Republic Services and Waste Connections have great prospects.
WE CONDUCTED OUR first proprietary survey on yield and volume trends at over 270 landfills, transfer stations and resource-recovery facilities across the country.
Our survey results indicate that the national average for disposal yield (pricing at the landfill, transfer station and resource-recovery sites) and volumes in the second quarter are up 1.8% and up 1.0% year-over-year, respectively, consistent with the general trend results from our industry forecast model (total yield up 3.1% and volume up 2.4%).
While our pricing data were focused on disposal yields, we believe that overall yield (pricing related to the overall waste chain) trend remains consistent with our expectations at the consumer price index (CPI) or CPI-plus level.
Our survey results suggest that volumes in the second quarter are likely to turn positive on a year-over-year basis, an earlier-than-expected inflection point helped by easier comparisons and a pickup in industrial and special waste activity. Although the positive volume trend noted in our survey is an incremental positive for the broader Solid Waste Services sector, we note that the improvement in volumes was driven mostly by activity in the Western and Midwest regions, which helped to more than offset the softness in the Northeast and South regions.
Volumes, on a year-over-year basis, are expected to improve in each of the next two to three quarters given easier comparisons, but we remain cautious on calling for more sustainable volume increases until signs of broader economic growth emerge.
With the recent flow of mixed macroeconomic data, namely on industrial activity and the employment scenario, we surmise that: i) the recovery process will likely be prolonged relative to that of prior economic cycles; and ii) the overall growth rate in economic activity is unlikely to be as robust as prior cycles. As economists expect the economy to tread along trough levels, likely at the inflection point between the late contraction and early expansion phases of the economic cycle, we continue to favor names exposed to the Solid Waste sector.
Companies in this sector generally have scaled operations as a result of the stability in municipal solid-waste streams, operating leverage in their business models, improving free-cash-flow generation, and the opportunity to increase shareholder return from capital-allocation strategies (e.g., share repurchases, dividends). Should the economic recovery progress toward the late expansion phase whereby federal, state and local budgets receive greater revenue streams from tax receipts, we would recommend a portfolio reallocation to favor the specialty waste-management companies, namely those focused on the higher-margin, specialized waste streams.
Based on the geographic breakdown of our survey results and the analysis of the macroeconomic scenario, we remain favorable on both Republic Services (ticker: RSG) and Waste Connections (WCN), especially given the potential upside surprise, relative to management guidance, in yield and volume trends heading into the second quarter and the second half of 2010.
Additionally, given the uncertainty on the timing of a more material recovery in economic activity, we favor Republic Services and Waste Connections as a result of: i) the noncyclical nature of their respective businesses (e.g., municipal solid waste); and ii) solid operations and efficiencies that could foster further margin expansion.
At current valuations and given the potential upside in volume from economic improvements as well as pricing, we believe both Republic Services and Waste Connections provide attractive share-appreciation prospects.
-- Al Kaschalk
-- Kevin Lee
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