Last month, 240,000 people lost their jobs in America. As financial, construction and car manufacturing firms collapse or face ruin, it’s easy to start wondering whether any part of the US economy can survive the slump intact. But one vital service has continued to thrive despite the downturn – garbage collection. And with two of the big three garbage companies set to merge before the year end, the sector could continue to be one of the US’s few success stories next year.
The US waste market is now a $52bn industry. Those big three firms – Waste Management, Allied Waste and Republic Services – have a combined market share of 45%. As we pointed out when we tipped Allied Waste in January, in recent years trash has become a commodity in itself, helped by rising raw materials prices and the recycling boom. The Environmental Protection Agency estimates 12% of global methane emissions come from garbage degrading at dumps. Capturing this methane and selling it to plants to generate electricity has become big business. So has recycling metals. A tonne of scrap from discarded PCs contains more gold than can be produced from 17 tonnes of gold ore. Falling commodity prices will hit this side of the business – firms are now stockpiling recyclable materials for when prices recover.
But the good news for waste firms is that this is very much a sideline. Making money in the garbage business is really about owning landfill space. It is very hard for new entrants to buy landfill permits. The process can take anywhere between three and ten years, depending on how angry you make the locals. That gives existing players a big advantage – with huge tracts of landfill real estate at their disposal, the big three make most of the real money. As the industry privatised in the 1980s, waste firms bought up huge tracts of land in “flyover country”, closing overflowing city dumps such as New York’s Staten Island landfill.
Now, with Americans dumping 200 million tons of solid waste every year, they can command between $20 and $40 per ton of trash unloaded at these Midwestern landfills. In the 1980s, they would have got $9 per ton. New York’s rubbish bill alone has doubled from $700m in 2001 to $1.4bn this year, notes Q1 Publishing’s Guy Bennett.
But won’t there be less rubbish to dump now that the economy is on the slide? Sure. However, that will barely dent revenues. Take Waste Management, for example. Last year the group earned 56% of its revenue from collecting garbage, explains Morningstar analyst Bradley Meeks. Of this 56%, roughly 29% is “roll-off activity” – the big containers you see at construction sites and outside factories. But only 50% of roll-off activity is temporary. So even though industry and construction are winding down across the US, the “worst-case scenario is that Waste Management will see an 8% decline in their revenue”.
So Waste Management’s biggest problem right now is the likely merger of its two main rivals. Spooked by the prospect of competing against a Republic and Allied alliance (see below), the group attempted to buy Republic itself, but failed. However, it can console itself with the fact that, with landfill space at a premium, both companies will be able to lift their prices by 4% a year over the next five years, according to Meeks. It looks like the dump might be one of the only safe places left for investors as recession takes hold.
The best bet in the sector
It’s been a good year for Allied Waste (NYSE:AW). The company’s stock has managed to trump the market, rising roughly 10% since we tipped it in January, against a 42% drop in the S&P 500. In the past, fears about the slumping US housing market have weighed on the stock. But profits in the last quarter were up fivefold on last year, as a result of the group steadily increasing its prices over the past couple of years.
The merger of Allied with Republic Services will create the second-largest waste-hauler in America, with 219 landfills and $9.3bn in annual revenue. The deal will save the combined group at least $150m a year, say Morningstar analysts, driven mainly by job cuts, office closures and lower fuel bills. Allied will inherit exclusive regional contracts in areas such as Las Vegas, Los Angeles and parts of Florida and Texas, representing roughly 40% of Republic’s revenue. There’s the scope for raising prices (mentioned above), but with some of these long-term contracts spanning close to 30 years, you also have a nicely predictable stream of revenue. If you bought it in January, it’s worth holding on now because beyond the other big player in the sector, Waste Management, few will be able to compete with this garbage-hauling colossus.