Investors are always worried about a recession affecting a company’s revenue or that business ceding market share to its competitors. Picking a recession- resistant company with recurring revenue solves the problem. Waste Management, Inc. (NYSE:WM), which provides waste-management services to a variety of residential, commercial, and municipal clients in North America, is a company with these characteristics.
Local regulatory barriers keep competitors at bay
Firstly, the ‘not-in-my-backyard’ mentality comes into play for the waste- management industry. Nobody will like to stay near landfills and live with the associated odors. New landfill approvals are rare to come by, favoring existing incumbents with a significant number of landfills. Waste Management, Inc. (NYSE:WM) had 264 active solid-waste landfills and five active hazardous-waste landfills as at the end of 2012.
Secondly, similar to cement, the low value-to-weight ratios of waste have an impact on the waste management business. It is uneconomical for waste to be transported long distances for the purpose of dumping.This makes foreign competition virtually non-existent in this space.
Last but not least, given that there is always a possibility of regulators changing their minds about certain things, companies regulated at the federal level have more to lose in the event of any single regulatory change. In contrast, landfills are approved at the local level, making Waste Management, Inc. (NYSE:WM) less risky in that regard.
Attractive business and financial profile
Companies operating in cyclical industries like automobiles and home building tend to see wide variations in revenue and earnings between financial periods, with their stock prices experiencing similar volatility. I prefer to invest in non-cyclical businesses with recurring revenue.
Waste Management, Inc. (NYSE:WM) provides essential ‘must-have’ services whose demand is not dependent on the health of the economy. A recession might mean less discretionary travel, but waste continues to be generated and needs to be disposed of. This is evidenced by Waste Management’s beta of approximately 0.6, which is far below 1.0. A low beta is indicative of the non-cyclical nature of a stock.
Also, Waste Management boasts of strong recurring revenue by virtue of its scale and the non-discretionary nature of its services. The customer retention rate for its commercial and industrial customers is high at above 90%, with more than fourth-fifths of its customers on long-term contracts exceeding three years. This is further supported by Waste Management’s strong financial track record, having delivered profitability and positive free cash flow in every single year for the past decade.
Future outlook
Waste Management is on track to meet full-year 2013 guidance of 4% to 6% growth in adjusted earnings per diluted share following a 5% increase in quarterly adjusted earnings per diluted share from $0.38 to $0.40 in the first quarter of fiscal 2013. Given the relatively stable level of demand, earnings growth for the company will have to come from accretive acquisitions and better cost management.
Waste Management spent $250 million and $180 million on acquisitions in fiscal 2012 and the first quarter of fiscal 2013, respectively. It even has a page on its website soliciting for solid-waste companies interested in divestiture. The fragmented nature of the market and long tenure of contracts result in acquisitions being the most viable way of gaining further market share. With respect to cost containment, its restructuring efforts announced in July 2012 are expected to contribute to a 100 basis-point reduction in selling, general and administrative expenses for 2013 and cost savings of 200 basis points to 400 basis points in the long term. About 700 employee positions were eliminated through the streamlining of back-office operations.
Peer comparison
Waste Management’ peers include Heritage-Crystal Clean, Inc. (NASDAQ:HCCI) and Waste Connections, Inc. (NYSE:WCN).
