Waste Management: Great Business, Great Outlook And A Waste Valuation
Summary
- Waste Management owns an extremely solid business model.
- There is strong evidence that more waste is being produced during the pandemic.
- Waste production in the US shows a clear upward trend since the 1960s.
- Only 32.1% of municipal solid waste was recycled or composted in 2018, offering a lot of potential for the future.
Investment thesis
Waste Management (NYSE:WM) owns an extremely solid business model. There is strong evidence that more waste is produced during the pandemic. The developed world is exporting a lot of plastic waste to other countries, but that could change in the future. Waste production shows a clear upward trend since the 1960s. The percentage of recycled and composted municipal solid waste was only 32.1% in 2018 and that offers a lot of potential for future business.
Introduction
No doubt, Waste Management owns an extremely solid business model. It's the perfect example of a boring company and a great choice when looking for a conservative stock that pays reliable dividends. Many people know that.
In this article I would like to discuss trends and facts that can have a positive long-term impact on Waste Management's business. High quality stocks tend to be expensive and this one is no exception. Anyway, I am going to analyze how the current valuation compares to its historical multiples and aspects I don't like so much about the company.
COVID impact on waste
COVID had a significant impact on many sectors and also on the garbage we produce. At the beginning of the pandemic the World Health Organization estimated a monthly demand of 89 million medical masks, 76 million examination gloves and 1.6 million goggles for the virus response. This huge amount of contaminated products didn't exist pre-COVID and requires a special waste management. An interesting report provides more background information and numbers on how the pandemic impacts our waste production.
The usage of protective clothing and equipment is just one aspect. Stay-at-home and lockdowns have changed our consumer behavior. Demand for takeaway food containers and bubble wrap for online shopping has surged. Parcels, food deliveries, ... produce a lot of waste.
The starting point for almost every piece of plastic is a fossil fuel and a depressed oil price makes new plastic even cheaper compared to recycled one. There was always a gap between new and recycled material, but the weak oil price has widened the gap. We already saw a price recovery, but it's still much more attractive for the industry to produce new plastic.
All in all, the pandemic has significantly increased the production of waste due to the usage of protective equipment, a changed consumer behavior and a depressed oil price. The facts described above also apply, of course, to other players in the business like Waste Connections (WCN) and Republic Services (RSG).
Waste export
Many people don't know that developed countries are exporting a lot of their plastic waste. Until January 2018, China was the main export destination. A new acceptance criteria for recyclable plastic changed that dramatically and the exporting countries needed new acceptors for their waste. The following image shows the impact on US plastic waste exports.
Source: Statista - US plastic waste export
The waste export to China and Hong Kong dropped by 92% and 77%, respectively, between 2017 and 2018. To compensate that, the export quantity to Malaysia, Thailand, Vietnam and others was significantly increased. Again, it's not only the US, predominantly G7 countries export their waste.
The Chinese decision to dramatically reduce the waste import changed the entire export chain and it can happen again. A foreign government might decide to stop importing plastic waste, or another US administration might stop exporting it. Of course, there are many question marks, but I would like to show that there is still considerable potential in the waste business.
Recycling
Waste Management's 2019 revenue mix shows that recycling contributed only 5% to the overall revenue. That's a bit surprising considering the strong trend towards more environmental awareness. On the other hand, it offers great potential for the future.
Source: Waste Management 2020 Investor Presentation
The United States Environmental Protection Agency "EPA" provides some interesting numbers about the municipal solid waste "MSW" production and how much of it is recycled or composted.
Source: EPA 2018 Fact Sheet
The plot on the left shows the total municipal solid waste production in million tons and the per capita generation. The upward trend for waste production since the 1960s is clearly evident.
On the right side the total municipal solid waste recycled and composted in million tons and the percentage of MSW recycled and composted are shown. The absolute number stagnates for a few years, whereas the percentage has actually fallen recently. Only 32.1% of municipal solid waste was recycled or composted in 2018 and therefore there is plenty of room to expand the business. Recycling is more expensive than landfill or incineration, but customers are willing to pay more for greener solution.
Current valuation
We saw a strong performance of the stock in recent weeks. Let's see how that affected the valuation and if there is an opportunity to start or expand a position. The dynamic fair value calculation from DividendStocksCash is used to calculate the fair value based on historical multiples. More details about the method and procedure can be found here.
Source: DividendStocks.Cash
The current valuation of the stock is analyzed with the P/E based on adjusted earnings per share and the historical dividend yield. Based on the time period between 2013 and 2023 (estimated by analysts), the calculated multiple for P/E adj. is 21.8 and the average dividend yield is 2.5%.
By looking at the plot, it's obvious that Waste Management is extremely overvalued based on both parameters right now. The projected annual yield of only 1.7% is coming from dividends only. The dynamic fair value calculation suggests a fair price in the range of $90 to $95, implying a potential 30% downside from current levels.
Risks
Consolidation took place in the waste disposal sector and Waste Management's balance sheet carries quite some debt, interest-bearing debt of $14.326B with $425M interest expense, and goodwill (almost $9B). Considering the solid business, it's acceptable, but something to keep in mind.
Source: DividendStocksCash
Waste Management is the biggest player in the business, but there are strong competitors like Waste Connections and Republic Services and price pressure must always be taken into account.
Conclusion
Waste Management operates in a boring, conservative business and that's a great aspect for many investors. There is strong evidence that more waste is produced during the pandemic. It's not only the obvious protective clothing and equipment like masks, gloves, goggles..., but also packaging material for food deliveries or online shopping. The depressed oil price during the crises made new plastic even more attractive compared to recycled material.
The developed world is still exporting a lot of plastic waste to other countries, but that could change in the future. Waste production shows a clear upward trend since the 1960s. The percentage of recycled and composted municipal solid waste was only 32.1% in 2018 and that offers a lot of potential for future business.
Debt and goodwill must be considered before investing in Waste Management, but I am more concerned about the current valuation of the stock. The dynamic fair value calculation has revealed a significant overvaluation and suggests a fair price in the range of $90 to $95. I like the business and the outlook, but because of the high valuation, Waste Management is only a HOLD.
This article was written by
Analyst’s Disclosure: I am/we are long WM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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