Published by Bob Ciura on June 1st, 2017
Trash removal and recycling company Waste Management (WM) might be among the steadiest, most consistent business models in the entire stock market.
It certainly seems to have a boring business model, but boring can be a huge plus for investors.
Being the biggest operator in a boring industry like waste disposal means Waste Management doesn’t have to worry about new technology or start-up competitors putting it out of business.
Given the high regulatory hurdles of the business model, Waste Management has a durable competitive advantage which gives it high returns on capital. The company remains steadily profitable, even when the economy goes into recession.
Dividend growth investors have reaped the rewards of Waste Management’s consistency.
Waste Management is a Dividend Achiever, a group of 264 stocks with 10+ years of consecutive dividend increases.
This article will discuss Waste Management’s business model, growth prospects, and why the stock is an attractive choice for risk-averse income investors.
Waste Management owns and operates waste-to-energy and landfill gas-to-energy facilities. As of its most recent investor presentation, the company had more than 100 recycling facilities, 136 landfill gas-to-energy facilities, 244 active solid waste landfills, and 297 transfer facilities.
In all, the company has more than 21 million customers, with more than $13 billion in annual revenue.
It has a large and highly diversified customer base. The company has the following operating segments:
- Collection (54% of revenue)
- Landfill (18% of revenue)
- Transfer (9% of revenue)
- Recycling (9% of revenue)
- Other (10% of revenue)
Waste Management is the largest operator in the industry.
Source: JP Morgan Aviation, Transportation, and Industrials Conference, page 6
2016 was a great year for the company. Revenue increased 5.0% for the year. Revenue growth came from a combination of acquisitions, organic volume growth, and price increases.
Operating cash flow increased 18% last year.
Going forward, the company is focused on continued volume and pricing increases, along with cost controls, to generate future growth.
Waste Management’s strong results have continued into 2017. For the first quarter, revenue and operating profit increased 8.3% and 10%, respectively.
Earnings-per-share rose 15% in the first quarter. Pricing remained favorable, and volumes rose 1.9% year over year.
Thanks to the consistency of its business model, the company continues to retain key customers while attracting new ones.
Waste Management’s strategy for revenue growth revolves around pricing and volume growth.
Source: JP Morgan Aviation, Transportation, and Industrials Conference, page 11
Customer churn fell to 8.3% last quarter, the lowest level since 2002. Service increases exceeded service decreases for the 13th quarter in a row.
The company is specifically targeting commercial customer growth within the core disposal business. These are more lucrative customers for Waste Management.
Last quarter, commercial volumes rose 2.5%, led by 2.7% growth for industrial customers. At the same time, residential volume fell 1.9% for the quarter.
Aside from commercial customers, another growth catalyst for Waste Management moving forward is recycling, which had struggled in recent years.
Waste Management’s turnaround strategy for its recycling business is starting to pay off.
Source: JP Morgan Aviation, Transportation, and Industrials Conference, page 13
Thanks to improved commodity prices and lower costs, Waste Management’s recycling business added nearly $0.07 to overall earnings-per-share last quarter.
These benefits should continue for the full year. Management expects 2017 to be another strong year for the company.
Adjusted earnings-per-share and free cash flow are expected within a range of $3.14-$3.18 and $1.5 billion- $1.6 billion, respectively.
Adjusted earnings-per-share are expected to grow 7%-9% for the full year.
Competitive Advantages & Recession Performance
Waste Management enjoys multiple competitive advantages. First is that it operates in highly regulated industry, which keeps competitors at bay.
Waste removal is also extremely capital-intensive. These two factors mean it would be extremely difficult for a new competitor to enter the market and take share from the established giant, Waste Management.
This gives the company pricing power. And, Waste Management’s returns on capital tower above its competitors.
Source: JP Morgan Aviation, Transportation, and Industrials Conference, page 9
In addition, the company enjoys a highly recession-resistant business model. Everyone takes out the trash, in good economies and bad.
This served Waste Management well during the Great Recession:
- 2007 earnings-per-share of $2.07
- 2008 earnings-per-share of $2.19 (6% increase)
- 2009 earnings-per-share of $2.00 (9% decline)
- 2010 earnings-per-share of $2.10 (5% increase)
Waste Management grew earnings-per-share from 2007-2010, which encompassed one of the worst economic downturns since the Great Depression.
Valuation & Expected Returns
Using Waste Management’s 2016 adjusted earnings-per-share of $2.91, the stock has a price-to-earnings ratio of 25. This is right on-par with the S&P 500 Index, which has an average price-to-earnings ratio of 25 as well.
As a result, the stock seems to be fairly valued, with the potential for a small expansion in the price-to-earnings multiple, given the company’s above-average earnings growth.
Aside from multiple expansion, Waste Management will generate returns based on earnings growth and dividends. A base-case scenario for future returns could be as follows:
- 4%-6% revenue growth
- 1% cost cuts
- 1% share repurchases
- 2.3% dividend yield
Based on this, total annual returns can reasonably be expected to reach approximately 8%-11% per year.
Dividends will make up a significant portion of Waste Management’s total returns. The stock currently pays an annual dividend of $1.70 per share, good for a 2.3% yield.
This is slightly above the S&P 500 Index average dividend yield of approximately 2%.
And, Waste Management raises its dividend on a regular basis. It has increased its dividend for 14 years in a row, including a 3.6% raise in 2017.
Waste Management has a payout ratio of 58% based on 2016 adjusted earnings-per-share.
Going forward, investors should expect the company to raise its dividend at mid-to-high single digit percentages. It will need to steer a significant amount of cash flow toward servicing its debt, which is considerable.
For example, Waste Management ended last quarter with $8.6 billion of long-term debt, compared with just $30 million of cash on the balance sheet.
Waste Management is a pillar of stability. Investors do not have to worry about competitive threats nearly as much as they do for other companies.
This gives Waste Management margins of safety. Investors have been rewarded for the company’s stability: Waste Management stock price more than doubled in the past five years.
And, Waste Management rewards shareholders with a rising dividend.
Waste Management stock appears to be fairly valued, which means its future returns may be more modest than in recent years.
But, the stock could still be attractive for investors interested in stability and steady dividends.