A High Roller Buys Into the Trash Business

 | Nov 07, 2012 | 3:30 PM EST
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We already knew that Microsoft founder Bill Gates loves trash. Cascade Investment, which manages much of his wealth, is a major shareholder at Republic Services (RSG). Now SPO Advisory, a fund managed by value investor John Scully, has taken a large position in the industry as well.

According to a 13G filed with the Securities and Exchange Commission, SPO has acquired 6.6 million shares of Progressive Waste Solutions (BIN); this represents nearly 6% of the total number of outstanding shares. According to our database of 13F filings, documents which disclose a notable investor's long equity positions at the end of each quarter, the fund had not owned any shares at the end of June.

Progressive Waste Solutions is based in Canada but also operates in 12 states and the District of Columbia. Lower trash volumes have negatively affected Progressive's business so far this year, but in the first nine months the company did report that revenue was up narrowly from the same period in 2011. This was generally driven by revenue growth from acquisitions. Earnings are down so far in 2012, including a decrease in the third quarter relative to a year ago.

As such, we see the business as struggling, and while it does have some good defensive characteristics going for it (the beta is 0.6, indicating a weak relationship to the broader market, and Progressive pays a dividend yield of 3.0%), we'd need to see a quite attractive price-to-earnings multiple to consider buying. Since the stock has a $2.2 billion market cap (the stock price has fallen 2% on the year, while the S&P 500 is up over 10%) and since analyst estimates combine to produce a forward P/E of 17, we believe we'd avoid it.

We've already mentioned Republic Services as another waste management stock; other peers include Waste Connections (WCN), Waste Management (WM) and to a lesser degree Stericycle (SRCL), which focuses on the disposal of medical waste products.

Waste Management, at a market cap of $15 billion, is easily the highest valued of these comparable companies. It's actually cheaper than Progressive on a forward earnings basis, at a P/E of 14, and pays a higher dividend yield at 4.4%. It also had lower revenue in the third quarter than in the third quarter of 2011, pushing its earnings down 21%, but it still looks to us like a better stock pick.

Republic Services is in a very similar position to Waste Management: It carries a forward P/E of 14, and its earnings were 21% lower last quarter than a year earlier. That company's dividend yield is a bit lower, at 3.5%, and it is about two-thirds the size in terms of its market capitalization. We believe that it too looks more attractive than Progressive, at least.

Waste Connections trades even with Progressive at 17x forward earnings estimates, a premium to Waste Management and Republic Services, but it can actually boast a growing business, since both its top and bottom lines are rising recently. At the same earnings multiple, we'd definitely rather own it than Progressive.

Stericycle draws the highest multiples of all, because of the niche nature of its business and the growing health care sector (which has done well at bringing its numbers up so far). It actually trades at 31x trailing earnings and has expectations of strong growth for 2013, bringing it to a P/E of 26. We'd like to see more progress from Stericycle before looking at it further.

It looks to us like SPO isn't making a good choice here. The waste management industry isn't doing particularly well, and when looking at generalist companies in the industry, there are two peers that are also struggling but carry considerably cheaper valuations and one that is priced even with Progressive but has been growing its business recently. Any of those three stocks could be a better buy and could even make for the long side of a pair trade with Progressive.

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