Here's Why Ecolab's Latest Report Might Worry You

Here at The Motley Fool, I've long cautioned investors to keep a close eye on inventory levels. It's a part of my standard diligence when searching for the market's best stocks. I think a quarterly checkup can help you spot potential problems. For many companies, products that sit on the shelves too long can become big trouble. Stale inventory may be sold for lower prices, hurting profitability. In extreme cases, it may be written off completely and sent to the shredder.

Basic guidelines
In this series, I examine inventory using a simple rule of thumb: Inventory increases ought to roughly parallel revenue increases. If inventory bloats more quickly than sales grow, this might be a sign that expected sales haven't materialized. Is the current inventory situation at Ecolab (NYSE: ECL  ) out of line? To figure that out, start by comparing the company's inventory growth to sales growth. How is Ecolab doing by this quick checkup? At first glance, not so great. Trailing-12-month revenue increased 31.0%, and inventory increased 126.4%. Comparing the latest quarter to the prior-year quarter, the story looks potentially problematic. Revenue expanded 85.1%, and inventory expanded 126.4%. Over the sequential quarterly period, the trend looks healthy. Revenue grew 52.3%, and inventory grew 1.7%.

Advanced inventory
I don't stop my checkup there, because the type of inventory can matter even more than the overall quantity. There's even one type of inventory bulge we sometimes like to see. You can check for it by examining the quarterly filings to evaluate the different kinds of inventory: raw materials, work-in-progress inventory, and finished goods. (Some companies report the first two types as a single category.)

A company ramping up for increased demand may increase raw materials and work-in-progress inventory at a faster rate when it expects robust future growth. As such, we might consider oversized growth in those categories to offer a clue to a brighter future, and a clue that most other investors will miss. We call it "positive inventory divergence."

On the other hand, if we see a big increase in finished goods, that often means product isn't moving as well as expected, and it's time to hunker down with the filings and conference calls to find out why.

What's going on with the inventory at Ecolab? I chart the details below for both quarterly and 12-month periods.

Source: S&P Capital IQ. Data is current as of latest fully reported quarter. Dollar amounts in millions. FY = fiscal year. TTM = trailing 12 months.

Source: S&P Capital IQ. Data is current as of latest fully reported quarter. Dollar amounts in millions. FQ = fiscal quarter.

Let's dig into the inventory specifics. On a trailing-12-month basis, finished goods inventory was the fastest-growing segment, up 173.8%. That can be a warning sign, so investors should check in with Ecolab's filings to make sure there's a good reason for packing the storeroom for this period. On a sequential-quarter basis, finished goods inventory was also the fastest-growing segment, up 1.6%.

Foolish bottom line
When you're doing your research, remember that aggregate numbers such as inventory balances often mask situations that are more complex than they appear. Even the detailed numbers don't give us the final word. When in doubt, listen to the conference call, or contact investor relations. What at first looks like a problem may actually signal a stock that will provide the market's best returns. And what might look hunky-dory at first glance could actually be warning you to cut your losses before the rest of the Street wises up.

I run these quick inventory checks every quarter. To stay on top of inventory and other tell-tale metrics at your favorite companies, add them to your free watchlist, and we'll deliver our latest coverage right to your inbox.

Seth Jayson had no position in any company mentioned here at the time of publication. You can view his stock holdings here. He is co-advisor of Motley Fool Hidden Gems, which provides new small-cap ideas every month, backed by a real-money portfolio. The Motley Fool owns shares of Ecolab. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy


Read/Post Comments (3) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 25, 2012, at 5:07 AM, wbarryp wrote:

    Seth:

    Please try harder. Ecolab bought Nalco in Q4 (an $8B acquisition). Q4 and Q1 inventory includes Nalco. Trailing 12 month revenue only includes 1 1/2 quarters of Nalco revenue.

  • Report this Comment On July 17, 2012, at 4:34 PM, supporter600 wrote:

    Ecolab may need to consider its hourly associates first. Ecolabs Board guru Larson along with other high exec's like Smith/Anderson and others should stop its assaults first with its hard working hourly associates. The end is near with all wrong doing from companies like Ecolab. Consumers need be aware of how Ecolab uses it farm raised managers around surrounding plants like the one in Mcdonough Ga & Joilet IL, using their human resource reps as punishing bullies towards hourly workers as well as its over price watered-down contaminated watered products they trick mom and pop stores into purchasing. Will this Foxconn company continue? Most say yes they will because they're Ecolab. I say no to the corrupted At Will bunch of lyers

  • Report this Comment On July 17, 2012, at 4:43 PM, supporter600 wrote:

    Abuse of authority is the unfair use of one's power to interfere with an employee's work and performance in the form of humiliation, intimidation or threat. It does not include professional duties, such as appraisals, counseling or usual managerial responsibilities.

    Employees need to distinguish between the various forms of abuse of power in the workplace. According to the Gender and Diversity program's website, supervisors can abuse their power through their speech, including making criticisms about employees’ physical appearance, work skills and intellect. The tone of a supervisor's voice--for example, a supervisor raising her voice at an employee or using foul language--can constitute emotional abuse. Ignoring employees and threatening employees with paycheck reductions or loss of a promotion are abusive. So are physical forms of abuse, including touching, hitting and slapping. Ecolab may want to take a long look at how their reputation is being damaged. Of course their just getting what they deserve. Their 600 plant in Ga contributes to all downfall ith this corporate greed

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 1921512, ~/Articles/ArticleHandler.aspx, 10/24/2014 12:29:44 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement