Potential investors in water, hygiene, and infection prevention company Ecolab (NYSE:ECL) are faced with a series of questions around the stock's valuation right now. On the one hand the stock is better positioned for growth now, and the pandemic will raise awareness of hygiene issues. On the other hand, many of its end market customers are continuing to suffer. Let's take a closer look at whether Ecolab is a good value or not right now.

Ecolab's valuation

The bull/bear debate over the Ecolab stock revolves around what its valuation should be in light of business developments in 2020. Frankly, there's a lot going on.

First, it's hard to argue that Ecolab is cheap in relation to its historical metrics. As the chart below demonstrates, the stock is trading toward the high end of its historical valuation ranges. While the COVID-19 pandemic has obviously reduced earnings expectations for 2020, it's worth noting that Ecolab still trades on 38 times 2021 earnings estimates. 

ECL EV to EBITDA Chart

Data by YCharts

Has anything happened in 2020 to justify a rerating? The bullish case has two strong arguments behind it.

The bullish case

First, the bullish argument is that the stock should be valued higher now that its upstream energy business has been separated via a public listing of ChampionX. Ridding the core business of the upstream energy division will take out a highly cyclical part of Ecolab's revenue stream. In addition, the company is now focused on its core activity of providing cleaning, sanitation, washing, filtration, and treatment solutions to its corporate and institutional clients.

Right now, these are very attractive markets. 90% of its revenue is recurring and Ecolab can grow as its customers grow globally. No one customer contributes more than 2% of its sales and Ecolab's customer list reads like a roll call of global corporations: McDonald's, Microsoft, Starbucks, Apple, Walmart, and Unilever are all included. In addition, growing regulatory compliance needs are likely to drive growth for many years to come.

As the leading player (10% market share) in a highly fragmented market, Ecolab also has an opportunity to generate growth by taking market share through a combination of organic and acquisition-led growth.

An upscale, modern bar and restaurant.

The hospitality sector is a significant end market for Ecolab. Image source: Getty Images.

The second argument naturally flows. Simply put, it's highly likely that the COVID-19 pandemic will create an increased awareness around public health issues and that should mean an increase in Ecolab's long-term growth potential. As such, Ecolab deserves a valuation rerating.

The bearish case

However, the bearish case highlights the risk that many of Ecolab's key customers, notably the hospitality sector, are struggling right now and their long-term growth prospects could be negatively impacted by the pandemic.

Restaurants, hotels, and entertainment facilities make up a major part of the company's revenue and Ecolab needs foot traffic to improve at their facilities. This was a point highlighted in the second-quarter earnings where a 36% year-over-year fall in its global institutional (restaurants, hotels, educational facilities) sales contributed to a 15% drop in overall sales. 

Things are improving in those industries, but there is still a long way to go and there may well be some long-term demand destruction. In the company's latest investor presentation management mentioned that 85% of U.S. full-service restaurants are open but are only operating at 50% of prior capacity. Meanwhile, U.S. quick-service restaurants are still operating "well below year-ago levels" and "global lodging rooms sold has risen globally from April lows and is now ~40% of prior-year levels."

It's a picture of a gradually improving market, but there's no guarantee that consumer behavior won't be structurally changed by the pandemic. For example, people might get used to shopping for groceries, particularly online, as opposed to eating in restaurants. Similarly, travel and vacation habits might change as individuals seek to avoid the possibility of exposure or infection amid the coronavirus pandemic.

Is Ecolab a buy?

On balance, Ecolab stock has excellent long-term opportunities but also a significant amount of near-term risk and uncertainty around it.

Ecolab does deserve a valuation rerating after the events in 2020, but as you can see in the chart above, it has already had a rerating. Moreover, the valuation suggests that investors are already assuming the bullish case for the stock as outlined above. 

All told, based on its current valuation the stock is probably worth avoiding right now, but it's definitely the sort of stock to look at buying on any significant weakness. Valuations still matter.