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Waste Management, Inc. (WM) is the largest industry participant in the North American waste management industry.
WM has recently announced its intent to acquire Advanced Disposal for $4.9B which would widen the gap between WM and the #2 and #3 industry participants by market cap (Republic Services and Waste Connections).
I currently view WM as slightly overvalued and have it on my 'Watch List'.
Summary
- WM is the largest industry participant in the North American waste management industry and its recent announcement of its intent to acquire Advanced Disposal for $4.9B will widen the gap between WM and the #2 and #3 industry participants by market cap (Republic Services and Waste Connections).
- The waste management appeals to me in that the barriers to entry are extremely high if you want to become a major player.
- Regardless of the outcome of trade negotiation between the US and other parts of the world, waste will continue to be generated.
- WM’s long-term credit rating assigned by Moody’s has improved 2 notches in the last 4 – 5 years.
- I currently view WM as richly valued.
Introduction
This is the fourth article in a series of articles where I review companies which are on my ‘Watch List’. The company being reviewed is Waste Management, Inc. (WM).
Business Overview
I am attracted to the waste industry and WM in particular because, regardless of the outcome of international trade negotiations, North Americans will continue to generate waste. In my opinion, the waste industry is an industry that is unlikely to be negatively impacted to the same extent as other industries if we encounter an economic downturn.
This certainly is not a ‘sexy’ business but I view the industry as attractive because nobody wants everyone else’s garbage in their backyard. The approval process to get a new landfill site is costly, lengthy, and rigorous. In essence, the barriers to entry to become a major industry participant are enormous.
WM is the industry participant which has attracted my interest because it the largest industry participant; Republic Services, Inc. (RSG) and Waste Connections, Inc. (WCN) are the 2nd and 3rd largest industry participants by market cap.
WM provides comprehensive waste management environmental services and its customer base is highly fragmented; in 2018, WM’s largest customer represented 1% of WM’s annual revenues.
In 2018, WM employed ~43,700 people and it owned or operated 252 landfill sites; this is the largest network of landfills in North America.
In order to make disposal more practical for larger urban markets, where the distance to landfills is typically farther, WM manages 314 transfer stations that consolidate, compact and transport waste efficiently and economically.
WM also uses waste to create energy, recovering the gas produced naturally as waste decomposes in landfills and using this gas in generators to make electricity.
WM is a leading recycler in North America, handling materials that include paper, cardboard, glass, plastic and metal.
WM’s ‘SolidWaste’ business is operated and managed locally by subsidiaries that focus on distinct geographic areas and which provide collection, transfer, disposal, and recycling and resource recovery services.
The ‘Traditional Solid Waste’ business excludes recycling and resource recovery services.
The gap in size between WM and RSG and WCN will be widening shortly. In mid-April 2019, WM announced that it had entered into a definitive agreement under which a subsidiary of WM will acquire all outstanding shares of Advanced Disposal Services, Inc. (ADSW) for $4.9B (includes ~$1.9B of ADSW’s net debt).
ADSW generated 2018 revenues of $1.56B, adjusted EBITDA of $0.427B and employed 6000 people. It serves more than 3 million residential, commercial, and industrial customers, including over 800 municipalities primarily in 16 states in the Eastern half of the United States. Its solid waste network includes 94 collection operations, 73 transfer stations, 41 landfills, and 22 owned or operated recycling facilities.
When you look at WM’s geographic and operational diversification and consider the hurdles it takes to create North American coverage of this magnitude you begin to realize the magnitude of the barriers to entry in this business.
Sure, anybody can start hauling garbage to:
- a local landfill;
- a materials recovery facility, materials reclamation facility, materials recycling facility or Multi re-use facility (MRF) which is a specialized plant that receives, separates and prepares recyclable materials for marketing to end-user manufacturers;
- a Transfer facility;
- an Incinerator
which might lead some investors to conclude the barriers to entry are low. Unless you own facilities in multiple jurisdictions, however, the probability of becoming a major player in this industry is remote. Furthermore, small time operators would have a very difficult time to satisfy the terms and conditions of large contracts.
I encourage you to review WM’s high level presentation presented at the March 5, 2019 Raymond James & Associates 40th Annual Institutional Investors Conference.
Q1 2019 Results
WM’s April 25, 2019 Q1 2019 Earnings Release can be accessed here and its Q1 10-Q can be accessed here.
2019 Outlook
WM’s 2019 outlook can be found on page 3 of its Q4 2018 Earnings Release.
Risk
WM’s senior unsecured long-term debt is currently rated Baa1 by Moody’s. As you can see from the following, WM’s rating has improved a few notches subsequent to early 2003.
