NLC Nalco Holding Company Common Stock

Leading cleaning and sanitation products maker Ecolab Inc’s (ECL) third-quarter fiscal 2011 adjusted (excluding special gains/charges and tax-related adjustments) earnings of 75 cents a share matched the Zacks Consensus Estimate while exceeded the year-ago adjusted earnings of 66 cents. The results met the top end of the company’s guidance of 73-75 cents.

Net income (attributable to Ecolab) for the quarter slipped 11% year over year to $154.3 million (or 65 cents a share). The bottom line was hit by roughly $28 million in charges, mainly associated with the Minnesota-based company’s European restructuring program and costs related to its $8 billion acquisition of Illinois-based water treatment company Nalco Holding Company (NLC), which offset double-digit growth in revenues.

Net sales spiked roughly 11% year over year (up 6% in constant currency) to $1,736.1 million, essentially in line with the Zacks Consensus Estimate. Sales were boosted by healthy growth at the company’s Food & Beverage business coupled with the contributions from Asia-Pacific, Canada and Latin American operations, backed by acquisitions and new products.

Segment Highlights

Revenues from Ecolab’s core U.S. Cleaning & Sanitizing division climbed 6% year over year to $763 million, led by Food & Beverage and Healthcare sub-segments. The U.S. Other Services segment revenues moved up 2% to $120 million. Revenues (at constant currency) from the company’s International operations rose 6% year over year to $797 million with emerging markets contributing to the growth.

Margins

Operating margin declined to 13.8% from 15.7% a year-ago, impacted by the hefty restructuring and acquisition-related charges. Gross margin fell to 49.4% from 51.1% a year ago as a result of a 15% hike in cost of sales, in part, due to the special restructuring charges.

Gross margin was also impacted by higher-than-anticipated raw material costs. Ecolab is employing effective pricing strategies to offset the raw material inflation and expects the impact to ease in the fourth quarter.

Financial Health

Ecolab ended the third quarter with cash and cash equivalents of $207.3 million, up 23% year over year. Long-term debt increased roughly 8% year over year to $700.2 million.

Guidance and Recommendation

Ecolab has narrowed its adjusted earnings per share target for fiscal 2011 to between $2.53 and $2.55 (a 13%-14% year-over-year growth) from its earlier forecast of $2.52 and $2.56. The adjusted earnings exclude charges associated with the acquisition of Nalco Holding. Ecolab continues to expect the transaction to close in fourth-quarter 2011. 

For the fourth quarter, Ecolab forecast adjusted earnings between 69 cents and 71 cents a share. The forecast assumes a dilution of roughly 20 cents a share, primarily associated with merger and integration costs related to the Nalco buyout. The current Zacks Consensus Estimates for the fourth quarter and fiscal 2011 are 71 cents and $2.55, respectively.

Adjusted gross margin for the fourth quarter is expected in the range of 50%-51%. Moreover, Ecolab expects improved year-over-year revenue growth in the quarter.

We are encouraged by Ecolab’s strong international exposure and recovery across its end-markets. However, the company is faced with aggressive competition from the likes of Clorox (CLX) and Church & Dwight (CHD). Moreover, raw material price hikes represent a headwind for Ecolab and its aggressive acquisition strategy has inherent integration risks. We are currently Neutral on the stock.

 
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