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Waste Management: Throwing Recession Fears in the Garbage
Stock Analysis & Ideas

Waste Management: Throwing Recession Fears in the Garbage

Headquartered in Texas and founded in 1987, Waste Management (WM) provides waste management environmental services to residential, commercial, industrial, and municipal customers in North America. It provides services that range from collection and disposal to recycling and renewable energy generation.

WM recently reported its first-quarter earnings, which led the stock to rally off the back of strong results. On top of that, management believes that the economy is strong based on key leading indicators such as special waste volumes.

Waste Management is undoubtedly a strong company with a measurable competitive advantage that creates value for shareholders. Nevertheless, we remain neutral on the stock because it appears that the upside is currently limited.

Waste Management’s Competitive Advantage

There are a couple of ways to quantify a company’s competitive advantage using only its income statement. The first method involves calculating the earnings power value (EPV).

Earnings power value is measured as adjusted EBIT after tax, divided by the weighted average cost of capital, and reproduction value (the cost to recreate the business) can be measured using total asset value. If a company’s earnings power value is higher than its reproduction value, then that company is considered to have a competitive advantage.

For Waste Management, the calculation is as follows:

EPV = EPV adjusted earnings / WACC
$35.425 billion = $2.834 billion / 0.08

Since Waste Management has a total asset value of $29.22 billion, we can say that it does have a competitive advantage. In other words, assuming no growth for Waste Management, it would require $29.22 billion of assets to generate ~$35.43 billion of value over time.

The second method to quantify a competitive advantage is by looking at a company’s gross margin because it represents the premium that consumers are willing to pay over the cost of a product or service. An expanding gross margin indicates that a sustainable competitive advantage is present. If an existing company has no edge, then new entrants would eventually take away market share, leading to a decreasing gross margin due to pricing wars.

Taking a look at Waste Management, its gross margin has remained flat in the past several years, hovering around 37.6% to 38.7% in the past six years. Therefore, its gross margins indicate that a competitive advantage is present in this regard as well.

Waste Management Creates Value for Shareholders

Great companies often have great management teams who can effectively allocate capital to profitable projects. To get a good picture of management’s effectiveness, we simply need to look at the numbers. A metric we like to look at is the economic spread which is defined as follows:

Economic Spread = Return on Invested Capital – Weighted Average Cost of Capital

The idea is very simple; if the return on invested capital is greater than the cost of that same capital, then the company is creating value for its shareholders through well-thought-out projects. Otherwise, the company is destroying value and would be better off simply investing its money into risk-free bonds.

For Waste Management, the economic spread is as follows:

Economic Spread = 12% – 8%
Economic Spread = 4%

As a result, the company is creating value for its shareholders, implying that management is efficiently allocating capital.

Profitability

In the last 12 months, Waste Management has recorded $2.42 billion in free cash flow. This indicates that the company doesn’t have to rely on equity raises to continue funding its growth. More importantly, its free cash flow has been trending up in recent years. To us, this means that the company’s free cash flows are reasonably predictable.

Risks

To measure Waste Management’s risk, we will first check if financial leverage is an issue. We do this by comparing its debt-to-free cash flow. Currently, this number stands at 5.6.

Overall, we don’t believe that debt is currently a material risk for the company because its interest coverage ratio is 8.7 (calculated as EBIT divided by interest expense).

However, there are other risks associated with Waste Management. According to Tipranks’ Risk Analysis, WM has disclosed 34 risks in its most recent earnings report. The highest amount of risk came from the Legal & Regulatory category.

The total number of risks has remained flat over the past two years, with the longer-term trend being upward, as shown in the picture below.

Dividend

For investors that like dividends, Waste Management currently has a 1.52% dividend yield which is above the sector average of 0.44%. When taking a look at its LTM free cash flow figure of $2.4 billion, its $998 million dividend payment looks safe.

Taking a look at its historical dividend payments, we can see that its yield range has trended downwards in the past several years.

At 1.52%, the company’s dividend is near the lower end of its range, implying that the stock price is trading at a premium relative to the yields investors have seen in the past.

Wall Street’s Take

Turning to Wall Street, Waste Management has a Moderate Buy consensus rating, based on three Buys, seven Holds, and one Sell rating assigned in the past three months. The average Waste Management price target of $166.00 implies 1% downside potential.

Final Thoughts

We believe that WM is an excellent business that is essential and resilient in all economic conditions. That said, analysts collectively don’t see any upside for the stock price, suggesting that its resilient business has already been priced in.

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