The Baa1 rating is the upper tier of the lower medium grade category.
S&P Global amended WM’s long-term debt credit rating to A- at the end of December 2013. This rating is the lower tier of the upper medium grade category and is one notch higher than Moody’s rating.
Both ratings are satisfactory for my purposes.
Free Cash Flow (FCF)
The following reflects WM’s FCF relative to Revenue going back to 2007.
WM experienced a few challenging years but FCF now seems to have been restored to more acceptable levels.
Valuation
I draw to your attention WM’s Consolidated Statement of Operations in the following 10-K reports.
I further draw your attention to pages 33 – 34 in WM’s 2014 10-K in which an explanation is provided regarding certain items that impacted the comparability of 2012 - 2014 results.
Note the restructuring charges in 2012 – 2014 and more importantly the significant Goodwill impairment charge in 2013 and the line item labelled ‘(Income) expense from divestitures, asset impairments (other than goodwill) and unusual items’. In 2013 WM incurred $0.991B in impairment and restructuring charges.
In 2015, WM also incurred a $0.555B loss on the early extinguishment of its debt. Furthermore, WM incurred a $0.112B net expense from divestitures, asset impairments and unusual items in 2016.
In 2007 – 2018, WM reported diluted EPS of: $2.23, $2.19, $2.01, $1.98, $2.04, $1.76, $0.21, $2.79, $1.65, $2.65, $4.41, and $4.45; the average annual EPS during this timeframe is ~$2.56 when we exclude the year in which it reported $0.21.
WM’s PE for 2009 – 2018 was ~16.8, ~18.6, ~16, ~19.2, ~22.7, ~223.1, ~23, ~28.5, ~27.7, and ~16.9. If we exclude 2013 then the average PE is ~21.
FY2019 guidance from WM is for adjusted diluted EPS of $4.28 - $4.38. In addition, FY2019 guidance from 12 analysts ranges from $4.24 - $4.40 in adjusted diluted EPS with the mean being $4.33.
In FY2018 there was $0.25/share in negative adjustments. There will undoubtedly be adjustments in FY2019 and if we proceed on the basis that FY2019 adjustments will be similar to FY2018 then WM should generate ~$4.53 - ~$4.63 in diluted EPS; WM only generated diluted EPS of $0.81 in Q1 so it has some ground to make up in the remaining three quarters of FY2019.
WM is currently trading at $109.35 so using my projected diluted EPS range from above I arrive at a forward PE range of ~23.6 - ~24.1.
I view this as somewhat rich with a PE of 20 or less being a level I consider reasonable. Using my forecast of ~$4.53 - ~$4.63 in diluted EPS I would begin to entertain the thought of initiating a position below ~$93/share.
WM’s dividend history can be accessed here.
On May 14, 2019, WM announced its most recent $0.5125 quarterly dividend which is payable June 21st.
On the basis of a $2.05 annual dividend and a current $109.35 share price, WM’s dividend yield is ~1.87%.
Non-US residents who hold WM shares in taxable accounts incur a withholding tax on dividend income; the withholding tax in Canada is 15% so the $0.5125/share quarterly dividend is reduced to $0.4356/share which reduces the dividend yield to ~1.6%.
I am disappointed to see the dividend payout ratios have not been consistent in recent years. I am willing to give WM the benefit of the doubt that one-time items of the magnitude incurred in 2012 - 2013 will not recur.
The average number of shares outstanding has been reduced from ~465.6 million in FY2014 to ~432.2 in FY2018. As at the end of Q1 2019, the number of shares outstanding amounted ~424.7 million.
The acquisition of ADSW is to be financed using a combination of bank debt and senior notes and not through the issuance of shares.
Final Thoughts
WM certainly experienced its challenges but matters now appear to have been regularized. I am cautiously optimistic WM shareholders will not experience adjustments of the magnitude reported earlier this decade.
The reason WM is on my ‘Watch List’ is because:
- the barriers to entry in this industry are extremely high;
- WM is the largest industry participant and the impending acquisition of ADSW is going to make WM an even more dominant player;
- WM generates strong FCF;
- Management is shareholder friendly as evidenced by the share buybacks;
- The dividend has increased for more than 15 consecutive years with a compound annual growth rate of ~6% over the last 5 years;
- WM’s credit ratings have been improving.
I recognize the sub 2% dividend yield might be unappealing but if WM retraces to ~$93, the dividend yield improves to ~2.2% ($93/$2.05).
I hope you found this article helpful and wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I do not hold a position in WM and do not intend to initiate a position within the next 72 hours.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
