In this episode of William Blair Thinking Presents, global services sector analyst Trevor Romeo dives into his team's latest white paper on the North American waste and recycling industry, exploring key structural trends and the growing imbalance between waste generation and landfill capacity.

Podcast Transcript

Chris
Hi, everybody. Today is October 11th, 2024. On today's episode of William Blair Presents. We welcome Trevor Romeo. He's an analyst covering companies in the global services sector. This is the first time he's on the podcast, so we're very excited to have him.

Trevor and his team recently published a white paper called One Man's Trash Is an Investor's Treasure, which examines the main structural themes affecting companies in the North American waste and recycling industry. With the main takeaway being that, as waste generation continues to grow alongside population growth and economic activity, there is an imbalance of waste generation, i.e. demand, landfill disposal capacity, which is supply that is set to tighten in the coming years.

So with that, Trevor, welcome to the show. Looking forward to talking trash with you this fine morning. To kick things off, I figured we can walk through each of the structural trends impacting the industry, starting first with the issue of fewer landfills being created in the recent years, despite a municipal solid waste stream that continues to grow with increasing population and economic activity. And my question to you is why the shortage and what are the implications?

01:26
Trevor
Yeah. Well, it's. Thanks so much, Chris, for having me. I look forward to talking some trash with you as well. Gotta love the, you know, garbage.

01:35
Chris
Yeah, it's my favorite to date.

01:37
Trevor
Yeah. So, I think I had heard a lot of things about the shortage of landfills in the country. You know, before I started really digging into the space.

I would say I was a little bit surprised when I really dug into the data, which, you know, we did a very deep dive on this in our reports. Not necessarily the land space that's the issue. But there is a lot of landfills are going to be closing in the next few decades. So, you know, it's taking a step back. I think the problem here is really it's pretty simple at its core. I think it's you have a growing, you know, waste stream is kind of the industry technical term. The waste stream is growing. I think people tend to generate anywhere from 5 to 7 pounds of, of municipal solid waste per day. And it's probably a little higher than I would have thought, but that's what it's kind of trended at the last, you know, decade or so. It's been pretty consistent.

02:32
Trevor
So anywhere, let's call it, you know, 6 pounds per person, per day of garbage.

Population growth has slowed, but, you know, population is still growing. So we are expecting waste generation to continue growing, you know, for the foreseeable future, I suppose.

At the same time, despite that, you have seen landfill capacity decline. We put several charts in our report, kind of showing a lot of this if you look over the past, say, 20 years or so, the number of new landfills that have opened in the US has been very, very low. I mean, some years I think it's even been zero, but usually it's maybe 1 or 2 new landfills per year.

The amount of landfills that have closed has, has certainly outpaced that. If you look at it on sort of a ton-weighted basis, I think some of the newer landfills are bigger now, but still you're seeing more tons closing then you are seeing new ones open. So, what does that mean?

You know, I think that will generally continue. You tend to see a lot of sort of not in my backyard or Nimby type pressure from communities when new landfills are proposed or expansions are proposed. I do think we'll see some expansions out of necessity, because, you know, we do need somewhere to put the trash. And until we can kind of get to a fully circular economy.

Maybe that'll happen someday, but, I think it's a long way off. But at the end of the day, you know, this is kind of the shocking part to me, is almost half of all the existing municipal solid waste landfills in the US are expected to close by 2050. Assuming there are no expansions, which, again, we would probably expect some expansions.

But the projected closing dates according to the EPA database, nearly half of all the landfills in the country are expected to close in the next two and a half decades. So it creates this kind of structural imbalance with, if you have waste continuing to grow in terms of the production or generation and fewer and fewer places to put it, creates this big structural challenge, particularly acute in some parts of the country because, you know, obviously trash is kind of a local business at its core. You're not going to be flying trash from, say, New York to California. It's more of a more of a local thing, although we are seeing with the northeast being, older cities, more population dense, these cities are packed kind of closer together.

The trash is increasingly being shipped out of the northeast on rails to other parts of the country because the shortage is so intense there, and we think that only gets worse over time.

