Why is Google such a good business? Because they skim the cream in terms of Internet revenues. Microsoft was one of the first to do this when they decided early on to just sell software. At that time there was no independent software industry -- computing was fully integrated so you bought everything you needed from one company -- most of the time that was IBM.
Microsoft realized that the true value add was in the software so why not just concentrate on that part. That's the cream -- by focusing on just operating systems, large scale applications as well as some programming tools, Microsoft was able to generate very high operating margins -- as in nearly 50% at their peak a few years ago.
Google is similar -- they generate most of their revenues from online search advertising which is the highest value added part of online revenues because most of the time when you are searching you are looking for something -- often something that someone else sells. How powerful is that information -- to know when someone is looking to buy something a high percentage of the time? That is incredibly valuable info and that is why some companies pay huge key word prices -- because what looks huge is actually a much smaller customer acquisition cost than other methods (offline advertising, promotions, store displays, etc).
I was reminded of this concept of skimming the cream when looking at a company called Landstar. They offer trucking services without the trucks -- non-asset based services is the term. They use independent truckers and serve as a middleman between them and those with goods to be shipped. They earn low margins but they don't have much in the way of assets so they can earn a high return on assets and a good return on equity. They also produce good cash flow too. In fact their cash flow is so good that they have bought back over 40% of the stock in the last 10 years -- a slow motion LBO I guess. Their costs are all variable just like revenues so margins are pretty consistent but revenues fluctuate with the economy -- now is not the best time to be almost all US based revenues in a heavily economically cyclical business like trucking. Still its a neat business and one to keep an eye on -- I think CH Robinson (CHRW) is similar.
In a way skimming the cream is also what Amphenol (APH) does -- completely focused on the higher margin parts in the business. I listened to a webcast of a recent presentation they made and learned a couple of insights. They divided up their markets into 2 parts -- the top 10 competitors of which they are number 3 and the next 1000 competitors. The top 10 have a bit more than 50% of the market, which leaves the rest of the market spread amongst 1000 others. They should have some advantages over the bottom 1000 including scale, customer relationships, broad product line etc. I still don't know for sure how much of the market is 20% margin but I now believe it is bigger than I first thought. Their scale (size) and focus on costs means they could be earning 20% margins on revenues that some of those 1000 competitors are only earning 10% on.
They are focused on organic revenue growth of 2X the industry and profit growth of 2X revenues -- if they could maintain that pace the stock is a bargain.
Tuesday, September 11, 2007
Monday, September 10, 2007
ADBE
The elevator speech on ADBE -- hey its 2:12 am right now so this the best I can do (still have to take out the garbage and recycling before bedtime too!)
Reasons to like ADBE:
1. Almost all web development involving video related effects is done in Adobe Flash. Quite a lot of other development on the web is done using other Adobe technologies. This makes them an indirect play on the growth in the web. Its not the best play -- that is a direct one where revenues directly move with usage. An indirect play benefits over time because the more websites there are the more people are needed to program them and make them look pretty and use all the latest technologies like ADBE's.
2. PDF -- its 25% of revenues and has grown very consistently in its history as ADBE has continually found ways to increase usage and productivity. Think forms like the irs website. In my own case we use it at work to pull together presentations from various packages -- rather than put everything into powerpoint we take information from excel, word, access and powerpoint and put it all together in Acrobat (PDF). Its just easier to do it that way.
3. CS3 -- their latest product launch means an upgrade cycle is at hand. That should drive results to be greater than estimates -- rising estimates is the best way to get this stock going.
4. Stock has been relatively flat since late September of 2006 -- stuck in a high 30's to low 40's range. Now we are at the high end of that range but still relatively flat yet EPS are growing.
5. Free Cash Flow is higher than earnings consistently -- I think they are selling for 21X 2008 free cash flow but they might be closer to 25X when looking at earnings estimates. As a software company there are very little needs for cap ex -- they have almost $4 per share in cash on the balance sheet.
6. Management knows how to build a software franchise and keep it fresh by continually adding innovative functionality in ways that build the size of their potential markets. slow and steady but adobe keeps growing. Their profitability is pretty solid too. Before purchasing the stock, I will have to get comfortable that I can envision them not as a $25 bill market cap but rather a $50-100 bill market cap stock over the next several years. Are Adobe's markets big enough to support $5-10 bill in sales at current margin levels?
stay tuned to see if this one gets added to the portfolio. They have a lot going for them but on the other hand if the US economy declines, Adobe will be hurt -- about 50% of sales are US based.
