2023-05-16 07:23:33 ET
Summary
- Waste Management has been an excellent low-beta compounder in the past decade, vastly outperforming the broader market.
- The company is seeing ample growth opportunities through industry consolidation, renewable energy, and recycling.
- The current valuation looks lofty with multiples elevated on a historical basis, which could limit the near-term upside.
- I rate the company as a hold.
Investment Thesis
Waste Management ( WM ) is one of my favorite SWAN (sleep well at night) stocks, with shares up over 300% in the past decade. Besides the appreciation in share price, the company also has very little volatility, as its business is highly resilient and counter-cyclical. Despite having grown a lot in size, I believe there are still ample growth opportunities through industry consolidation, renewable energy, and recycling. However, the company's valuation is an issue as the current multiples seem pretty lofty after the rebound. I believe the upside will likely be muted in the near term therefore I rate the company as a hold.
Industry Dynamics
Waste Management is currently the leading company in the US waste management market with 550 collection sites, 340 transfer facilities, and 260 active landfills. It mainly provides services such as waste collection, waste transfer, recycling, and landfill. The company has a diverse presence across different industries including the public sector, residential, manufacturing, and others. The waste management market is very attractive as most services are counter-cyclical and are needed regardless of the economic backdrop. Most of these services are performed regularly therefore they also have a "recurring nature", which further increases the industry's resiliency.
The market size of waste management is also massive. According to Grand View Research , the US waste management market is forecasted to grow from $330.1 billion in 2022 to $487.7 billion in 2030, representing a CAGR (compounded annual growth rate) of 5%. Most of the market expansion is driven by the ongoing increase in waste disposal. While the market growth is pretty weak at just 5%, companies should continue to benefit from industry consolidation, as it is currently quite fragmented.
As you can see in the chart below, only Waste Management and Republic Services ( RSG ) have over 10% market share, while 44% of the market is owned by smaller players. In the past 5 years, Waste Management acquired over 88 companies for $5.5 billion, adding over $1.8 billion in annualized revenue. Given their prior success, I expect ongoing acquisitions to be a major growth catalyst for the company.
Waste Management
NRG Presents A New Opportunity
While core segments such as waste collection and waste transfer have matured, Waste Management is now seeing growth opportunities in smaller segments including renewable energy and recycling. For instance, the company has the largest landfill network in the US and it is aiming to better monetize this asset by transforming LFG (landfill gas) to NRG (natural renewable gas).
It currently has 91 owned facilities to process its byproducts but most of the LFG collected are usually transformed into electricity or industrial gas. In order to expand its NRG capability and increase its capacity, the company is now planning to open 20 new NRG facilities. This could boost the total output of renewable energies by 10%-50% from 120 million MMbtu in 2021 to at least 135 million MMbtu in 2026, with 20% being NRG.
The company is prioritizing NRG over other renewable energies as its demand is expected to rise in the coming decades. According to the management team, the demand for NRG could be 4x to 5x by 2030 due to decarbonization, tighter government regulations, and new renewable fuel standards being implemented. The favorable market tailwinds should benefit pricing and the company expects RNG to generate $500 million in incremental annual adjusted EBITDA by 2026, or 10% of the current annual run rate.
Waste Management
Growing The Recycling Segment
Recycling is another focal point for Waste Management, which currently includes materials processing and commodity sales. There are still a lot of growth opportunities within the segment as it only accounts for roughly 7% of total revenue right now. The demand for recycling is expected to rise rapidly as the usage of packaging and consumer products continues to grow. For instance, the company estimates the demand for plastic material recycling to be 4x by 2030.
In order to capture the growing demand, the company is planning to open or automate 43 MRFs (materials recovery facilities) in the coming few years. It is also expanding into 8 new markets including Miami and Brooklyn, with 4 additional ones pending, as the demand for recycling continues to increase. The expansion should substantially increase the total capacity by 56% from 5 million tons currently to roughly 7.8 million tons by 2026.
On a more micro basis, the company is seeing opportunities through better sorting and processing systems. It is implementing more scanners and control centers to better separate materials, increase capture rate, and reduce residuals. Not only does this improves utilization, but it also boosts the top line as higher-quality materials can sell for a premium of up to 15%. They are also investing more in automation MRFs to improve operational efficiency. These automated MRFs allow the company to cut down on headcount and save over 30% in labor. These efforts combined are expected to generate over $240 million in incremental annual adjusted EBITDA by 2026.
Waste Management
Lofty Valuation
While Waste Management has outstanding fundamentals, its valuation is not cheap by any means. The company is currently trading at a PE ratio of 30.9x, which is quite elevated in my opinion. As you can see from the chart below, the current multiple is near the high end of its historical range, only below the euphoric pandemic period from 2021 to 2022. It also represents a premium of 4.4% compared to its 5-year average PE ratio of 29.6x. The company's latest revenue growth was also pretty underwhelming at just 5%, which should not be enough to support further expansion in multiples. Given the backdrop, I believe the company's upside potential in the near term will likely be limited.
Investor Takeaway
I believe Waste Management has superb fundamentals and should continue to do well in the long term. The waste management industry is highly resilient and the overall waste disposal will only continue to increase as the population rises. This alongside the opportunities in industry consolidation, renewable energy, and recycling should help the company generate very durable long-term growth. Thanks to the company's heavy emphasis on sustainability, it is also ranked highly in different ESG ratings. This allows the company to be included in many ESG funds, which significantly increases the demand from institutions and provides support for the share price. Unfortunately, the current risk-to-reward ratio seems muted given the lofty valuation. Therefore, I believe investors should wait for a more compelling price point before entering.
For further details see:
Waste Management: NRG And Recycling Are Growth Drivers