Salvage from Garbage

09/29/2009 12:01 am EST

Focus: GLOBAL

Gavin Graham

Chief Strategy Officer, INTEGRIS Pension Management Ltd

Canadian trash hauler IESI-BFC is mounting a comeback after its stinker of a dividend cut, writes Gavin Graham in The Income Investor.

Garbage collection is one of the more stable businesses around. IESI-BFC (TSX: BIN, NYSE: BIN) (formerly BFI Canada) is an excellent example of this enduring stability, having managed to grow its revenue over the last 18 months through one of the worst recessions in the last 50 years.

Granted, picking up nonhazardous household and business waste, transporting it to collection and sorting stations, and disposing of the unusable remains safely is about as boring as it gets. There are, however, few competitors, surprisingly high barriers to entry, and high and rising margins to recommend it as an industry.

Now rechristened IESI-BFC to emphasize its US operations (its stock ticker symbol has been changed from BFC to BIN, reflecting its core business), the stock did not do well when I recommended it the first time around as an income trust. Management decided to cut the distribution sharply in late 2008 by a greater amount than a number of investors felt was justified by the company's operational performance.

The reason for such a large cut in the payout was the transformation of the operation from a stable, income-generating model to a more growth-oriented company. This was precipitated by some of the major players in the US waste management business who decided to merge—for example, Republic Services (NYSE: RSG) merged with Allied Waste—and needed to spin off subsidiaries to avoid monopoly concerns. This activity allowed smaller operators such as IESI-BFC to grow by acquisition.

Investors who had bought primarily for the income stream expressed their unhappiness by selling the stock, even though their protests persuaded BFC to pay an extra 50 cents in distributions this year on top of its reduced dividend level of 50 cents a year, down 72% from C$1.825 last year. The company also transformed itself from an income trust into a corporation in November 2008, thus avoiding the restraints on issuing stock and growing the business which the change in taxation in 2006 had introduced.
 
However, although the stock has given a total return of 40% year-to-date and has outperformed the S&P/TSX Composite by 10%, it is still down 24% from a year ago, underperforming the index by [ten percentage points] in that period.

Because of the higher municipal ownership, aggressive "green" initiatives to improve recycling rates by increasing the cost of disposing of garbage in landfills, and longer collection contracts (five to seven years compared to two to three years in the US), Canadian EBITDA (earnings before interest, taxes, depreciation, and amortization) margins in the industry are higher than in the US (16.8% vs. 16%). BIN had the second-highest margins among the listed waste collection companies over the last few years (27.8%).

BIN's management is well-regarded for its ability to expand margins by effective scheduling of the collection operations. This has seen the EBITDA margins in the southern US division of its IESI acquisition expand by 570 basis points from the takeover in 2005. The acquisition of Winter Brothers in New York City, largely a garbage collection company, was done to drive business through to its three landfills.

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