Cleaning Up on Fracking’s Dirty Water; 100 years ago, it took about a barrel of water to get 10 barrels of oil out of the ground. Today, generating the equivalent amount of shale-gas energy requires five times as much water

SATURDAY, APRIL 27, 2013

Cleaning Up on Fracking’s Dirty Water

By LESLIE P. NORTON | MORE ARTICLES BY AUTHOR

With two recent acquisitions, Ecolab has become a top provider of water-treatment services used in energy extraction. Why the stock could still gush 20% or more higher.

It’s often said that 100 years ago, it took about a barrel of water to get 10 barrels of oil out of the ground. Today, generating the equivalent amount of shale-gas energy requires five times as much water, which is why hydraulic fracturing, or fracking, “is more of a water issue than it is about gas,” says Deane Dray, the water analyst for Citigroup. That has enhanced the long-term prospects of water-related stocks, including Ecolab (ticker: ECL). “The opportunities we’re seeing in water supply and water treatment are exciting,” says Ian Simm, CEO of Impax Asset Management in London and a fan of St. Paul, Minn.–based Ecolab. Despite a run-up in Ecolab’s stock this past year, Impax believes it can still rise further, citing the company’s strong management, the stock’s steady uptrend in a volatile environment, and its “mission-critical products,” says Simm. As much as 140 billion gallons of water are used in the 35,000 wells fracked annually in the U.S. Most of it simply disappears underground; the rest is rendered so toxic by the process that communities are wary of fracking. Plenty of companies will treat the water, but two specialists are Nalco and Champion, both owned by Ecolab.

FOUNDED IN 1923 as Economics Laboratory, a hotel-carpet cleaner, Ecolab today offers products and services that provide clean water and dozens of other treatments–ranging from pest elimination to laundry to kitchen repairs—for food processors, beverage makers, hospitals, power generators, and other industries; many of these offerings came in with the company’s late-2011 acquisition of Nalco, which then generated about $11 billion in annual revenue. Nalco, which made the chemicals used to help clean up the BP oil spill, gave Ecolab a leading position in energy; among other things, it treats water to ensure it’s free of bacteria and doesn’t corrode pipes and pumps, separates water and oil, and prepares water for shipment. Now, the acquisition of Champion this month will mean that energy accounts for at least a quarter of Ecolab’s roughly $13 billion in revenues. Both Champion and Nalco make chemicals that treat fracking water; the combined company offers equipment, services, and engineering capabilities to help manage the process. Fracking, Ecolab notes, is a small but growing part of its business.

Until recently, Ecolab’s additives brought the company about a nickel per barrel of oil that a customer produced. The new wells mean that amount now ranges between 30 cents and $3 a barrel, depending on how difficult the energy is to extract. “The stuff in the ground is more corrosive and needs more treatment,” says Doug Baker, Ecolab’s CEO. That has also made Ecolab more profitable.

“Once you secure the business, you end up with a very attractive business for a long period” because the water must be treated over the well’s life, says Baker. Ecolab’s business is largely consumable—packages of regularly dispensed chemicals and services. “It’s more annuity-like, not as cyclical as what people equate with the word energy. We may grow faster when more wells are dug, but we don’t shrink when they’re not,” he says.

ENERGY REVENUES GREW at a 21% rate in 2012. That pedal-to-the-metal growth is unsustainable, but Baker believes that energy revenues will grow at a 13% to 14% annual clip “for a long period.” Overall revenues are forecast to rise 12% this year. The company has a lot of tail winds that range from more-aggressive energy extraction to water conservation to growing global populations; Ecolab gets 50% of its revenues abroad.

Baker and Ecolab management are well regarded by investors. For that matter, so is the stock. Over the past 12 months, Ecolab shares are up 34%, giving the company a market value of nearly $25 billion, within spitting distance of all but the most bullish analysts’ target prices. The high is $94, or 12% higher than the recent $83.73, but the median is $87, just 4% higher. For the current year, Ecolab is expected to earn $3.35 a share, up from $2.35 in 2011, on revenue of $13.2 billion, up from $11.8 billion last year. Next year, the company is expected to earn $4.13 a share. Add in, say, 25 extra cents of earnings from the Champion acquisition, and that still puts Ecolab at 19 times earnings, a premium of 50% to the S&P 500.

Baker maintains that the premium is warranted. “Foundationally, we have a business that grows at a much faster clip than the S&P 500,” he says. Earnings per share grew 23% last year and are forecast to rise another 42% this year; S&P earnings rose 6% a share last year and are expected to gain about 8% in 2013. “As I look at the next five years, there’s every reason to believe we’ll grow at a faster clip than the past five,” he says. “Our portfolio is better; we have synergies as a consequence of the Nalco merger and the Champion acquisition, and the economy will be equal or better than the past five years,” adds Baker.

The Bottom Line

Ecolab stocks still has 20% or more upside, based on expectations of strong growth in its energy-services business and overall earnings in coming years.

Peter Bates, an analyst at T. Rowe Price, one of Ecolab’s largest shareholders, justifies the firm’s continuing stake this way: “You’re investing in a low-cyclical, high-growth secular franchise.” For another thing, Ecolab pays an annual dividend of 92 cents a share, for a 1.1% yield. Meanwhile, earnings are artificially depressed by the company’s recent acquisitions, says Bates, and cash flow more accurately reflects its prospects. By that measure, analysts on average expect Ecolab to generate cash flow of $4.88 a share this year and $5.93 in 2014. Putting a lower multiple of 17 on the 2014 figure gives the stock a value of $101, or about 20% higher. Bates figures cash flow will be at least $7.25 a share in 2017, which would support an even higher price. For the immediate future, energy trends are still Ecolab’s friend.

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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