Introduction
Roughly one year ago, on August 21, I became bullish on Waste Management (NYSE:WM), America’s largest operator in the industry with the same name as the company.
Since then, WM shares have returned 27%, beating the impressive 24% return of the S&P 500 by a few points. Over the past ten years, shares have returned nearly 460%, more than twice the 226% return of the S&P 500.
What’s so fascinating about this is that we aren’t dealing with a high-tech company, the seller of hot consumer products, or a healthcare company that just found the cure to a widespread disease.
Waste Management collects, disposes, and recycles garbage, using a wide network of hundreds of landfills, transfer facilities, collection sites, and landfill gas-to-energy facilities in both the United States and Canada.
That said, my most recent article on the company was written on May 6, when I wrote the company “May Be Perfect For Your Portfolio” in the title.
In that article, I highlighted three pills responsible for long-term growth.
- Solid growth in general waste management operations.
- Inflation protection in times of sticky inflation (more than half of its operations are priced on the open market. The remaining contracts are index-based).
- Secular growth in waste management (i.e., sustainability).
As my dividend (growth) portfolio is aimed at finding companies critical to certain supply chains, Waste Management would be a great addition, as it offers low-risk, long-term growth tailwinds with secular growth opportunities.
It also has a wide-moat business model, something I’m very keen on.
We assign WM a wide economic moat because we have very high confidence in the firm’s ability to generate excess returns over the next 10 years, and we think it’s more likely than not that excess returns will persist over the next 20 years.
We believe that intangible assets stemming from its irreplaceable landfill footprint is WM’s primary and most durable moat source. Federal and state regulations and not-in-my-backyard activism have made it very costly to operate and close landfills and extremely difficult to receive approval for new landfills. – Morningstar (emphasis added)
The problem is that I never bought WM because I always had a reason, including other investments, my elevated tax bill last year, and savings related to the non-stock investments I was planning.
Now, the stock offers new opportunities, as it sold off after its just-released earnings. While I’m writing this, WM shares are 12% below their 52-week high.
With all of this in mind, let’s dive in!
Strength Despite Weakness
In the second quarter, the company operating EBITDA margins of 30%, which is an all-time high.
This was mainly driven by efficiencies gained from technology investments and effective pricing strategies (pricing power!).
It also helped operating EBITDA to increase by 12% in the first six months of this year – fully organically. According to the company, this was driven by effective price and cost optimization in the collection and disposal business and incremental earnings from investments in recycling and renewable energy.
Moreover, this success started all the way at the top, as the company’s focus on its “customer lifetime value model” is supportive of strong topline growth.
And finally, turning to revenue growth. Our customer lifetime value model continued to drive organic revenue growth from price in line with our full year expectations. Our pricing results relative to plan remain on track, reflecting our team’s focus on using customer-specific data and insights to deliver price increases that keep pace with inflation and margin expansion objectives. Churn remains at 9% and service increases continue to outpace decreases, further reinforcing our execution. – WM 2Q24 Earnings Call (emphasis added)
While some segments, such as roll-off volume, have shown softness, overall volume trends in commercial collection, MSW, and special waste remain strong.
Adding to that, and with regard to yields, disciplined revenue management and cost optimizations should allow the company to perform very strongly in the remaining two quarters of this year.
This includes automation.
According to Waste Management, the automation of recycling plants has improved labor costs per ton by 30% to 35% and increased the blended value of commodity sales by 15% to 20%.
According to the company, it completed automation projects in Pittsburgh and Atlanta, with seven more projects expected to be completed by the end of the year and new additions in New York, Florida, and Portland.
These improvements could expand the company’s recycling capacity by more than 1 million tons.
Combining all costs, second-quarter operating expenses as a percentage of revenue improved by 130 basis points to 60.9%. The company achieved a 90 basis point decline in labor costs as a percentage of revenue, thanks to the aforementioned technology implementations.
