Utility companies aren’t usually fan favorites among investors, but these protected and counter-cyclical companies are my favorites for a long-term portfolio. Consistent cash flow means high dividend yields and sales don’t fluctuate like in other industries.

But rising rates are weighing on utilities and inflation could start to eat into profits for regulated producers. The Utilities Select Sector SPDR (NYSE: XLU) is up just 0.6% over the last year, lagging the broader market by nearly 13% over the 12 months.

There is one industry, however, that shares some of the same characteristics but is less affected by rising interest rates. The industry is highly regulated, and business activity is about as consistent as it comes, even during a recession.

#-ad_banner-#When higher rates and inflation threaten my utility stocks, I look to this industry to take over and provide those solid returns I can count on.

Utility-Like Safety In An Industry Primed For Growth
Companies in waste management are highly protected with regulatory permits for collection routes and to operate landfills. Federal and local approvals around zoning and environmental protection give existing providers almost monopoly status in some markets.

Even on trends to higher recycling, waste is an immutable fact of life with volume growing steadily along with population growth and economic activity. New landfills are extremely unpopular whenever put to a vote, making existing landfills strong assets.

Rates companies charge for waste collection are negotiated at the local level, and almost all commercial and residential property owners are required to pay for service.

The industry is highly fragmented but trending toward consolidation among the top three players, which control approximately 42% of the domestic market. More than a third (35%) of the market is held by small private companies with the remaining quarter held by municipalities.

While smaller players are able to compete, scale and route density are big factors in profitability. Larger, vertically-integrated companies that own the landfills have a clear advantage and can still make money on lower rates.

That puts the smaller haulers at a disadvantage, driving consolidation in the industry. Municipalities, struggling to strengthen their balance sheet, have also been a key driver in the trend to consolidation.

Prices on recycled commodities have weakened since China limited imports late 2017 but recycling accounts for a small percentage of revenue for the top three players. Rising fuel costs cut into margins slightly but the industry is able to recover as much as 80% of fuel costs through special Fuel Recovery Fees charged to customers.

With business almost entirely within the United States, the industry should benefit broadly on tax reform and won’t have to worry about an escalating trade war. The domestic focus also shields the industry from currency issues around the strengthening dollar, a growing problem this year.

On a longer-term outlook, the industry could be one of the biggest beneficiaries of automation with self-driving trucks and robotics in the landfills.

Three Companies Control Waste Collection
Three companies control nearly half of domestic waste management and economies of scale should drive even more consolidation.

Waste Management (NYSE: WM) is the largest of the three with approximately 20% of the $60 billion domestic market. The company owns 249 landfills across the country for a fully-integrated solution. Revenue has grown a consistent 1.2% annual rate over the last five years, but cost savings measures have helped turn that into 5.5% annual growth in operating income.

Free cash flow has grown at a 16% annual rate over the period and the company pays a 4.2% cash return between the dividend and repurchase program. Earnings are expected 25% higher to $4.02 per share in 2018 from last year for a 20.5 times valuation.

Republic Services (NYSE: RSG) controls approximately 15% of the domestic market with 195 landfills and service routes across the United States. The company counts Bill Gates as its largest investor. The Microsoft founder owns a third of the company through his private wealth fund, Cascade Investment LLC.

Revenue has grown just under 2% annually over the five-year period with a 4.2% annualized increase in operating income. The shares pay a 4.5% total cash yield between the 2% dividend and repurchase program. Earnings are expected 25% higher to $3.06 per share in 2018 from last year for a 22.4 times valuation.

Waste Connections (NYSE: WCN) is reaching the economies of scale that will help it increase profitability but currently only holds about 7% of the domestic waste market. To avoid competing with the larger players, the company has focused on secondary and exclusive markets with 90 landfills across the U.S. and Canada. Waste Connections acquired the largest private hauler in North Central Illinois and local collections in Alaska last year.

That strategy has paid off with leadership and growth in its markets. Revenue has surged 23% annually over the last five years though the company hasn’t been as focused on profitability with just 20% annualized growth in operating income.

Shares have surged over the past few years and only pay a 0.73% yield, though the company recently approved an annual repurchase program to take 5% of the outstanding shares off the market. Earnings are expected to be 16% higher to $2.50 per share this year making the company the most expensive of the three at 30.6 times earnings.

Risks To Consider: Waste collection is a highly acquisitive industry which brings execution risks integrating new assets, higher debt burden and the risk of overpaying.

Action To Take: Position in these utility-like businesses for returns that should hold up against potential weakness in the economy over the next few years.

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