Resilient demand and steady revenue make this an ideal stock for low-risk investors
New York-listed Waste Management Inc (WM) provides waste management services including the collection, transfer, recycling, resource recovery and disposal services, and operates waste-to-energy facilities. The company serves municipal, commercial, industrial and residential customers throughout North America.
Our case for investing in the company is simple — it is a business that will always have demand and be profitable. Waste management is essential to the population and as the population grows, so will the amount and type of waste. This means waste management companies like WM can expand their business and grow earnings. WM has the largest and most diverse asset and customer base as an industry leader. WM is able to drive efficiency through technology and leverage its industry-leading asset network to achieve revenue growth goals. WM’s business is recession-resilient and — to a certain extent — pandemic-resilient compared to other industries
WM’s largest revenue driver is its collection operations. Collection involves picking up solid waste and recyclables from where they were generated and transporting them to a transfer station, material recovery facility or landfills. About 40% of collection contracts are based on pricing that fluctuates with an index while the remaining 60% periodically increases with market prices. Generally, contracts based on an index are municipal contracts or franchise agreements. Commercial and industrial customer churn is about 9%, implying that customers stay with the company for more than 10 years on average.
The second-largest revenue driver for WM is its landfill operations. The operation and closure activities of a solid waste landfill include excavation, construction of liners and complex air and liquid monitoring and control systems, continuous spreading and compaction of waste, application of approved daily cover, and final capping and monitoring of the landfill. There are different types of landfills to handle different types of waste. The most abundant type handled by WM is municipal solid waste (MSW), which is the trash generated by people and businesses. MSW landfills produce landfill gas and the majority of WM’s MSW landfills have gas-to-energy facilities to convert this gas to electricity that can be sold to many types of customers. Some convert landfill gas to renewable natural gas.
WM’s next significant revenue-generating segment is transfer operations. Transfer stations consolidate waste so that it can be compacted and transported to disposal sites. WM has a network of more than 300 transfer stations where they and third-party hauliers deposit waste. Access to transfer stations is critical to hauliers who collect waste in areas where there are no disposal sites. Fees charged to third-party hauliers are based on the type and volume or weight of the waste deposited, distance to the disposal site, and market rates for disposal costs. WM’s transfer station network allows it to improve internationalisation and manage disposal costs.
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WM performed strongly for the 3QFY2021 ended Sept 30, 2021, as the company saw more than a 14% increase in adjusted operating ebitda and 15% increase in operating cash flow, mainly driven by strong organic growth and integration from the US$5 billion ($6.78 billion) acquisition of Advanced Disposal, which further strengthened its position in the solid waste industry and increasing its market share to 25% in the markets it has a presence in. For the same period, net cash provided by operating activities was US$1.18 billion compared to US$1.03 billion in 3QFY2020, while, free cash flow was US$773 million compared to US$691 million in 3QFY2020.
The full-year FY2021 outlook guided by management is also promising, with a 17% revenue growth and free cash flow of around US$2.5 billion. The company also expects cost savings of over US$150 million from the acquisition of Advanced Disposal and is projected to repurchase an additional US$350 million of its common stock for the full year.
Chart 1 illustrates the company’s operating and net margins, which reflects the company’s strong moat in the business. This is expected as WM has a strong presence in the waste management value chain. The company has a strong track record of positive net income, operating cash flow and free cash flow over the past 10 years as well. WM has relatively attractive yields, as its earnings yield, operating cash flow yield and free cash flow yields are 3.2%, 6.8% and 4.2% respectively, compared to the risk-free rate of 1.8%. WM also trades at a discount compared to regional peers for its forward P/E and forward EV/Ebit at a 16% and 15% discount respectively.
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Sentiments-wise, there are eight “buy” calls, seven “hold” calls and two “sell” calls on the company from analysts. The average target price for the company is around 17% above its current trading price of US$146.25. Our inhouse valuations indicate that the company is worth at least 15% above its current trading price. Waste Management is a stock to buy and hold and is suitable for long-term investors with low risk tolerance.
