2023-03-06 11:28:24 ET
Summary
- Waste Management, Inc. is one of those companies to keep in a long-term portfolio when the stock valuation is favorable.
- Even in times of recession, waste collection and recycling are a basic need.
- With several indicators pointing to a recession, investors should take less risk and invest in companies with stable revenue, earnings, and free cash flow like Waste Management.
- In this climate of high interest rates, I prefer to wait for a better price to get in.
Introduction
Waste Management, Inc. ( WM ) is one of Bill Gates' (Bill & Melinda Gates Foundation) stocks. It ranks 4th in his stock portfolio with a current allocation of 15.5%.
Bill Gates has shown that he cares about the environmental footprint in the United States, as his stock portfolio also includes Waste Management's competitor Republic Services, Inc. ( RSG ) and Ecolab Inc. ( ECL ). These are seen as necessary companies that perform strongly even during a recession. With recession indicators pointing to a possible recession within a year, investors should look for stocks with predictable earnings and free cash flow and limit their risks. Waste Management is a company with predictable and growing earnings and free cash flow ("FCF").
Waste Management collects waste and has about 260 active landfills and about 340 transfer stations. It is also the largest recycler in North America and has more than 20 million residential, commercial, industrial and municipal customers .
Waste Management has performed strongly, and its share price has reflected that. Its total return far exceeded that of the S&P 500 (SP500), with an annualized return of 17.8% versus 12.4% for the S&P500. However, the stock's valuation seems on the high side, but the earnings outlook is strong.
Fourth Quarter Earnings And Outlook
Waste Management's fourth quarter results show strong growth in revenue, EBITDA and net income. Revenue for the fourth quarter increased 5.5% year-over-year, EBITDA by 8.8%, and net income by 1.7%.
For 2023, the board expects adjusted EBITDA between $5.8 billion and $6.0 billion, representing growth of 7% on average. This growth rate is strong given the uncertain macroeconomic outlook now.
Waste Management collects gases from landfills and converts them into electricity, which generates additional revenue and serves as a renewable energy source. These gases are called renewable natural gases ("RNG"), and Waste Management is investing heavily to increase the return-on-investment from their projects. Incremental adjusted operating EBITDA is expected to reach $500 million by 2026, while CAPEX is expected to decline. The company is doing well to realize additional returns for shareholders and become an environmentally friendly company.
Dividends And Share Repurchases
Waste Management returns a lot of cash to shareholders, and the company has returned all the cash generated to shareholders over the past 4 years through dividends and a share buyback program. The dividend has grown from $1.42 in 2012 to $2.60 in 2022, representing an annual increase of 6.2%. Currently, the dividend yield is 1.9%, much lower than the risk-free rate of 5.5%. This suggests that Waste Management, Inc. stock's valuation seems a bit on the high side.
If we examine the cash flow statements , we see that the total return to shareholders (dividends + share buybacks) is equal to the net income for the past 4 years. This means that the company returns all of its net income to shareholders. Share repurchases increase the dividend per share and are considered a tax-efficient way to return cash to shareholders. Most companies buy back shares when they believe their stock is undervalued. It also increases earnings per share, and, therefore, lowers the P/E ratio (when the stock price remains the same). In addition, share repurchases can drive up the share price because they reduce outstanding shares and increase demand. So, let's see if Waste Management, Inc. stock is undervalued.
The Stock Seems Expensively Valued
The first metric we look at is the EV to FCF ratio. This ratio includes cash and debt in the valuation equation. Republic Services is a close competitor of Waste Management, and if we include those two companies in one chart, we see that Waste Management is currently more expensively valued than Republic Services. Generally speaking, Waste Management's EV to FCF ratio of 39 is also very expensive. Based on this ratio, I think the company is a bit overvalued.
Another metric to gain insight into the stock's valuation is its P/E ratio, which currently stands at 28. That is slightly lower than its 3-year average of 33, but generally a P/E ratio of 28 is also expensive compared to the general market. The earnings yield is the inverse of the P/E ratio and is usually compared to the risk-free rate. Waste Management's earnings yield is currently 3.5%, which is low compared to the risk-free rate of 5.5%.
Many analysts are positive about its earnings outlook, and 8 analysts expect earnings per share to rise to $7.65 by 2025, representing a P/E ratio of only 19.6. This suggests that the company is undervalued based on its P/E ratio.
In the table, however, we saw that Waste Management distributes all of its net income to shareholders. Suppose net income equals free cash flow, so net debt remains the same. Now we are still left with the high EV/FCF ratio of 39. Although the FCF should increase along with earnings, I think it is still far too expensive in a high interest rate environment.
Conclusion
Waste Management, Inc. is one of those companies to keep in a long-term portfolio when the stock valuation is favorable. Even in times of recession, waste collection and recycling are a basic need. With several indicators pointing to a recession, investors should take less risk and invest in companies with stable revenue, earnings and free cash flow like Waste Management. Waste Management is growing strongly and its prospects look good. And looking at its cash flow statements, the company has been paying dividends for the past 4 years and buying back as many shares as it generated in net income. The company returns all the net income generated to its shareholders. However, there is one caveat, and that is that the Waste Management, Inc. share valuation seems expensive. In this climate of high interest rates, I prefer to wait for a better price to get in.
For further details see:
Waste Management: Predictable And Growing Earnings, But One Caveat