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Waste Management's Economic Moat Makes it a Buy

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One of my favorite thoughts from legendary investor Warren Buffett is to look for companies with large ‘moats.’  Simply put, Buffett intends to hold stocks for long periods of time—usually forever.  To do this, a company needs to have a strong competitive edge in order to survive over time.  Businesses that operate in industries that are hard for competitors to penetrate stand a much better chance of surviving for decades.  The waste management industry fits the bill perfectly, and Waste Management (NYSE: WM) can offer investors dependable results.

The Economic Moat Surrounding Trash Collection

As it stands, there are only a few companies operating in the industry other than Waste Management.  Waste Management is the largest operator of landfills in the country.  Republic Services (NYSE: RSG) is the closest competitor to Waste Management.  Republic Services has a market capitalization of over $10 billion, compared to Waste Management’s $15 billion value.  Both companies provide their services to residential, commercial, and industrial customers.  Also, both have similar valuations:  Waste Management trades for a trailing price-to-earnings multiple of 18 and a price-to-book ratio of 2.5.  Meanwhile, Republic Services’ P/E and P/B ratios are 17 and 1.4, respectively.  Much smaller competitor Casella Waste Services (NASDAQ: CWST) also trades, but is a much smaller company with only a $171 million market value.  Casella reported a net loss for the trailing twelve month period and the company’s stock lost a third of its value in 2012.

The fact that the industry is essentially a duopoly shows how difficult it is to enter.  The waste management industry is extremely capital-intensive.  Barriers to entry including regional scale and route density cement Waste Management’s business and allow the company to pass on regular price increases to customers.  Revenue for the company grew by almost 7 percent in 2011 as compared to the prior year.

Green Energy Opportunity

Waste Management is also capitalizing on the search for renewable sources of energy.  After the company collects and disposes of trash, it is able to recover valuable resources and create renewable energy.  The company prides itself on being a leading developer, operator and owner of waste-to-energy and landfill gas-to-energy facilities in the United States.  The results of these efforts are impressive: Waste Management uses waste to create enough energy to power more than 1 million homes every year.  By 2020, the company expects to double that output.  Furthermore, the company is the largest recycler in North America.

In addition, the company has begun efforts to transition its fleet of trucks from traditional diesel engines to those that use natural gas, to simultaneously take advantage of the declining cost of natural gas and protect itself from the rising cost of fuel.  Through a joint venture, Waste Management built a plant that converts landfill gas into liquefied natural gas for use as fuel in their trucks.  Waste Management currently has more than 1,000 natural gas-powered trucks in their fleet, more than any other company in the industry. 

Cash Flow and Dividends

Waste Management generates strong free cash flows and uses this cash flow to pay generous dividends to shareholders and buyback shares.  In 2011, Waste Management paid $637 million of dividends and completed $535 million in share buybacks.  The company projects 2013 operating free cash flow to grow by double digits.  Operating free cash flow is expected to be higher than $1 billion.  In addition, last month the company raised the dividend, and as a result now yields almost 4.25% at a current stock price of $34 per share.  Waste Management has increased its dividend for ten years in a row and should continue to do so for the foreseeable future, as a result of its necessary and reliable business and economies of scale.  Waste Management is an attractive stock for buy-and-hold investors.

Robert Ciura owns shares of Waste Management, Inc.. The Motley Fool recommends Republic Services, Inc. and Waste Management, Inc.. The Motley Fool owns shares of Waste Management, Inc.. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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