seeing that MEA has accelerated since we've broken it out, We have increased focus. We have a handle on our supply chain challenges and opportunities. And I would also point out Europe has done better since we've taken MEA out as well. Just simply it drives increased focus on the region that's left. So, that would be a good example of how we are investing in what we think are critical markets long term. Latin America, we grew by basically 10%, or 9% I guess in the quarter. We continue to do well in a region that's obviously under a lot of pressure, Brazil being the most notable headline owner right now. And I would say it's two things. I think we've always tried to focus on what matters most in these areas. Our food and beverage business, which is important throughout all those economies, is up 19%. Even our paper business, through some big wins, is having a very strong quarter. Water is up double digit down in that market as well, and we believe those businesses in particular are going to be very strong players in Latin America for a long time to come, and that's what our focus has been and is paying off.

Sure. Within the Energy segment, did you see any change in client behavior around pricing? And just to check, would you still expect pricing in the production side of that segment to still see a modest decline in 2016?

Yeah. Well, I just – we didn't see a change in customer behavior towards pricing, which would be accepting price increases. So, no, they are under pressure and this is not unusual, and they are certainly putting pressure on us. You got competitive pressure as well. Pricing still remains, in total, in the low-single digits and we expected to be there for the year, but it's real pressure and a challenge. And what I would say is that's an average. So, you've got some much more material givebacks in certain situations in other areas where we've been able to hold price either because we have very, very unique technology and a high need, or it's a customer not under the same pressure given their geographic position. So, I would expect you'll continue to see that. I think the other things that we're seeing in that market, I don't know if they're surprising, customers are turning off programs and services. We've expected some. We're seeing a little more than we expected, but that's always a temporary issue. And so, people will take some risks, particularly in North America, where the huge market pressure is really coming to bear. And the business outside of North America continues to perform at a much higher rate, simply because the market really reacts here and everywhere else. People are typically pumping oil to meet builds, not necessarily to meet capital demands and trying to make money. So, we'd expect to continue to see that. We're remaining physically disciplined. Some of the pain is self-induced. Last year, we had only $4 million in bad debt write-offs. In the Energy business, we expect it to be greater this year, but still in the single-digit millions, which is pretty low given the size of that business. And a lot of it is because the Energy team has been very, very acutely aware of the risks there. We're putting customers on cash-on-demand quite early. We're staying out of some bankruptcy situations, customers where we don't believe there's a future either before or after bankruptcy, we are walking from if they won't go to cash on delivery, etc. So, those are the type of steps that we're taking, and they accentuate some short-term pain. But ultimately, even within the year, we think they're going to be fiscally responsible moves because we're just going to avoid some big write-offs and other challenges.

Sure. Thank you for the – for all that color. Just a quick add-on to that. Since you spoke about the trends outside the U.S. being positive, what was the net new business contribution or the share gain contribution that you saw in Energy in the first quarter? Thank you.

Yeah, net, $55 million, roughly.

Hi. Good afternoon. First question. In Energy, can we hold EBIT margins here in the back half of the year? Or can you, big picture, just quantify that for us? Are we – or is this a good rate for the foreseeable future?

Look, I mean, the first quarter seasonally is always the low margin. I mean, for the year, the margin is going to be greater than what Energy showed in the first quarter.

Yeah. Healthcare, I think, is going to strengthen throughout the year. They had a very, very good new business quarter in the first quarter, second best that they have and measured. So, we feel good about what's going on. They are now – the recall that really started last year in the third quarter, is fully behind them. And while that wasn't a huge top line hit, it was a huge hit in terms of focus and energy of the group. And now, that's fully done, fully resolved and moving forward. I expect good things out of healthcare this year. They'll continue to improve. It's not going to be a dramatic inflection in one quarter, but I think you'll see sequential improvement.