North America's largest waste services company Waste Management (NYSE:WM) is trying hard to alleviate concerns over falling waste volumes in the industry and lower commodity prices for recycled goods. It has been executing new pricing strategies, cutting costs, and investing in technology. The initiatives have started bearing fruit, with the company posting a healthy 22.5% increase in earnings per share in the first quarter and hiking its dividend. But, from a more fundamental perspective, here are three solid reasons why investors cannot ignore Waste Management.
Integrated waste management is a highly regulated and capital-intensive industry, which creates lofty entry barriers for new entrants. Companies providing the services have to own, operate, and maintain landfills, which is a very costly affair. Each acre of a landfill (constructing, organizing, and complying with regulations) costs more than $1 million. Higher costs apart, getting a municipal permit for operating landfills is a long procedure as it requires fulfillment of several environmental standards.
Service providers also have to develop transfer stations (to dump wastes), create a fleet of vehicles to transfer wastes to landfills and power generation stations, set up waste-to-energy facilities for generating electricity, and build recycling facilities for producing reusable materials from recyclable waste.
Waste Management spends well over $1 billion in capital expenditure every year, which is considerably higher than its closest rival, Republic Services (NYSE:RSG). Over the years, even Republic has had to increase its capex budget -- from $300 million annually in 2004, to $900 million and thereabouts in the past few years.
Thanks to years of capital investment, Waste Management has the largest asset base in the industry, substantially higher than Republic and the others. This precludes new entrants from posing any immediate threat to the company.
Waste Management has a good business model that allows it to provide consistent return on equity (ROE), as shown in the graph below. There was an abrupt fall in 2013 because of an unusual $1 billion impairment charge of writing down goodwill in its electricity business and some landfills, waste-to-energy facilities, and investments in waste diversion technology companies.
The company consistently focuses on saving costs, managing capex, and achieving targeted return on capital employed, with executive incentives tied to this. Waste Management's policy of tailoring services to suit individual customers' needs has resulted in high customer retention. It states that the "typical customer" in commercial and industrial segments remains with the company for 10 years, while municipal customers stay for an even longer period of 12 years.
Around 80% of its permanent commercial and industrial customers are bound by contracts spanning three years or more. These multi-year contracts with customers provide annuity-like revenue, together with greater top- and bottom-line visibility. Republic Services also has 80% of its revenue tied to multi-year contracts, but its ROE lags behind Waste Management's.
Improvement in construction sector could facilitate revenue growth
Bloomberg has reported that the Architecture Billings Index, an indicator of non-residential construction, jumped to 52.6 in May, marking the highest level in the previous eight months. Research agency McGraw Hill Construction expects a growth of 9% in the construction sector.
Waste Management provides specialized services for the sector that include expert advice on every stage of a construction project, and a series of solutions, namely dumpsters, bagster (for small projects), portable toilet rentals, portable storage, and mobile surveillance.
Improvement in the construction sector could boost the company's collection business (generating roughly 61% of total revenue), which includes collecting debris from construction sites, among other activities. Waste Management has improved yield from its collection and disposal operations for the past seven consecutive quarters and expects the trend to continue this year.
Waste Management is the largest waste disposal company in North America with a superior asset base to its peers. It enjoys a wide moat and is a formidable competitor to any new entrant in the industry. The company has a strong business model and generates consistent returns on equity. Growth in the commercial construction segment could come in as a revenue booster. With all of these factors put together, it is hard to brush aside Waste Management.
ICRA Online and Eshna Basu have no position in any stocks mentioned. The Motley Fool recommends Republic Services and Waste Management. The Motley Fool owns shares of Waste Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.