Headwinds For Waste Management Inc.

Feb.27.14 | About: Waste Management, (WM)

Waste Management Inc. (NYSE:WM) is the leading provider of widespread waste management and environmental services in North America. The company is involved in collection, transfer, recycling and resource recovery, and waste disposal services. Additionally the company owns waste-to-energy and landfill gas-to-energy production facilities and its customers include residential, commercial, industrial, and municipalities in the U.S.

The company has recorded 2.45% growth in its revenue for FY 2013 in comparison to FY 2012 as shown in the table below. The U.S. waste management industry is going through evolving trends such as consumer sentiments regarding waste reduction in daily lives. Therefore, I am writing this article to determine what contributed to the current top-line growth of the company and if this revenue growth will continue in the years to come.

Source: WM 2013 10K Filing

Current Revenue Drivers and their Performance

You can see from the table above that the company generated 81.64% of its revenue from solid waste treatment services. The business has recorded 3.22% growth mainly due to the performance of collection, landfill and recycling services as shown in the table below.

Source: WM 2013 10K Filing

You can see from the table above that the collection, landfill, and recycling services are the major revenue generating services for the company. Combined, these services generated 91.18% of the company's total revenue for FY 2013. The company's collection as well as its recycling services recorded a decline in their revenues in FY 2012, but a recovery was logged in FY 2013.

Now let us determine some of the key evolving trends for the industry in which the company operates. These will impact the company's upcoming revenue performance, and we can determine the outlook for the company's revenue growth based on these headwinds.

Headwinds for Revenue Growth

Collection Services to be Affected by Consumer Sentiment

The company's customers are progressively diverting waste to alternatives to landfill and waste-to-energy disposal such as recycling and composting. Moreover, the consumers are also working to reduce the amount of waste they produce. Additionally, various state and local governments oblige recycling and waste reduction instantly at the source and forbid the disposal of certain types of waste, such as yard and food waste, to be carried to landfills or waste-to-energy facilities. In other areas where such organic waste is not forbidden from the landfill or waste-to-energy facility, some large customers such as grocery stores and restaurants are diverting their organic waste from landfills. Zero-waste targets (transferring no waste to the landfill) have been set by many of North America's leading companies.

In line with current trends, the collection and landfill business remains dull, and the outlook for 2014 looks similar to that of 2013.

Landfill Revenues to Be Affected by Lower Natural Gas Consumption and Demand

The company's landfill operations generate revenues from turning landfill methane gas-to-energy and selling the product as natural gas to run generators in order to produce electricity. The following chart forecasts the recovery in natural gas consumption to generate electricity in 2014. Growth in the consumption of natural gas to produce electricity will come in 2015, but the growth rate is projected to be less than 1%.

Source: EIA

You can see the same pattern of use of natural gas to generate electricity is evident in the following chart. Twenty-seven percent of electricity is forecasted to be produced using natural gas in the year 2014, a fall from 27.5% in 2013. In 2015, the proportion of natural gas to generate electricity will return to 27.5%.

Source: EIA

The company also projected that the long-term trend of energy prices and disposal volumes in the plants will not radically improve from current levels. The stagnant natural gas prices in recent years has already hindered the company from getting desired results from its landfill and waste-to-energy operations.

Recycling Revenues to Be Affected by Paper Pulp Market Outlook

The bulk of the recyclables that the company processes for sale are paper fibers, including used corrugated cardboard and old newspapers. The fluctuations in the market prices or demand for paper pulp negatively affected the company's operating results as seen in the company's financial results of FY 2012 and FY 2013.

The increasing emphasis on electronic media continued to hurt the newspaper and magazine business in 2013. The NPTA Alliance has projected a drop in return in the Paper & Products Production Index, commending producers to "stay competitive on pricing." The Alliance presumes the Pulp, Paper & Board Mill Production Index to continue posting meek gains in 2014 and perhaps stagnate by 2015. The Paperboard Container Production Index could hit a negative streak in the latter half of 2014. The Paper Bags & Treated Paper Products Production Index could also smash a similar knock from anticipated falloffs in retail sales. Finally, the Paper Producer Price Index is expected to remain legitimately strong during 2014 as rising energy costs will keep prices high.

P/E and My Take

The company's stock is currently trading at 196.1 times P/E ratio that is high above the industry average of 42.6%. This has made the stock overpriced. Additionally, the company's 3-year average revenue growth is 3.8% which is also below the industry average of 6.5%. Although the company recorded a slight recovery in its revenue growth in FY 2013, I do not see the company's revenue growth improving in FY 2014. This is due to the headwinds that are likely to impact the revenue performance of three major revenue driving services of the company. These headwinds include changing consumer sentiments towards waste generation and management and moderate natural gas and paper industry growth. Considering all of these factors and the stock being overvalued based on P/E, I recommend a sell position for the stock.

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

Business relationship disclosure: The article has been written by a Blackstone Equity Research research analyst. Blackstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Blackstone Equity Research has no business relationship with any company whose stock is mentioned in this article