This Turnaround May Be For Real

04/12/2007 12:00 am EST

Focus:

George Putnam

Editor, The Turnaround Letter

George Putnam III, editor of The Turnaround Letter, finds a waste processing company that has restructured itself and now looks ready to boost earnings and cash flow.

Allied Waste Industries (NYSE: AW) is a full-service, vertically integrated waste processing company including collection, recycling, and disposal services, and serving about ten million residential and commercial customers in 37 states and Puerto Rico.

Founded in 1992, Allied grew rapidly through the 1990s, culminating in the acquisition of Browning Ferris in 1999 which was financed with more than $11 billion in debt. The stock peaked above 31 in 1998 after rising nearly 900% during the preceding four years.

The economic downturn of 2000the first since the company’s foundingand the fallout from 9/11 led to broad-based weakness that began to affect the company’s profit margins. As results softened, Allied found it increasingly difficult to manage its heavy debt load. Operations suffered as the company’s fleet of trucks (the oldest in the industry) deteriorated, maintenance costs rose, and employee morale declined.

After several years of lackluster performance, a new chief executive officer, John Zillmer, took the helm in 2005. Mr. Zillmer brought extensive operational experience in the service sector from ARAMARK, a food service giant with revenues of $11 billion and 240,000 employees.

Upon his arrival, Mr. Zillmer instituted a strategic plan. After reorganizing the company into five broad regions in 2005, management focused on identifying and fixing underperforming units. By early 2007, 65% of the weaker markets were showing improvement, and other operations had been sold off or shut down. Moreover, the company began to reinvest in its equipment, purchasing more than 1,000 new trucks in both 2005 and 2006.

Allied has also been able to keep revenues growing with modest volume gains augmented by price increases. With revenues growing and operations becoming more efficient, cash flow has improved, allowing the company to pay down some of its debt. During 2006, debt was reduced by more than $200 million.

In addition, Allied has also been able to refinance much of its debt to reduce interest costs and extend maturities. Thus, while total debt is still considerable at $6.9 billion, the company has much more financial flexibility than it did a few years ago.

Allied has some savvy large shareholders who will keep up pressure for better results. Two large and very successful private equity groups, Apollo and Blackstone, control a total of 22% of Allied’s stock.

The waste disposal industry has historically offered stability and predictable cash flow. With new leadership, the company is once again capitalizing on these strengths to produce growing earnings and cash flow. In addition to improving earnings, we foresee a time when the company will reduce its debt burden to a level where it will be able to utilize its cash flow for dividends and stock buybacks. We recommend buying Allied Waste up to $19. (It traded above $12 Thursday—Editor.)

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