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How This David Beat Goliath in the Waste Management Industry

Source: Waste Connections

In 2013, Waste Connections (NYSE: WCN  ) , the third-largest solid waste company in the U.S., managed to raise prices by close to 3%, compared with a price increase in excess of 1.5% for its larger peer Waste Management (NYSE: WM  ) . With revenues less than 15% of Waste Management's, how did Waste Connections exhibit stronger pricing power? Also, how does Waste Connections compare with other peers, such as Stericycle (NASDAQ: SRCL  ) ?

Large where it matters
Waste Management serves about 21 million customers, compared with Waste Connections' customer base of 2 million customers. But this doesn't necessarily mean that Waste Connections is at a disadvantage. This is because market share matters only at a local level for the solid waste business.

The costs associated with any single waste collection trip, such as driver salaries, fuel costs and depreciation expenses for the trucks, are mostly fixed. Waste Connections benefits from operating leverage to the same degree as Waste Management, if it's the market leader in its local markets and makes more stops per route as a result.

Waste Connections understands this dynamic very well and has focused on secondary and exclusive markets in a bid to gain the largest market share in its targeted markets. In fact, Waste Connections specifically avoids urban markets where competition is more intense; and any market where it isn't among the top two players.

In some of these cases, Waste Connections owns the only landfill in the area, giving it tremendous pricing power over its customers. In addition, its dominant market share in these markets also results in higher profitability. Based on its internal estimates, its 2013 adjusted EBITDA margins of 34% are significantly higher than Waste Management's 24% EBITDA margins.

Source: Waste Connections

Specialized waste
Waste Connections generated 13% of its 2013 revenues from a niche area -- oil field waste. Tightening environmental regulations and higher waste intensity per well as a result of increased drilling in unconventional areas have contributed to a rise in demand for oil field waste treatment, recovery, and disposal.

Waste Connections claims to be a market leader in this area, boasting a footprint of close to 40 facilities across multiple oil-rich basins, including the Permian, Bakken, and Eagle Ford. More importantly, oil field waste management has a high benefit-to-cost ratio. The inappropriate disposal of oil field waste could lead to regulatory penalties significantly higher than the cost of Waste Connections' services.

In the first quarter of 2014, Waste Connections experienced close to 20% increase in its quarterly revenues for its oil field waste business, compared with a moderate 5.5% sales increase for its solid waste business. Looking ahead, Waste Connections expects its oil field waste business to continue outpacing the growth of its solid waste business, guiding for 12%-15% growth in 2014.

Another company dealing with specialized waste is Stericycle, a medical waste disposal company providing regulated waste management services for its clients. Similar to Waste Connections' oil field waste management services, the cost of Stericycle's services are small relative to the benefits (or "insurance") that it provides.

For example, regulated medical waste such as syringes, gloves, and blood products could be the source of infections if not handled properly. Stericycle's pricing power is reflected in the contractual terms of its customers, with more than 95% of its revenues governed by long-term contracts with price increase provisions.

Foolish final thoughts
Waste Connections has managed to deliver stronger profitability and growth than its larger peer, by choosing its battlegrounds wisely. Firstly, it has avoided crowded urban markets and chose to focus on rural markets with limited competition for its solid waste business. Secondly, it has ventured into niche segments such as oil field waste, where demand is strong and customers see the value in such services.

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  • Report this Comment On June 16, 2014, at 9:51 AM, mikefee wrote:

    nice article mark. i like all three of the companies in this story.

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Mark Lin

Mark is a private value investor and is the author of website which uses a systematic quantitative screening approach to filter the global stock markets for cheap cigar-butts and wide-moat compounders.

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