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Waste Services: Trash to Treasure

Posted on: September 18, 2008 - Email Article - Printable Version

Mahir Desai

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While the markets are in complete turmoil and the overall Industrial sector seems to be in a bearish environment, the waste services sub-industry has managed to stay afloat. The waste services industry is very simple: it is comprised of companies that collect, transfer, recycle, and dispose of garbage. It is an industry that has few competitors and very stable demand. Let’s face it; there will always be garbage that needs to be disposed.

So to give you an introduction to the industry, there are three major competitors:

Waste Management [WMI: 33.57, 0.00 (0.00%)]: Waste Management offers trash collection, transfer of waste services, recycling, disposal and waste-to-energy conversion services. In addition they rent and service portable restroom facilities, provide street and parking lot sweeping services, they offer portable self-storage and fluorescent lamp recycling services and other industry related services. These additional services help them separate themselves from the competition in a fairly monotonous industry. Geographically, they are located all throughout North America and service regions all throughout the United States.

Waste Connections [WCN: 31.05, 0.00 (0.00%)]: Waste Connections is a solid waste services company that provides solid waste collection, transfer of waste services, disposal, and recycling services. They are much smaller than Waste Management and are exclusively based in the southern and western regions in the United States.

Republic Services [RSG: 25.61, 0.00 (0.00%)]: Republic Services provides solid waste collection and disposal services for commercial, industrial, municipal, and residential customers in the United States. They are the smallest of the three big waste services companies and they operate throughout the United States, however they are not as concentrated as Waste Management in many of these areas.

The major differences between the three of these companies is their market cap and the geographic region which they serve.

A Historical Perspective

This sub-sector seems like an ingenuous “safe-haven play” in my opinion. To better rationalize this, let’s take a more historical look at this sub-sector’s performance in a recessionary time period. In the March-to-November 2001 recession, the S&P Index returned -8.91% (calculated from 3/1-11/30). To get more sector specific, the Industrial Select Sector SPDR returned -8.66% over the course of that recession (calculated using the same dates as above). Here are the returns of the three major companies in this sub-sector (calculated using the same dates as above):

Waste Management: 18.88%
Waste Connections: -6.55%
Republic Services: 2%

All three companies had substantially outperformed both the S&P Index and the Industrials Select Sector SPDR. I feel that the industry’s concrete management as demonstrated through returns, and consistent revenue, as well as demand streams make these companies a perfect play in a recessionary time period.

Effects of High Oil

One of the concerns regarding this industry is the volatility of oil. Over the course of the past few months we have seen oil trade as high as nearly $150 a barrel and as low as $92 a barrel. Most companies that are highly dependent on transportation have seen a large impact to the downside in their stock price due to the volatility of oil. Companies like UPS [UPS: 55.18, 0.00 (0.00%)], FedEx [FDX: 63.95, 0.00 (0.00%)], and UAL Corp. [UAUA: 11.45, 0.00 (0.00%)] have seen large slides in their stock price due to increase in fuel costs. However the waste services industry has dealt with the instability of oil very well. Their stock prices do not reflect the same drop due to the volatility of oil that other transportation dependent companies have faced.

How can an industry that is highly dependent on fuel manage to mitigate the risk of high oil prices? There are two key reasons why this is so:

Many of the Waste Services companies have implemented ways to hedge against high oil. For example: Waste Management has a fuel surcharge program that is designed to minimize the damage done to margins from high and volatile oil.
As stated above, there is very consistent demand for the service and thus a fairly consistent revenue stream based on the demand. There will always be a need to collect trash and dispose of it.

Current events in the Industry

There are a series of mergers and acquisitions that have either taken place or are in the midst of possibly happening. The industry itself already has only a handful of competitors and as of late the trend looks like there may be even fewer than before. Lets start with the merger of Republic Services and Allied Waste. Allied Waste [AW: 0.00, N/A (N/A)] is a small waste services company based out of Phoenix, Arizona. This merger, with Republic Services in the driver’s seat, is expected to generate $150 million in pre-tax synergies, which according to analysts are expected to be almost all exclusively via cost savings. These pre-tax synergies are only expected to be about 1.6% of sales, but have the potential of adding 13% to the combined market caps. The merger was officially completed on June 23, 2008.

Waste Management is in the process of trying to acquire Republic Services. Waste Management had made an original bid of $34/share for RSG; however, that offer was rejected by Republic Services. Nevertheless, on August 11, 2008 WMI increased their bid by 9% to $37/share. Currently, there is no decision by Republic Services regarding the offer. The acquisition of RSG would make WMI even more of a force in this industry than they already are. This is assuming that they pay a reasonable price for them. In my opinion, that is the sole risk factor that faces Waste Management in regards to this acquisition.

Summary

Overall, I’m bullish on the waste services industry. I feel that with the stable demand for the service and the historical performances of the larger companies in this sub-sector make it a very recession proof, attractable, “safe-haven play”. They have shown proper management in regards to the volatile oil and overall commodities market. In my opinion I would stick to the larger cap plays in this industry. such as Waste Management, as they have proven to have a stellar track record in down times. I feel that this is a great industry to invest in while there is so much uncertainty and volatility in the overall markets.

-Mahir Desai

Disclosure: None.

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