Solid Play in Solid Waste

by Debra Fiakas CFA

The last article “Advanced Disposal Services:  Hauling a Heavy Load” on July 18th inspired a closer look at the solid waste management sector in which it competes.   The solid waste industry is growing at a good pace between 1.6% and 2.0% per year, largely on population growth and the human penchant for consumption and waste.  In the U.S. solid waste collection is still populated by many localized, family-owned businesses, despite the emergence of several large consolidators that now command as much as 55% of the revenue in waste handling and disposal.  Fragmentation creates ample opportunity for the incumbents to ratchet up growth rates.

Advanced Disposal Services is the most recent in the sector to enter the public capital markets with an initial public offering of stock.  There are several seasoned securities in the sector and that begs the question, what is the best stock to own in the group. 

For investors who are looking for value, the solid waste sector is not fertile ground.  The average price multiple in the selected group presented in the table here is 35.31times expected earnings.  This is well above the average ‘forward price earnings’ multiple of the S&P 500 Index at 17.6 times expected earnings in 2017.  Only Stericycle (SRCL:  Nasdaq), a provider of specialty waste collection and disposal services for the health care industry, compares to the broader market with a forward PE of 16.08.  Among the plain vanilla garbage haulers, Waste Management (WM:  NYSE) appears to be the best value with a forward PE of 21.71.

Since its growth that is the primary attraction to the solid waste industry, a view on value relative to growth might be a better method for sussing out a winner.  The Price-Earnings to Growth Ratio puts value and growth in perspective.  Here again it is another specialty services player, Heritage Crystal Clean (HCCI:  Nasddaq) that offers the most attractive value against growth with a ‘PEG ratio’ of 1.07.  Even that measure suggests just fair valuation for the Heritage parts cleaning and waste solvent handling service for auto maintenance and other industrial companies.  The outsized PEG ratios of the rest of the regular waste haulers reveals just how much investors seem to like this sector.

Some investors might be quite happy ‘paying up’ to own shares in a solid waste management company. The business model is conducive to strong cash flow generation on the back of reliable recurring revenue streams.  Several pay ample dividends, delivering enticing yields even at current price levels.  The top of the list is Covanta Holding (CVA:  NYSE) with a forward dividend yield of 7.49%.   

The skeptical investor might need some comfort in the quality of an investment target.  Return on assets provides a measure of efficiency to see which company makes the most out of the trucks, handling equipment and landfills that are necessary for waste management. The winner in this contest is the ‘big guy’ Waste Management, which last year wrung income from its assets at rate of 7.42%.

This simple exercise reveals one truth in waste handling:  scale matters.  The most asset efficient company, Waste Management, is also among those that deliver strongest earnings and dividends, making it a solid play in the solid waste sector.

Debra Fiakas is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.

Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.