Casella Waste Systems

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 3/5

Casella Waste Systems, Inc. is a vertically integrated regional solid waste services company operating in the Northeastern United States, providing collection, landfill, recycling, and other related services.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview and Moat Analysis

Casella Waste Systems (CWST) operates primarily in the solid waste industry, a sector characterized by essential services and high regulatory barriers. Their main operations include:

  • Collection: Pickup and hauling of waste from residential, commercial, and industrial sources.
  • Landfill: Owning and operating landfills for waste disposal.
  • Recycling: Sorting and processing recyclable materials.
  • Other Services: Organics management, customer services, and related operations.

While the waste industry is generally considered difficult to create sustainable competitive advantages, CWST has some potential moats based on their strategic positioning:

  • Location-Based Cost Advantages: CWST’s operations in the Northeast often place its landfills in strategic locations where fewer new permits are being issued, giving them limited competition. In some areas, high landfill capacity may represent a geographic barrier to new entrants. For example, they use regional landfills as “hubs,” or long-lived assets, that can generate above-average rates of return relative to the size of the capital required.
  • Regulatory Advantages: Landfills are very difficult to permit and permit changes make them hard to replicate. Obtaining new permits involves a time-consuming process with substantial costs and uncertainty of approval, creating a high barrier to entry in specific geographic regions. Also, states and regulations are increasingly requiring facilities to do more and more complex actions with waste.
  • Solid Customer Base: The essential nature of their services and the fact that many customers want stable relationships, create high switching costs, making them loyal. This helps to protect some cash flows and ensures a level of stability.

Given these factors, CWST earns a narrow moat rating of 2 out of 5. They have potential for sustainable competitive advantage based on geographic barriers, regulatory advantages, and sticky customers.

Legitimate Risks that could Harm the Moat and the Company’s Resilience

Despite the moat, several significant risks could threaten CWST:

  • Regulatory changes: Stricter environmental regulations could increase capital expenditure for new landfills or operation costs for the existing ones, reducing their profitability and margins. Also, regulatory changes by state, local, and federal governments are always possible, impacting future prospects of the company and making past assumptions wrong.
  • Technological Disruption: If alternative waste treatment methods such as advanced recycling technologies become cheaper and more scalable, it could reduce the need for traditional landfills and shrink demand for CWST’s services.
  • Economic Slowdown: Economic downturns lead to lower waste production. Any negative macroeconomic issues affect the amount of volume. Economic slowdowns may also reduce demand from construction and other commercial customers, affecting revenues.
  • Pricing Pressure: While CWST can often pass on increases in operating expenses to their customers, the risk is always present that competition or customer consolidation could make it harder to raise prices. Specifically, prices charged to larger customers are more likely to be affected by competition.
  • Acquisition Risk: Companies with high leverage may take on excessive debt, especially if integration issues or unexpected economic shocks arise.
  • Rising Interest Rates: A lot of CWST’s debt is in floating rate. Higher debt costs will lower returns and reduce equity. Higher rates make new debt and new acquisitions less attractive.
  • Climate/Weather: Extreme weather events and natural disasters can cause disruptions, damage to the facilities, cause difficulties in collections, and increase costs.

Despite these risks, CWST’s essential service nature helps it demonstrate strong resilience. Waste disposal is always needed, and that helps provide stability in revenues and the predictability of recurring services, making them generally recession resistant.

Detailed Business Explanation

CWST operates three main segments: collection, landfill, and recycling & resource solutions.

  • Collection (53% of 2023 Revenue): This segment involves the collection and transportation of solid waste from residential, commercial, and industrial customers. Collection accounts for approximately half of CWST’s revenue.
  • Landfill (31% of 2023 Revenue): CWST owns and operates landfills for waste disposal. This is where they make most of their economic profits from, as landfills require large capex, making them rare assets.
  • Recycling & Resource Solutions (16% of 2023 Revenue): This segment includes the sorting and processing of recyclables and the generation of energy from waste.
  • The company also provides services such as hauling, transportation, and processing of recyclables, including metals, paper, and glass. Revenue also comes from operations of its Resource Solutions segment which utilizes its expertise and technology for finding value in previously wasted materials like ash for use in concrete or waste-to-energy facilities.

  • Revenue Segmentation:By geographical segment, Western operations accounted for 25%, Mid-Atlantic accounted for 45%, and Northeast accounted for 30%.

