Our goal in this paper is to understand the domestic Waste Management space and crystalize a perspective on investable trends and companies. More specifically, we provide the backstory to key trends and link these trends to underlying companies poised to benefit. At the end of the article, we segment the different classes of players to help as a reference when reading. We hope this will be useful for the investor seeking to advance their knowledge of the Waste Management space while developing perspectives on potential investment opportunities.
Privatization & Consolidation
According to the Waste Business Journal, the U.S. waste and recycling industry generates about $75 billion in annual revenue. Overall, roughly 80% of that revenue is generated from the private industry while the rest comes from the public sector. Although some cities may choose to have more control and ownership over aspects of waste management, a vast majority of cities contract almost all functions of waste management to private entities. This generally leads to reduced costs on the side of municipalities and increased efficiency. Cities negotiate contracts and can impose restrictions on any company that is involved in the collection, disposition, recycling, or composting of waste. This is in large part why a sizeable degree of fragmentation remains in the space. Scaling a large waste management business while meeting all the varied regulatory requirements imposed across a multitude of municipalities is no easy task. Because of this challenge, when assessing expansion plans across municipalities or states companies have opted more for the M&A route instead of organic sprawl-type expansion. It is easier to acquire a company that is already getting the job done in the target municipality than building it from scratch. This is evidence by the data. The largest firm in the space, Wealth Management (WM), has averaged roughly 10 deals a year over the past decade with an average deal size of roughly 200mm. Acquisitions targets include waste haulers, landfill operators, and MRFs (Recycling facilities formally known as Material Recovery Facilities). Although there remains a healthy amount of fragmentation, consolidation has been consistent for the past three decades. Vertically integrated players have been steadily acquiring landfills, MRFs, and waste haulers and using this integration to undercut their horizontal competition.
Rise of Recycling and Persistence of Landfilling
The rise of recycling was marked by the advent of Earth Day in 1970. The public was clamoring to do something to combat the harm caused to the environment by the mass production of disposable goods and increased generation of carbon emissions. Although still highly imperfect, recycling was society’s answer to the problem. Consumers started to become educated on the benefits of recycling and the ills of harmful methane gas production and groundwater contamination caused by landfilling. With the rise of single-stream recycling beginning in the early 2000s (disposing of all recyclables into a single bin instead of multiple bins to have sorted at a “clean” MRF) and mixed waste recycling (disposing of all waste including recyclables into a single bin to have sorted at a “dirty” MRF), the industry found a way to increase recycling rates by making it more convenient for consumers. All this assisted in rapidly increasing the proportion of waste recycled (Figure 1). Large waste management players did not remain idle in the face of this change and began purchasing and building recycling facilities (MRFs).
Today Waste Management (NYSE:WM) for example, owns roughly half the MRFs in the United States. Recycling trends continue and some cities have even set targets in the future to achieve 100% diversion from landfills and incinerators (aka “Zero Waste”). This would mean all organic waste is composted and 100% of the rest of the trash is recycled. Sadly, we are very distant from achieving anything close to this goal even with pressure from the EPA and local and state governments to restrict certain trash from being dumped in landfills. Looking at figure 1, it is clear that although the % of waste going to landfills has declined over time, the amount of waste going to landfills continues to persist. In a world of disposable consumption where per capita trash volume continues to rise, landfills are a necessary evil and an increasingly scarce one at that. It is safe to say that domestically, the supply of landfills is heavily restricted and that building a new landfill takes nothing short of an act of congress. NIMBY is in full effect. Figure 2 shows tipping fees (fees charged to dump at landfills) continuing to climb north as a result of this supply and demand imbalance. Because supply is so restricted, owning the only landfill in town is a huge competitive advantage that can be leveraged to drive out the competition if owned by vertically integrated players. They can charge other haulers for dumping their trash (“tipping fees”) and effectively drive out the competition by charging collection fees that are lower than the market. Competition in multiple municipalities has tried to take legal action, citing anti-trust legislation but this has led nowhere, and tipping fees continue to increase and horizontal competition continues to give way to vertically integrated players. Competitors have to be creative. Some players have carved out a niche by focusing on the more hazardous waste that takes extra care and effort to dispose of. It is clear that for competition to survive, they cannot compete solely on price and must differentiate.
