Investor's Business Daily, September 28th, 2007
Most Americans probably sleep through the pre-dawn arrival of the garbage truck. But if you do happen to be there when it comes, you might want to take a look at who owns it. Chances are, that has changed in the last 15 years.
The waste management industry went through a massive consolidation in the 1990s. Today, almost half the market belongs to a few publicly traded companies, which are still buying up small local concerns. Now the challenge is keeping prices in line with rising costs.
At the same time, specialty and nontraditional waste management has become a factor, as recycling, waste-to-energy and hazardous-waste management offer alternatives to the traditional landfill. The combination of these trends has helped drive the sector's stocks upward since early 2003.
1. Business
Most companies in this sector deal with traditional trash generated by homes and businesses. There are three parts to this business: collection, processing and disposal. The publicly traded firms do all three of these to varying degrees.
Collection services generally are done by contract, with a homeowner, business or municipality. In western states, local governments grant franchise contracts that give a company exclusive rights to a geographic region, though fees are still paid by individuals. Elsewhere, companies have to compete for every customer.
The company's trucks often drive to transfer stations, which consolidate trash from all around onto trains or barges. From there the garbage goes to its point 15f disposal, usually a company-owned landfill. In the northeast, where landfills are old and full, more than half of the trash is recycled or converted into energy. Recycling also is popular on the West Coast.
IBD's Pollution Control Services group also includes some specialty players. Stericycle SRCL specializes in medical waste (see related story, this page). American Ecology ECOL focuses on radioactive and hazardous waste. Industrial Services of America IDSA recycles scrap metal. Other companies perform water treatment and environmental cleanup, but most of the money is still in solid waste.
Name Of The Game: With trucks, trains, boats, facilities and landfills involved, waste management is a capital intensive business. Currently, the industry's focus is on pricing high enough to get a decent return.
2. Market
According to analyst Jagdeep Ghuman of Credit Suisse, the total domestic market for solid waste management is $46.5 billion. It's a mature industry, so top-line growth isn't its strong point; Ghuman pegs it at about 4.5% a year.
At the collection end, the market is evenly divided between residential and commercial customers. Commercial markets are more sensitive to economic cycles than residential markets, Ghuman says. In particular, the recent slowdown in residential construction has hurt the industry, since construction sites generate a huge amount of trash.
The market varies by region. In the West, waste management is treated as a public utility, with municipalities managing it directly or signing companies onto franchise contracts. This gives companies a lot of job security, since contracts typically run longer than 20 years.
Waste Connections WCN has a strong presence in franchise markets but also serves nonfranchise regions. Chief Executive Ronald Mittelstaedt says there's a big difference between this type of market and a more competitive one.
"If you go to Denver or Houston, a community might have 15 houses on one block serviced by 15 different waste haulers," he said. "In non-West Coast markets, we compete based on service and price. There's a heavy emphasis by the sales force on telemarketing and direct marketing."
Collection provides more than half of the industry's revenue. Another 29% comes from disposal services, about two-thirds of that from landfills. Some landfills belong to the waste companies, which charge tipping fees to anyone else using it. Other landfills belong to municipalities that pay the waste firms to operate them by contract.
About 12% of total revenue comes from recycling, waste-to-energy plants and other methods of alternative disposal. This varies greatly by region. According to BioCycle, the New England market is almost evenly divided between landfill, recycling and waste-to-energy by volume. Recycling is biggest on the West Coast and in the mid-Atlantic region. The Rocky Mountain region uses alternative disposal the least, with 85% of trash going to landfills.
3. Climate
According to Mittelstaedt, the industry began consolidating in the 1970s. But things really picked up in the early 1990s, when regulations made landfill operation a lot more capital intensive.
Currently, Waste Management WMI owns 27% market share, with Allied Waste Industries AW in second with 12% and Republic Services RSG controlling 6%. The public sector has 29% of the market, with smaller players finding their own niches in the remaining 23%. Waste Connections concentrates on rural and Western markets, leaving the big cities to the bigger guns.
While much of the consolidation was probably necessary, Ghuman says that in the past, waste companies have sometimes chased volume to the detriment of margins.
"The nature of the business is volume times price equals revenue," Ghuman said. "Now we're seeing a focus on return on invested capital, using price as the lever to improve returns. (The industry leaders) have been willing to sacrifice volume growth in an effort to improve pricing."
Mittelstaedt says the present focus on price also comes from an explosion in costs. The prices of diesel fuel and steel have shot up, making a truck fleet much more expensive to maintain. The cost of the petroleum-based plastics used in landfill construction has doubled in the last four years.
Waste Management is a leader in this effort with its "Pricing Excellence" initiative. This shows in its two most recent quarters, when year-over-year profit growth topped 20% even though revenue actually dropped.
Some acquiring is still going on, but on a much smaller scale. Observers generally agree that the era of megamergers is over.
4. Technology
At the collections end, trash trucks have started to come tricked out with new gear. Mechanical arms have replaced human arms in lifting and emptying trash cans into compactors. Global positioning systems help drivers make the rounds more efficiently. Just recently, Mittelstaedt says, customers have started setting up pickups on their PDAs.
At the disposal end, the process of converting trash into energy has drawn attention both as an alternative to fossil fuels and as a way of reducing landfill. Currently, this takes up only 6% of the business, and mainly involves simply burning trash to power electrical turbines. Newer, more experimental methods involve collecting methane gas at landfills and even converting waste into oil.
Ghuman, however, says these technologies are still in their early stages. "We maintain that landfills will remain the primary means of disposal for the foreseeable future," he wrote in a June 5 note.
5. Outlook
After a stretch of turmoil, the waste management industry has been pretty stable the last few years. No major new regulations or game-changing technologies have come along lately, and most people expect that to continue.
Upside: The calm environment and the greater focus on pricing has analysts hoping for more profit even if revenue slows. Ghuman says the industry has been "right-sized" and is set for steady performance.
Risks: The industry is somewhat sensitive to economic downturns, though it typically turns at least six months after the general economy does. The residential construction slowdown has already dinged waste firms, and a commercial slowdown could do the same.
Despite the lack of new regulations in recent years, the long-term trend has been toward tighter environmental regulations, Ghuman says. The consolidated ownership of landfills means that the new owners may also discover pollution violations in their landfills that they didn't realize were there.
