FOLSOM, Calif. (
) -- Investing in small-cap stocks is a profitable strategy if you can identify undervalued businesses that are poised to grow.
, a disposal and recycling company with a $2.6 billion market cap, is a strong example.
The collection and disposal industry has been marked by consolidation over the past few years.
bought Allied Waste Industries in December 2008, boosting its quarterly revenue to $2.1 billion and narrowing the gap with rival
. Even smaller players, like Waste Connections, scooped up assets during the recession.
Folsom, Calif.-based Waste Connections has purchased landfills, collection operations and transfer stations from Republic during the past year. These acquisitions added 19% to revenue during the first nine months of 2009, offsetting an 8% decline in organic sales.
Trash collection might not seem like a growth industry, but the green-energy movement will provide a swath of growth prospects in the coming years as scientists develop new ways to convert stored trash to energy. So far, synthesis gas, autoclaves and biofuels can generate energy using decomposing materials. Although no technology has established itself as the preeminent solution, all offer growth avenues as the U.S. and other industrialized nations seek cleaner and cheaper alternatives to fossil fuels.
During the past three years, Waste Connections has increased revenue 12% annually, on average, and boosted profit 15% a year. Third-quarter net income increased 24% to $34 million as revenue grew 16% to $316 million. Its gross margin of 43% and operating margin of 21% are superior to those of larger peers.
Rapid expansion hasn't been without its downsides. Since last year's third quarter, the company's debt has increased 38% to $886 million and its cash has plummeted 97% to $10 million. The company's return on equity and return on assets, both in the single-digits, trail industry averages.
Stocks in environmental and facilities services are also more expensive than the broader market. However, Waste Connections shares are cheaper than those of peers based on earnings, book value, sales and cash flow. The shares trade at a price-to-earnings ratio of 24 and a projected P/E ratio of 19. Those figures represent a discount to the industry averages of 27 and 23, respectively.
The old adage, "one man's trash is another man's treasure," could prove an economic principle of the 21st century. In this respect, Waste Connections offers an underappreciated investment. We rate the stock "buy."
-- Reported by Jake Lynch in Boston.