Contamination Rates and the Rise of China
Assisted by single and mixed stream recycling, recycling rates increased substantially but a new problem was introduced: namely, contamination rates were on the rise. As it turns out, throwing all recyclables into a single container makes it more difficult to separate and clean. The problem is even more challenging when the waste is mixed. Recycling done properly works well and the commodity output generated can be quite valuable however the investment required to sort and clean can offset any rewards. High contamination rates are a large problem and the main reason the industry has gotten away with this practice is that no matter how high contamination rates were, there was always a buyer for our dirty recyclables. This large buyer was China. Because China’s industrial capacity was growing like gangbusters, they needed all the raw materials they could get their hands on even if these materials were contaminated. Everything from corrugated cardboard, mixed paper, aluminum cans, glass bottles and jars, and HPDE (High-density plastics). China’s solution to de-contaminate recyclables was to throw loads of dirt-cheap labor at the problem. However, eventually, China reached a size where they began to create enough recyclables of their own. This, along with their gradual increase in wages rendered this no longer profitable for them. In 2018 China instituted the National Sword Policy, which for practical purposes bans imported waste into China. The world’s largest buyer of developed economies’ recyclables vanished overnight. This was a watershed moment in the waste management world that meant other countries need to handle waste and produce clean recyclables within their own borders.
Even though the U.S. tried to redirect contaminated recyclables to other countries, they could not find willing buyers. This left the U.S. with really only one option—to solve the problem of contaminated recyclables at home by improving MRFs so the contamination rates would decline. The other option ostensibly could be to bring back multiple-stream recycling and we have no doubt that this will happen in some pockets of the U.S. but our nation is predominantly trained on single-stream recycling. This behavior will be difficult to change at scale and once more reiterates that technology must come to the rescue. Below from the largest owner of MRFs in Northern America, Waste Management (WM).
Q1 2019 Earnings Call, SVP & CFO Devina Ranking:
“We’ve also done a good job of managing the cost side of the equation and we’ll remain focused on ensuring that we’re working through the contamination headwinds that we see on the inbound materials to manage those more efficiently in our processes. And as John mentioned earlier, the focus on technology in the MRF like of business will be important to us and we’re advancing those efforts. “
MRFs will have to be outfitted with better sorting technologies and more efficient processes to ensure sorting is advanced and contamination rates decline.
“Zero Waste” Initiatives and the Circular Economy
Despite the technological enhancements in MRFs and the increased efficiency that they will achieve, the goals of “Zero Waste” (100% landfill and incinerator diversion) are far from sight. Yes, technology enhancements in MRFs will go a long way to sorting efficiently but the issue remains that some products cannot be sorted. For example, how does a facility sort composite material like a Pringles can that is made up of metal, plastic and paper? Items like this will always go to a landfill because they cannot be sorted properly. Single-use plastics are also notoriously difficult to recycle. Only 10%-20% of plastics end up being recycled. The rest are either landfilled or incinerated (see table below). To achieve anything close to Zero Waste pressure must be placed on producers to create recyclable-friendly production processes that use recyclable friendly materials and produce products that can be broken down into recyclable components. In short, most producers would have to substantially change their production process for societies to achieve Zero Waste. Below is the conclusion from a paper in the Journal of Cleaner Production written in 2014 that holds every bit as true today.
”Zero waste is a holistic approach to tackling waste problems in the twenty-first century. Based on the review of the literature, this study concludes that zero waste is still in development. Professionals have proposed various ideas, plans, policies, and strategies and have implemented them in cities to achieve zero waste goals. However, we need to redevelop the holistic ZW strategy in regards to its implementation practices and practicality. At this moment, ZW strategy is targeted toward zero landfills through diverting waste from landfills. However, the study acknowledges that achieving a 100% diversion rate is not currently possible in production, consumption and waste management systems in our society. We require a universal transformation of existing extraction, production, marketing, consumption, management and treatment systems. Therefore, studies on how to transform existing systems into ZW systems are important for moving towards ZW goals.”
Producers will have to be more “Circular” in their business model-- they must ensure all materials and packaging used is either reusable, recyclable, or compostable if we are ever going to achieve Zero Waste.
Trends and Companies that are Poised to Benefit
Trend #1 Technology in MRFs
MRFs will continue to make investments in the labor and sorting technology in order to achieve lower contamination rates leading to high quality recyclables. Companies that focus on providing technological solutions to MRFs have a long runway. Not only do MRFs need better sorting technology, the number of MRFs are growing substantially both domestically and globally.
TOMRA (TOM-NO), a mid-cap Norwegian company, is well-positioned to enjoy this trend. This company was originally founded in 1972 and began life as a reverse vending machine company but realized policymakers were far too slow to realize the efficacy of such a new technology and decided to expand into other segments in the value chain of waste and recycling solutions. In 2004 they acquired Titech, a company that specialized in providing industrialized solutions to companies involved in the sorting of waste. Originally this was only for paper and plastic but since they have acquired and developed solutions for all kinds of waste including metals and food. They are the industry leaders in providing sorting and processing solutions to the waste management industry. The company is a play on sorting technology and the circular economy. Forward valuations of 60 P/E are quite high but this is an ideal long-term capital compounder and should be on everyone’s watchlist.
Trend # 2 Circular economy
The promise of the circular economy is that all waste will be viewed as a resource to be broken down and re-used, thus the strain on virgin materials will be significantly lessened ensuring we are living well within Earth’s ecological limits. As stated above, companies will need to think “circularly” which would mean a change in production processes, packaging, and materials used. We believe more and more companies will do their part to achieve sustainability goals. These companies will need external help as they start to think more circularly and organizations that can tailor solutions will benefit.