05:10
Chris
You talk about this large-scale ownership of scarce, capital-intensive landfill assets giving these large, vertically integrated waste and recycling providers significant pricing power across the waste and recycling value chain. And this, you say, will ultimately drive resilient revenue growth and consistent margin expansion for solid waste and recycling providers. Can you can you unpack this for us?

05:37
Trevor

Sure. Maybe we start with the resilient piece of it. I mean, at the end of the day, waste and recycling services are. You know, we view it as an essential type of service. You can't have trash just sitting around your house. If you're a small business, you can't have trash piling up, you know, on your floor or in your restaurant or whatever it is.

So, you need someone to pick it up. Trash doesn't go away in a recession. Volumes can decline for sure. On the margin. Businesses can shut down. But people still produce trash in recessions. So, this really does tend to be a very resilient, repeatable business. And that's a key part of it. On the pricing power side, you know, I mean, we talked about the landfill situation already, but if you look at kind of the market share, who owns the land or who operates the landfills, really, the top two companies in the space, I'm sure, you know, people see their dumpsters and their, you know, garbage trucks all over the place. Almost half of the total landfill volumes in the country are managed just by those two companies alone. You extend that out to the top, you know, seven, which includes the public companies and a couple of larger private companies, it's more like 65% of all the landfill volumes are managed by the top seven.

So, what you get is, you know, an increasingly, I think oligopolistic structure where the assets are concentrated in a smaller and smaller amount of hands. And so that just lends a lot of pricing power on the disposal side that also flows all the way through the value chain.

Because if you're a collection company with a garbage truck that picks up the garbage, you got to put it somewhere, right? And when you do that, you pull up to the landfill. You have to pay the owner of the landfill, a tipping fee to, you know, literally tip the back of your truck over and dump the trash in the landfill.

So, you can imagine if the end disposal capacity is only owned by a small amount of companies, the collection providers that don't have those landfill assets. That's an increasing area of cost pressure for them. So, the vertical integration here for the large companies is another really important piece, because the large companies, they own the collection trucks, they own the transfer stations, and they own the landfills so they can pick up the trash and put it in their own landfills. And they don't have to face that increasing cost pressure that smaller players that maybe only own the collection piece of it that they do face when they pull up and drop the trash off at competitor landfills.

08:10
Chris
Let's shift the conversation a bit. Let's talk about circular alternatives to waste management. So those are things like recycling, and you know, other waste diversion alternatives. This is an area you believe will continue to grow as a percentage of the waste stream is diverted away from landfills, which we just talked about a bit, given the structural tightness of disposal capacity and increasing societal focus on environmental sustainability and circularity. It's a direct quote.

What's your thinking there?

08:36
Trevor
Yeah. This is this is an interesting one. I think we've seen a lot of, you know, areas of the country try to increase and increase recycling rates over time. If you look at the EPA data on waste generation, and what happens with all that waste generation essentially, data is admittedly a little bit old. I think the last update was in 2018.

But you've seen landfill volumes. You know, the absolute number of tons going into the landfills, pretty stagnant over the past 2 or 3 decades. You know, as we talked about earlier, we have seen the amount of overall waste generated increase over time. So that would imply, you know, we have seen that excess generation where landfills are kind of flat, the excess has been going to more sustainable alternatives like recycling and composting, which now I think are anywhere from 30 to 35% or so of kind of total municipal solid waste ends up being diverted from landfills and recycled or composted. And so, I think we see that trend generally continuing. I mean, from the kind of the first couple points we talked about, we don't really see, a huge increase in the tons going into landfills, if anything. You know, probably the reverse if landfills keep coming offline more than they're being replaced.

But obviously waste is going to continue to grow. So, I think we will need as a society will need more recycling and more circular alternatives. And we see legislative support for that on kind of both the supply and demand ends of the spectrum for, for recycled, commodities, which a lot of these big waste and recycling producers run the materials through their facilities and then they'll sell, sort of a processed and cleaned and sorted commodity to, you know, paper mills or bottling companies or packaging companies or things like that.

So, on the demand side for those recycled commodities, we're seeing, I think four states I believe have implemented minimum recycled content laws.