Reasons to like ADBE:
1. Almost all web development involving video related effects is done in Adobe Flash. Quite a lot of other development on the web is done using other Adobe technologies. This makes them an indirect play on the growth in the web. Its not the best play -- that is a direct one where revenues directly move with usage. An indirect play benefits over time because the more websites there are the more people are needed to program them and make them look pretty and use all the latest technologies like ADBE's.
2. PDF -- its 25% of revenues and has grown very consistently in its history as ADBE has continually found ways to increase usage and productivity. Think forms like the irs website. In my own case we use it at work to pull together presentations from various packages -- rather than put everything into powerpoint we take information from excel, word, access and powerpoint and put it all together in Acrobat (PDF). Its just easier to do it that way.
3. CS3 -- their latest product launch means an upgrade cycle is at hand. That should drive results to be greater than estimates -- rising estimates is the best way to get this stock going.
4. Stock has been relatively flat since late September of 2006 -- stuck in a high 30's to low 40's range. Now we are at the high end of that range but still relatively flat yet EPS are growing.
5. Free Cash Flow is higher than earnings consistently -- I think they are selling for 21X 2008 free cash flow but they might be closer to 25X when looking at earnings estimates. As a software company there are very little needs for cap ex -- they have almost $4 per share in cash on the balance sheet.
6. Management knows how to build a software franchise and keep it fresh by continually adding innovative functionality in ways that build the size of their potential markets. slow and steady but adobe keeps growing. Their profitability is pretty solid too. Before purchasing the stock, I will have to get comfortable that I can envision them not as a $25 bill market cap but rather a $50-100 bill market cap stock over the next several years. Are Adobe's markets big enough to support $5-10 bill in sales at current margin levels?
stay tuned to see if this one gets added to the portfolio. They have a lot going for them but on the other hand if the US economy declines, Adobe will be hurt -- about 50% of sales are US based.
DFR
Before we get to more on Adobe, I thought I would take a moment to go over my latest thoughts on DFR. Merrill published a report last week cutting numbers slightly but still expecting them to have earnings and dividends that would drive a 20%+ dividend yield at current prices. I was surprised they were as optimistic as they were. I will be pleasantly surprised if their Q3 results are as good as Merrill thinks.
I wonder what everyone's thoughts would be if DFR was able to still do the deal for DCM but used all stock instead of the current terms of cash and stock. If they kept to the original terms but cancelled the cash portion, then the deal would be for just $80 mill -- probably too much of a drop from the original value of $290 million. But if they could increase the number of shares and get the deal done for $125-150 mill, that would be interesting. By paying stock, they wouldn't have to worry about the liquidity impact of borrowing money for the deal. It would make sense that DCM's value has dropped a lot -- no new CDO's will be issued for quite some time -- so maybe a drop of 50-60% in value makes sense -- well to a DFR shareholder (I'm not so sure those terms would excite a DCM shareholder. Under the current terms the deal likely won't happen -- too difficult to get bank financing.
If DFR's mortgage assets have not dropped in value, that would mean book value should still be in the $13 range assuming no new credit losses from the alternatives side. From that level they should be able to produce a dividend that is actually higher than the 42 cents they have paid so far. Reading the merrill note, I didn't get the feeling that they had talked to management and gotten some kind of scoop -- it was more just that analysts analysis of the situation. I am afraid he was too optimistic but I hope he is right!
With any luck maybe DFR will do a midquarter update like TMA is doing.
If they make it through the current liquidity crisis, then the stock's value will jump back to the mid teens. On the other hand, one of the reasons I so liked the story was the ability to play the growth in an alternative asset manager and their ability to rapidly raise the dividend to the $2.50 range. Now I doubt the deal goes through so that leg of the thesis is gone. They probably won't be raising the dividend to $2.50 any time soon so that leg of the thesis is questionable too. So why hold on if the thesis is not playing out? Because the loss has already hit the stock hard -- question is what new issue could bring it down further besides a liquidity one. At this point the only risk I see is the liquidity one. Even if you assume their future earnings power has been impaired, has it been hurt more than $8 a share? I doubt it. As long as they survive this is a low risk high gain play. Of course that risk they might not survive is real and is what keeps this from being a buy. but a hold -- why not?
