Food safety, clean water, and hygiene company Ecolab (ECL -1.45%) is what Wall Street analysts might describe as a battleground stock. In other words, it's the kind of stock that's going to generate sharp disagreement between bulls and bears in the current environment. Is Ecolab a net beneficiary of a post-COVID-19 world or is it set to struggle? Let's take a look at the case for and against buying Ecolab stock.
Ecolab's management describes the company as being the global leader with a 10% share of a highly fragmented market. In a nutshell, Ecolab provides companies and institutions with cleaning, sanitation, washing, and filtration and treatment solutions aimed at ensuring a secure, hygienic environment. Its key end markets are food service, healthcare, food and beverage, and a host of industrial end markets. As such, key customers include companies like McDonald's, Coca-Cola, Walmart, Unilever, and Abbott Labs.
The bullish case
The best investment case for the stock has five key arguments attached to it:
- In a post-COVID-19 world there will be an extra emphasis on issues such as public health and sanitation, so Ecolab has a long runway of growth ahead of it.
- The upcoming deal to separate Ecolab's upstream energy business and merge it with Apergy will remove Ecolab's exposure to dramatic movements in the price of oil.
- Ecolab is a company with 90% of its revenue from recurring sources -- something that should provide it with relative stability in any economic slowdown.
- It's a dividend aristocrat -- a company that has raised its dividend for more than 25 consecutive years -- and has raised its earnings at 11% a year over the last 20 years.
- Environmental concerns and regulatory compliance on hygiene are only going to rise in an increasingly connected and urbanized world.
Putting these points together, there's clearly a powerful case to be made for buying the stock. Moreover, the recent price falls have left its valuation looking attractive compared to what it's been in recent years. A current price-to-earnings ratio of 29 times earnings may seem high, but if the bullish case above is correct, then Ecolab's double-digit growth prospects and relatively stable income stream would seem to justify it.
Throw in some extra growth in a post-COVID-19 world -- due to extra emphasis on hygiene maters -- and you have a powerful case to argue that its valuation deserves a positive rerating.
The bearish response
Just like Goldilocks, the bulls have three different bears to contend with. The strong bear argument has it that the global economy is heading for a recessionary environment. In such a scenario, Ecolab will turn out to be a highly rated stock whose earnings are about to come under pressure.
A more moderate bear argument is that the economy will recover, but the measures taken to contain the COVID-19 pandemic will lead to multiple bankruptcies in hotels, restaurants, and hospitality companies. These are all industries containing key customers of Ecolab. In other words, Ecolab's growth aspirations are going to receive a negative shock, and so will Ecolab's earnings in the near term.
The third bear argument is that in the post-COVID-19 world, there will be an extended period of unwillingness among consumers to travel, visit restaurants, or attend public events. This will lead to a sales slowdown at Ecolab.
What it means to investors
There's obviously some merit in both the bullish and bearish arguments. For example, Ecolab's CEO Douglas Baker talked of how government action to limit social interaction has "significantly affected our restaurant and hospitality customers and are negatively impacting demand for our products in these segments" on a press release on March 18. As such, there's little doubt that Ecolab's earnings are going to come under severe pressure in the near term. Moreover, no one really knows when the crisis will end or how consumers will behave afterwards.
On the other hand, Ecolab's stock is down around 20% on a year-to-date basis at the time of writing. If the bulls are right, then the company's long-term earnings prospects are still intact, and they might even be enhanced by extra awareness around public health. If this argument holds, then it doesn't make sense to discount a stock's value by 20% just because of a few quarters of weak earnings.
Ultimately, the decision to buy or sell the stock comes down to your view on how the crisis will play out. A relatively quick resolution followed by a gradual normalization would probably mean Ecolab is worth buying on weakness, but a protracted slowdown would put it in the "one to avoid" box.