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Nalco: We Can Double Our Growth Rate

Daniel Rohr, CFA

Daniel Rohr: Hi. I am Dan Rohr, Morningstar Analyst on the Basic Materials team at our 2010 Stocks Forum, and joining me today is Rich Bendure from Nalco. Rich is the Global Marketing President for Water and Process Services.

Rich, thank you much for joining us today.

Rich Bendure: Thanks for having me, Dan.

Rohr: So, let's jump right into the questions. Nalco's management team has expressed a relatively aggressive long-term real growth target of 6% to 8%. Ambitious I might say given the general uncertainty in the economy today, and relative to Nalco's historical sales performance. Would you care to break down for us what sources of growth Nalco sees?

Bendure: Historically, we've grown at about a 3% to 4% organic growth rate as you mentioned, excluding currency and acquisitions. We're right now targeting to double that growth rate to 6% to 8% by the end of 2011 timeframe. The way we're going to do that is really into a couple of key areas. One is our BRIC-plus strategy and for us BRIC-plus is more than industrial growth, because these countries have low water capability, low availability of water, and so for us there is sort of a multi-play on the BRIC strategy, the BRIC theme. We get the benefit of both the industrial growth as well as the water scarcity itself contributing to even higher growth rates.

We've also turned around our European, Western European theater which had been a problem for us a couple years ago, now into a growth mode by consolidating some backend activities and relocating our headquarters Q1 of next year.

We've got a great theme on some technology deployments, both on the water platform, the water automation that we have, as well as some of our technologies like enhanced oil recovery, and also in the paper segment for OxiPRO and PARETO technologies.

Beyond those themes, we've also got some bolt-on M&A aspirations that because of our channel, because of our 7,000 sales engineers in the field, we've got a really great leverage around incremental technology or geography placed to have synergy around bolt-on M&A. So if you add all that up based on our historical or the underlying market growth rate of 3% to 4%, we're very confident that we can run that 6% to 8% growth that we talked about.

Rohr: You mentioned the BRIC-plus strategy, it seems every company we speak with here at the Stocks Forum is really excited about the opportunity in emerging markets. I guess the risk being that if everyone's going after an attractive bet, folks crowding the bet can render it unattractive and less profitable than it might have looked a priori.

What are you guys seeing as far as profit margins in China, in Eastern Europe relative to what you guys generate in your more established markets here in the U.S. and in Western Europe?

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Bendure: Well, the great news for us is that the revenue and the margins that we generate from our BRIC-plus economies are actually at or above our company averages in our model. Because of the stickiness of our service model, the technology that we have deployed, we're actually very successful in the value proposition to the industrial customer that allow us to command those premiums.

That said, in fact the last two quarters, we've grown at a 40% top line growth rate in the BRIC-plus economies, and based on the investments we've made in 2009 and 2010, we're extremely confident and excited about that continuing trend going forward.

Rohr: You mentioned today in your presentation that the paper industry is the largest industrial consumer of water. Fun fact. Given the long-term secular decline that I don't think anyone would disagree with for paper demand here in the OECD economies at least, do you guys think you can maintain what are relatively attractive operating margins? And I guess second part of that, what's the breakdown revenue wise between your developed markets and your Indias, your Chinas, where per capita consumption of newsprint and magazine paper may still be on the rise?

Bendure: In the paper industry, if you look at the global growth rate forecast for that industry, it's going to be in the 1% to 2% underlying production growth. I am anticipating that our growth rate is going to be in that 4 or so percent – 3%, 4%, 5% range going forward.

And the way we're able to realize that is a very focused and targeted strategy around deployment of the right technologies, very simple focus on three or four key technologies with the right assets and the right accounts. And so in this case, we're able to take market share and grow faster than market because of the segmentation that we take and the prejudice we have around resource deployment.

The second part of your question around the long-term margin trends that we would expect for this business, we anticipate that that business for us will be a high-teens contribution business in the go-forward consistent with historical patterns that we've seen.

Rohr: Just one last question and it's about the capital structure. In the last dip, we saw there were a los of companies over-levered basically got caught swimming without shorts. Nalco, just looking at very basic ratios is a fairly levered company, perhaps a consequence of its LBO history. I think TTM, debt-to-EBITDA is around 3.9, call it 4. What's your target capital structure and how do you see it evolving as the company pursues these attractive growth opportunities?

Bendure: Yeah. You're right. I mean back in 2003 in our LBO, we were actually seven times multiple levered and over the last several years because of our good cash flow generation capabilities, consistent revenue and EBITDA growth, plus ability to ring out cash from the balance sheet in terms of inventory and receivables, we have been able to naturally de-lever south of four, as you mentioned.

Our targets that our Board has asked us to focus on are taking one more turn out of that, probably around the three range, and we think we can do that in a next 18 to 24 months in a very natural, very normal pace.

Rohr: Well, thank you very much, Rich. I appreciate it.

Bendure: Thank you, Dan. Thanks for having me.