Image Source: Waste Connections
In a sign of the health of the US economy, garbage haulers are experiencing rates of top-line growth not witnessed in years, but their earnings multiples reflect share prices that may be disconnected from normalized fundamentals. No matter how much we love their business models, we’ve already “cashed in” our chips.
By Brian Nelson, CFA
Industry economics in the municipal solid waste industry are generally easy to understand. Industry pricing power essentially emanates from disposal operations. Waste generated, for example, must end up somewhere, and therefore whichever entity has the disposal operations has the power to set the bar with respect to pricing, directly or indirectly, from transfer facilities all the way through collections within certain regions. After all, garbage pick-up operators won’t be in business for long if they have to pay more to dispose of waste than they charge to pick it up. It may not be a glamourous business, but it is a very good one, and those with disposal operations tend to rule the land.
As for the key municipal solid waste operators in the US, Waste Management (WM) and Republic Services (RSG) have the largest networks of disposal operations. At the end of 2016, for example, Waste Management owned or operated 248 landfill sites, the largest network of landfills in North America. That number stands at 192 for Republic Services and 93 at number three, Waste Connections (WCN). These companies dominate the municipal solid waste industry and will for some time to come. We view disposal pricing as having oligopolistic tendencies, even if collection operations face some of the most intense pricing competition of any industry. As of late, the industry may not have ever experienced better times than what it is experiencing right now (italics added).
Jim Fish, President and Chief Executive Officer of Waste Management, commented, “We are hitting on all cylinders right now with the cash generating strength of our business shining brightly in 2017. We achieved the highest quarterly operating EBITDA in our history, with operating EBITDA growing about 8.0% in the second quarter when compared to the second quarter of 2016. Our strong operational performance led to record free cash flow generation in the first half of 2017. Together, our strong core price results, robust volume growth, and continued cost improvement focus led to earnings per diluted share growth of almost 10%.” – Waste Management’s second-quarter report
During Waste Management’s second quarter, results released July 26, overall revenue increased 7.4%, a very impressive mark for a garbage collector, and approximately 4.7 percentage points of that expansion came from price increases, suggesting a very rational “playing field.” The company also noted that it is on track to “meet the upper end of (its) full-year 2017 guidance of adjusted earnings per diluted share of between $3.14 and $3.18 and free cash flow of between $1.5 and $1.6 billion.” Republic Services experienced similar strong trends in its second-quarter report, released July 27, when it said revenue growth came in at a whopping 7.5% and included core price increases of 4.1 percentage points. The top-line mark was the “company’s highest level of growth in over 8 years.” Republic also upped its full-year adjusted diluted earnings per share guidance to the range of $2.36-$2.39 (was $2.32-$2.36).
“Our second-quarter performance underscores our ability to grow both price and volume, increase earnings and free cash flow, and consistently improve cash returns to shareholders,” said Donald W. Slager, president and chief executive officer. “Given the strength of our business and the ongoing successful execution of our strategy, we are raising our guidance to reflect our expected out-performance for the year.” – Republic Service’s second-quarter report
Waste Management and Republic Services are generating a pace of revenue growth that the industry hasn’t experienced in years, levels that were even greater than that of the industry’s traditional growth “play,” Waste Connections, which showcased “5.1% solid waste price + volume growth” in its second quarter, results released July 25. Waste Connections’ results are muddied from its acquisition of Progressive Waste, completed in June of last year, but general commentary from the company remains in line with what we are hearing across the municipal solid waste landscape. Fundamental momentum in the industry remains positive, and the top-line growth rates across the industry are a very healthy sign for the US economy.
“Continued strength in solid waste volumes, recycled commodity prices and E&P waste activity enabled us to once again exceed our outlook for the quarter. Given our strong results in the first half of the year and expected continuing momentum from these trends, we believe we are on track to report approximately $1.45 billion of adjusted EBITDA in 2017, exceeding our initial outlook provided in February,” said Ronald J. Mittelstaedt, Chairman and Chief Executive Officer. “More importantly, full year adjusted free cash flow, now estimated at approximately $750 million, or almost 52% of adjusted EBITDA, is also pacing ahead of initial expectations.” – Waste Connection’s second-quarter report
In the past, we included Republic Services in both newsletter portfolios, but we have since removed it from both after its very strong share-price run higher. At the high end of its 2017 bottom-line guidance, for example, shares are currently trading at ~27 times current-year earnings. At the high end of Waste Management’s bottom-line guidance, the company is trading at ~24 times current-year earnings, while Waste Connections sports a current-year earnings-per-share multiple of ~30 times on consensus numbers of $2.12. These are extraordinarily high earnings multiples placed on these companies, and unfortunately, in this context, the risk-reward for investors of garbage stocks may not be in their favor in coming years. No matter how much we love their business models, we’ve already “cashed in” our chips.
Environmental Services: CLH, CVA, CWST, DAR, ECOL, RSG, SRCL, WCN, WM