Digging Deeper for Value

 

The New Year brought a dramatic market rebound. Performance was driven by a combination of a cautious Federal Reserve rethinking its plan to increase interest rates, and a “relief rally” during earnings season.  First quarter earnings reports weren’t impressive, but stocks rallied as investors realized that earnings, while mediocre, were not nearly as bad as they could have been. This is in contrast to just a few short months ago when markets seemed to be assured of an imminent collapse.

I continue to believe that, while growth is slowing, the chances of a significant economic downturn within the next year are relatively low.  Despite market reports of negative economic indicators being triggered, the Federal Reserve is aware and taking action.  Election season is gearing up, and it behooves the current administration to do all they can to keep the economy running and trumpet an “It’s the economy, stupid.[1]” campaign message through 2020.

We are likely late in the economic cycle, and this truth influences my thinking as I consider new investment ideas.  Late economic cycles are characterized by high stock valuations and stocks moving up purely based on momentum… “others are buying this stock, perhaps I should too.”  As I search for ideas, I am increasingly aware that markets are evolving. I continue to believe in value investing and that a company should be valued based on the expected value of future cash flows. However, the concept of mindlessly searching for companies with a low price to earnings ratio or low price to book ratio becomes challenging later in the cycle.  Those metrics have meaning and value, but the pervasiveness of simple stock screeners allows thousands of investors to identify these “value stocks.”   If I can run these screens, then so can thousands of other investment managers who have also seen the same results and decided not to invest, and likely for good reason. During periods such as this, a low multiple is no longer a signal of value. Investors have to dig a bit deeper to identify companies that may not show up on screens. It takes a bit more work to identify companies that have value in their brand, franchise, and ability to consistently earn and grow cashflow for years into the future.

I believe one such company is Waste Connections (WCN).  Waste Connections is the third largest waste disposal company in North America.  The waste disposal industry is, by itself, not that attractive. It’s a commodity-based business, and the industry is highly price competitive and fragmented.  There are 4 large players competing against 50 mid-tier companies each with revenues over $100M and thousands of smaller “mom and pop” operations all competing for market share based on price. The industry has been historically plagued by price wars where companies price their services unprofitably to maintain their turf.

WCN Truck
Within this industry, WCN is a shining star.  The company has uniquely positioned itself as the only company focused on rural and exclusive markets.  This strategy is akin to Sam Walton establishing his Walmart empire by building low cost superstores in rural areas where he was not forced to pay high rents while competing with every other national store chain.  WCN is able to operate in markets where they have exclusivity and pricing power.

Waste Connections has also developed its own unique decentralized culture that empowers managers to make decisions at the local level to improve speed and profitability.  This is important because each market is its own unique community populated by customers with specific needs.  This decentralized culture allows WCN to manage what are really hundreds of local businesses at the national level.  It also makes WCN a preferred employer and a preferred acquirer for smaller business owners looking to sell their business to a larger entity.  M&A is a key component of the growth strategy, and Waste Connections has a successful track record of acquiring profitable, niche businesses and then integrating them while creating efficiencies that lead to enhanced cash flow.  In 2016, WCN completed their merger with Progressive Waste Management to form a company with more than $4B in annual revenue.

Waste Connections consistently generates cash and has provided consistent positive shareholder returns for 14 years.  They are also attractive in terms of their ability to compound cash flow growth through the multiplicative effect of price increases combined with volume growth. At this potentially late stage of the business cycle, the waste disposal sector offers an opportunity to not only grow earnings faster than the market, but to do so with less volatility and fewer earnings drawdowns.  People create trash regardless of the economy.  You can read our full investment analysis here – “Every Tuesday and Thursday.”

 

[1] A slight variation of the phrase “The economy, stupid”, which James Carville coined as a campaign strategist for Bill Clinton’s successful 1992 presidential campaign.

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