Deep Dive on Garbage

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Hello and welcome to the Barron Streetwise Podcast. I'm Jack Howe. The voice you just heard, that's Trevor Romeo. He's an analyst covering waste and recycling at William Blair. This week's episode is all about garbage. Isn't that every week? I hear you thinking. No, and that's very hurtful. We're going to talk about landfills and margins and recycling, all of it. First, we'll have a few words to say about the latest on obesity meds. That's next. Listening in is our audio producer, Alexis. Hi, Alexis. Hey, Jack. Late July in New York City. You're in New York City. I lived there for many, many years. What is the— what's the trash situation like? Because When I was there, what used to happen— this was like garbage season this time of year because in New York they piled the bags sometimes like right on the sidewalk and the pile can get pretty high at certain times of the week. And in the hot months, in the hot months, you can get, you know, there's a stink a little bit sometimes depending where you are. Sometimes you see a little river of garbage juice on the side of the street. There's all kinds of wacky things going on. I mean, I know you want me to say that nothing has changed since you've lived here, but it's gotten better. It's gotten better because of the rat czar. Okay. And there's a bunch of rules about how we have to do things so that we don't get rats. I see. So there's no, no more big piles. Well, I wouldn't say no more. I once saved a woman's life. Well, not quite, but we were walking down the sidewalk in, uh, this was in, uh, Midtown Manhattan and we were chatting and she was not looking the right direction and she almost walked into a big pile of garbage. And I grabbed her arm at the last minute before she fell into a pile of garbage. That's not— that's saving a life, right? Yeah, if not her life, her dignity. All right, we're gonna come to trash in a minute. It's a very important business. There's a few key players that have a lot of market share, and there's a reason to believe that this business is going to become more profitable in the years ahead. I wanna say a few words first about another July non-garbage development. This one is at CVS, the drug chain, and it has to do with obesity drugs and a formulary change. We've spoken many times in this podcast about obesity drugs. We've had the chief of Eli Lilly on about CVS. We've had the former CEO there on. CVS owns what's called a pharmacy benefits manager called Caremark and PBMs, as they're called. They do business with health plans and large employers. They basically manage drug benefits. And Caremark has made the decision to change its formulary. It's now preferring Wegovy, the weight loss drug from Novo Nordisk. The key competing drug is called Zepbound. That one's from Eli Lilly. It means that for patients whose plans deal with this PBM, many of them will have coverage for Wegovy, but not for Zepbound.. And I think that's an important and telling development. I just wanna mention what it means for investors. For everyone who's not familiar with these drugs, uh, I'm really not that guy to explain to you how they work. I've tried to figure it out myself. What I can tell you is they really work. These drugs were made first for diabetes and approved there. Now they've been approved for obesity. They're called GLP-1 agonists. That refers to a particular hormone that's secreted in the gut after you eat, and these drugs can sort of mimic the action of that hormone. Novo Nordisk had a head start here. They have a drug that deals with GLP-1 specifically. Eli Lilly came behind them with a dual agonist drug. It deals with that hormone and another one. Ozempic is the first one people heard of, and that's become sort of a, a catch-all name for these type of drugs. Ozempic was specifically marketed for diabetes. When that same underlying drug was approved for obesity, it was called Wegovy. So those two are the Novo drugs. The Lilly drugs, the diabetes one was called Mounjaro, and now when it's marketed for obesity, it's called Zepbound. I know it's super confusing, but the key thing to keep in mind is that Lilly, because that drug was the dual agonist drug, it works in two ways. It was designed to be more effective and studies have really borne that out. There was a December study that pitted these two drugs for weight loss. Head-to-head, and the Zepbound patients, the patients on the Lilly drug, they lost 20.2% of their body weight. And the Wegovy patients, the ones on the Novo drug, they lost 13.7%. So that is a big difference in terms of weight loss. That's not the maximum weight loss. That's not what everyone loses. That just gives you an idea of how these two drugs compare. And patients seem to be well aware of this because everyone is preferring Zepbound. Well, not everyone, everyone, but Zepbound has now a 60% market share, and that includes 75% of treatment starts. I think that's reflected in what has been going on with the stocks over the past year. Novo Nordisk stock has lost half its value. Lilly is down too. It's down 9%. The S&P 500 during that time is up 14%. Now, both of these stocks are still up for longer-term holders over the past 5 years. Lilly is up much, much more than Novo at this point. Clearly the much deeper decline for Novo shows that obesity patients like the Lilly drug more. So why would CVS switch to the other drug? It has explained that by doing so, it can make the drug cheaper and more available to more patients. It says that maximum weight loss isn't the only thing that matters for patient health. I take their point, but I think that anyone who has equal access to these drugs is probably going to prefer the Lilly drug on the numbers right now. I think that's borne out in what patients are choosing. And a lot of patients are paying their own way on these drugs. Both companies have launched in-house pharmacies where they will deliver these drugs directly to patients who are cash payers. These are people whose insurance won't cover the price of the drugs. The programs are pretty