The Capital Cycle Podcast - Mucky Business

Episode Date: August 29, 2025

Waste management can be a highly lucrative endeavour. Edward Chancellor talks to Robert Anstey, a North American Portfolio Manager.For more information, or to access select articles from Marathon’s Global Investment Review publications which accompany this podcast series, please visit www.thecapitalcycle.co.uk  Hosted on Acast. See acast.com/privacy for more information.

Hello and welcome to another episode of the Capital Cycle podcast. I've got with me today Rob Anstey, who's a US portfolio manager at Marathon. And we're going to talk, Rob, about an investment opportunity you've written about that's in the business of cleaning up and disposing of waste from Canada's oil industry. Why I thought it would be interesting to talk about this piece is that it fits with several marathon investment themes. And the first is a current tilting of marathon's portfolios towards smaller caps and away from the large caps

that dominate both the US and the global market index. And there's also been a long-standing marathon theme to invest in cyclical businesses that have strong competitive advantages, what are sometimes called quality cyclicals, And the stock we're going to talk about fills the bill. And then there's an even longer-standing theme in Marathon to invest in businesses that are boring, unglomerous, and sometimes outright dirty, think dredging.

But they often provide the best investments, whereas fashionable growth stocks, possibly AI, today, have historically, over the very long period, if not over the last 15 years have disappointed. So let's start, Rob, with the old Yorkshire proverb that you cite, where there's muck, there's brass. You know, I think you're absolutely right about the boring, unglomerous businesses. I've often felt that you can find the best investments in those areas.

And actually, with regards to the capital cycle, of course, capital doesn't tend naturally to chase after boring, on glamorous businesses. It's much more likely to chase after those fashionable investments. So I think you're right. And I think, I mean, that's historically why value has delivered superior returns to growth is that value was unglamorous and therefore not attracting huge amounts of capital. Value was everything else being equal, trading below book. Growth was trading above books. So I've always thought that the growth value dichotomy could largely be explained by the capital cycle dynamics. And now let's get back to waste and muck.

Yes. In America, the municipal waste stocks have had stellar returns over the last 10, 15 plus years. They trade on very high multiples today, so I don't think this is, it's not an unrecognized story at all. And then when you start to think about why have they been such attractive investments, they've been phenomenal compounders of earnings and cash flow. I kind of put that down mainly to two things. One is they've had pricing power. So if you look at waste disposal pricing, it's far outpaced out inflation over a long period. And then also it's been

industry consolidation. So you've had these companies which have basically bought smaller waste companies at lower multiples than their own and using sort of bootstrapping. They've then taken those assets and filled out their root densities. So if you've got a fixed asset network of landfills and disposal sites, and then you can improve that root density along with your collections, it improves your margins. And so really that's it. It's those two things, really. It's been pricing power and an improvement in margins through consolidation. And you say that they've been able to deliver strong returns. Yeah. And credit investors, even though their top line revenue growth has been lack. Well, no, revenue growth has been strong because of the pricing. What I found

interesting is, if you look at volume growth, actually over the last 20 years, volume growth in terms of actual waste volumes, have been kind of pretty anemic, like 1% a year. Now, if you went back to an earlier period, so from, say, the 1960s to 1990s, actually waste volumes grew quite a bit faster, and that was consumption growth was quicker. People were buying a lot more disposable product. Whereas in the last 20 years, I think what's happened, and if you think about it, it makes total sense, is we use a lot as paper. So that's diminished. We've been encouraged to recycle, being economic incentives to consume less. And spending patterns have tended more towards, you know, larger ticket items as well over that period.

So actually waste volumes in the US have only grown at about a percent a year since the turn of the century. So actually, the incredible compounding these companies have had has not been through volume growth. It's been through pricing power and consolidation. And high returns on capital. And so if you look at just a couple of them now, Republic Services and waste connections, probably the best operators, they trade on PE multiples in the 30s

and EV to EBITDARA about 18 times. So as I say, they're not unrecognised. So let's talk about the Canadian waste business that you've recently invested in. Yeah, I've invested in this small company called Secure Waste Infrastructure. As market cap is about 3.5 billion Canadian. They essentially have a network of transfer sites, disposal facilities,

landfills and so on, that process waste from the energy sector, so from the oil and gas sector in Canada. And they've really built out this network. It's been built out over two or three decades. they have about 70% market share of energy waste disposal. So most energy producers actually outsource solid waste disposal. And then they have around 30% share of water disposal. Most energy producers actually do the water disposal themselves

because they'll often have a water well next to their drill site. So they've got a dominant position in waste disposal. I found that quite attractive. And you say that like the North America, American municipal waste companies, Secure has very strong barriers to entry. Yeah, and I think it's taken a long time to build out this network of assets. So a new disposal facility would cost in the region of $50 million. And I believe that there hasn't been a new facility built since around 2016,

which I think is interesting in and of itself. And this company counts all the major energy producers as its customers. How does business operate? What will happen is if you think about drilling an oil well or a gas well and the life of that, you'll tend to have a lot of solid waste when you first drill the initial well and also at the end of life of the well. Interestingly, water tends to increase across the life of the well. So waste water is created throughout the life of the well. But basically the solid waste will arrive, well either solid or sort of slurry will arrive,

will arrive at the company's facilities either on a vacuum truck or through pipeline. And then the company will, if it's solid waste, it will tend to go to landfill. If it's a sort of slurry, the company has kind of chemicals where they will separate out the sludge from the oil. And then actually that oil is then resold to the market. So there's quite a nice kind of circularity about that business. And then for water, it's either disposed of through deep well injection. Ideally, if the company can get a water contract, it will build a pipeline from the well site.

So it becomes wedded to the customer for that water disposal. If they can get that, that's quite attractive. You know, one key point, I think, is that if you think about the waste streams, about 80% of those waste streams are production related. So in other words, irrespective of what the commodity prices are doing, these companies are still producing oil and gas at any level of oil and gas price. So actually there's a continuous stream of waste. And then about 20% would be related to drilling new wells or completions. So that part of it will be cyclical because obviously if the oil price is low, you're not going to drill a new well, etc.

Rob, tell us a bit about the company's history. I think this is what, in a way, raised my antennae when I was meeting with this company because there's quite a checkered history and it's a little bit like thinking about the bottom of half of the capital cycle and taking back sort of 30 years. Originally there was a company called Canadian crude separators which became CCS Income Trust and this was a stellar stock in the 1990s through the early 2000s, a stellar compounder. So much so that the Globe and Mail in the sort of mid-2000s said, you know, it's one of the best sort of track records of performance of any investment in Canada. Anyway, in about 2007, the founder of the company decided to take it private.

And he did that using 70% debt. And unfortunately, of course, this hindsight is a wonderful thing. But we knew this on the eve of the great financial crisis. Really, it never recovered from that. It then sort of came public again through a merger with a company called New Alter, which I had heard of. By then it was called Tervita. And so Tervita and New Alta merged, but New Alter itself, I think, was quite heavily leveraged.

So it was too much debt. And it was then in 2021, what was then called Secure Energy Services, pounced and bought the assets of Ter Vita in 2020. 21, they paid $1.4 billion for those assets. And you say then that attracted antitrust action from the authorities? Yes. I think you know that you're on to a good thing when the Competition Bureau starts to look at your business and say, hold on a sec. So, yeah, in June of 2021, the Canadian Competition Bureau,

what sort to block the acquisition? And they said that basically secure energy services and Turvita, There were the two largest suppliers, and in many areas, the only suppliers of waste services, the Northern Gas companies in Western Canada. And so the Bureau was worried that that would likely result in higher pricing and loss in quality of service. The fact that they thought that tells you something about the business. You say that the financials understate the underlying profitability of the business. So I think if you were just to do a Bloomberg screen on this company, you know,

it shows up as having $10 billion of revenues and a 4% profit margin. Well, there's basically very misleading numbers because eight and a half to nine of that 10 is basically related to the company's infrastructure business. So it has three pipelines. It's about a quarter of the business. And what it does is it is required to purchase oil from customers, which it then aggregates and moves through those pipelines. and then the oil is then sold back to the end.

So basically it's a pass-through. What they care about is the volume of oil moving through the pipelines, which is actually incredibly profitable for them. But in fact, the numbers to really focus on are that, you know, this underlying waste processing business, you're looking at revenues in the region of one and a half billion Canadian with 32% EBITR margins. But I want to just go back to that history and capital allocation.

This is one of the most extraordinary. ordinary examples of capital allocation I think I've ever seen. Recall, I said, they paid $1.4 billion for these assets. Sure enough, after the Competition Bureau came out, two years later, the Competition Tribunal said, we want you to divest some of those assets. And they were forced to sell 29 facilities to waste connections, one of the municipal waste companies. And waste connections, this was at the start of 2024, paid $1.1 billion for those 29 facilities. Now, in that intervening two-year period, secure waste had actually generated the difference between the 1.1 and the 1.4 in profits. So effectively, they ended up with 70% of the original

asset base for free. Not only that, the profits and cash flow they generated in the interim and the money that waste connections paid them, they bought back a quarter of their stock. And the market hasn't recognised. Oh, no. The shares have gone up quite a lot on the back of it. But this is a relatively new company, if you think about it, is really only formed as it is now through this merger in 2021. It was called Secure Energy Services.

It's only at the start of this year changed its name to secure waste infrastructure to sort of try and highlight that this is a waste processing business. So I think in many ways this is a sort of, unless you're a Canadian, specialist. This is kind of an under-the-radar, relatively new waste processing business that up until now has been followed mainly by oil service analysts. Can I ask you, Rob, about the risk to this investment. Former Bank of England Governor Mark Carney is now Canadian Prime Minister. If you remember, between leaving the Bank of England and landing his job in Canada running the country, Mark Carney was going around warning investors and banks not to invest in hydrogen.

ultra-carbon businesses or related businesses because they would be stranded assets and the inevitable, inexorable move towards net zero. So is there a risk that this business dries up, so to speak, in the coming years? Or how do you see the sort of long-term business flow? I think the risks are twofold in my mind. So one risk is that these waste streams are more cyclical than, for example, or the municipal waste companies. Now, in actual fact, if you look at the volumes of oil production coming out of Canada, it's been about 3% a year over like 30 years. If anything, I could make the argument that the volume growth in this industry is better.

By the way, as you say in your piece, we're not talking about Canadian tar sands. No, no. So is that 3% volume? Does that presumably include tar sands? That would include everything, I think. Right. The gas volumes have been relatively flat, although there are some indications that there's some big LNG projects which could improve that. But I would still feel that actually historically, the volumes in this industry, the waste volumes, have been better than the municipal waste volumes that we talked about at the start.

But of course, that will come with a degree of cyclicality. So I think that's the first risk. And I think where this company will prove itself out will be in a energy down. turn or if commodity prices are low and it's still able to process volumes and get some pricing, then actually people start to realise this is actually a more stable business than it's perhaps being valued at. When it sells the oil back that it's separated from water and back to the energy company, does it get any margin pick up there?

I think it will depend on the contract that they have with the producer, but there could be some cyclicality there. So, as I say, that's the first risk would be some. more cyclicality, given that the ultimate waste stream is a commodity, but as I say, 80% of it is production related. And then I think the second longer term risk is that if we stop using hydrocarbons, then you don't have any waste to dispose of. But when it comes to that, I think that's way beyond my time horizon. I certainly won't be here any longer at that point. But I think in the medium to long term, the prospect for volume growth is actually quite good. The prospect for

pricing power is quite good. You believe really finally that secure is actually more attractive than the much higher rated North American solid waste businesses. In many ways I could argue that because this is a more consolidated industry. It's basically only two players now. It's secure waste and waste connections. Interesting that a municipal waste company has decided to buy these assets. It has higher margins than the municipal waste companies. So it's more consolidated, higher margins, I could argue the volume growth is slightly better, you know, on a long-term basis, and it trades at half the price, less than half the multiple. If the company can prove through the cycle that it can process those waste volumes of pricing,

then it could re-rate higher over time as it gains more recognition from investors. You know, in valuation, you know, this is a three and a half billion Canadian dollar market cap, I estimate that its discretionary free cash flow, i.e. after maintenance cap X, is around $300 million. So it can throw off about 10% of its market cap. Not quite as much, but it's about 11.5 times discretionary free cash flow. And I think that can grow at, you know, mid to high single digits. Not bad. Very interesting story. Look forward to speaking to you again soon. Thanks, Edward. Thank you for your time today.

I hope you will listen to the next edition of the capital cycle. This communication is provided for information purposes only. Please refer to Marathon's website and the Global Investment Reviews for further information, including important disclosures.