Waste Management's Renewable Energy and Recycling Investments Should Boost Profits

Sector Director

Brian Bernard

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Waste industry leader WM enjoys leading market share and unmatched dominance in landfill ownership, which is nearly impossible to replicate given immense regulatory hurdles. This leadership position expanded after the firm's October 2020 acquisition of Advanced Disposal, which had been the fourth-largest publicly traded waste collection and disposal company in the United States. 

As a fully integrated waste-hauler, the company leverages a vast network of collection routes and transfer stations, which bestow significant control over the waste stream, funneling waste from numerous end-market customers (commercial, industrial, and residential) into its highly valuable landfill assets. WM collects fees (known as tipping fees) from third-party waste haulers that use the firm's transfer stations and landfills.

Management execution has been impressive over the past five-plus years, with a renewed focus on yield management and optimizing the cost infrastructure. These factors have enabled the firm to translate North American macroeconomic expansion into waste volume gains, core pricing above inflation, and positive operating leverage. WM's recycling business was adversely affected by China's import restrictions, which pressured recycled commodity prices. However, WM has made efforts to reduce contamination rates and transition to a fee-for-service model, which has mitigated these headwinds.

WM has earmarked over $2 billion of capital expenditures to expand its renewable energy and recycling operations. By 2026, management expect its landfill gas-to-renewable natural gas and recycling projects to deliver EBITDA of $500 million and $240 million, respectively. While we think WM’s sustainability investments will allow the firm to further monetize its landfill footprint and boost profitability, its core solid waste collection and disposal activities will continue to account for most of its earnings. 

We expect WM to continue its acquisition strategy, focusing on tuck-in opportunities to boost market share in established geographies. WM can usually raise core prices on acquired volume thanks to its vast ownership of landfills, a preferred asset.

Business Strategy & Outlook

We assign WM a wide economic moat because we have very high confidence in the firm's ability to generate excess returns over the next 10 years, and we think it's more likely than not that excess returns will persist over the next 20 years. 

We believe that intangible assets stemming from its irreplaceable landfill footprint is WM's primary and most durable moat source. Federal and state regulations and not-in-my-backyard activism have made it very costly to operate and close landfills and extremely difficult to receive approval for new landfills. As such, the number of landfills has fallen from approximately 10,000 in 1980 to only about 1,500 today. Small landfill owners couldn't afford to implement environmental requirements such as plastic linings and leachate and methane recovery equipment and were replaced by large regional landfills. Today, we estimate that public companies own or manage 60% of municipal solid waste landfills, including life-of-site agreements to operate municipal-owned landfills. After its acquisition of Advanced Disposal, WM operates approximately 260 landfills, which is 30% more than Republic Services (198 landfills) and almost three times the size of Waste Connections' landfill footprint (97). Landfill scarcity has supported pricing power for WM with annual core price increases consistently exceeding inflation. Furthermore, WM can generate profits (through tipping fees) from competitors that don't own landfills or own landfills that are located too far away to be cost competitive. 

Because disposal costs are the most significant expense for waste haulers, owning well-placed disposal assets (landfill and transfer stations) can yield a cost advantage in local markets over competitors that transport waste over longer distances. However, cost advantages related to the proximity of disposal assets wouldn't persist without the presence of intangible assets. Transfer stations (which require permits to operate) are extensions of landfills that consolidate and compact waste into high-volume transfer vehicles. Transfer stations can reduce disposal costs, but significant waste volumes are needed to yield favorable economics.

The largest public waste collection and disposal businesses have been able to expand existing landfills, but regulations and NIMBY make it difficult for even the largest, most powerful players to construct new landfills. However, if regulations were relaxed and landfill construction costs decreased, we think that there would still be limited incentives for new entrants because waste disposal has most of the characteristics of an efficient scale market—mature demand, excess capacity (existing landfills have long useful lives), commodity products, inelastic demand, and high sunk costs—and new entrants would lower the industry's returns below the cost of capital. 

Route density has the capacity to provide cost advantages for firms with significant local scale. Scale matters in route-based businesses (in this case, collection through disposal) because it provides greater utilization and leverage over a vast cost base (costs linked to landfill ownership, collection equipment, transfer facilities, and so on). In our view, WM benefits from its industry-leading route density.

We believe the major waste management companies, including WM, face low environmental, social, and governance risk. This may come as a surprise given the dirty work these companies perform (that is, garbage hauling and disposal). However, the waste business is highly regulated, and these firms have spent billions of dollars to reduce the environmental impact from their operations. 

Nevertheless, WM is still exposed to environmental risk as mishandling waste could result in substantial fines and remediation costs and damage community relations. Even so, the firm has a strong track record and has mitigating controls and processes in place to minimize environmental risk from mishandled waste. 

WM also faces environmental risk tied to greenhouse gas emissions from its landfills and large truck fleet. According to the Environmental Protection Agency, landfills accounted for 17% of U.S. methane emissions in 2019. However, the industry continues to heavily invest in clean technology to capture landfill gas and convert it into electricity and renewable natural gas. The industry has also been replacing internal combustion engine vehicles with ones powered by electricity and compressed natural gas.

Wide

Economic Moat

Waste Management

Waste Management, Inc. is a holding company, which engages in the provision of waste management environmental services. It operates through the following segments: Tier 1, Tier 2, and Tier 3. The Tier 1 segment consists of areas in the Southern United States. The Tier 2 segment consists of areas located in the Midwest and Northeast United States. The Tier 3 segment consists of all remaining areas, including the Northwest and Mid-Atlantic regions of the United States and Eastern Canada. The company was founded on September 30, 1987 and is headquartered in Houston, TX.

Earnings data Q2 2023

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Waste Management, Inc. is a holding company, which engages in the provision of waste management environmental services. It operates through the following segments: East Tier, West Tier, and Other. The East Tier segment consists of Eastern U.S., the Great Lakes Region, and Canada. The West Tier segment includes the upper Midwest region and British Columbia, Canada. The Other segment covers segments which are not evaluated and overseen through the East and West Tiers. The company was founded on September 30, 1987 and is headquartered in Houston, TX.

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