similar in price. If you're going to do Wegovy, that's the Novo drug, as a cash payer, you can start for $299 for one month, no matter no matter which dose you start with, and then it's $499 a month thereafter. I know that's a lot of money, but we used to talk about list prices of over $1,000 a month for these drugs. These drugs are not at all like weight loss drugs in the past. They've shown themselves to be very effective, and they can help with conditions that are related to obesity. The Lilly drug, that's $349 a month for the starting dose. And then $499 a month for higher doses. It's typical for patients to start these drugs at low doses and work their way up, uh, afterward. One small difference with the Wegovy drug, you get this injector pen. With the Lilly drug, if you're a cash payer, they make you take a syringe and draw it yourself out of a vial and give yourself a shot. That might be icky for some people. If they're covered by insurance, they get a nice auto-injector pen where they push a button and the pen does the work for them. The CVS change has to do with people who are covered by insurance. And what does this mean for investors? The CVS change will affect around 200,000 Zep-bound patients. These patients are probably going to have to make a decision whether to pay more for the medicine or switch to Wegovy. There are more details than I'm going through here about patients who want to appeal and so forth. So it's 200,000 patients, but Lilly has been adding 500,000 Zepbound patients per month overall. So this loss is not going to totally offset growth for the month. What investors might see here is a small dent to growth for Lilly for one quarter, followed by a reacceleration of growth in quarters ahead. So I don't think that's a big deal for the stock. In fact, there's two other developments for Lilly. One matters probably at least as much, and the other matters a lot, lot more. It's working on an even newer obesity drug. I mentioned before that Lilly's current drug is a dual agonist drug. The new one it's working on, I guess you call it a tri-agonist drug. The nickname for it among drug researchers is 3G, and 3G has shown itself in trial results to be even more effective than Zepbound. I guess that matters for extending Lilly's dominance, although as I said before, the drugs that are already out there are pretty darn effective. The other development is called orforglipron. That's the sciencey name. The thing will get a, uh, marketing name if and when it's approved, which analysts think could be as soon as next year. This Lilly drug just had some impressive results for diabetes. Wall Street is waiting to see some obesity results in August, and the thinking on Wall Street is that this drug might might, based on results analysts have seen so far, might be not quite as effective as Zepbound for treating obesity, but about as effective as Wegovy. Why would that matter? Why would you want a drug that was only as effective as the second best drug? Because this is what's called a small molecule drug. Basically, in this business, when researchers say small molecule drugs, they mean ones that are made from chemistry. When they say large molecule drugs, those are ones that are made from living organisms. So the obesity shots that are out now, these are large molecule drugs. Large molecule drugs tend to be finicky. You have to handle them a certain way. You have to refrigerate these drugs and they have to be injected. But a small molecule drug, aspirin is an example of a small molecule drug. They tend to be stable. And that means that you can deliver them as pills. So what Lilly is working on is a pill for diabetes slash obesity that appears to be about as effective as the injections that Novo currently has on the market. Now, of course, in the drug business, everything depends on what are the trial results? Uh, what, what about the regulatory approval? So let's not get ahead of ourselves, but you can imagine a world where these pills are cheaper to make, cheaper to sell. You can distribute them anywhere in the world. It opens up more global markets, places in the world where they might not have, for example, a lot of access to refrigeration to store drugs. So it makes the market for these drugs a lot bigger, potentially. I have read reports that speculate maybe you treat obesity in rich markets with injections and poor markets with pills, or maybe people start with injections, they lose their weight, and then they switch to pills for maintenance medications. I don't really know how the thing is going to shape up in the years ahead, but the obesity drug market stood at $15 billion last year. Morgan Stanley predicts it will hit $150 billion by 2035. It'll multiply by 10, in other words. Just over half of that will be in the US alone. These stocks are not particularly cheap. I'm not going to go through all the numbers here. I wrote a column about this recently in Barron's. But Eli Lilly is a company that last year its earnings per share doubled to $13. By the end of this decade, by 2030, they could be at $55 a share. So if you don't own Lilly stock, if you're an index fund holder, you're not missing out. Eli Lilly is now the 12th largest company in America by stock market value, which means you have a pretty good weighting in your index fund. If you're wondering what's going to happen with the stock from here, My first advice would be to ask anyone but me. I'm not a particularly skilled predictifier in such matters, but I would just say that if you believe the estimates, there's sufficient earnings growth to keep investors excited about the stock. If they stay as enthused in the years ahead as they are now, and you extrapolate out the earnings growth, you can come up with a decent gain for shares. JP Morgan calls the stock a top pick. And it predicts a rise to $1,100 a share in a year. Who knows? The recent price, $765. So they're bullish. Most of Wall Street is bullish. I think it's pretty easy to see what all the fuss is about. And that is obesity drugs. Now for some garbage and recycling. That's next after this quick break.

