2023-09-27 23:25:47 ET
Summary
- Waste Management's share price has seen an increase of 74% in the past 5 years but is down over 5% in the past year.
- The company is focusing on renewable natural gas from landfills as a potential area for future growth.
- WM is implementing automation measures to lower operating costs.
- Despite these measures, the company's valuation remains stretched.
Introduction
The renowned investor Peter Lynch was known for his affinity for investing in seemingly mundane businesses. Waste Management ( WM ) fits that description perfectly. After all, what could be more mundane than collecting other people's trash. In the past 5 years, the share price has seen an increase of 74%. However, over the past year, the share price is down over 5% and trades on a forward PE ratio of 26.33. While WM holds a promising position in the growing renewable natural gas from landfill sector and maintains a solid core waste collection business, the current share price seems stretched. Considering this I suggest not to invest new money into the stock.
Company Overview
Waste Management, headquartered in Houston, Texas, is a leader in the waste management and environmental services industry in the United States and Canada. The company boasts a diverse array of services, including waste collection, recycling, material transfer to recycling facilities, efficient disposal site management, and the operation of numerous landfill facilities. Within these landfill facilities, Waste Management actively captures landfill gases, harnessing them for the generation of electricity. Serving both municipal and private clients, the company has established itself as a versatile leader in the field.
Gas from Landfill
Although most of Waste Management's business is mature with no significant volume growth, there is one bright spot that could help drive future growth. This initiative involves harnessing landfill gases by capturing them and then using them to generate electricity. The gas captured is primarily methane and is produced as a natural by-product from the decomposition of organic matter in the landfill.
This is a growing area for the company with Jim Fish, the CEO, stating in the Q2 earnings call :
On the renewable energy front, we opened our Eco Vista renewable natural gas facility in Arkansas during the quarter, the sixth WM-owned RNG facility and the second of our 20 planned projects in our sustainability growth program.
This quote clearly shows management's belief that renewable natural gas from landfill can help drive future growth, with strong market demand for this product and 20 planned facilities. Tara Hemmer, the chief sustainability officer, highlighted later in the call that their project pipeline extends further than the 20 planned sites and they see ample opportunities in the future for monetisation. Analysts at HSBC agree, with them believing that renewable natural gas could add 6% to Waste Management's earnings CAGR rate.
Greater Automation
With much of the business operating in mature markets, Waste Management is increasingly turning to automation to enhance its returns. Automation in recycling facilities, for example, has yielded significant results. Fully automated facilities have witnessed a remarkable 33% reduction in labour costs per ton, leading to an overall 18% decrease in total operating costs per ton.
Another area where automation is making inroads is the replacement of rear-loading trucks with side-loading trucks. These trucks feature a setup where the operator sits in the cab and controls the vehicle using a joystick. This not only reduces the need for manual labour but also enhances safety while delivering a remarkable 25% to 30% increase in productivity. The company only has around 100 trucks like this so far, but in their Q2 earnings call , it was suggested that this could increase to over 1000 trucks in the next couple of years.
The expanding automation initiatives are poised to translate into lower operating costs for the company, potentially leading to improved margins. However, it's worth noting that if competitors also embrace similar automation measures, Waste Management may lose its competitive edge. In such a scenario, the company might need to adjust pricing strategies to remain competitive, potentially affecting margins.
Q2 Results
Waste Management released its Q2 results on July 25th and demonstrated a resilient performance. Earnings were below expectations with non-GAAP earnings per share of $1.51, a miss of $0.04 against expectations. This was on the back of revenue of $5.12 billion, a miss of $110 million, and a small 1.8% growth compared to the equivalent quarter in the year before.
On the back of these results, management cut revenue growth expectations for the year by 100 basis points to between 3.25% and 4.25%, and EBITDA to between $5.775 billion to $5.875 billion. These revisions were indicated to be largely related to the sustainability business where electricity and natural gas prices are lower than expected and lower recycled commodity prices.
Valuation
To value Waste Management, I employed an EV/EBITDA methodology for the period to 2028. I used management's midpoint in their EBITDA forecast for this year. I assumed Waste Management would continue buying back shares at a rate of 1.5% a year, reducing the share count from the current 405 million shares to 373 million at the end of 2028. For purposes of simplicity, I assumed cash and debt levels remain constant.
Based on Waste Management's EBITDA margin over the past 5 years, I expect it to remain constant at 28%, with the large size of the company meaning there is little room for EBITDA margin improvement from economies of scale as revenue grows. For future revenue, I used analyst estimates on Seeking Alpha.
Created and calculated by the author based on Waste Management's Financial Data found on Seeking Alpha and the author's projections
To determine an exit EV/EBITDA multiple, I took the midpoint of the company's 5 year average of 13.72 and the industry average of 10.83, giving an exit multiple of 12.275.
Performing the calculations implies a market cap of $63 billion at the end of 2028. With an estimated 373 million shares outstanding, this corresponds to a price target of $211.50 per share, an upside of 36% from the current price for a CAGR of 6.3% over the next 5 years.
Risks
When investing in Waste Management, I believe there are two main risks to consider.
Firstly, regulatory risk. Waste Management operates in a highly regulated industry, where failure to meet regulations or environmental issues can lead to substantial fines. Additionally, regulations can change, or new ones can be introduced, particularly concerning environmental regulations, waste disposal, or permits. These changes in regulations could result in additional costs of doing business for the company.
Secondly, Waste Management's operations are exposed to volatility in the market price for recyclable materials, given its large recycling business. Changes in recycling commodity prices can significantly impact the company and Waste Management is a price taker for this commodity. Similarly, due to Waste Management's involvement in converting landfill gases into energy, fluctuations in the energy price can affect its revenues and profits.
Conclusion
In conclusion, Waste Management presents a robust and resilient business model, especially with its expanding landfill from waste operations. With the US continuing to produce 4.9 pounds of waste per person per day, the company stands as a reliable long-term player in the industry.
However, while my calculations suggest a potential upside for the shares in the coming years, the projected return of 6.5% CAGR over the next 5 years falls below my investment threshold. Therefore, I assign Waste Management a "Hold" rating at this time. Investors seeking steadiness might find value, but those pursuing more aggressive returns might want to explore alternative opportunities.
For further details see:
Waste Management: A Solid Business, But Valuation Is Stretched