With much of Wall Street preoccupied with big tech companies and electric vehicle start-ups, you could easily forget that market-beating returns can come from the most mundane of places. Three major waste companies are all telling almost the exact same story. Let's look at that story, and see which company is best positioned as the economy continues to recover.
Waste Management (NYSE: WM), Republic Services (NYSE: RSG), and Waste Connections (NYSE: WCN) have a lot in common. Each have outperformed the S&P 500 index over the previous 10 years on a total return basis with dividends included. While Waste Management is the biggest, valued at $50 billion, Republic Services and Waste Connections are far from small companies, valued at $31 billion and $27 billion, respectively.
Listeners to the companies' recent earnings calls might have a hard time telling these companies apart. Each was almost identical, down the paragraph. Paraphrasing, they went something like this.
Despite the challenges of COVID-19, this quarter shows the resilience and strength of our business. We are proud to say that although revenue and earnings were down slightly, we were able to cut costs and increase margin. We expect that going forward, as the economy improves and our revenue returns to normal, the savings we've seen will mean even better performance in the coming years.
The trash business can be great. Downsides are limited, since there will always be some demand. Waste Management's year-over-year revenue fell 10% in its most recent quarter ending June 30, 2020 . Waste Connections and Republic Services saw their revenue for the same period drop 4.7% and 5.8% respectively -- not bad compared to airlines, cruise lines, and restaurants.
... Same plans
The steadiness of trash also limits the businesses' upside. Waste companies have virtually no control over the demand of their services, and they can't market us to make more trash. Increasing profits only come from more trash volume, hiking prices, or expanding margins by making the business more efficient.
An economic downturn, when your customers' budgets are tightest, is not the time to increase prices. The CEOs of Waste Management and Waste Connections each spoke to pausing price increases. All three companies said they can retain their improved margins going forward -- but which of them is most likely to succeed in that goal?
WM: Managing margins
The industry's preferred marker of efficiency is operating EBITDA margin -- the company's earnings before interest, taxes, depreciation, and amortization, calculated as a percentage of overall revenue. It sounds complex, but it does allow investors to compare how efficiently different companies are managing their operations.
For the most recent quarter, Waste Management reported an EBITDA margin of 28.8%, and guided that to dip a bit lower between 28% and 28.5% for the year. This is currently the lowest margin of the three companies, but it may have room to improve, since Waste Management still has a long way to go in incorporating its acquisition of Advanced Disposal. Waste Management also spoke clearly about passing along increased costs to its customers .
It also highlighted plans to fast track more "end-to-end" technology for its entire business. Imagine signing up for trash services as easily as ordering Dominos Pizza. Management did note some margin pressures on the horizon, such as expiring tax credits.
RSG: Dealing with debt
Republic Services' improved EBITDA margin for the same quarter came in at 29.6%. And while its management team sounded much more positive on the outlook for margin going forward, citing permanent savings in real estate, travel, and personnel , the company's balance sheet is stressed, with about $8.6 billion and debt and only $269 million in cash, a 32:1 ratio. Waste Management, for comparison, has a debt-to-cash ratio of 3.3:1, while Waste Connections comes in around 6:1. Republic is betting on its strategy of mergers and rolling up smaller regional operators to pay off, but that's a big hole to climb to out of, it and leaves little room for error or other investments in efficiency.
WCN: Rooting for an oil recovery
Waste Connections' margin story has more nuance. Like its competitors, it saw some margin expansion in its primary solid waste businesses. However, it had more exposure to servicing the struggling oil and gas industry. The challenges in that business pressured the company's overall EBITDA margin . Waste Connections also has a track record of using mergers and acquisitions to add to its bottom line, but it needs oil to recover for its efficiency engine to really turn on. The waste collection and disposal business for Waste Connections had a been a 50% margin business, but as of the last quarter, it was down to 20%, with ever-lower volume compounding the problem .
Is treasure hiding among this trash?
A trash company can fill a steady role in a diversified portfolio. None of these stocks are back to their pre-pandemic highs, and now could be good buying opportunity for investors. While each has outperformed in the last 10 years, none of these stocks are likely to have outsize returns soon. If you are looking to add one of the three above, Waste Management -- with its strong balance sheet, technology focus, and lesser exposure to oil and gas -- looks like the best option.
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