Intangible Assets, Cost Advantage Boost Waste Management

Matthew Young: We recently upgraded our economic moat rating for Waste Management to wide from narrow. Recall Waste Management provides collection, disposal, and recycling services to customers across commercial, industrial, and residential end markets.

In terms of the wide moat, we have a high level of confidence the firm will be generating economic returns a decade from now. Waste Management enjoys a robust competitive positioning in the waste-services landscape, especially relative to the hundreds of small providers, most of which aren't vertically integrated with landfills, a preferred asset. In short, we think the moat is rooted in intangible assets and cost advantage.

In terms of intangible assets, regulatory permits and ubiquitous environmental regulations make construction, maintenance, and closure of landfills a difficult, capital intensive endeavor, not to mention NIMBY, or not in my backyard opposition to new sites. On the cost advantage side, Waste Management's unmatched local-route density provides superior leverage over fixed-costs associated with its vast collection and disposal operations. For context, Waste Management is the largest integrated provider, followed by Republic, Waste Connections, and Advanced Disposal. We estimate the top four have roughly a 45% market share. Size falls off quickly outside the large players, and the market becomes quite fragmented.

On valuation front Waste Management is an excellent company that generates solid free cash flow, and we wouldn't hesitate to recommend the stock at an adequate margin of safety to our fair value. That said, it's trading at roughly a 10% premium to our DCF derived $75 fair value, placing it in borderline overvalued territory.

The firm's traditional solid-waste business has been firing on all cylinders lately, comfortably offsetting headwinds from depressed prices for key commodities its recycling division extracts and sells. However, this dynamic is no secret to investors.