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Hi, I'm Kelly Cavanearo, Managing Director, Head of North America Institutional Distribution at Janus Henderson Investors, the We believe working together is the way to work better, like combining your portfolio plans and our in-depth strategy, your valued assets and our valuable insights, your mission and our vision, working in harmony to seek the right investment opportunities. Janus Henderson Investors, investing in a brighter future together. Welcome back. There's been a little bit of a sell-off in waste management stocks. These stocks kind of trade like prized possessions on Wall Street. They're not cheap. So with this opportunity for a little bit of a discount from where they were, I figured it's a good time to take a look at the group. I'm not a waste management expert by any means. I can't really tell you what happens after the fellows come by and pick up the trash cans. We have a few simple systems here at the house that seem to work for us. Put bungee cords on the cans to keep the raccoons out. I have a long steep driveway, so when it's time to bring the cans up from the bottom after they're emptied out, I use the rolling down the window and reaching one arm out to hold one can at a time on the way back up the driveway method. It's crude but effective. Or else I just tell the boy to bring them up. That's about all I know. Except I also know that there is a huge rush of landfill closings coming., and I know that from reading the research of Trevor Romeo at William Blair. He did a deep dive on this industry last fall. He's out with a new report that says there's buying opportunities in this group. So I figured this is a good opportunity to reach out to Trevor for an industry rundown and, and to look at which stocks he likes most. Let's listen to part of that conversation now.

It's kind of an interesting setup for the waste companies right now. I think what you've seen in the last, maybe month or a little bit more has been some of the weakness on the commodity price side. When you think about recycled commodity prices that can fluctuate, and then the RIN prices, which are a lot of the economics on the renewable natural gas business at the landfills that a lot of these companies have developed, those have declined lately as well.

A RIN is like a credit that you get for producing this stuff, right?

Exactly. It's through the EPA's Renewable Fuel Standards program. It's where petroleum refiners and those types of companies have to buy a certain amount of these credits. They're generated when the landfill gas is used in an application that these companies produce. So both the commodity prices on the recycling and on the RIN side for renewable natural gas have declined. The solid waste business for these companies, meaning kind of the traditional garbage collection and disposal, is usually very, very steady and predictable. You know, the investors really value the predictability of the garbage business, and this is one area where you can get a little bit more volatility. It's when you tend to see the recycled commodities and the RIN prices fluctuate. You know, in April, for example, when Liberation Day hit, we noticed an uptick in investor inbounds to us with interest in these solid waste names because they are so predictable. And I think some of that lately with a little bit of the uncertainty on the tariffs being resolved, the market getting a little bit more comfortable with them. I think you've probably just seen a little bit of investor rotation out of these types of really defensive growth quality names. We've done some analysis of the valuations for the waste group relative to the overall market, and at this point, the premium you've seen the waste companies trade at the last 3 to 5 years on average, you're actually below that now with the recent sell-off.

These are usually premium-priced stocks. It's not often that you get a little bit of a discount like that on these stocks.

Have I got that right? You absolutely have that right. I think the main pushback we get from investors on these names when we recommend them is usually just the valuations are high. And we've seen this with other high-quality service names outside this group even. You don't tend to see that many really obvious attractive entry points. So whenever you get a pullback like this, it tends to be a pretty good buying opportunity. In terms of the premium, I think you have typically seen, I guess over the past 3 to 5 years, I'd say you've seen this group trade at a 15 to 20% premium to the S&P 500 on an EV-to-EBITDA basis, and now you're at about an 8% premium. So still slightly more expensive than the overall market, but definitely less than you've seen over the past 5 years on average.

