Although ‘wide moat’ isn’t a term often applied to small cap investments, this unusual combination does exist.

Take US Ecology, Inc. (Nasdaq: ECOL), a relatively small waste-management firm that handles hazardous, non-hazardous and radioactive waste. With only about $1 billion in market value and sales of $447 million last year, US Ecology is dwarfed by industry giant Waste Management, Inc. (NYSE: WM). That firm is worth nearly $25 billion and boasts annual revenue of $14 billion.

Yet US Ecology displays consistency more often associated with much larger companies. Indeed, revenue and net income grew every year during the past decade (except 2009 and 2010 when the economy was in bad shape). Plus, this year will be the firm’s eleventh straight with a dividend.

Free cash flow, now $43 million annually, is at an all-time high, which bodes well for dividend growth. And despite large acquisition costs last year, US Ecology is in solid financial shape, with debt levels not much greater than the industry average.

Such results would be impossible to achieve without a formidable moat, a term coined by investing legend Warren Buffett to describe hard-to-penetrate economic defenses typically surrounding the strongest companies. US Ecology boasts several.

Recurring Revenue
US Ecology typically generates about 60% of revenue through long-term contracts with government entities and a broad range of industrial waste producers. 

A June 2014 buyout of Environmental Quality Company, a waste management firm with operations throughout the eastern United States, should help enlarge US Ecology’s footprint in key East Coast industrial centers. The acquisition conferred a rare asset, a hazardous waste disposal site. It also came with 13 waste treatment and recycling facilities, raising US Ecology’s total to 19. 

Although this business line carries lower margins, it provides a solid base to support US Ecology’s pursuit of higher-margin but unpredictable special-project work such as emergency clean-ups and unique disposals.

In just the last two quarters of 2014, Environmental Quality added $228 million in revenue and tacked $0.20 a share onto earnings. Between greatly expanded recurring revenue and double-digit growth in special projects, the top line is set to climb about 7% annually to roughly $550 million by 2017. This should support a 10% pace of earnings growth to about $2.35 a share during that time.

Niche Domination
There are only 20 commercial hazardous waste landfills currently operating in North America, says Morningstar. US Ecology now owns five, including one that can accommodate radioactive waste, giving the firm 20% of total domestic capacity. That’s equal to Waste Management and not far behind Clean Harbors, Inc. (NYSE: CLH), another much larger rival with seven hazardous waste landfills.

US Ecology’s radioactive waste disposal site is one of only three in North America.

Moreover, breaking into hazardous waste management is extremely difficult for would-be competitors: The barriers to entry are so extensive that no new sites have been added in the United States for more than 15 years. A big factor here: Regulators tend to resist plans for new hazardous waste facilities, preferring instead for established firms to expand existing capacity.

Even if regulators were amenable to a new site, launching new hazardous waste management operations typically involves a multi-year, costly process of location hunting, zoning approvals and permit applications. Sufficient groundwater containment systems must also be constructed. For established sites, there are onerous and constantly changing regulatory requirements to meet as well.

Expertise
US Ecology serves thousands of customers — about 4,000 last year — in many industries including oil refining, chemical production, power generation and manufacturing, to name a few.

Having a wide range of end-markets lessens earnings volatility by providing exposure to numerous industrial cycles, management points out. It also creates a broad base of customers who count on the firm for know-how in handling many forms of routine waste, like tank and sewer sludges, solvents and metal catalysts, as well as substances involved in cases of accidental environmental contamination.

Customers also rely on US Ecology to navigate the waste management industry’s complex regulatory landscape, an ability honed over six decades of operation. Such expertise is difficult to replicate, and it has enabled the firm to obtain permits spanning more than two decades for three of its landfills, according to Morningstar.

US Ecology also has decades of experience with hazardous waste transport, a value-added nationwide service that’s especially helpful in winning contracts that span across far-flung geographies. The firm operates a fleet of more than 700 specially built railcars and two rail transfer facilities. While this might seem like an undue cost burden, management says the company-operated railcar fleet has reduced transportation expenses by largely eliminating the need for more costly short-term rentals.

Although it handles many hazardous substances, US Ecology has a strong reputation for safety. Its biggest issue in the past few years: allegations by the EPA in 2012 of regulatory violations at a thermal recycling facility in Texas. The matter was ultimately settled a few months ago for $138,000.

Risks To Consider: While its safety record is good, US Ecology is in a risky business with the potential for hazardous waste accidents and costly fines for regulatory violations. Also, an unexpected drop in higher-margin special-project work could mar profit forecasts.

Action To Take –> Investors who favor wide-moat stocks should consider US Ecology, which has developed considerable defenses not often seen in a smaller firm. Projected revenue and earnings give the stock 30% upside potential over the next couple of years. There should be room for a couple dividend raises during that time, too. By 2017, shares could conservatively yield about 1.8%, compared with 1.4% currently.

My colleague Andy Obermueller devotes his time to identifying exceptional companies that are poised to return triple-digit gains investors — much like US Ecology. This has led readers to investments that went on to gain triple-digits. More recently, Andy has been talking about the threat that cyber criminals pose on individuals, multinational corporations and even governments. This is a serious problem, in its infancy and one that will take decades to fight. But don’t let this scare you. Andy has identified four companies that specialize in protecting sensitive information from criminals. These are young firms, just like US Ecology, provide robust upside potential for early investors. If you haven’t heard about this opportunity yet, then I urge you to check out his comprehensive report on how to profit from the world’s greatest threat, by clicking here.