With a market cap of almost $15 billion, Waste Management (WM) is one of the largest integrated waste management companies in the U.S. Along with its subsidiaries, Waste Management offers collection, transport, recycling and dumping services. Its facilities include 270 landfills, around 110 material recovery facilities, 290 transfer stations and nearly 20 energy plants. I think the stock is fairly valued based on fundamental metrics and my FED+ model supports this notion.
As of the time of writing, WM stock was trading at $32 with a 52-week range of $30 - $37. Trailing twelve month P/E ratio is 16.2, and forward P/E ratio is 12.5. P/B, P/S, and P/CF ratios stand at 2.4, 1.1, and 5.9, respectively. The 3-year annualized revenue and EPS growth stand at 0% and -2.3%, respectively. Operating margin is 14.3%, and net profit margin is 6.7%. The company has a debt-to-equity ratio of 1.5. WM pays nifty dividends. Based on the most recent quarterly dividend of 35 cents, the stock has a projected yield of 4.43%.
WM has a 3-star rating from Morningstar. While its trailing P/E ratio is 16.2, it has a 5-year average P/E ratio of 16.3. Thus, WM is trading just an inch below its historical P/E ratio. Out of 4 analysts covering the company, 3 have hold, and 1 has sell ratings. Wall Street has diverse opinions on WM's future. The bottom line is 7.6% growth, whereas the top-line growth estimate is 13.9% for the next year. Average five-year annualized growth forecast estimate is 5.4%.
What is the fair value of WM given the forecast estimates? We can estimate WM's fair value using discounted earnings plus equity model as follows.
Discounted Earnings Plus Equity Model
This model is primarily used for estimating the returns from long-term projects. It is also frequently used to price fair-valued IPOs. The methodology is based on discounting the present value of the future earnings to the current period:
V = E0 + E1 /(1+r) + E2 /(1+r)2 + E3/(1+r)3 + E4/(1+r)4 + E5/(1+r)5 + Disposal Value
V = E0 + E0 (1+g)/(1+r) + E0(1+g)2/(1+r)2 + … + E0(1+g)5/(1+r)5 + E0(1+g)5/[r(1+r)5]
The earnings after the last period act as a perpetuity that creates regular earnings:
Disposal Value = D = E0(1+g)5/[r(1+r)5] = E5 / r
While this formula might look intimidating for many of us, it easily calculates the fair value of a stock. All we need is the current-period earnings, earnings growth estimate, and the discount rate. To be as objective as possible, I use Morningstar data for my growth estimates. You can set these parameters as you wish, according to your own diligence.
Historically, the average return of the DJI (DIA) has been around 11% (including dividends). Therefore, I will use 11% as my discount rate. In order to smooth the results, I will also take the average of ttm EPS along with the mean EPS estimate for the next year.
E0 = EPS = ($1.97 + $2.37) / 2 = $2.17
Wall Street holds diversified opinions on the company's future. While analysts tend to impose subjective opinions on their estimates, the average analyst estimate is a good starting point. Average five-year growth forecast is 5.4%. Book value per share is $13.32.
The rest is as follows:
Fair Value Estimator
Fair Value Range
(You can download FED+ Fair Value Estimator, here.)
I decided to add the book value per share so that we can distinguish between a low-debt and debt-loaded company. The lower boundary does not include the book value. According to my 5-year discounted-earnings-plus-book-value model, the fair-value range for WM is between $27 and $40 per share. At the current valuation, the stock is trading right at the middle of my fair value estimate.
While there are many companies in the waste management sector, Republic Services (RSG) is probably the closest competitor of Waste Management. Similar to WM, Republic Services stock did not perform well this year. It returned only 3% so far, which is well below the market average. Republic Services offers a dividend yield of 3.4%, which is also below the yield of Waste Management. My FED+ valuation suggests that RSG is fairly valued at the moment.
Another player, Heckmann Corporation (HEK) is also establishing a stronger position in the industry. After announcing a merger with Power Fuels, Heckmann has also acquired a majority stake in Appalachian Water Services. Compared to WM, Heckmann is a much smaller company. However, Heckmann's bold move into the oil-rich fields could be a strong catalyst for future growth.
Last month, J.P. Morgan (JPM) downgraded Waste Management stock from neutral to underweight. J.P. Morgan claimed that the industry conditions are becoming more challenging as the competition becomes fiercer. The decline in recycled commodity prices and the company's exposure to spot electricity prices were also effective in J.P. Morgan's downgrade decision. The analysts at J.P. Morgan even claimed that "the lower cash flow outlook cuts into WM's ability to increase dividends or buy back shares".
Contrary to J.P. Morgan, our cash flow analysis suggests that WM is a cash spring. The company generates at least $1 billion in free cash flow, which is more than enough to cover the current dividends. Moreover, the interest coverage ratio of 3.38 and debt service coverage ratio of 1.46 indicate that the firm has adequate buffer of funds to service its debt.
WM's nifty yield of 4.43% puts it among the top dividend payers in the industry. Unlike J.P. Morgan, I think that the dividends are totally safe. There is even a potential for dividend growth in the future. Waste Management also has a low Beta of 0.54. In case of a market downturn, WM is likely to show strong resistance to the market sell-off.
According to my FED+ analysis, WM is trading at a fair price. I assumed a pretty conservative growth estimate of only 5.4% in my analysis. Based on this estimate WM has a fair value range of $27 - $40. Several analysts also agree with me. Wunderlich has a target price of $40. Wedbush has a relatively lower target price of $34. As there is an ever increasing need for recycling facilities, I expect WM to increase its revenues as well as profits. There is room for the company to grow in different segments of the business. I expect WM to maintain its impressive dividends.