2023-11-14 20:11:45 ET
Summary
- Waste Management's financial performance remains strong, with a 2.5% YoY increase in revenue and a 4% increase in net income.
- The company has a P/E ratio of just under 30 and a modest dividend of 1.7%.
- Waste Management's FCF yield is around 3%, making it an expensive investment compared to U.S. treasuries offering a 4.8% yield.
Waste Management ( WM ) continues to receive accolades. The company operates in an incredibly strong industry, and that strength is reflected in its valuation, and a share price that has dropped much less than the overall market. As we'll see throughout this article, Waste Management is a great business that's dramatically overvalued.
Waste Management Financial Performance
The company's financial performance remained strong YoY.
Waste Management Press Release
The company has just under $15 billion in net debt . In the most recent quarter, the company earned $5.2 billion in revenue, a roughly 2.5% YoY increase. That was less than inflation. The company's net income managed to increase further as margins improved some, improving by almost 4%. Supported by share buybacks, EPS managed to increase ~5%.
That annualized gives the company a P/E ratio of just under 30. The company maintains a modest dividend of 1.7%, and the rest of its cash goes towards share buybacks primarily.
Waste Management Free Cash Flow
Perhaps more important than financial importance is the company's FCF.
Waste Management Press Release
The company had just under $1.3 billion in net cash provided by operating activities along with just under $500 million in capital expenditures. This resulted in just under $800 million in FCF not counting growth. That was a much stronger YoY performance. The company spent some capex on growth, resulting in just over $600 million towards shareholder returns.
This is the total that the company can use to provide shareholder returns. However, with the recent rise in interest rates, it's also worth noting the company's debt could cost $500 million in additional interest expenditures, depending on how long rates remain higher. That's because the company has hefty debt and interest rates have gone up substantially.
Interest, on the other hand, will be more significant. As I mentioned in my prepared remarks, about 20% of our debt is at floating rate. When I look at that, combined with the rate resets on maturing debt, you've got about $2.2 billion of our debt balances that will be exposed to some rate lease set in the next 12 months. We're currently projecting that could be about $100 million headwinds in the year ahead, but more color because, candidly, that number has changed very dramatically in the last 3 months. Source .
Here's the statement from management on that floating rate debt. The company is already acknowledging the impact of higher rates on its core floating rate debt, which is expected to be more immediate. The size of the impact is also very noticeable, with a 5% net rate increase on floating rate debt over a 1-year period alone.
That shows that if rates remain higher for longer as the company's debt rolls over expenses could go up dramatically.
Our View
The comparison for an individual investment in Waste Management is two-fold.
The first is a pure investment in something like U.S. treasuries. The current 30-year yield on the U.S. treasury is ~4.8% and it shouldn't be tough to make the point that U.S. treasuries are lower risk than the equity of a singular company. So the question then becomes returns and what are the potential of those returns.
Waste Management has a ~3% FCF yield, and its long-term FCF matters more than EPS. That's because in our view share repurchases don't count when you're growing steadily because you're just forced to reinvest shareholder returns. Let's assume that the company can continue growing that FCF at 4% annualized.
As we can see revenue growth is slower and most growth is operating margin improvement, but we'll assume that can continue forever. At that rate, it takes 13 years for that 3% FCF yield to line up with what your 30-year bonds are paying you. Summing it all up at the end of the day the cash flow from your bonds is 150% of the purchase price over 30 years.
For your Waste Management investment, doing the summation of the compound interest per year, the answer is 175%. So over 30 years, you manage to outperform by a fraction of a %, with a riskier investment. Keep in mind most companies don't even last that entire time in the S&P 500 , 30 years is a long time.
This provides an indication of how the company is overvalued, given its minimal growth and a high-yield environment.
Thesis Risk
The largest risk to our thesis is the company accelerating its growth rate dramatically. A 1-2% change in growth rate would dramatically change the math and help support Waste Management as an interesting growth opportunity or investment opportunity.
The second risk to our thesis that could support the company's long-term growth is the "sweet spot". Regulations are increasing, which is putting pressure on the company, but increased pressure can also decrease competition. That could enable the company to increase prices, increasing its earnings with minimal cost.
Conclusion
Waste Management is an expensive company in a high-yield environment. The company trades at just a few % FCF yield not counting the risk that rising interest rates pose towards its debt. Additionally, current 30-year bonds are now offering almost 5%, an incredibly strong yield versus the company's current valuation.
The company, at its current growth and valuation, could offer returns for investors with an incredibly long time period versus bonds. However, it's also worth noting that during that same time, there are risks to the company's ability to maintain its growth and staying power. Those risks are worth paying close attention to.
For further details see:
Waste Management Can't Justify Its Valuation