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Waste Management (NYSE:WM) is the largest provider of waste services in the United States. Their operations include 266 active solid-waste landfills, 390 waste collection operations, and 17 waste-to-energy plants. In 2011 the waste-to-energy plants generated enough electricity to power 705,000 homes, while renewable energy projects at landfills generated enough power for an additional 500,000 homes.

(click to enlarge)WM Chart

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As a possible long-term holding for a dividend-focused portfolio, the company needs to be in an industry that will still be around in a few decades. The waste services industry is a perfect example of this. Waste Management is the dominant player in the industry, and with most customers under long-term contracts the revenue stream should be very reliable. (Presentation - PDF file)

Waste Management currently trades at $32.50 with a hefty 4.37% dividend yield. Of course, yield is only one half of the equation, the other being dividend growth. Here is the ten year dividend history for Waste Management.

YearDividendGrowth
2002$.010%
2003$.010%
2004$0.757400%
2005$0.806.67%
2006$0.8810%
2007$0.969.09%
2008$1.0812.50%
2009$1.167.41%
2010$1.268.62%
2011$1.367.94%

The dividend growth has been a bit sporadic but since 2005 has averaged 8.89%. Let's take a look at the payout ratio, which I will calculate as a fraction of the free cash flow.

YearFree Cash Flow (Mil $)Float (Mil Shares)Payout Ratio
2002$8666180.71%
2003$7265940.82%
2004$96058345.55%
2005$1,21156637.39%
2006$1,21154739.75%
2007$1,22852240.81%
2008$1,35449539.48%
2009$1,18349448.44%
2010$1,17148251.86%
2011$1,14547155.94%

There are two concerns here. First, the free cash flow has been stagnant over the last three years and has declined from a high in 2008. Second, the payout ratio has been growing to support the dividend growth, and obviously this can't continue indefinitely. Because of this I think in the future we'll see a dividend growth rate which is lower than the historic values.

Valuation

I will use the Dividend Discount Model to put an estimated value on the company. This model assumes that the value of a company is purely the sum of all future dividends discounted back today. This is a reasonable valuation method if you are a dividend investor. The discount rate should be your required rate of return, and I will use a discount rate of 8%, which is roughly the long-term growth rate of the market as a whole. I will assume that the dividend will grow by 6% next year, and then let that growth rate decay over 20 years to a perpetual growth rate of 3%, as per the growth table below.

YearDividend Growth Rate
20124.41%*
20136%
20145.85%
20155.7%
20165.55%
20175.4%
20185.25%
20195.10%
20204.95%
20214.8%
20224.65%
20234.50%
20244.35%
20254.2%
20264.05%
20273.9%
20283.75%
20293.6%
20303.45%
20313.3%
20323.15%

*Dividend increase already announced

Using these parameters I arrive at a fair value estimate of $35.50 for a share of Waste Management.

Conclusion

Waste Management is the leader in a necessary industry. The company's revenue stream is extremely stable due to long term contracts and the total amount returned to shareholders since 2007 through dividends and share buybacks is a hefty $6 billion. Even accounting for slowing dividend growth due to payout ratio saturation Waste Management shares currently trade for a few dollars less than my fair value estimate. With a yield of over 4% Waste Management looks like an excellent choice for a dividend-focused portfolio.

Source: Waste Management's Dividend Is A Bargain