Trash Economy

by Overheard Wall Street
  • Intro
  • Trash Services Universe
  • Waste Management
  • Republic Services
  • Conclusion/Recommendation

Intro

You may have heard recently about all the trash accumulation in NYC and the new rules around placing trash on the sidewalks after 8 pm to cut down on the rat infestation.

You may have never experienced the trash build-up and rat infestation of NYC.

Maybe you’re like me, and trash trucks come through your neighborhood every week, picking up the trash you’ve carried to the end of your driveway the night before.

The only trash animals you’ve contended with were the trash pandas, aka Raccoons, that always seem to know precisely when you’re bringing out the trash but never when they need to get themselves out of your way before you bring the dog outside…

The point is that we all deal with trash and trash collectors in one way or another.

Have you ever wondered if the trucks driving down your neighborhood street at 6 am, waking everyone up within a 1-mile radius, and dropping your cans without care are publicly traded?

Trash Services Universe

The universe of trash encompasses more than just the truck that picks up your trash each week off the curb or, in NYC, the sidewalk between 8 pm and 12 am.

For most of us, trash collection and maybe some recycling concern is about as far as we go when evaluating the waste management value chain.

Waste management is more than just trash collection – it spans from collection to transportation to sorting and recycling and ultimate disposal options – biological treatment, landfill, or incineration.

The chart below provides an overview of the entire waste management value chain, courtesy of the International Conference on Industrial Engineering and Operations Management in Rome:

The global waste management market was $989 billion in 2021 and is estimated to grow at a CAGR of 6.2% through 2030 to $1.6 trillion.

Logically, this should make sense – as we continue to expand on population size, city density, and urbanization, there will be more trash and more need for trash collectors.

What is uniquely attractive about waste management is landfill operations. This is where most waste is hauled to be stored and broken down naturally over time.

From Environmental Engineering (Fourth Edition):

The landfill operation is a biological method of waste treatment. Municipal refuse deposited as a fill is anything but inert. In the absence of oxygen, anaerobic decomposition steadily degrades the organic material to more stable forms. This process is prolonged and may continue for as long as 25 years after the landfill closes.

But in the last 40 years, landfills have disappeared from the landscape. In 1980, there were approximately 10,000 landfills across the US.

But with the rise in federal and state regulations and the consumer desire to live nowhere near a landfill, that number has fallen to 1,500 today.

Massive consolidation in landfill operations and an increase in regulations means that the barrier to entry for this market is exceptionally high. The companies that manage existing landfills have a competitive advantage over potential entrants without ownership of these assets and would have to pay for use.

The United States has the largest waste management companies by market cap, with the top two positions held by Waste Management & Republic Services.

Let’s dive into these two companies and see if investors are getting something different by investing in one vs. the other.

Waste Management

Waste Management is the largest waste collection company, operating the most extensive portfolio of landfill assets (260) and an extensive network of transfer stations.

In 2021, WM did over $17 billion in revenue, split among collections, landfill operations, transfer station “tipping fees,” and recycling operations.

While collection accounts for 65% of WM’s revenue, its key asset is its extensive portfolio of landfills and transfer stations.

Due to the regulatory nature of these operations, many smaller competitors cannot own and operate new landfills, which drives them to utilize WM’s transfer stations and landfills. This provides an excellent revenue source for WM – accounting for the remaining 35% of revenue.

In 2020, WM acquired Advanced Disposal, which at the time was the fourth largest waste collection company, for $30.30 per share in cash, or $4.1 billion in total value.

This acquisition provided WM access to over 3 million new customers primarily located in the Eastern US and over $1.6 billion in additional revenue.

Bulls
  • WM’s landfill footprint provides a strong moat of competitive advantage against other competitors. Public companies manage 60% of all solid waste landfill operations.
    • 1,500 landfills in operation currently, 900 are managed by public companies, and WM controls 290 of these or 32%. Their nearest competitor is Republic Services which operates 198 landfills.
    • Next to these two giants, the next largest operator and owner of landfills is Waste Connections, which has 98 landfills.
  • WM has the pricing power to continue raising collection fees on dense transfer routes that have been able to outpace inflation over the last few years.
    • This provides them access to continued revenue growth into the future, even during high inflationary periods. In 2021, WM raised its collection fees by 4.2%, surpassing the 2.5% price increase in 2020 and slightly below the 4.7% average inflation rate of 2021.
    • So far into 2022, WM has been able to outpace inflation on commercial and industrial trash collection operations:

Bears
  • Waste Management has been a successful acquirer over the years, but as the market consolidates in this space, targets are becoming more expensive and potentially less accretive to WM’s business.
    • If it plans to continue acquiring, analysts see a potential risk in overpaying for targets and getting less value out of those acquisitions.
  • Waste collection, in general, has been a target of many ESG activists, and as the world focuses more on the impact of environmental actions, WM is at the center.
    • Mishandling of waste can result in substantial fines, remediation costs, and brand issues in local communities where it operates. They have a strong track record of minimizing environmental risk through its operations, which should help to mitigate this future risk.
    • Landfills are also the subject of ESG concerns, given that the greenhouse gas emissions stem from them and the fleet of trucks transporting waste to and from landfills. WM will need to continue investing in clean tech to help mitigate these emissions.

Key Metrics (10/21/22)
  • Current Price: $160.28
  • Cash: $924M
  • LT Debt: $14 billion
  • NTM:
    • Revenue: $19.7 billion
    • EBITDA: $5.55 billion
    • EV/EBITDA: 14.5x
    • P/E: 28x
    • P/FCF: 30.2x

Republic Services

Republic Services is the second largest waste collection company operating in the US. It works in 41 states through 356 collection facilities, 239 transfer stations, 198 active landfills, and 71 recycling processing centers.

In 2021, RSG did $11.3 billion in revenue across the collection, transfer tipping fees, and landfill operations.

What is unique to RSG is its fleet of trash collection vehicles, which is ranked as the 5th largest vocational fleet in the United States.

RSG’s revenue breakdown is more collection-heavy than Waste Management’s, as 74% of total revenue was derived from collection services. This provides RSG a better opportunity to pass through costs as inflation continues to be a significant concern.

In 2022, core prices increased by 6.6% in the year’s first half. While this has not kept up with inflation, they have been able to raise prices for customers as costs have increased with inflation.

Bulls
  • RSG’s higher reliance on trash collection vs. landfill operations presents them with a unique opportunity to weather the inflationary storm currently hitting the US.
    • They have already been able to raise prices steadily in 2022 as inflation has continued its upward trend. Looking ahead, they should have no issue continuing to raise prices to keep up with inflation.
  • RSG has created standardized vehicle maintenance and service method, which is a critical factor for keeping costs low given its large fleet of vehicles.
    • This new method of maintenance and ongoing vehicle servicing should help to mitigate future significant increases in expenses related to this.

Bears
  • One key note related to the current maintenance program is that RSG is working to pilot electrified trash collection vehicles and further electrify their vehicle fleet. This will add new costs to their CapEx spend to update the fleet and will require an update to their maintenance program that will most likely increase short-term expenses related to maintenance.
  • RSG acquired US Ecology in 2022 for $2.2 billion, or $48 per share. The hope is that both companies’ combined waste collection and management portfolios will increase RSG's footprint and allow for cross-selling opportunities and cost-saving synergies.
    • This transaction was funded with debt, which increased RSG’s net debt-to-EBITDA ratio above 3x and is highly reliant on estimated synergies.
    • While RSG has been a serial acquirer in the past, there is still uncertainty around its ability to realize the proposed synergies and revenue opportunities.

Key Metrics (10/21/22)
  • Current Price: $132.78
  • Cash: $119M
  • LT Debt: $11.8 billion
  • NTM:
    • Revenue: $13.4 billion
    • EBITDA: $3.9 billion
    • EV/EBITDA: 13.9x
    • P/E: 27.9x
    • P/FCF: 25.2x

Conclusion/Recommendation

Trash collection has never been a sexy business. Most kids aren’t going to college with plans to be trash collectors, even though the job has incredibly appealing benefits.

But when we look closer at these businesses, they appear to be highly capable of surviving both an impending recession and a high inflationary environment.

Both RSG and WM may not be the high-flying returns you want to see in your portfolio, but they both appear poised to produce steady returns over the long term.

Both are generating solid free cash flow, paying dividends to shareholders, and engaged in active shareholder buyback programs.

Each is a mature business with little concern over being acquired and even less concern about going out of business.

If you want exposure to the trash industry, you can’t go wrong with choosing either of these businesses. Our preference here would be Waste Management, which offers a higher net income margin and a greater cash balance to offset its debt load.

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