Waste Management (WM) is the largest US waste management company involved in the collection, transfer, recycling, and disposal and waste-to-energy services. The company operates through five Groups namely Eastern, Midwest, Southern and Western Groups, which provide collection, transfer, recycling and disposal services; while the Wheelabrator Group provides waste-to-energy services. WM has a solid competitive advantage through ownership of a number of solid landfills which is a necessity for all solid waste management companies. Landfills are heavily regulated and are a high entry barrier for new entrants. WM also operates five secure hazardous waste, 345 transfer stations, 16 waste-to-energy facilities and 5 independent power production plants.
Why we like Waste Management
- Waste Industry is a safe one - The Garbage Industry is one of the safest industries to operate, being relatively recession proof and low competition intensity. The entry barriers in terms of regulation and capital requirements are quite high. Like electricity and water, garbage collection and disposal is one of the essential activities which won't see demand destruction in the near future.
- Growing Dividends - Waste Management has consistently increased dividends in the last few years, as it diverts more of its earnings to shareholders due to limited growth opportunities. Dividends have increased steadily from 75c/share in 2004 to $1.36 in 2011. The payout ratio has also increased from ~46% to 67% during the same period.
- Possible conversion to REIT - Waste Management may convert itself into a REIT, which will substantially reduce its tax outgo making it more attractive from a profit viewpoint. A number of companies have recently converted themselves to REITs, to take advantage of the favorable tax treatment as well as greater investor appetite for dividend securities in a low interest rate environment.
- Recycling and Efficiency are secular growth trends - As the human population continues to grow and resources become increasingly rare, recycling will become more and more important. Waste Management gets a substantial chunk of its revenues from recycling of waste. Though recycling revenues have declined recently due to commodity price decrease, the long term future seems quite bright. Efficiency plays will also become more important as the human race tries to improve efficiency. Waste Management is one of the leaders in the waste management technology area.
- Investing in CNG Transportation will pay-off in the future - Waste Management is converting its fleet to run on natural gas to reduce fuel expenses. The company has already built 17 CNG stations and looking to build more to power its NG truck fleet. NG has a 40% advantage over gasoline in North America and will start to generate big cost savings for WM in the future. The company is using newer NG transportation technologies from companies like Westport Innovations (WPRT).
- Waste to Energy Potential is not fully Realized - WM has 669 MW of waste to energy capacity, as it uses waste to generate energy revenues. Note the fuel for WTE plants has a negative cost for WM, since it takes money to collect waste from customers. The company can continue to extend its WTE capacity as it has thousands of tons of waste which is not converted into energy. WM is also looking into turning trash into other useful products like chemicals which will generate additional revenue without too much increase in costs.
- Landfills provide a competitive moat - Solid Landfills are the biggest competitive barriers for big waste management companies like Republic Services (RSG). Starting a solid landfill has become very difficult due to stringent environment regulations which mean existing landfills have become very valuable assets. With more than 200 solid landfills, WM has the biggest portfolio amongst waste management companies.
Waste Management Risks
- Flat Revenues and Profits - WM revenues and profits have hardly increased in the past 5 years, with revenues flat at around ~$13 billion and profits at ~$1 billion. The company operates in a mature industry which does not have a lot of scope for growth. With flat earnings, growing dividends is a difficult task. The company's payout ratio has increased to more than 66%, from 47% in 2004.
- Commodity Prices Declining - The slowing down of global economic growth has hurt WM through declining commodity prices. As WM receives less money for its recycled commodities, the revenues from this segment have gone down. We don't see much chance of rebound in commodity prices in the near future.
- 2012 Earnings Revision - WM has kept lowering its earning guidance for 2012 due to the macro headwinds. The company lowered its earnings by ~4% in its current quarter, due to the declining commodity and energy prices. The company has been hurt by the lower electricity prices in the US, due to the low natural gas prices.
WM has traded in a narrow range of ~$24 to $39 in the last 5 years, hitting a high of ~$39 in April 2011.The stock has underperformed the S&P500 by ~10 percentage points in the last year. The company has performed more or less in line with the S&P500 and RSG giving a return of ~9% in the last 5 years. WM is a low beta, solid US utility stock which can be held as insurance during volatile times such as the Lehman crisis.
WM trades at a conservative valuation forward P/E ratio of 13.1x which is a ~15% discount to the S&P 500. Waste Management gives a dividend yield of 3.9% which is more or less the same as the industry average. The company's P/B at 2.7x and P/S of 1.2x is also in line with the rest of the industry.
Waste Management is a safe dividend paying utility, which offers upside options through monetization of its trash through WTE plants. The company will also benefit through the long term secular growth trends in recycling and efficiency. The company has focused on the waste management business by growing in adjacent areas like providing waste consulting and waste to energy services. The company faces some risks due to the slowing global economy and lack of growth options. However, we like Waste Management because of its leadership position in a relatively recession proof industry, high entry barriers, and a decent dividend yield. We think buying Waste Management will help in diversifying a dividend portfolio, which in general has a high percentage of electric and gas utilities.