And when you mention the commodity prices coming down, is that just macro-related? That's just people's thoughts about the economy, or what, what tends to drive that? Is there any concerned that maybe that's going to continue, or those are just kind of things that fluctuate every so often?

Yeah, it's a good question. I mean, they do tend to fluctuate quite a bit, even from month to month sometimes. But, you know, ultimately it's tied to the supply and demand for these recycled products that our companies are processing. When they collect plastics and fibers and cardboards and all that stuff, they run it through their facilities and sell it to a paper mill or a plastic bottling company or something like that. When the tariffs hit in April, I think it's probably fair to say that consumer packaged goods producers who are probably a very large consumer of these recycled commodities because they use it in their packaging, probably took a little step back and said, maybe I want to pause and, you know, see what happens in the world the next few months. So I was just looking at our file that tracks commodity prices over time. At this point, for the main commodities, you're below the 5-year average on those prices at this point. So that gives us maybe a little bit more confidence that even if you do see further downside, it's not going to be hugely significant. But it's just really hard to tell because they can be volatile at times.

Talk to me about how these companies make their money. You know, as a regular homeowner, I see the fellows come by and pick up the trash cans. That's a valuable service and they get paid for that, and that's what I see. But there's more money that's made down the road for these companies. What all are they involved in and where does their money come from?

For sure. So I think with the 4 public companies that we cover especially, there's a very high degree of vertical integration. I mean, you pay them when they collect your garbage at your house, or if you're a small business owner or an industrial facility or anything like that, you pay them to collect your waste. Beyond collection, there are transfer stations which will take a lot of the trash out of the garbage trucks, compact them, and make it more efficient before it's sent off to a landfill or a recycling facility. And that's an important piece of infrastructure. And then beyond that, after it goes through a transfer station, you have the landfill business, which is on an EBITDA margin perspective, the most lucrative business at these companies and the recycling business. So at every point along the way, our waste companies, if they own those assets, are making some sort of return, whether it's revenue or if it's just saving internal costs by dumping in their own landfill versus having to pay a competitor at their landfill to dump. And then now you even have with this renewable natural gas business, once the garbage is in a landfill, it creates this methane over time. And rather than just flaring that off into the atmosphere, which is of course bad for the atmosphere, the companies are able to collect that gas, purify it, extract kind of the pure methane or close to 100% pure methane, and then it becomes pipeline quality natural gas. And so they're able to monetize that as well.

You know, not too far from me, there's an area that I gather used to be a landfill. You couldn't tell it today. It's no longer a landfill. It's been turned into this really lovely park. I gather from reading your research that there's a lot more of that coming in the decades ahead with America's landfills.

Absolutely. I think that was really the main trend that we identified that gives a lot of these companies structural competitive advantages over time. The EPA has this great database of landfills in the US. It may not include every single one, but it includes over 1,200 landfills, which we think is kind of the majority of the current operating landfills. If you look at the projected closing dates, which are just based on the current permits in existence now, almost half of all the landfills that are open today are expected to close by 2050. And what you've seen over the past several decades and still today is the amount of new landfills being created has drastically shrunk. As well. Now the trend has been toward bigger landfills owned by a smaller amount of competitors. And so again, it's the large public companies that we cover that own the majority of landfill volumes in the US now. So it's really been concentrated into a smaller and smaller amount of hands. Yes, I think half of the landfills are expected to close by 2050. I don't think that'll actually happen in practice because I think out of necessity you'll likely see some communities decide they do need to expand and you'll end up with, again, more and more landfills being concentrated in the biggest players' hands.

Yes, I vote for more landfills where everyone else lives, not where I live. I gather that that's how everyone feels. So I can see how that would be a problem and how this coming shortage of capacity would really support higher prices for these services and higher profit margins going forward. And it, there are not many players that are in position to benefit from this in terms of the publicly traded ones, right? This is a business that seems like, as you said, there are many small players, but these large vertically integrated ones, we're talking about just a few of them. Can you run us through the group that you cover and tell us what you think differentiates them?