So that means if you were a producer of consumer-packaged goods, you are required to have a certain percentage of recycled content in your packaging. Otherwise, you can't sell the product, or you face some kind of a fee. So that's a direct, tailwind to demand for these recycled commodities.

On the supply side, we I think we've seen five states now that have implemented extended producer responsibility laws for packaging. And that means, you know, if you basically if your recycling rates on your packaging for your products that you're selling don't increase, then you face financial penalties. And so that's a tailwind on the supply side, because theoretically these companies are going to be forced to create their packaging with more sustainable materials that that can be more easily recycled.

So, you tend to see, I think those tailwinds will continue to ramp up over the next several years as the laws that were recently signed to continue to kind of ramp up year to year, and then more and more states seem to be considering similar types of laws. So, we think that's a tailwind that continues because of that.

I think because of the demand for these recycled commodities, you've seen a lot of the large recycling providers in the space invest very heavily in upgrading their recycling facilities. So, we talked a little bit about this in the report. You know, some of these companies are pouring over $1 billion, for example, of CapEx, into upgrading their recycling facilities.

Think robotics, optical sorting equipment, where, you know, it's a conveyor belt with a bunch of materials and you have these robotic arms that come out and grab different types of materials at different points along the line. And so, we've seen anywhere from with some of the specific facilities we looked into for our reports, anywhere from 20 to 100% improvements in sort of the throughput for these facilities, meaning like the number of tons per hour of materials they can process.

And significant labor cost reductions as well for these companies, you know, finding people to manually pick things off a conveyor belt. It's not necessarily easy. There is a labor shortage out there. And so, these companies can, we think, get anywhere from 30 to 40% cost reductions in their labor footprint with these upgrades.

And then maybe really quickly, another, another sort of sustainable or maybe not alternative but sustainable portion of the waste stream I wanted to hit on is renewable natural gas.

So, you can imagine when waste that's sitting in landfills decomposes, it produces this landfill gas, which I believe is about 50/50 methane and carbon dioxide.

So the methane from this landfill gas, can be refined and sort of purified and processed into a pipeline quality natural gas that can be used for transportation fuel that could be used for, you know, heating your house or whatever industrial uses.

So, these landfill owners that kind of own the methane stream coming from the landfills, have this opportunity now to monetize renewable natural gas because of significant legislative support. Mainly the EPA's renewable Fuel Standards program. So, with that, every time a gallon equivalent, I believe, of renewable natural gas is sold, the producer of the gas gets what's called a renewable, renewable identification number or a RIN credit. And that's, significantly valuable for these companies. A little bit of volatility because the credit prices can bounce up and down. But similarly, you're seeing particularly, you know, the largest companies in the space put billions of dollars cumulatively, into building out these renewable natural gas plants on their landfills.

14:51
Chris
Finally, there's a there's a section of the report that talks about how the operating environment in this space is becoming more complex and costly, disproportionately affecting the smallest integrated providers while driving more value to the largest players as key assets become increasingly concentrated among fewer owners. Let's break that down a bit.

15:11
Trevor
Sure. So, I think we talked a little bit already about, you know, as it stands today, I think 65% or so of the landfills are owned by the top seven players. I think there are several reasons for that and several reasons why that continues.

You know, one I think is the capital intensity across the industry has increased. Landfills are not cheap. Out of all the business lines that these companies run, you know, collecting, transfer stations and disposal, the landfills are sort of the most capital intensive, out of all the business lines. Yeah, it takes it. I mean, it's a lot of, you know, space you're working with. There's a lot of regulation in place. You can imagine, you know, you're dumping stuff into the ground. You gotta make sure that it's not, you know, the leaching or the sort of rainfall that runs through landfills. Doesn't have a bunch of chemicals in it. Like, you know, PFAS is a is a big area of emerging concern.

16:14
Chris
As Tim Mulrooney knows very well.

16:16
Trevor
Yep. He wrote a whole 100-page report on that.

16:20
Chris
We've got a couple podcasts on that actually.

