As the saying goes, one person’s trash is another person’s treasure. No company epitomizes that more than Waste Management (WM, Financial).
Waste Management will never be a hot investment idea. Its business model is based on garbage, so it certainly does not qualify as exciting.
But, what Waste Management does offer is stability. It remains steadily profitable each year and pays dividends. It also grows the dividend regularly.
Waste Management is a Dividend Achiever. It has increased its dividend for the past 14 consecutive years.
It is easy to write off Waste Management as a boring stock, but it has proven that boring is beautiful.
Business overview
Waste Management operates in waste disposal. It owns and operates waste-to-energy and landfill gas-to-energy facilities.
It has a very large and diversified customer base. Its customers are in the following industries:
- Collection (55% of revenue).
- Landfill (19% of revenue).
- Transfer (9% of revenue).
- Recycling (8% of revenue).
- Other (9% of revenue).
In all, it has 21 million customers spread across the U.S. and Canada. This protects the company against the risk of any individual customer. Waste Management’s largest customer represents just 1% of its annual sales.
Business conditions last year were challenged. In 2015, Waste Management’s revenue fell 7% to $13 billion.
Still, the company increased adjusted EPS by 13%. It achieved this through a combination of cost controls and share repurchases.
Profit margins remain high for Waste Management, because it provides a necessary service and operates in a stable industry.
Source: JP Morgan Aviation, Transportation, and Industrials Conference, page 14
Conditions have significantly improved this year. Revenue increased 4.4% over the first three quarters of 2016. EPS increased 80% in this period, although it should be noted the prior-year period was impacted by a $552 million debt repayment.
Waste Management’s operating income rose 8.8% over the first three quarters of 2016. Going forward, the company should continue to grow from a variety of catalysts.
Growth prospects
Going forward, Waste Management has solid—albeit unspectacular—growth prospects. It operates in the U.S. and Canada, so it does not have many opportunities for international growth at the present time.
In addition, waste disposal is not a growth industry in general. There are not many parts of the country that do not have waste removal services.
That being said, Waste Management has a strategy for future growth.
Source: JP Morgan Aviation, Transportation, and Industrials Conference, page 10
Its future growth will be focused on higher volumes and pricing as well as acquisitions. Volumes increased 1.6% last quarter.
Furthermore, the company makes strategic acquisitions from time to time, which help boost growth. Acquisitions, net of divestitures, contributed $60 million of revenue growth last quarter. This accounted for 32% of revenue growth for the quarter.
Pricing also expanded by 0.70% last quarter. Waste Management can continue to pass through price increases to continue growing revenue.
The company’s pricing power stems largely from its competitive advantages.
Competitive advantages and recession performance
The waste industry is highly competitive. Waste Management faces threats from a variety of commercial and governmental competitors.
In addition, the business is involved in several matters that face regulatory risk. Some of these include zoning, environmental protection and land use. The permits and approvals necessary for compliance are often time consuming and costly.
Waste Management separates itself from the competition because of its financial strength. It is the largest publicly-traded waste disposal company:
- Waste Management market cap of $31.0 billion.
- Republic Services (RSG, Financial) market cap of $19.2 billion.
- Waste Connections (WCN, Financial) market cap of $13.6 billion.
This provides it with a competitive advantage. As a result, it generates returns on capital that lead its peer group.
Source: JP Morgan Aviation, Transportation, and Industrials Conference, page 9
Waste Management has a strong financial position, and it has worked to reduce its debt load in recent years. This allows it to raise capital at attractive rates and invest in its business to retain its competitive advantages.
Source: JP Morgan Aviation, Transportation, and Industrials Conference, page 17
Its competitive advantages allow it to stay profitable, even during the recession. EPS through the Great Recession are shown below:
- 2007 EPS of $2.07.
- 2008 EPS of $2.19 (5.8% increase).
- 2009 EPS of $2.00 (8.7% decrease).
- 2010 EPS of $2.10 (5% increase).
Waste Management’s reliability is why the stock enjoys a premium valuation.
Valuation and expected total return
The one blemish on Waste Management’s stock resume is that the valuation is a bit high. The stock trades for a PE ratio of 28.
By comparison, the S&P 500 Index has an average PE ratio of 26.
Since 2000, Waste Management stock has held an average PE ratio of 20. As a result, the stock appears to be slightly overvalued.
This is only because the stock has performed so well in recent years. The stock is up 31% year-to-date.
Waste Management’s dividend is a significant boost to shareholder returns. The company has increased the dividend consistently over many years.
Source: JP Morgan Aviation, Transportation, and Industrials Conference, page 16
It recently upped the dividend by another 3.7%. It simultaneously increased its share buyback by $750 million, which will help EPS growth.
A possible breakdown of future EPS growth could be:
- 2% to 4% volume growth.
- 1% price increases.
- 1% acquisitions.
- 2% share repurchases.
- 1% margin improvements.
This would result in 7% to 9% EPS growth. In addition, Waste Management stock has a 2.4% dividend yield. Overall, the stock has expected total returns of 9.4% to 11.4% per year.
Final thoughts
Waste Management’s business model may be boring, but its returns are anything but. Investors have done extremely well over the past few years.
The stock trades at an elevated valuation right now. Income investors may want to wait until a better buying opportunity emerges.
But long term investors should continue to hold Waste Management for its high-quality business and reliable dividends.
Disclosure: I am not long any of the stocks mentioned in this article.
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