Quest Resource Holding Corporation (NDAQ:QRHC) is a micro-cap waste broker that focuses on developing strategies for businesses with a national footprint to reduce and recycle waste. Large grocery stores for instance have to decide how to streamline their waste and who the best counterparties are in each location they manage. This can be logistically challenging to do this in house and keep up to date with the rules and regulation of every municipality.
QRHC: To quote QRHC management in the last earnings call-
“Longer term we believe, the trend towards sustainability will continue and the companies will continue to deploy programs, in order to divert more waste from landfill.>> Is this the key trend” They provide tailored solutions to businesses in need of optimizing their waste streams. Their main specialty is to help customers divert 100% of organic waste from landfills. This gets their customers away from any penalties or issues with the municipality down the road.”
Big box retailers and large grocery food chains and restaurants are routinely fined for improper disposal of waste. Furthermore, the challenge increases the more sustainability goals are pursued. All this spells more business opportunities for Quest down the road. Given recent revenue growth and margin enhancement, current multiples seem reasonable.
Trend #3 Landfilling
Landfilling is likely to remain highly profitable for quite some time. True, this trend is in direct opposition to the “circular economy” trend however the circular economy trend will take decades to reach critical mass. In the interim given the amount of increased trash the world is producing landfills will continue to reap rewards. The core of this dynamic is in part because the amount of waste continues to grow rapidly and there are a restricted number of landfills. Despite recycling being much higher in the future, the supply and demand imbalance enjoyed by landfills will continue for quite some time. The flywheel is clear: As a population grows, waste grows in unison. As that population becomes richer and urbanizes, consumption per capita increases which again leads to more waste.
Waste Management (WM) is the second-largest waste management company in North America and boasts ownership of 250 landfills and roughly half the MRFs in the U.S. in addition to the associated transfer stations that serve as the connect point. All this infrastructure contributes to one of the largest and most defensible moats we have ever seen. They own the entire value chain and total waste is projected to keep increasing. In the last earnings call, WM hit economies of scale out of the park with double-digit revenue growth and consistent margin enhancement. Forward P/E stands at about 28 and given industry tailwinds and company dynamics this stock is attractively priced for investors looking to buy and hold for a considerable amount of time. If we had to own one stock for the next ten years, this one would be a top candidate.
Waste haulers have contracts with the city to collect and dispose of Municipal Solid Waste (MSW)- more commonly known as trash or garbage- includes everyday items that people discard including food waste, yard trimmings, bottles, cans, plastics, appliances, batteries etc. They charge a collection fee to pick up waste, and then deliver that waste to transfer stations where the waste can then be directed to MRFs, landfills, incinerators or composting facilities.
Material Recovery Facilities (MRFs)
Facilities that parse through waste to collect package recyclable items like glass, paper, and plastic to be re-sold to manufacturers that can break the recyclables down to be re-used in new production. MRFs generate revenue by separating recyclables into saleable commodities.
Composting is the natural process of breaking down organic matter like food scraps and yard trimmings into fertilizer. Composting facilities generate revenue from charging to receive organic waste and from the selling of fertilizer. Unlike landfills, composting facilities engage in the decomposition of organic matter by using microorganisms that require oxygen. This is called aerobic composting and is magnitudes better for the environment compared to organics being dumped in a landfill—anaerobic composting. This produces abundant amounts of methane and is terrible for the environment. This is why anaerobic composting is being penalized by state and local officials.
This class is any company involved in technology that promises to upend the entire industry. The focus is generally on trying to convert waste into reusable energy or breaking down plastics into high-value materials. Technologies like syngas have long threatened to upset the traditional order and revolutionize the waste management industries but these technologies have proven extremely difficult to scale and with waste mixtures ever-changing, the feasibility of these innovations has not yet succeeded. Based on our research, we do not see these technologies achieving any degree of wide-scale utilization in the next decade. Technologies that have a high degree of being successful are those that serve to enhance the current paradigm, not ones that trigger structural change.
Landfill operators charge “tipping fees” in order to dispose of waste. As the name suggests, waste is dumped in the landfill. Despite enhancements in landfill infrastructure, they are notoriously bad for the environment. The number of landfills in the US has been declining and many cities and businesses are under pressure to divert their waste from landfills. Organic waste that is directed to landfills instead of a composting facility produces harmful methane that is released into the environment and is 20x worse than carbon emissions.
The Vertically Integrated
These are large companies that have successfully integrated waste hauling, landfilling, and recycling all under one brand.
Organizations that partner with primarily commercial entities to advise and direct waste management streams. Revenue models differ but usually, waste brokers are contracted for specific waste streams. They serve organizations that need external help in order to achieve waste management diversion goals.