I wonder what everyone's thoughts would be if DFR was able to still do the deal for DCM but used all stock instead of the current terms of cash and stock. If they kept to the original terms but cancelled the cash portion, then the deal would be for just $80 mill -- probably too much of a drop from the original value of $290 million. But if they could increase the number of shares and get the deal done for $125-150 mill, that would be interesting. By paying stock, they wouldn't have to worry about the liquidity impact of borrowing money for the deal. It would make sense that DCM's value has dropped a lot -- no new CDO's will be issued for quite some time -- so maybe a drop of 50-60% in value makes sense -- well to a DFR shareholder (I'm not so sure those terms would excite a DCM shareholder. Under the current terms the deal likely won't happen -- too difficult to get bank financing.
If DFR's mortgage assets have not dropped in value, that would mean book value should still be in the $13 range assuming no new credit losses from the alternatives side. From that level they should be able to produce a dividend that is actually higher than the 42 cents they have paid so far. Reading the merrill note, I didn't get the feeling that they had talked to management and gotten some kind of scoop -- it was more just that analysts analysis of the situation. I am afraid he was too optimistic but I hope he is right!
With any luck maybe DFR will do a midquarter update like TMA is doing.
If they make it through the current liquidity crisis, then the stock's value will jump back to the mid teens. On the other hand, one of the reasons I so liked the story was the ability to play the growth in an alternative asset manager and their ability to rapidly raise the dividend to the $2.50 range. Now I doubt the deal goes through so that leg of the thesis is gone. They probably won't be raising the dividend to $2.50 any time soon so that leg of the thesis is questionable too. So why hold on if the thesis is not playing out? Because the loss has already hit the stock hard -- question is what new issue could bring it down further besides a liquidity one. At this point the only risk I see is the liquidity one. Even if you assume their future earnings power has been impaired, has it been hurt more than $8 a share? I doubt it. As long as they survive this is a low risk high gain play. Of course that risk they might not survive is real and is what keeps this from being a buy. but a hold -- why not?
Sunday, September 9, 2007
update -- DCI, APH, IEX, ADBE
Wow, I apologize -- didn't realize that the last post I made was last Tuesday -- I swear I wrote another piece since then but its not on the site so it doesn't count.
Been doing lots of reading -- more than I should have about various stocks -- mostly industrial types like Donaldson (DCI), IDEX (IEX) and Ametek (AME) as well as many others. I was looking for a consistent grower with good return on assets that had strong free cash flow as well as high international sales that also wasn't just an acquisition story. Didn't really find one yet. I would say I like the ECL story better than all of those others.
Donaldson (DCI) really looked good until I looked at the cash flow. Here are the numbers -- free cash flow (cash flow from operations minus cap ex) and net income.
2002 $107 mill (vs. net income of $86.9 mill)
2003 $99 mill (vs. net income of $95.3 mill)
2004 $70 mill (vs. net income of $106 mill)
2005 $87 mill (vs. net income of $110 mill)
2006 $79 mill (vs. net income of $132 mill)
2007 $40 mill (vs. net income of $150 mill)
The decline in free cash flow is both due to lower cash flow from operations (higher receivables and inventories) and increased cap ex. Notice the progression from more FCF than net income in 2002 to FCF of barely more than 25% of net income. This sure implies that earnings quality is poor and that the reported EPS are overstating the profitability of the company -- not that you would notice from the stock, which has done well. I would touch it myself -- it may work through this with no trouble or it could blow up hard with a huge earnings miss -- not worth the risk.
APH -- hugely successful over the last few years with much faster growth and much higher margins than its peers -- its all about management focus and execution. The management is focused on the higher margin products and on adding new product areas to drive growth. They are less than $2 bill in sales amongst a $40 bill industry -- very low market share. However they are earning 20%+ operating margins vs. others in the industry closer to 10% at most. That's great, I love managements that focus on profitability and not just growth. They also have great return on assets -- 12-14% so its not just margins but they also know how to manage assets too. What concerns me are 2 things -- 1. is the valuation/stock performance and 2. just how much of the industry is 20% margin business?
