Waste Management Hauls In Cash

By Sham Gad | February 19, 2010 AAA

Waste disposal can be a very lucrative business. It's a required service and in many cases, you only have one company handling your area. Private companies like Waste Management (NYSE:WM), the largest private provider of waste management services in the U.S., are regulated in order to keep prices fair. But as Waste Management has shown, it is possible to haul in cash while adhering to pricing parameters.

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Hauling In The Profits

According to management, the company experienced encouraging signs of improvement in the industry. Volume declines improved from the third quarter while the commercial segment saw a 1% lift in revenues. On the residential front, revenues were up by 1.5% while the company also benefited from a nearly 20% increase in the price of recycled commodities.

Net income for the quarter surged 45% to $0.64 a share from $0.44 a share in the year ago quarter. Excluding any special items, net income for the quarter was $0.52 a share. Over the course of the year, net income was down slightly to $2.01 a share versus $2.19 in 2008. In 2009, free cash flow was $1.2 billion versus $1.46 billion in 2008. For 2010, the company expects to produce $1.2 to $1.3 billion in free cash flow.

Size Helps
Waste Management, with a market capitalization of $16 billion, is the largest public waste management company. Its closest competitor is Republic Services (NYSE:RSG) with a $10 billion market cap. After these two names, everyone else is dwarfed. Casella Waste Systems (Nasdaq:CWST) is valued at just over $100 million. Being the biggest is very advantageous in waste management. Greater routes and geographic exposure leads to tremendous economies of scale.

Both WM and RSG have remained consistently profitable over the years while Casella continues to turn itself around. Casella, however, looks intriguing as it trades at 25% of its annual sales. A return to profitability could lead to a substantial increase in its valuation. Consider that WM and RSG have profit margins of 14% and 7%, respectively. At a 3% margin, Casella would be earning around $15 million in profit, or less than eight times its market cap. Yet doing so is not as easy as it looks as evidenced by the multiples assigned to the big two.

Waste Management and Republic currently trade at 18 times and 28 times earnings, respectively. It has taken years of growth and smart acquisitions for these to get where they are today, and their monopoly-like disposal routes will generate cash for a long time to come.

Boring is Good
The need for waste disposal is as basic and boring an industry as it gets. You might not get exciting growth, but you can count on solid cash flow generation year in and year out. Those factors excite guys like Warren Buffett, whose holding company Berkshire Hathaway (NYSE:BRK.B) (NYSE:BRK.A) recently disclosed that it has doubled its investment in Republic Services.

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