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June 2006

Investors boost solid waste stocks

Investors are once again starting to take notice of the solid waste industry.

“The excitement, which we definitely see out there, is a function of growth and profit margins,” said Tod Holmes, chief financial officer at Republic Services Inc. “We’ve got a business that is a pretty dependable, steady performer.”

Ft. Lauderdale, Florida-based Republic Services, the country’s third largest solid-waste company, reported that first quarter revenues increased 8.9 percent to $737.5 million, compared to $677.2 million in the same quarter in 2005. Internal growth totaled 9.4 percent, with 4.3 percent from price increases and 5.1 percent from volume growth.

Net income slipped to $64.6 million, or $.46 a share during the first quarter, compared to $65.5 million, or $.43 a share last year during the same quarter. But operating income increased to $122.4 million, compared to $119.5 million last year.

Holmes said investors are noticing the sector’s price and volume growth along with a focus on free cash flow. “We’re not going after growth for the sake of growth. Our focus is to grow the business where it makes sense internally,” Holmes said.

Stock prices for solid waste companies increased 18 percent on average during the first quarter, compared to a 2 percent return for the S&P 500 Index, according to a research report by Leone Young, an equity analyst in New York for Citigroup.

The stock price for Allied Waste Inc. increased 38 percent, Waste Management Inc. increased 15 percent and Republic Services increased 11 percent in the first quarter.

“Stock performance in the first quarter was the best in more than five years,” Young said. Better industry conditions and pricing environments fueled interest in the sector. “Investor interest has also been driven by improved earnings,” Young said.

Houston-based Waste Management, the country’s largest solid-waste company, took a leadership position in regards to pricing, Young said. “This has been followed, albeit slightly more erratically, by the other major publicly traded companies.”

Waste Management reported revenues increased 6.3 percent during the first quarter to $3.23 billion, compared with $3.04 billion a year ago. Net income totaled $186 million, or $.34 a share, compared with $150 million, or $.26 a share last year.

“Price is really the engine that makes the companies work,” said Corey Greendale, an equity analyst in Chicago with First Analysis. Solid waste companies are now getting increases of 4 to 5 percent compared to almost no price growth last year.

“They are bidding municipal contracts at levels where it is possible that they may actually not get them, because they are coming in at a higher rate,” Greendale said.

“But they say that’s ok, because they don’t want to win contracts at any price.”

When investors see stocks are going in the right direction other investors start to look closer at the sector and start to bid up the stocks, Greendale said. “The whole market has done very well and the solid waste companies are still reasonably priced.”

Allied Waste has performed especially strong in this environment because the company has a lot of debt leverage, Greendale said. “The downside to that is in a bad environment you have to service the debt. You don’t have a lot of excess free cash flow.”

Phoenix-based Allied Waste, the second largest solid-waste company, reported revenues for the first quarter increased 7.3 percent to $1.4 billion from $1.3 billion during the same quarter in 2005. Net income increased to $41 million, or $.08 a share, compared to $25 million or $.05 a share during the comparable period last year.

“The late cyclical waste industry is finally hitting the up cycle,” said Amanda Tepper, an equity analyst in New York with JPMorgan, in a research report.

Volumes began to weaken in the waste industry about 18 months after the last recession started, Tepper said. Even with manufacturing and construction gaining strength over the past five year, Tepper said the waste industry is just now improving.

“After two years of market under-performance, we think the waste stocks should deliver meaningfully better returns in 2006, as cash flow compounding benefits of modestly strengthening fundamentals become more apparent,” Tepper said.

Stewart Scharf, an equity analyst for Standard & Poor’s in New York said solid waste companies continue to focus on organic growth and improving operating margins.

Major solid waste companies will risk market share loss in order to boost revenues through price increases, Scharf said. “With the economic growth fairly strong, volume should gradually increase.” The waste companies in return will attempt to enhance customer service in an effort to retain market share, Scharf said.

“Although we think solid waste volume should gradually pick up during 2006, we still expect pricing initiates to be the primary driver of organic growth,” Scharf said.

“In our view, most waste companies will continue to focus on generating cash for debt reduction, share buybacks, dividends, and some tuck-in acquisitions and asset swaps. We are forecasting mid-single digit organic growth for 2006.”

John Skinner, chief executive officer of the Solid Waste Association of North America in Silver Spring, Maryland, said it’s a good trend for the industry to focus on return on investment. “It makes the companies more efficient,” Skinner said.

“I think it makes them much better investments than just growing by acquisitions and acquiring companies by issuing more stock. I hope it continues.”

The focus on renewable fuels has also helped the image of the solid industry, since landfill gas is a renewable fuel, Skinner said. “It is looked at by many groups as an industry sector that is participating in environmental improvements.”

Recent advertising campaigns by solid waste companies have also helped the industry’s image. Skinner said the ads by Waste Management running on a daily basis, “portray the industry in a much more positive, environmentally conscious way.”


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