Ecolab Expects Double-Digit Earnings Growth in 2019 (Sort of)

Last year, Ecolab (ECL -0.34%) had to navigate headwinds including global currency fluctuations made worse by a strong U.S. dollar, rising delivery costs, and volatility in energy markets. The business attempted to offset cost increases by improving operating efficiency and increasing selling prices, but those efforts weren't enough to stop fourth-quarter operating income from sliding 4% compared to 2017. Revenue increased 3% year over year. 

While investors may be discouraged by those results, it's important to consider that one year may not be enough time for a globe-spanning business such as Ecolab to fully mobilize against the myriad headwinds it faces. What's more, the company remains comfortably profitable and delivered year-over-year operating improvements when financial results are adjusted to account for currency fluctuations.

Here's what investors need to know about the reported results for 2018 and what's ahead in 2019 and beyond -- including a planned spinoff.

Image source: Getty Images.

By the numbers

Ecolab delivered strong operating results across its three business segments of energy, industrial, and institutional products. Revenue gains outpaced operating income growth in each segment, namely due to the fact selling price increases (used to offset higher product delivery costs and currency fluctuations) lagged behind cost increases.

It hardly mattered given the sizable increase in the corporate segment -- used to track special gains and expenses such as asset sales and write-offs -- which alone led to a $94.5 million increase in operating loss compared to the year-ago period. That more than offset profit expansion in all three business segments combined. 

Data source: Ecolab press release. Note: All numbers are reported in public currency rates and are not adjusted.

Management is working to keep corporate expenses in check. Ironically, a significant portion of the expense recorded in 2018 was related to executing Ecolab's efficiency initiative, including the implementation of a new resource-planning system. The efficiency initiative is now seeking to reduce total operating expenses by $325 million per year, up from a previous target of $200 million per year.

Investors are hoping that strategic program, when coupled with the expected margin-boosting effects from increased selling prices, can reverse the recent slide in operating margin. Ecolab saw total operating income flatline in 2018, despite a year-over-year rise of 6% in revenue.

Data source: Ecolab press release. Note: All numbers are reported in public currency rates and are not adjusted unless specified. GAAP = generally accepted accounting principles.

While the company attempts to adjust earnings to account for currency fluctuations between comparison periods, investors should generally rely on GAAP results.

Check out the latest Ecolab earnings call transcript.

Looking ahead

Ecolab maintained the preliminary guidance offered three weeks before it formally issued full-year 2018 operating results. Full-year 2019 guidance is headlined by expectations for double-digit earnings growth of 10% to 14% compared to last year -- on an adjusted basis, anyway. Aside from that, not much is expected to change for the business in the year ahead.  

Data source: Ecolab press release.

Perhaps the biggest news item for the slow-growing conglomerate is its intention to spin off its upstream energy business. The unit generated $2.4 billion in revenue and $170 million in operating income for Ecolab in 2018. That makes it an easy target for jettisoning from the broader company.

Thanks in part to the difficult dynamics of American energy production, the upstream energy business had an operating margin of only 7% last year. Considering it represented 16% of total sales in 2018, the unit significantly weighed on the parent's operating income. In fact, Ecolab would have reported an operating margin of 14.5% by excluding its contributions last year, much better than the 13.3% reported when the upstream energy business is included.

The transaction will reduce Ecolab's energy segment sales by 70% and shift its focus to less volatile opportunities downstream (refining, fuel additives, and petrochemical production). It's a predictable outcome for the global business that had already begun to focus on higher-margin opportunities in life sciences, food manufacturing, and institutional services. Management tentatively expects the spinoff to occur in mid-2020.

Image source: Getty Images.

Investors need to keep an eye on operating margin in 2019

Ecolab expects to deliver year-over-year adjusted earnings growth of 10% to 14%. While that's a useful metric for gauging the impact of currency fluctuations on the business, unadjusted (read: GAAP) metrics are what matter at the end of the day. From that perspective, the GAAP earnings growth delivered in 2019 will likely fall short of the double-digit increase headlining the press release.

Investors can rest assured knowing Ecolab's financial heft provides insulation against small changes here and there over the short term. However, shareholders will need to keep an eye on operating income and operating margin going forward to ensure the slide doesn't become a prolonged fall. The business expects to begin clawing back some of the recent margin erosion through price increases in 2019, while the efficiency initiative and plans to spin off underperforming assets bode well for the long-term health of the company. It will just take a few quarters to see if the initiatives are having the intended effect.