Absolutely. So there are 5 public solid waste companies or companies that primarily operating in the solid waste industry. So we cover 4 of them. So that would be WM, or Waste Management, is the biggest. Republic Services is number 2. Waste Connections is number 3. And then Casella Waste Systems, which is a smaller regional company based in the Northeast. They are probably, at least in terms of the landfill volumes that we can see, maybe like the 5th or 6th or 7th largest player in the US. There is a 5th company, GFL, who is based in Canada, but also is the number 4 in all of North America, which we, we don't cover, but is very similar to all of our companies. And so what differentiates them? Well, I mean, at the end of the day, picking up garbage is pretty similar everywhere, but there are a lot of specific regional differences. So for one, the Northeast is facing the most, I'd say, critical shortage of landfill capacity. I mean, there's a nationwide shortage of capacity, I guess, but in the Northeast it's especially acute. So Casella, for example, being based in really the New England states primarily, and they've expanded a little bit the last several years. And then otherwise, I think all of the other public companies, the, the primary difference I'd see there at this point would be, you know, the different ancillary businesses that they're in. So for example, Waste Connections has an E&P waste business where they have landfills that dispose of oil and gas drilling. Clippings and things like that, which is a little bit more sensitive to the cyclicality. Republic Services has this Environmental Solutions segment where they will manage hazardous waste. They have landfills that only accept hazardous waste, and they'll have a bunch of industrial cleaning and field services and disaster remediation and things like that. And then Waste Management, they just acquired Stericycle last year. So that is the biggest medical waste company in the country. So picking up sharps and hazardous materials from hospitals and such, and sanitizing and eventually disposing of those items.

The companies that you cover, you have a bullish rating on all of them. Is there one that's a favorite of yours?

So I think with the deep dive that we've done on the industry, we do have a structurally positive view on the solid waste business. So we do favor all 4 of the companies and think they will be good investments over the long term. I think our top pick has, and then will continue to be for the near term at least, Casella Waste Systems. 2 things that are really important about Casella. One, it's essentially just a pure play solid waste and recycling company. So when I was talking about those ancillary businesses for the other 3 companies we cover, Casella doesn't really have any of that because they haven't gotten large enough to where the growth opportunity for the garbage and recycling business has slowed down at all for them. In fact, they have accelerated their M&A in, in that space in the last probably 5 years. And with them being in 10 states now, there's still plenty of runway for them to expand into additional states and to add increasing density to the states that they're already in.

And does that manifest itself in them being a, a faster grower? You see them as being able to grow earnings or free cash flow or what have you faster than the other players?

On a total basis, including the acquisitions, yes, I, I definitely would. It's really to some degree just a function of size. Generally, we see a big M&A opportunity across the whole solid waste business. It's just when you're talking about Casella at a $7 billion market cap versus Waste Management with a $90 billion market cap, there's a big difference in terms of what buying a few mom-and-pop small operators can do for your revenue and your earnings on a percentage basis. I think I would expect most of these companies to have pretty similar organic growth rates, but the M&A opportunity for Casella on a relative basis for their smaller size, it's so much larger.

Last question. These are steady earners. They traded premium prices. So I'm guessing that the upside for investors, what investors should expect or hope to make from these stocks isn't, you know, the same as they might have on a go-go growth stock or, you know, something like that. Where are your predictions for these stocks? Like for your favorite Casella, what would you expect that investors can make there over the coming years in that stock or the next year?

Yeah, it's a great question. So I think generally, as you say, these are typically expensive stocks. So when we make our forecasts and our rating decisions, we don't usually build in multiple expansion into the upside case. I think it's really more about the growth that you'll get. And so Going back to Casella, I think double-digit free cash flow growth compounding over the next several years is a pretty fair assumption. We don't explicitly model that in future years because, you know, we never know when an M&A transaction will happen, but I think it's pretty fair to expect that given the track record and the amount of opportunities out there. And when I say double digits, I think it's a fairly conservative way to describe the opportunity. I think it is a really strong value proposition to investors.

Thank you, Trevor. I want to thank Trevor Romeo at William Blair. Anyone else to thank this episode, Alexis? New York City's rat czar. Yeah, the rats. But that's a public official. We don't have to thank public. Do we have to? All right. Alexis feels like you're doing a pretty decent job. Is that fair to say? Yeah. No more rivers of hot garbage juice. That's a plus. Congrats. And of course, I want to thank all of you for listening. If you have a question that you'd like played and answered on the podcast, I mean, not like romance or fishing or something, it's got to be a little bit invest-y. You can send it in. It might be in a future episode. Just use the voice memo app on your phone and send it to jack.hough@barons.com. Alexis Moore is our producer. You can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen. If you listen on Apple, you can write us a review. See you next week. Data is everywhere, but is it ready for consumption?

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