An Acquisition That Makes Sense
Waste Management has always been focused on M&A to expand its footprint. This year, it is buying Stericycle, a leading player in a market with significant secular growth trends.
Stericycle is a leader in medical waste disposal, which is very beneficial in a world with an aging population and strong growth in healthcare.
The deal will likely close in the fourth quarter and is expected to come with 13-17% adjusted annual EBITDA growth through at least 2027.
It also adds international exposure, as Stericycle generates roughly 15% of its revenue in Western Europe, including key markets like Germany, the United Kingdom, and Spain.
This $7.2 billion deal (including debt) is a 100% cash deal valuing Stericycle at 13x EBITDA, which is a fair valuation. The company expects the takeover to be accretive to its operating EBITDA within one year.
Moreover, after the deal, the company is expected to lower its leverage ratio to the 2.75-3.00x EBITDA range within 24 months after the deal closes. Until that happens, the company will halt buybacks.
The company enjoys a credit rating of A-.
Shareholder Value
In the first six months of 2024, the company generated $1.24 billion in free cash flow, driven by the aforementioned double-digit operating EBITDA growth rate and favorable working capital trends.
Moreover, WM’s cash flow from operations surged by almost $450 million, or 22% compared to the same period in 2023.
According to the company, it is on track to achieve its free cash flow guidance of $2.00 billion to $2.15 billion for the full year.
This bodes well for its dividend. The WM dividend yields 1.5%, has a 42% payout ratio, a five-year CAGR of 8.2%, and a track record of 20 consecutive annual hikes. In other words, just like its business model, the dividend screams stability.
Adding to that, over the past ten years, WM has bought back 12.4% of its shares, which contributed to its favorable stock price performance.
Valuation-wise, we’re dealing with a mixed situation.
Using the FactSet data in the chart below, WM is expected to maintain elevated growth, potentially growing EPS by 17% this year, followed by 10% and 12% growth in 2025 and 2026, respectively.
Currently, WM trades at a blended P/E ratio of 29.5x. Even after its recent correction, the stock is still expensive, trading almost five points above its ten-year average of 25.1x.
Although I will stick to a Buy rating, as the fair stock price of $224 is roughly 13% above the current price, I want to see a 5-10% bigger correction before I consider making it a core position in my portfolio.
Hence, for the time being, I’ll focus on rebuilding my cash position after a number of aggressive investments this year and hope this fantastic dividend grower comes down a bit – while being fully aware that “hope” is not a good strategy.
Takeaway
Waste Management has delivered impressive returns, outperforming the S&P 500 by a wide margin.
Despite its recent sell-off, I am convinced the company remains a great investment due to its strong fundamentals, efficient operations, and strategic acquisitions like Stericycle.
WM’s focus on technology and automation is driving significant improvements in cost efficiency and revenue growth.
While its current valuation is a bit lofty, I remain bullish on its long-term prospects.
Pros & Cons
Pros:
- Consistent Outperformance: WM has consistently outperformed the S&P 500, offering reliable returns.
- Strong Fundamentals: The company has shown double-digit EBITDA growth and solid margins driven by technology and pricing strategies.
- Strategic Acquisitions: The Stericycle acquisition improves growth potential and international exposure.
- Efficient Operations: Automation and cost optimizations improve margins and operational efficiency.
- Stable Dividends: A 1.5% yield, 20 consecutive annual hikes, and a solid payout ratio indicate dividend/income reliability.
Cons:
- Valuation Concerns: Trading at a P/E ratio significantly above its ten-year average, WM has little room for error when it comes to growth.
- High Leverage Post-Acquisition: The Stericycle deal increases leverage, potentially impacting the company’s short-term financial flexibility.
- Cyclical Sensitivity: While largely anti-cyclical, WM’s performance may still be impacted by macroeconomic factors like a slowing housing market.
- Competition and Market Concentration: Increasingly concentrated markets and competition pose challenges for sustained growth, as growing through M&A is getting harder.
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