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.
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.
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.
|Year||Free Cash Flow (Mil $)||Float (Mil Shares)||Payout Ratio|
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.
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.
|Year||Dividend Growth Rate|
*Dividend increase already announced
Using these parameters I arrive at a fair value estimate of $35.50 for a share of Waste Management.
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.