We note the following risks to the shares achieving our target price:
Volume cyclicality – Total company volume growth has a strong correlation with US GDP as MSW generation is a product of the larger economy and overall consumer spending. US housing starts also carry a meaningful correlation. While housing starts are a sign of broader strength in the economy, they also produce further tailwinds including MSW generation from new residents, C&D waste from construction, higher-margin special waste generation (largely soil from land clearing activities), and new commercial activities (retail locations, offices, etc.) from recently created homes.
Recycled commodities – Although the industry has been working to increase processing fees and revenue sharing on commodity sales, waste companies carry an earnings sensitivity to changes in recycled commodity prices, specifically OCC, mixed paper, used beverage cans, plastic (mostly PE and PET), and glass. When recycled commodity prices fall, recycling earnings will drop and could be below our forecasts. Conversely, when commodity prices rise, earnings could exceed our forecasts.
M&A integration – Acquisitions are an integral part of growth in the US waste industry. From 2017-2021, the three largest public companies (comprising 47% of the market) completed $10.2B in M&A activity comprising 25% of cash outlays (including capex, dividends, and buybacks) and have spent another $2.81B in 2022. Although deals are typically quite small (<$100mm purchase price), they still carry integration risks and actual earnings could fall short of pro-forma targets.
Labor costs – Waste is a labor-intensive industry with labor & benefits comprising ~20% of revenue for peers; when including subcontractor costs (~10% of revenue; includes payments to third-party haulers), all-inclusive labor is ~25-30% of revenue.
Collection competition – Competition amongst peers can be intense given low barriers to entry, and providers may struggle to differentiate given little opportunity for innovation or customer relations.
If the impact from any of these factors proves to be more negative than we anticipate, the stock will likely have difficulty achieving our financial and price targets. However, if any of these factors proves to have less of an effect than we anticipate, the stock could materially outperform our target.
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