Economic Moat
Matthew Young, Eq. Analyst, 25 July 2018
Upon transferring coverage to a new analyst and a fresh
review of the company’s competitive positioning, we
upgraded our economic moat rating for Waste
Management to wide from narrow. In our view, the
company’s flagship traditional solid waste operations
enjoy robust, sustainable competitive advantages rooted
in intangible assets (regulatory permits) and cost
advantage (route density). Overall, we have a high level
of confidence that the company will be generating
economic returns a decade from now, our definition of a
wide moat.
In terms of intangible assets, regulatory permits create
immense structural barriers to entry for the company’s
disposal operations. Developing and operating a landfill
requires facility permits, various licenses, and a host of
federal and local government approvals associated with
zoning and environmental protection, and such approvals
are costly and a challenge to secure. On top of that, NIMBY
(not in my back yard) opposition is no small barrier to
creating a new landfill.
Furthermore, the company benefits materially from cost
advantages stemming from superior local route density
relative to small regional providers, most of which aren’t
vertically integrated in terms of landfill ownership. Waste
management is the largest provider in the approximately
$60 billion nonhazardous solid waste services industry,
with a ballpark 20% share. Of note, the solid waste
management landscape is fragmented with hundreds of
participants, including private operations and municipal
and other local government authorities. Size drops off
quickly after the three or four largest providers; Waste
Management operates 249 landfill sites, Republic
Services has 195, Waste Connections has 90, and
Advanced Disposal has 40
Scale matters in route-based businesses (in this case,
collection through disposal) because it provides greater utilization and leverage over a vast cost base (costs linked
to landfill ownership, collection equipment, transfer
facilities, and so on) relative to smaller providers. Consider
that landfills must adhere to strict federal, state, and local
environmental regulations that dictate design, construction,
operation, monitoring, and closure. Landfill operators
must also possess the resources to deal with NIMBY
opposition, which can be costly, time-consuming, and
politically charged. Thus, regulation effectively supports
high fixed costs, drives the need for significant capital
expenditures on environmental protection, and creates
material financial liabilities for the final capping and
closure of landfills. When combined with financial and
legal resources and a strong local market presence, landfill
ownership (enjoyed by vertically integrated providers)
translates into a formidable advantage that keeps smaller
competitors at bay thanks to lofty fixed costs, political
opposition, and regulatory hurdles. Industry players that
control the greatest amount of landfill assets ultimately
command pricing power in the form of tipping fees or
disposal facility fees, including incremental benefits from
third-party haulers diverting volume to their landfills. Even
the third-largest player, Waste Connections, minimizes
direct competition with the two large incumbents by
concentrating on secondary markets.