The stock has done really well over the last several years -- remember its the future that matters -- but you have to have confidence in the business and what it is likely to do to make sure you are not buying in at the top. I guess I just don't have that confidence, given the second point. There is $40 bill in industry revenues but how much of it is 20% operating margin business? To earn twice the industry average you have to find niche areas that have much less competition. Either these are technically very difficult or they are small volume customized deals or they are protected in some other way from price competition. So how much of the $40 bill is high margin? tough to say but it means their market share is higher than it first appears. Say the high margin part is 20% of the total -- that's $8 bill and that means they are at 25% market share rather than the 5% you first thought. I'm sure they have plenty of room to run for at least the next couple of years but at some point they are going to hit a wall and either have to accept lower margins or slower growth.
APH has some good secular growth parts -- electronicization of more products (i.e. increased electronics content in more products) has been going on uninterrupted for about 50 years. That should drive industry growth of high single digits. I will definitely keep a watch on this one but I'm nervous at these valuation levels.
I was reading something on real money last Friday and it got me thinking about ADBE again. I have watched this one from a distance for many years but never bought any or really understood its position. I spent some time over the weekend in between the Greek festival and my church's annual picnic reading up on ADBE -- its a great story but I'll save the details for the next note.....
Been doing lots of reading -- more than I should have about various stocks -- mostly industrial types like Donaldson (DCI), IDEX (IEX) and Ametek (AME) as well as many others. I was looking for a consistent grower with good return on assets that had strong free cash flow as well as high international sales that also wasn't just an acquisition story. Didn't really find one yet. I would say I like the ECL story better than all of those others.
Donaldson (DCI) really looked good until I looked at the cash flow. Here are the numbers -- free cash flow (cash flow from operations minus cap ex) and net income.
2002 $107 mill (vs. net income of $86.9 mill)
2003 $99 mill (vs. net income of $95.3 mill)
2004 $70 mill (vs. net income of $106 mill)
2005 $87 mill (vs. net income of $110 mill)
2006 $79 mill (vs. net income of $132 mill)
2007 $40 mill (vs. net income of $150 mill)
The decline in free cash flow is both due to lower cash flow from operations (higher receivables and inventories) and increased cap ex. Notice the progression from more FCF than net income in 2002 to FCF of barely more than 25% of net income. This sure implies that earnings quality is poor and that the reported EPS are overstating the profitability of the company -- not that you would notice from the stock, which has done well. I would touch it myself -- it may work through this with no trouble or it could blow up hard with a huge earnings miss -- not worth the risk.
APH -- hugely successful over the last few years with much faster growth and much higher margins than its peers -- its all about management focus and execution. The management is focused on the higher margin products and on adding new product areas to drive growth. They are less than $2 bill in sales amongst a $40 bill industry -- very low market share. However they are earning 20%+ operating margins vs. others in the industry closer to 10% at most. That's great, I love managements that focus on profitability and not just growth. They also have great return on assets -- 12-14% so its not just margins but they also know how to manage assets too. What concerns me are 2 things -- 1. is the valuation/stock performance and 2. just how much of the industry is 20% margin business?
The stock has done really well over the last several years -- remember its the future that matters -- but you have to have confidence in the business and what it is likely to do to make sure you are not buying in at the top. I guess I just don't have that confidence, given the second point. There is $40 bill in industry revenues but how much of it is 20% operating margin business? To earn twice the industry average you have to find niche areas that have much less competition. Either these are technically very difficult or they are small volume customized deals or they are protected in some other way from price competition. So how much of the $40 bill is high margin? tough to say but it means their market share is higher than it first appears. Say the high margin part is 20% of the total -- that's $8 bill and that means they are at 25% market share rather than the 5% you first thought. I'm sure they have plenty of room to run for at least the next couple of years but at some point they are going to hit a wall and either have to accept lower margins or slower growth.
APH has some good secular growth parts -- electronicization of more products (i.e. increased electronics content in more products) has been going on uninterrupted for about 50 years. That should drive industry growth of high single digits. I will definitely keep a watch on this one but I'm nervous at these valuation levels.
