Buy, Sell or Hold: Talking Trash about Waste Management

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Nothing is more unappealing than having to discuss the finer points of garbage. While on the contrary, nothing is more exciting than discussing America's transition to a "greener" society.

This is where Waste Management (NYSE: WM) finds itself – caught in the middle of these two discussions.

With a market cap of nearly $19 billion Waste Management is the largest trash collector and processor of waste in the U.S. The company owns 264 active solid-waste landfills and services over 21 million customers.

Waste Management recycled 9 million tons of trash in 2012. It also produces sustainable energy through landfill gas and burning waste.

That's the down 'n dirty basics of the company's operations. But let's do a little bit of dumpster-diving and look somewhat deeper at its business model.

Collection & Landfill

The large bulk of Waste Management's revenues starts with those trucks we see visit our home every week. Waste Management enters into multi-year agreements with local governments and commercial customers for garbage pick-up. The trash then gets hauled to a local landfill or transfer station.

The fees Waste Management receives from these established customers act very much like an annuity since it is unlikely that the customer will ever leave. Local governments are trying to lower costs, so the idea of them starting (or even continuing with) city sanitation departments are quickly discarded.

The startup costs for a new company to enter the field are monumental, thus leaving Waste Management a very wide economic moat around its business.

Plus, the sheer size of Waste Management's operations and its large network of landfills make it monopoly-like in many respects.

The company's closest competitor by comparison is Republic Services (NYSE: RSG) which has 191 solid-waste landfills. Between the two there is actually very little threat from an upstart competitor.

And even if there is a company that has an edge over them in some capacity they are quickly brought into the fold. For example Republic Services merged with Allied Waste in 2008 and earlier this year Waste Management acquired recycler Greenstar.

Recycling

With the acquisition of Greenstar, Waste Management increased its recycling capacity to 15 million tons and has set a goal of 20 million tons by 2020.

However, while Waste Management has embraced the future of recycling the present is not so bright.

In the first quarter of 2013 recycling commodity prices were down 12% from the previous year. A number of reasons for this can be attributed to the lack of demand for commodities due to a slower economy, China's slow GDP growth or the Eurozone crisis to name a few.

But when and if there is an economic turnaround where demand for certain commodities returns, Waste Management's recycling segment will show substantial earnings.

Recycling is one of the three main components of Waste Management's operations which have branded it in the eyes of many as a "Green" company.

Power Generator

Waste Management burns trash. It sounds horrible but it's not. Waste Management owns 17 waste-to-energy facilities where it burns waste in order to boil water and produce steam in fancy broilers. The steam can then be sold directly to the energy companies.

Another odd or perhaps even futuristic way Waste Management produces energy is through a process whereby garbage is used as a fuel source.

Waste Management is very clever by using its landfills to produce compressed natural gas fuel.

The company boasts that through its innovative technology and techniques it produces more electricity than all of the American solar industry combined. You hear that Solyndra!

The company is very motivated in its renewable energy efforts. It looks to increase production 67% by 2020. Estimates are that by then the company will be able to produce enough energy to power up to 2 million homes.

Waste Management even has what seems to be its own little ecosystem of sorts with its California landfill. The landfill is producing natural gas that it uses to directly fuel 300 of its very own trucks. That's quite a neat trick in lowering the company's largest expense – fuel.

By the end of 2012, 13% of the company's fleet (approximately 2,000 trucks) was using natural gas. Waste Management looks to convert nearly 90% of its trucks to natural gas within the next few years at a pace of about 1,000 new natural gas trucks per year.

At current prices, it is estimated that this conversion will save the company $2.50 to $3.00 per gallon in fuel costs. The company even has fueling stations in strategically-placed locations – some of which even serve the public.

Dividend Thrown 'In'

When evaluating Waste Management the first thing that jumps out is its fantastic 3.6% dividend yield. The company has succeeded in increasing its dividend for nine years in a row.

However, Waste Management's very high payout ratio of 82% brings into question whether or not the dividend is sustainable. Basically, the ratio measures how much of its earnings it is paying to its shareholders in the form of dividends. The lower the ratio, the more confidence you can have that it will get paid.

Waste Management is a high free cash flow business. The company projects that it will generate between $1.1 billion and $1.2 billion of free cash flow for 2013.

With this free cash flow, it has more than enough to cover its dividend burden – not to mention it also has $307 million sitting in cash on its balance sheet.

Plus, Waste Management is in the midst of a $500 million share repurchase program which will, in effect, help increase dividend yield further.

One other thing that Waste Management can do with its free cash flow is pay back its absurd long term-debt of $9 billion. With interest rates on the rise the company should address this issue.

Typically a growing company can grow revenues to help offset its interest costs. But even with its move into renewable energy, Waste Management is not considered a growth company.

It has increased revenues at about 0.5% per year over the last seven years. The only way for it to really increase revenues today is through increased volumes.

All things considered, maybe Waste Management should be viewed as a type of utility where high debt levels are more acceptable. After all it is a capital intensive business with its numerous landfills and works under near-monopoly conditions.

Buy Now or Buy Later

Waste Management's share price is up over 23% year to date. That is quite significant considering the slow growth results reported in recent quarters. Obviously, the story laid out above has bled into the share price.

Waste Management Investing

The price has come off its recent highs and has rebounded above its 50-day moving average as it is following the trend of the recent general market selloff and bounce.

Further volatility in the market may have the share price drop a bit and provide us with the opportunity to BUY.

Perhaps a better game plan would be to purchase a portion now and the remainder after Waste Management announces earnings for the second quarter on July 30.

By purchasing after that date, maybe some of the shorter-term investors who view Waste Management as a 'current' growth story or perhaps even an atypical industrial services company will be disheartened and move on.

For me, this is a long-term hold that won't require as much oversight on my end other than making sure that I remember to put out the trash every week.

Check out David Mamos' recent recommendation on a company that sells paper before it turns into trash, the world's largest office supply firm, Staples.

[Editor's Note: If you have a stock you would like to see us analyze in a future issue, leave us a note in the comments below and we'll add it to our list.]

About the Author: David Mamos brings nearly 15 years of analytical experience to the table with a background ranging from big-picture fundamental analysis to highly technical trading decisions. He began his career working as a financial advisor with Royal Alliance in 2001 and helped clients with portfolio management as well as buy-sell decisions before transitioning to the development, implementation and execution of trading strategies for aggressive investors.

Join the conversation. Click here to jump to comments…

  1. John Covington | July 15, 2013

    I would like your opinion of Futurefuel Corp as a good growth stock.

  2. Steve Foss | July 15, 2013

    Take a peek at these:

    NUAN

    and

    http://www.ebsco.com (not on the market yet — that's the whole point; they tripled their number of employees and bought up all the land, even raizing buliding, for parking in my home town)

  3. Peter | July 16, 2013

    The one thing you are overlooking about Waste Management is bankruptcy. If California or many other cities go the way of Detroit, there could be a big hole in WM bottom line, especially if they get 10 pennies on the dollar.

    It is Just a thought, as we know many cities in the US are facing difficult financing situations. Detroit might hold the key to the future and also to WM's bottom line.

    Peter

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