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Andrew Kuhn

Waste Management (WM): A Capital-Intensive, Wide-Moat Garbage Collector That A Middle-Aged Warren Buffett Would Like

by JONATHAN DANIELSON

Waste Management is not a cheap stock. It does, however, have nearly all the markers of a really good business. And it doesn’t necessarily look overvalued at these levels either. It leads its industry, has consolidated returns that look to be both of high quality and extremely stable in nature, looks to have a wide moat which will be discussed further below, and all easily discernible indications would lead to the conclusion that management is competent and perhaps even value-add. Waste Management might not be a quantitatively cheap stock, but then again it’s the type of stock that never really looks too cheap. As far as valuation multiples go we have to go back to the Financial Crisis to see a time when the P/E touched low double digits. So, it’s the type of stock that takes a true crisis for it get into the “standard” fair value range as far as valuation multiples are concerned. We could classify it as a blue chip stock. Even though most normal day-to-day people are probably not familiar with the company, most investors are certainly aware of it. It would probably get the attention of a 1980s Warren Buffett. In fact, if you’re reading this write-up then you might be aware that site-favorite Allan Mecham (everyone’s favorite hedge fund manager) owned WM back in the early 2000s.

 

So we know Waste Management is a leader of its market, they also have a long runway for growth, and in addition the market in which they operate is extremely durable and continually generates robust cash flow throughout various economic cycles. The reasoning for this is pretty intuitive. That is, people are going to have trash whether or not the economy grows or contracts by X% in a given fiscal year. Now the degree to which the company is sheltered from the economy is minimal, I want to stress that. But the business isn’t overly cyclical certainly. Compared to most companies – certainly compared to the index – WM is a far more stable business.

 

Given that the characteristics of this company are such that investors only need complete preliminary due diligence to begin to reach the conclusion that WM is likely to be extremely high quality, the goal of this article is to serve as a comprehensive overview of the business.

 

Business Overview

 

Founded in 1971, Waste Management (WM) is a Houston, Texas based company with 43,700 employees and services over 20 million customers. Of the greater than 20 million customers, close to 18 million are residential, 1 million are commercial, and .2 million industrial. No one single customer accounts for more than 1% of total revenue.

 

Waste Management is its current form is largely the product of the late 1990s merger between Waste Management and USA Waste. Management has described the several years following this merger as the darkest in the company’s history. The entire industry had been on a buying spree as the industry leaders were swallowing up all of the small to midsize players. Waste Management had ultimately taken on too much debt and acquired unrelated/non-core assets. The acquisition proved much more difficult then management anticipated. The stock cratered by >65% and new management was brought in. Since the 1990s the company, although still consolidating the industry to some degree, has changed directions materially by placing more emphasis on achieving adequate returns on capital employed and returning capital to shareholders. Waste Management, as it stands today, is the market leader with only two other notable competitors operating at the same level as WM.

 

As the name would suggest, Waste Management is a waste service provider to their commercial, industrial, and residential customers. Put simply, Waste Management is a company that collects and disposes of garbage. They also operate 314 Transfer stations and offer recycling to their customers. Waste Management owns and operates the largest landfill network in North America, which was 247 sites as of their latest filing. This is their principal asset and serves as the main source of their moat, which will be discussed further below. On an operational level, the main place of contact for the business with their customers is the collection phase. This segment totaled 54% of revenue in fiscal 2018. For the commercial and industrial side of the company, they typically have contracts with these customers that are 3 years in length. Waste Management provides the trash containers (typically the large steel bins you see in the back of a business) and then charges a fee for the service which varies on a customer-to-customer basis. On the residential side of the collect business, Waste Management usually has contracts that are not shorter than 3 and not greater 10 years with the local governmental body or homeowners' association. Typically these contracts are for Waste Management to exclusively service all or some portion of homes in a given area - the barriers to entry here are especially compelling and don’t need to be expounded on. Break down of each customer type is as follows: Commercial 41%, Industrial 29%, Residential 26%, and Other 4%.

 

The next operational phase of the business is taking the collected items to the Transfer stations. Approximately 10% of revenue comes from this segment. The company owns 314 of such stations (technically a portion of these are leased, but WM operates and collects fees at all of these sites). At these stations the waste is compacted to a smaller size and shipped off to the disposal sites.

 

Further, Waste Management operates 247 Landfills (20% of revenue). This is simply a designated area where the company can dispose of the collected waste. The regulatory and capital requirements in order to set up and maintain these sites are substantial. The average landfill typically costs $550,000 on a per acre basis. WM has over 150,000 acres in total with the average site totaling over 600 acres. This substantial amount of capital required is why WM provides local regional players the option of using Waste Management’s site and paying a “tipping fee”. This aspect of Waste Management’s business model is one of the key differentiators between them and the regional players. The assets the company has simply cannot be duplicated by competitors. Waste Management has the largest asset base of its kind in North America.