I was reading something on real money last Friday and it got me thinking about ADBE again. I have watched this one from a distance for many years but never bought any or really understood its position. I spent some time over the weekend in between the Greek festival and my church's annual picnic reading up on ADBE -- its a great story but I'll save the details for the next note.....
Tuesday, September 4, 2007
GGG
I have been nervous about GGG due to its housing exposure but recently I had a thought -- I remembered that the company's worst performance was during Q1 when GDP growth was near 1%. Q2 saw a rebound in the company's results and a reacceleration in GDP growth back over 3%. Housing has remained weak but their overall results jumped in Q2 vs. Q1.
This suggests they are more exposed to GDP growth then to housing. Wow. If true, that makes them a bargain because I believe GDP growth is going to be Ok -- certainly a lot better than the growth of housing.
The other thing I noticed is that the current revenue estimates for GGG for the next 4-6 quarters are only assuming mid single digit growth -- the 5-7% kind of range. Seeing those numbers got me thinking about the different segments of their business. If you assume the industrials segment provides mid teens growth, then the US contractor business can shrink 20% or more and they will still hit the overall numbers. That's comforting to know that the estimates are THAT conservative. reassures me that they are going to hit the numbers.
GGG is selling for less than 16X 2008 EPS estimates. Not bad for a company with a mid 40's ROE, 30% ROA, 8-10% revenue growth, strong free cash flow, etc. its a keeper.
This suggests they are more exposed to GDP growth then to housing. Wow. If true, that makes them a bargain because I believe GDP growth is going to be Ok -- certainly a lot better than the growth of housing.
The other thing I noticed is that the current revenue estimates for GGG for the next 4-6 quarters are only assuming mid single digit growth -- the 5-7% kind of range. Seeing those numbers got me thinking about the different segments of their business. If you assume the industrials segment provides mid teens growth, then the US contractor business can shrink 20% or more and they will still hit the overall numbers. That's comforting to know that the estimates are THAT conservative. reassures me that they are going to hit the numbers.
GGG is selling for less than 16X 2008 EPS estimates. Not bad for a company with a mid 40's ROE, 30% ROA, 8-10% revenue growth, strong free cash flow, etc. its a keeper.
NVT, ECL, SIAL, etc.
Sold some more NVT today -- this is the 2nd time I have taken profits on NVT -- the total sold is about 1/3 of my original position. That still leaves me with some skin in the game but I have reduced my risk a bit after this stock's run -- it is one of the best performing stocks in the Russell 1000 index -- especially AFTER the market peaked. Still love the story or I would have sold all of it. You will find over time that I generally take profits in the stocks I shouldn't and let ride the ones that I should take profits -- oh well, if it were easy they could teach a computer to do it (Doh! sorry about that quant funds He! He! He!)
Did some more thinking about ECL -- those who have read me for a bit now should be familiar with the fact that I do lots of reading on stocks and usually don't do anything about it. Its all good for learning more about business but one doesn't want to churn the accounts either.
I took another look using Factset -- an amazing tool -- of the performance of ECL and Sigma Aldrich (SIAL) and realized that while ECL outperforms over the longer term, that is because SIAL had huge outperformance from the 1970's till 1992 and then sucked until 2000. If you include any time from 92 to 00 in your comparison, then ECL wins hands down. If you just look at either the 70's to 92 or 00 till now, then SIAL wins hands down. So what happened? my guess is sloppy management on SIAL's part that was fixed with a change in strategic direction in 2000. Still, even though SIAL has done well and has pretty good numbers, they haven't grown revenues as well as they wanted based on their 2001 annual report.
ECL isn't much better -- that stock actually underperformed the market from the 1970's till around 2000 -- since then they have done really well. Now there are years in the 90's when they outperformed but overall it's kind of an index like stock. Graco is similar but that company was transformed starting in the early 90's to become an incredibly profitable company. So when I see that they didn't really outperform the market for most years until the last 10, I don't mind because its a different company now then it was pre-outperformance. ECL doesn't look any different. Its still about cleaning solutions and whatever other products they try to shove down the same customers (leveraging their relationships to boost profits without increasing investment). I still might end up buying ECL but for now I am continuing to read -- in this case I'm on to DCI. I looked at this one last year but passed on it. Not sure why. I also passed on Neogen but that wasn't exactly bright either -- ouch, it was up again today!
