Don't Waste Your Money On Waste Management

Don't Waste Your Money On Waste Management

Investment Thesis

What’s the best business in a world where everybody seeks to acquire more stuff daily? Invest in a company that takes care of all that stuff! Waste Management (NYSE:WM) owns the largest network of recycling facilities, transfer stations, landfills, recycling facilities, and processing plants in the industry.

Being the biggest in this playground pays. WM benefits from a large network to efficiently transport all waste and recycle materials. It also enjoys economy of scale due to its size and owns the largest number of landfills in North America. This is such an important asset that smaller competitors actually pay WM to use its disposal facilities.

The problem I see here is I’m not the first guy who gave some thoughts on WM’s business model. This is how WM’s stock soared, over 150%, over the past five years and now trades at a 26 PE ratio. Is it a smart idea to invest in a boring company with a boring business model with steady but limited growth? Let’s dig deeper to see if there is any value in entering in the waste business now.

Understanding the Business

Waste Management collects, transfers, disposes or recycles waste for commercial, industrial and residential client. It has a wide diversification of clients and activities enabling a stable income flow year after year.

Author’s charts, 2016 annual report data

The company has over 21 million customers with none of them representing over 1% of its total revenue. This is the type of business with a natural barrier to entry. There are significant regulations around waste management and the number of landfills is limited. Therefore, new competitors will have no other choice but to pay a toll to WM or another big player to use their facilities. As this is the type of business that is capital intensive, it makes it difficult for another player to start competing from scratch. It’s not like a tech company could start managing waste with their drone army and their fast shipping warehouses!

Revenues

Source: YCharts

While one may think the business always goes up in the waste disposable industry, you can see that fluctuations arise even in that field. WM sold its waste-to-energy business, Wheelabrator, in 2014. This move hurt WM’s revenue growth the following year, but management did it to reduce its exposure to commodity prices. The company has decided to focus on trash management and recycling products.

Waste Management can benefit from a few growth vectors to boost its revenue in the future. Since the amount of landfills is limited, WM can now charge a “toll fee” for any competitors in need of additional disposable facilities. This is easy and recurring cash flow coming in each year. I also think it’s time for WM to acquire smaller competitors to benefit from its larger size and create synergies.

Earnings

Source: YCharts

After taking a few hits with the Wheelabrator and some landfill impairments in 2014, the company showed an interesting EPS progression. As the economy does well, people consume more, leading to additional trash disposal needs. As long as the U.S. economy grows, you can expect WM’s revenue and earnings to follow this trend.

Management is using a part of its profit to buy back its shares since the last recession. The company has reduced its number of outstanding shares by 13% over the past 10 years.

Source: YCharts

Dividend Growth Perspective

With such a reliable business model, Waste Management has rapidly become a steady dividend grower. WM has successfully increased its dividend for 14 consecutive years. This makes it part of the elite Dividend Achievers list. The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least 10 consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

Source: YCharts

WM’s yield used to be attractive for income-seeking investors until 2016 where the yield went under the 3% mark. The quest for recession-proof business models let several investors to invest in WM. This phenomenon pushed WM’s price to new highs in 2017.

Source: YCharts

If we ignore the impairments of 2014, WM has made a solid job managing its payout ratios around 50%. While I would require a little more dividend growth to get excited, I can appreciate cautious management regarding distributions. Waste Management meets my 7 dividend growth investing principles.

Potential Downsides

Each North American generates a few pounds of trash each day. It seems there is a natural market for Waste Management that will never disappear. However, the amount of trash going to landfills is relatively stable for the past decade.

https://static.seekingalpha.com/uploads/2017/6/30/saupload_Waste-Management-WM-Dividend-Trash_thumb1.jpg

We now see various other ways to dispose of our trash like composting and recycling. A part of the population is looking at taking care of a part of its trash and reducing its waste disposal needs. In a perfect world, this trend would grow in the future. This would be good for the planet, but not the best news for WM.

Also, while the core business model is recession proof, revenues will be affected during a recession. Since WM must invest massively in its truck fleet, any reduction of its volume will result in a more significant drop in earnings.

The biggest problem I see with WM now is a core business evolving in a mature market but trading like a growth company in terms of valuation.

Valuation

Over the past two years, the stock price gained 51% (as at November 9). At first, I thought this was the perfect case of a PE expansion. In other words, you were just ending up paying more money for the same business. However, during the same period, the PE ratio only increased by 13%. Still, WM looks expensive when you look at the current valuation.

Source: YCharts

I think there is a growth opportunity for WM through acquisitions. For this reason, I decided to use the DDM with a dividend growth of 5% for the next decade and 6% afterward. I wanted to see if there is a possibility of entering in a new position at the current price.

Input Descriptions for 15-Cell Matrix

INPUTS

Enter Recent Annual Dividend Payment:

$1.70

Enter Expected Dividend Growth Rate Years 1-10:

5.00%

Enter Expected Terminal Dividend Growth Rate:

6.00%

Enter Discount Rate:

9.00%

Discount Rate (Horizontal)

Margin of Safety

8.00%

9.00%

10.00%

20% Premium

$99.10

$66.30

$49.89

10% Premium

$90.85

$60.77

$45.73

Intrinsic Value

$82.59

$55.25

$41.57

10% Discount

$74.33

$49.72

$37.41

20% Discount

$66.07

$44.20

$33.26

Please read the Dividend Discount Model limitations to fully understand my calculations.

Assuming an optimist scenario, I still find WM overvalued by a mile. This is not exactly what I was expecting. This shows you how difficult it is these days to find solid companies trading at a good value.

Final Thought

After my analysis, I can say I really like the WM business model. I think this company will be around for a long time and will reward shareholders with increasing dividend. However, the high valuation and relatively low dividend growth policy have left me cold. I will revisit WM from time to time, but I’m not willing to pay anything over $60 at the moment.

Seriously, if you made it this far, it’s because you liked what you read. Don’t be a stranger; leave a comment and tell me what you think! I’m asking you one more thing, click on “follow” button (it’s orange, you can’t miss it!) and you will get notified each time I write a great piece like this one.

Disclosure: I do NOT hold WM in my DividendStocksRock portfolios.

Additional disclosure: The opinions and the strategies of the author are not intended to ever be a recommendation to buy or sell a security. The strategy the author uses has worked for him and it is for you to decide if it could benefit your financial future. Please remember to do your own research and know your risk tolerance.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Related:

  • No Related Found

The Original Post is Located Here: Don't Waste Your Money On Waste Management

100
Like
Save