  • Industry Trends: The waste industry is a mature one with stable and predictable demand. Increased emphasis on recycling and sustainability may change the traditional landscape. Regulatory pressures continue to become more and more important. Demand for services generally tracks with economic growth and the trend of new housing/commercial developments, but the industry as a whole is fairly resilient.
  • Margins:
    • CWST’s operating margins have fluctuated in recent years. In 2022 it was 17.8%, increasing to 18.5% YTD 2023, then to 19.3% in 2023. This illustrates the difficulty of sustaining and improving margins in the industry.
    • Gross margins have improved to 29.1% from previous years, but is still below many peers.
  • Competitive Landscape: The industry is competitive, especially within the collection and recycling segments. Many smaller regional players compete with larger national companies. They compete on routes, cost, regulations, and quality of service.
  • What makes the company different?: CWST focuses on owning and operating “hubs” of regional landfills and vertically integrating solid waste operations in the Northeastern U.S. They also have very strong local relationships and are highly involved with their communities.

Financial Analysis

  • Revenue: Casella’s revenue has been steadily increasing, from $677 million in fiscal 2020 to $915 million in fiscal 2022. YTD for September 2023 revenues are $1,008.7 million. Solid financial growth.
  • Earnings: Net income has been more volatile, driven by several one-time charges, especially in 2022, when they had -$55M income. For the three months ended September 30, 2023, net income was $16.6M.
  • Return on Invested Capital (ROIC): Historically ROIC has been in the low double-digits, but it has been improving. In 2022 it was 11.2% and has increased to 11.5% in YTD 2023, showing decent performance in capital utilization.
  • Leverage: CWST has a significant amount of debt. Total liabilities are $1.4 billion with shareholders’ equity is around 1.1 billion. This indicates high leverage, which can be concerning to investors. Debt-to-equity is about 130%.
  • Cash Flow: Operating cash flow is strong for CWST, but it also relies heavily on financing for expansion and acquisitions. In 2022 their operating cash flow was $267.6 million, and for the 9 months ended September 30, 2023 it’s at $291.6 million.
  • Note that cash is not an exact representation of value, and while they are generating cash flow, they are also spending a lot on debt servicing.
  • Acquisitions: The business relies heavily on acquisitions to gain market share and diversify operations. They have spent a considerable amount on acquisitions, using debt and equity.

Recent Concerns, Controversies, and Management Outlook

  • High Debt Levels: The company has a high amount of debt, that is mainly used for acquisitions. Investors need to keep an eye on debt and repayment schedules. In the November 2, 2023 earnings call, the company stated that they were focused on deleveraging in 2024, which signals a push to get more responsible with their balance sheet.
  • Price Elasticity: While the essential nature of the business makes it resilient, the company’s ability to continue passing on pricing increases to customers needs to be monitored. The company mentions in their reports that they have faced higher transportation and personnel costs, requiring them to charge customers more to keep up.
  • Labor Costs: Wage pressures are currently rising and have affected profitability, especially in the collection segment. In the recent earnings call they talked about increased costs and personnel expenses, and they mentioned that they are looking to mitigate them, and have had success.
  • Growth Outlook: Management is bullish about future growth. In the recent earnings call management mentioned a pipeline for acquisitions in the mid Atlantic and Northeast, with a focus on smaller tuck in acquisitions. They also stated that they are focused on increasing revenue in existing facilities through process efficiencies and innovation.
  • Capital Expenditures: The business plans to invest more than 500 million in 2024. The large amount of capital spending also shows the strong amount of money spent on growth and operations.

Understandability Rating: 2/5

The business model is somewhat complex for a layman to understand. The intricacies of waste management, landfill operations, and regulations require some understanding, but their financial statements are not very difficult to make sense of. Additionally, a lot of moving pieces and different segments that they have complicate understanding the business as a whole.

Balance Sheet Health Rating: 3/5

CWST’s balance sheet is concerning but not disastrous. They have a decent amount of assets compared to liabilities, but their significant debt and their interest rate risk bring the rating down. The company is focused on deleveraging but is still far from an ideal level of debt. The company may be prone to failure in times of economic stress if they cannot keep up with the high debt load.

Note: All financial statements are based on the last reported 10-Q report which was for the period ended September 30, 2023