Those reading from the yahoo board --- I haven't been able to post under my CA-man ID so I haven't posted. Either I have been blocked due to posting a link, or I am a victim of a bug or I need to start posting using another ID. anyway, question for goutah3006 (the guy with experience in semiconductor packaging from the TSRA board) -- I was wondering if you have the expertise or if you asked around about the quality of micro pilr, TSRA's new packaging technology? Is it as much of a leap forward as the company's comparison's suggest? This new technology is critical because it opens up big new markets as well as provides an incentive for existing customers to renew their licenses. just post here or on the yahoo board -- thanks!
Did some more thinking about ECL -- those who have read me for a bit now should be familiar with the fact that I do lots of reading on stocks and usually don't do anything about it. Its all good for learning more about business but one doesn't want to churn the accounts either.
I took another look using Factset -- an amazing tool -- of the performance of ECL and Sigma Aldrich (SIAL) and realized that while ECL outperforms over the longer term, that is because SIAL had huge outperformance from the 1970's till 1992 and then sucked until 2000. If you include any time from 92 to 00 in your comparison, then ECL wins hands down. If you just look at either the 70's to 92 or 00 till now, then SIAL wins hands down. So what happened? my guess is sloppy management on SIAL's part that was fixed with a change in strategic direction in 2000. Still, even though SIAL has done well and has pretty good numbers, they haven't grown revenues as well as they wanted based on their 2001 annual report.
ECL isn't much better -- that stock actually underperformed the market from the 1970's till around 2000 -- since then they have done really well. Now there are years in the 90's when they outperformed but overall it's kind of an index like stock. Graco is similar but that company was transformed starting in the early 90's to become an incredibly profitable company. So when I see that they didn't really outperform the market for most years until the last 10, I don't mind because its a different company now then it was pre-outperformance. ECL doesn't look any different. Its still about cleaning solutions and whatever other products they try to shove down the same customers (leveraging their relationships to boost profits without increasing investment). I still might end up buying ECL but for now I am continuing to read -- in this case I'm on to DCI. I looked at this one last year but passed on it. Not sure why. I also passed on Neogen but that wasn't exactly bright either -- ouch, it was up again today!
Those reading from the yahoo board --- I haven't been able to post under my CA-man ID so I haven't posted. Either I have been blocked due to posting a link, or I am a victim of a bug or I need to start posting using another ID. anyway, question for goutah3006 (the guy with experience in semiconductor packaging from the TSRA board) -- I was wondering if you have the expertise or if you asked around about the quality of micro pilr, TSRA's new packaging technology? Is it as much of a leap forward as the company's comparison's suggest? This new technology is critical because it opens up big new markets as well as provides an incentive for existing customers to renew their licenses. just post here or on the yahoo board -- thanks!
Monday, September 3, 2007
start to the week
Back from the beach now and ready to start the week. Had a good day on Friday with nice gains in several stocks.
My plan is to trim some winners and potentially buy ECL this week. I had dinner with someone in the pest control business this weekend who also used to help manage a bar/restaurant. He was familiar with ecolab basically saying the core business of cleaning supplies is pretty good but its clear their other stuff like pest control is just an add on service -- as in "since we are already helping you with cleaning, why don't you sign up for our pest control service -- we can do it cheaper" but they are not specialists so if you have problems, ecolab is probably not going to be able to fix them. This all makes sense -- just like Google is best at search and Microsoft is best at Windows/Office; Ecolab is best at its original core business. That core is still growing and the other businesses add incremental cash flows with little incremental investment.
The risk is Patterson Dental -- they were a phenomenally successful company that sold equipment and other stuff to dentists for a long time. Fantastic record of consistent growth with most of it organic and some acquisitions helping. At some point they ran out of growth in their core business and the add on business' couldn't support the high multiple the stock had -- it declined sharply. Return on capital had declined because the other businesses were not as profitable. Patterson was stuck in a no win situation -- their core was a great business but they couldn't put new cpaital to work in the core and continue to earn high returns. That meant either giving the money back to shareholders or diluting the returns. they chose to dilute. I need to do some double checking on ECL to make sure this isn't occuring here but I don't think its an issue. International has been the problem because they are not growing as fast and they have lower margins. US continues to do well.
