Ecolab Shares Rally on Q4 Cost Inflation Progress; Shares Undervalued

After updating our model to incorporate Ecolab’s fourth-quarter results, we maintain our $210 per share fair value estimate. During the quarter, Ecolab grew adjusted operating income 14% versus the prior-year quarter while continuing to make progress on its margin recovery versus the beginning of 2022. Management expects the growth will continue in 2023, guiding to first-quarter adjusted operating income growth of 15% to 25%.

The results and guidance were in line with our view that cost inflation would have a temporary impact on Ecolab’s profits, but the company’s strong pricing power, which underpins our wide moat rating, would allow it to pass along cost inflation over time. In addition to product price increases, Ecolab implemented energy surcharges to cover higher energy costs last year. While the company began rolling out the surcharges last April, it took a couple of quarters to be largely implemented, with 2022 second- and third-quarter results still being largely affected by higher energy-related cost inflation. Going forward, Ecolab should see less of an impact. As cost inflation stabilizes, we continue to forecast a full profit recovery and margin restoration over time.

Ecolab shares rallied on the solid results and guidance and were up nearly 7% at the time of writing. However, at current prices, we view Ecolab as undervalued with the stock trading in 5-star territory and at a 25% discount to our fair value estimate. As such, we view current prices as a good entry point for long-term investors.

During the quarter, Ecolab’s water business grew 14% versus the prior-year quarter as the company continued to win new customers through its value proposition to reduce water and energy expenses in excess of the cost of Ecolab’s products. As fresh water costs continue to rise globally—we expect U.S. median costs will double by 2030—Ecolab is well positioned to continue to grow its water business at a high-single-digit to low-double-digit annual rate.