Three Stocks That Turn Garbage into Cash
Though far from glamorous, this moat-worthy industry boasts high-quality stocks.
Some of the companies most admired by Morningstar stock analysts aren't flashy tech names or hot commodity companies. Rather, they are the companies that provide essential services for everyday life. Although the waste management industry is by no means glamorous, it comprises companies with business models that are profitable during good times and bad--and that generate ample cash. Despite these companies' historical resistance to economic cycles, the broad market sell-off has caused some of the highest-quality stocks in the industry to trade at a discount to our fair value estimates.
Moaty and Profitable in Tough Economic Times
The waste market is a $52 billion market, and the "Big Three" ( Waste Management (WMI), Allied Waste (AW), and Republic Services (RSG)) have a combined market share of roughly 45%. Waste haulers generate the majority of their revenues from two main services--waste collection and waste disposal. The waste collection business is a commodity service that isn't moat-worthy, in our view. Basically anyone who can purchase or finance a dump truck can bid on collection services and enter the industry. Also, switching costs for cities and residents are relatively low, and there is virtually no brand loyalty. Therefore, the source of many of our waste haulers' narrow moats lies in the disposal business. The most successful firms in the industry typically exhibit one competitive advantage: ownership of landfill airspace. Obtaining landfill airspace is no small feat. Landfill permits and approvals can take anywhere from three to seven years to obtain and are typically fraught with NIMBY ("not in my back yard") opposition from citizen groups. Waste collectors that also own the landfill airspace near a route can charge higher tipping fees to collectors who don't own landfills, giving the landfill operators a distinct low-cost advantage. The Big Three waste haulers are also the largest domestic landfill owners, and accordingly generate operating margins 400 to 600 basis points higher than the industry average of 11%. The landfill business usually represents around 30% of these firms' revenue, but close to 50% of operating profit, due to the higher-margin nature of this business.
Bradley Meeks does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.