But one note of caution is why did their largest cleaning competitor in the US get out last year? Cleaning is a scale business (size matters) so that may explain it -- Ecolab definitely has scale. Perhaps the business is not as good as people think -- perhaps the competitor left because they knew the future stinks and so does ECL, they are just good at hiding it in these new businesses. I don't think that's true but some more digging couldn't hurt.
Last week I mentioned that Ecolab's international business should be much larger than its US business -- we have only 5% of the population and 25% of GDP so the rest of the world is 95% of the people and 75% of the GDP. True but labor conditions overseas are different -- they can throw bodies at cleaning problems without regard to cost because labor is practically free. Emerging markets also still cook at home mostly but rising incomes are increasing the amount of food eaten out. This is a long term trend -- increased consumer spending by Asians -- they won't just save money in the future.
Basically, when I look at a few good businesses in areas that I don't already own, I see most of them have done well recently but Ecolab has not. Praxair has done well; Sigma Aldrich has done well; etc. Ecolab beats them all longer term but over the last few years, Ecolab has not. Then its a matter of why? either the growth story is over -- which doesn't make sense so far given the record numbers they have put up. Or its due to something temporary like poor management in Europe. They have taken a lot of actions in europe to get growth and margins up -- I'm fairly confident this is a good chance to buy in when there are doubts about the growth story -- that's the time to do it because the price is good.
Secular drivers -- growth in travel (hotel cleaning, laundry), increase in eating out, focus on food safety; etc.
My plan is to trim some winners and potentially buy ECL this week. I had dinner with someone in the pest control business this weekend who also used to help manage a bar/restaurant. He was familiar with ecolab basically saying the core business of cleaning supplies is pretty good but its clear their other stuff like pest control is just an add on service -- as in "since we are already helping you with cleaning, why don't you sign up for our pest control service -- we can do it cheaper" but they are not specialists so if you have problems, ecolab is probably not going to be able to fix them. This all makes sense -- just like Google is best at search and Microsoft is best at Windows/Office; Ecolab is best at its original core business. That core is still growing and the other businesses add incremental cash flows with little incremental investment.
The risk is Patterson Dental -- they were a phenomenally successful company that sold equipment and other stuff to dentists for a long time. Fantastic record of consistent growth with most of it organic and some acquisitions helping. At some point they ran out of growth in their core business and the add on business' couldn't support the high multiple the stock had -- it declined sharply. Return on capital had declined because the other businesses were not as profitable. Patterson was stuck in a no win situation -- their core was a great business but they couldn't put new cpaital to work in the core and continue to earn high returns. That meant either giving the money back to shareholders or diluting the returns. they chose to dilute. I need to do some double checking on ECL to make sure this isn't occuring here but I don't think its an issue. International has been the problem because they are not growing as fast and they have lower margins. US continues to do well.
But one note of caution is why did their largest cleaning competitor in the US get out last year? Cleaning is a scale business (size matters) so that may explain it -- Ecolab definitely has scale. Perhaps the business is not as good as people think -- perhaps the competitor left because they knew the future stinks and so does ECL, they are just good at hiding it in these new businesses. I don't think that's true but some more digging couldn't hurt.
Last week I mentioned that Ecolab's international business should be much larger than its US business -- we have only 5% of the population and 25% of GDP so the rest of the world is 95% of the people and 75% of the GDP. True but labor conditions overseas are different -- they can throw bodies at cleaning problems without regard to cost because labor is practically free. Emerging markets also still cook at home mostly but rising incomes are increasing the amount of food eaten out. This is a long term trend -- increased consumer spending by Asians -- they won't just save money in the future.
Basically, when I look at a few good businesses in areas that I don't already own, I see most of them have done well recently but Ecolab has not. Praxair has done well; Sigma Aldrich has done well; etc. Ecolab beats them all longer term but over the last few years, Ecolab has not. Then its a matter of why? either the growth story is over -- which doesn't make sense so far given the record numbers they have put up. Or its due to something temporary like poor management in Europe. They have taken a lot of actions in europe to get growth and margins up -- I'm fairly confident this is a good chance to buy in when there are doubts about the growth story -- that's the time to do it because the price is good.
Secular drivers -- growth in travel (hotel cleaning, laundry), increase in eating out, focus on food safety; etc.
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