 

Separately, recycling is also available to the company’s customers. Once said waste is recycled, it is sold on the market at the spot price. This aspect of operations does open the company up to sensitivity from the recycled commodity prices. To illustrate the inherent unstable nature of this line of revenue, in 2017 revenue for this segment was up 20% while the following year, 2018, it declined by 20%. Nevertheless, the impact on the business of this exposure to commodity prices is negligible as only ~9% of revenue is sourced from this line of business.

 

Durability

 

The waste management services industry is not one investors are likely to get euphoric about. There are no society-changing innovations currently underway, no business magazines writing about which CEO is the Next Steve Jobs, and no “reasonable” forecasts of neck-breaking growth rates. You won’t find the next undiscovered Amazon with this industry is basically what I’m trying to tell you. So if there’s no potential for awe-inspiring growth rates then what does this industry offer investors?

 

Stability. This industry is unusually immune from a changing competitive landscape. While no competitor operating in this industry is going to invent the next product the world has to have, investors also get the peace of mind that no competitor is going to fundamentally change the game. A durable product is one that is worthwhile of investor’s attention. And with the waste management industry, that’s precisely what investors get.

 

As we live in an era that could arguably be considered the most economically competitive as has been seen, as the trend towards globalization continues relentlessly forward, the internet continues to usher in competitive forces and bring down what were once considered god-like businesses - Waste Management offers investors a safe haven, as it remains sheltered from most forces of competition. It does so as there is no conceivable way the services the company provides could be outsourced to nations with lower cost structures. Technological advances that threaten other industries largely appear to benefit and even enhance the business models of companies in this industry.

 

Let’s take the clean energy movement as an example. Hybrids/electric vehicles appear to be the method of choice to combat the negative effects cars have on the environment for most governmental bodies and corporations moving forward. Along with this movement we have autonomous driving that is currently on the receiving end of billions of dollars in capital investment from some of the largest players in the world. Both of these industry trends serve as existential threats to numerous business models. But Waste Management already has trucks that are fueled by natural gas and has stated that they are willing and able to make further investments in their fleet by way of electric and autonomous trucks - the technology just simply isn’t feasible yet. It doesn’t appear to me that using clean cars would necessarily have an impact either way as it pertains to WM shareholders, but it should be relatively easy to envision a scenario where autonomous vehicles would prove to be a positive for the company. While Management hasn’t disclosed any exact figures (as it would be far too soon to do so), any reduction in the cost of labor the company has to incur with the operations of the fleet would obviously benefit shareholders. So with this case at least Waste Management, and along with its industry at large, appears to be on the beneficiary end of technological advancements. Even if it turns out labor costs are not reduced (if the fleet still has to manned in order collect the waste) then worst case this major societal change would prove to be a non-event for the business.

 

While there are certainly innovations that might affect the company that we haven’t discussed, the point remains that this a mature, extremely durable, and inherently stable industry that doesn’t appear to be going anywhere anytime soon. As long as there is trash in the world, someone has to collect it. And as long as someone has to collect it, there will have to be somewhere they take it to. 

 

Quality

 

This is the type of industry that tends toward an oligopoly. It wasn’t always this way, however. Up until the 1990s the waste services industry was largely fragmented. The reasoning for this is that it just was not all that difficult to start a waste collection services company. There wasn’t anything in particular differentiating the business models. This led to a proliferation of regional participants that could compete strongly at the local market level. The force that mostly started to change this was regulation. At the crux of it, this is a government-made oligopoly. This certainly isn’t the only industry where governmental agencies have regulated the competition out of business, so the topic should be familiar to readers.

 

As noted above, this is what fueled the consolidation of the industry leading up to the turn of the century. Smaller competitors simply couldn’t compete anymore due to the costly regulations. If you don’t want to take my word for it, here is Mr. Boettcher, Chief Legal Officer of Waste Management at the 2019 investor day,

 

“I think in general the starting point for us with regulation is we thrive in a heavily regulated environment. The mom and pops and the smaller players tend to fall out because they are not as good at complying with regulations. So we don't, we don't sort of shy away from regulation, we are not living in fear of the regulatory environment, and of course, the picture you paint where it could get too far the other way, that could be damaging to any industry if it goes all the way to heavily regulated environment or too regulated environment. But I don't think we see that.”

 

The three market leaders as it stands today are (from smallest to largest): Waste Connections, Republic Services, and Waste Management. Corporate-level economics are largely what you would expect from a company that is largely capital-intensive yet enjoys several competitive advantages

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