The company provides cleaning, repair, and sanitizing services to the hospitality, food-service, health-care, and industrial markets. The U.S. represents about half of total sales; services in the 70 countries Ecolab operates in throughout the globe account for the other half. Among the few companies that qualify as publicly traded competitors, ServiceMaster
Details of the company's second-quarter results, released on Tuesday, were largely in line with what investors have come to expect -- sales grew 6%, while diluted earnings climbed 16%. For the full year, management expects earnings of $1.41-$1.43 per share, or growth of 15%-16% from 2005.
The company possesses an outstanding track record of earnings and dividend growth. It has grown earnings for 13 out of the past 14 years -- the exception being 2001, during a domestic economic downturn -- while dividends have not missed a beat in growing during each of those years. Over the past 10 years, both sales and earnings growth has averaged about 13% annually. While earnings growth has slowed to just less than 10% each year over the past five years, sales growth has accelerated slightly, to an annual average of just less than 15%.
Ecolab represents the classic case of a great company that sports an expensive stock. Annual net income approximates free cash flow each year, so the P/E multiple is a good indication of the price-to-free cash flow multiple, which stands at about 34. That means the free cash flow yield, or the inverse of price-to-free cash flow, is only about 3%.
However, that does not take into account the expected growth in free cash, which has averaged about 12% over the past five years. If we add the current yield plus the expected growth, we get close to 15%. Bill Miller calls this figure free cash flow total return, and if you have confidence in Ecolab's ability to continue to grow in the double digits for many years, then using this metric, you can see that the stock is likely a buy right now.
However, the current stock price leaves little room for error, or a margin of safety, in case growth doesn't turn out to be that high. Right now, to justify the current stock price, I estimate that Ecolab will have to grow cash flow 15% for 10 straight years, then spend the next 10 ramping down to the overall growth rate in the economy, or 3% per year. My estimated discount rate is 13%, but it's always important to perform a sensitivity analysis to see how the model changes when certain assumptions are tweaked.
Add Ecolab to your all-star watch list, along with equally impressive companies such as Fastenal
For more related Foolishness: