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Over 20 Years of Middle Market Investing | | | |
IRONWOOD’S ENVIRONMENTAL SERVICES INVESTMENT PERSPECTIVE FOR 2024 AND BEYOND | |
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In this post, we will discuss Ironwood’s perspective on environmental services (“ES”) and the firm’s approach to investing within the sector. ES has seen sustained economic growth and robust M&A activity over many years, which has been bolstered as of late by significant tailwinds tied to ESG and environmental sustainability trends. Ironwood has been an active investor within ES for two decades, completing 18 transactions across sub-verticals that include traditional solid waste (hauling & disposal), textile recycling, wastewater/sludge removal, and medical waste disposal. Ironwood is focused on continuing to build our portfolio around three major verticals: i) Traditional Collection & Disposal, ii) Recycling & Resource Recovery, and iii) Specialty Waste. We will go into further detail on each specific vertical in subsequent posts.
Broadly, the environmental services sector is well-positioned to withstand a potential economic downturn given the necessity of its services, continued growth in waste volumes, ability to pass along price increases, and potential positive impacts from the $1.2 trillion Infrastructure Investment and Jobs Act (“IIJA”). Also, sub-verticals within the recycling and specialty waste service industries have the potential for outsized growth given emerging ESG policies and resulting circular economy trends. These tailwinds are being offset by the continuing labor shortages and supply chain constraints, which will likely spur further industry consolidation. With that backdrop, Ironwood will continue to be an active investor within the space, while expanding our focus to include new sub-verticals we feel are particularly attractive. Our most recent investment in John To Go, a provider of portable toilet and restroom trailer rentals and services to customers across a variety of end markets throughout the Tri-State and southern Florida regions, fits well within our strategy of broadening our ES vertical beyond solid waste and recycling services.
Let’s begin by outlining some of the industry trends shaping our thesis:
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Robust M&A activity driving industry consolidation – Collective M&A investing by the solid waste industry’s publicly traded companies approached an estimated $6.3 billion in 2022, up from $4.3 billion in 2021, and is approaching nearly $3.0 billion through the first three-quarters of 20231. Additionally, there has been a proliferation of private equity and investment funds with a focus on ESG considerations and infrastructure that view the ES sector as attractive due to its recession-resilient characteristics, recurring revenue streams, strong margins, consolidation opportunities, and necessity of service. New infrastructure funds entering the financial sponsor ecosystem (e.g., KKR, I Squared, Macquarie, Apollo), are driving increased demand for Tier 1 assets. These M&A tailwinds have been offset slightly in 2023 by the tightening within the credit markets resulting from recent bank failures and rising interest rates. Lenders have become increasingly selective and are driving more conservative capital structures to meet requirements for fixed charge coverage and leverage covenants. Given the capital-intensive nature of businesses within the industry, the recent interest rate increases have also impacted company cash flows and the ability to purchase new equipment needed for both maintenance and organic growth initiatives. | |
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Persisting labor shortages and supply chain constraints – Ironwood’s portfolio, including within environmental services, has been impacted in recent years by the shortage of both skilled and unskilled labor. Labor challenges driven by the COVID-19 pandemic continue to persist, and critical employees to a company’s infrastructure (e.g., truck drivers, machine operators, laborers) continue to be in short supply, which in turn has led to wage inflation. Given these dynamics, companies have put an increased emphasis on recruiting new employees and retaining key talent. Many companies have hired in-house recruiters or invested in human resource executives to ensure adequate labor and enhance company culture to support growth objectives.
Additionally, supply chain challenges resulting from the pandemic continue to hinder access to new vehicles and equipment, creating extended delivery timelines and increased costs. The lack of key parts on hand that are necessary for repairs has also hindered fleet operators and resulted in fleet downtime. As 2024 begins, we will continue to monitor the supply chain to see if manufacturers start catching up on their lengthy backlogs due to the slowdown within the economy.
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Dwindling landfill capacity driving diversion opportunities – U.S. landfill capacity for municipal solid waste ("MSW") continues to shrink. Ironwood has seen this trend firsthand due to our presence and portfolio holdings within the northeast, which has seen increasing tip fees at its limited disposal outlets, as well as alternate methods of transportation (e.g., waste-by-rail) to dispose of MSW and Construction & Demolition (“C&D”) waste. This development has emphasized vertical integration for private equity-owned waste companies, as it is seen as a key differentiator during a sale process that can position a business as a market leader with strategically desirable assets and control over disposal. This trend has also accelerated the interest in landfill diversion and zero-waste-to-landfill ("ZWTL") solutions, as the shrinking landfill capacity will not be replaced at the rate necessary to keep up with projected waste volumes. This global initiative continues to be a key focus for municipalities, as 97 cities and regions have signed on to the C40 cities declaration to advance towards zero waste (U.S. cities include New York City, Philadelphia, San Francisco, and Washington D.C., among others)2. | |
Continued regulatory impacts – Environmental service companies must adapt to an ever-changing regulatory environment. A key area of focus seen in 2023 was around plastics and the determination of which types are truly recyclable. Throughout state governments, we have seen increased Extended Producer Responsibility (“EPR”) legislation being introduced to reduce and regulate plastic consumption. Statewide decisions could ultimately impact future markets for plastic packaging and cause Materials Recovery Facility (“MRF”) operators and haulers to change how they operate. Outside of plastics, other sectors of environmental services, such as organics treatments, hazardous waste disposal, and zero waste, are expected to see further state legislation that could result in varying rules from state to state. For example, Massachusetts instituted a ban on textile and mattress disposal in November 2022, citing its 2030 Solid Waste Master Plan that established a goal to reduce statewide disposal by 30% over the next decade3. | |
Development of emerging technologies to support the industry – The ES landscape is everchanging, in part based on the development of new technologies that assist the operations of existing service providers with solutions to existing bottlenecks or that deliver new efficiencies. Some of the emerging technologies we have taken note of throughout this year include i) devices that actively monitor facilities and activate in case of fire, notifying authorities and mitigating fire damage in the process, ii) alternative landfill covering solutions ("ADC") that preserve landfill airspace and neutralize odors, iii) dumpster monitoring systems that are placed within dumpsters to notify collection companies when to pick up, making routing more efficient, and iv) valet trash services to meet the demands of multi-family housing by simplifying the process of waste removal for property managers. Ironwood is committed to tracking emerging technologies and services within the ES vertical, as they help drive change and result in competitive differentiation. | |
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Conclusion
As the current macro environment continues to add complexity to the M&A landscape, we at Ironwood are eager to collaborate with sponsors and business owners within environmental services to navigate and capitalize on the accelerating trends discussed herein, and feel our flexible junior capital solutions and two decades of experience within environmental services make us an ideal partner.
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To learn more, please visit our website and reach out to one of our environmental service leaders: | |
The information contained herein has been obtained from sources believed to be reliable, but the accuracy of such information cannot be guaranteed. Views expressed are as of the date provided. Ironwood is under no obligation to update this information or to advise on further developments relating to the investments discussed herein. References to a particular investment is not a recommendation to buy or sell such investments. The information contained in this document is prepared for general circulation and is circulated for general information only. Past performance is no guarantee of future results. Any investment contains risk including the risk of total loss. There is no assurance that the investment objectives will be achieved or successful. Please refer to the Firm’s Form ADV 2A Brochure for more information about the Firm, services and fees on file with the SEC, www.adviserinfo.sec.gov. Firm CRD #321642. You may also contact us at 860-409-2100 or visit our website for a complete list of investments at https://www.ironwoodcap.com. | |
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Sources:
1 Waste Dive
2 C40 Cities
3 Mass.Gov
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