16:24
Trevor
So, I mean, that's an increasing area where the landfill owners are, you know, potentially going to be facing higher regulation on that front. It's sort of paradoxically, you know, we think that actually ends up being an advantage for these large landfill owners. Not because, you know, we're excited for them to have to, you know, deal with more regulation and incur more costs. But because it means the smaller providers that don't have the capital to do so, it becomes even harder for them.

So, in a sort of a perverse way, it strengthens the competitive position for these large landfill owners. You know, when they see higher regulation and higher costs, because smaller players just can't do it.

Along with that, I mean, post closure requirements for landfills have increased when the landfill closes, you don't just seal it up and then call it a day.

Now it's about 30 years where the owner of the landfill has to monitor you know, what's coming out of the landfill, basically the emissions and stuff like that. That used to be five years, decades ago. Now it's close to 30.

So, it's just increasingly difficult and costly to manage these landfills. So, the competitive position is very strong for the owners of those scarce assets.

If you move to the collection side of the business, I think we talked about this earlier. But when you have the scarce landfill assets as a big cost of your business, when you pick up the trash and you have to dump it somewhere, that pressure is not going away because these landfill owners are likely going to continue increasing prices. And that's a headwind for smaller collection only providers.

We've also seen operating cost challenges like labor costs have skyrocketed in the last few years. Maintenance costs for vehicles have increased as well. So, what we're seeing is a lot of the small mom and pop type players in the industry, of which there are quite a few, are increasingly being driven to sell their businesses because it's getting so difficult.

And just one quote that I would quickly pull out. We put this in the report I came across. I think it was a like a Facebook post from a, a local mom and pop company that sold to a bigger player, and they wrote like a, you know, thank you note to their customers over the years. The quote was "the days of the single-family owned landfill has faded away," and I thought that was really interesting and just encapsulated the whole situation with all of these increasing costs and regulations and difficulties that that this company sort of attributed, you know, the reason why they sold.

19:03
Chris
Well, Trevor, this has been great. Is there anything else you'd like to mention from the report before we close out? I'm sure that we've missed 1 or 2 areas. If you want to call that out real quick.

19:12
Trevor
Sure. Well, I would encourage, you know, the listeners to read the report. I think there is a lot, a lot more detail in there, that you know, you can't hit on in a quick podcast, maybe for one quick theme to hit on would be, you know, valuation.

I think that's one thing that we've seen a little bit of increasing concern from, you know, some of the other sell side analysts that cover the waste space about high valuations for these companies. Fair concern. I mean, valuations have improved or increased over the last ten years. I think along with that, though, you've seen a corresponding increase in some of the operational metrics, like the pricing power, which is, you know, we think structurally higher than it was ten years ago.

Margins, which have consistently improved and are quite a bit higher, cash flow conversions improved. So, one way we thought would be kind of a cool idea to, to dimensionalize valuations in waste is compare it to other high quality service business models. You know we have a great global services group here. The other two analysts, do a great job and I used to support one of them covering info services companies, which, you know, you might think on your face, data businesses versus, you know, trash businesses, you know, that's not similar at all.

Well, I think if you dig one layer deeper, a big portion of the value proposition for info services companies like, think the credit bureaus, for example, is their scarce data assets. They have data on everybody's, you know, credit information that is held really by three companies. Nobody else has it. And it's like a hundred plus years of data for some of these companies that can't be replicated by anybody else. So that scarce data asset gives them, you know, considerable pricing power and competitive positioning. So, I thought, you know, that's very similar to what we see with the landfills here on waste. So, if you look at valuations for those companies and other, you know, commercial services companies that are high quality service businesses, those valuations have increased even more over the past five, ten years. And the waste businesses have.

So, I won't get into all the numbers here. But I think it just suggests that valuations for waste companies are pretty reasonable when you consider the quality of the companies, the competitive positioning and the consistency and predictability of their businesses.

21:40
Chris
For those interested in read the report. You request a copy by reaching out to us at www.williamblair.com/contact-us. Trevor, thanks for being here with us today. Hope to do it again soon.

21:52
Trevor
Good. Thanks, Chris. Enjoyed talking some trash with you.

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