2023-12-23 07:23:20 ET
Summary
- Waste Management's acquisition of Advanced Disposal Services strengthened its position in the US solid-waste industry.
- The company achieved better-than-expected results in Q3 2023, with reduced operating costs and maintained its outlook for 2023.
- The stock is trading at a premium valuation leading to my hold rating.
Thesis
The acquisition of Advanced Disposal by Waste Management, Inc.'s ( WM ) in 2020 has consolidated the company's leadership status in the $80 billion solid-waste industry. The management has emphasized on pricing and operational efficiency has enabled the company to grow in the recent past. The large scale of the company has meant that the WM can continue to expand EBITDA by mid-high single digit rate in the near-term. While I have a positive view of Waste Management's prospects, I remain cautious for now since the stock is trading at a premium, and any delays in the company's progress on its sustainability targets may lead to multiple compression. Hence, I assign a hold rating to the stock.
Q3 Review and Outlook
Waste Management reported better-than-expected results for the third quarter of 2023, achieving an adjusted EBITDA of $1.54 billion, mainly due to reduced operating costs. The SG&A expenses as a percentage of revenue remained low at 9% for the quarter. Labor cost inflation decreased to a 5-6% year-on-year increase in the third quarter, and repair and maintenance expenses saw a 6-7% year-on-year inflation level, partly because WM received more trucks. The management maintained its adjusted EBITDA outlook for 2023, with a range of $5.7 billion to $5.8 billion. The company anticipates a 40-60 basis point expansion in the adjusted EBITDA margin to 28.5% at the midpoint of the range.
I believe Waste Management's EBITDA may grow 5-6% in 2023, in line with its long-term target, as price increases should offset inflation in driver wages and fleet costs. I believe acquisitions could add to total revenue expansion, but could be offset by declines in recycling and renewable-fuel credits. Adjusted EBITDA margin could expand 50 bps after holding steady in 2022, driven by automation and technology investments that could reduce head count and increase employee efficiency.
WM has plans to launch its seventh RNG plant, the third in its growth program, in January 2024. Four additional projects, including two of the company's largest ones, are anticipated to be completed in 2024. WM has deferred $150 million of its sustainability capital expenditure to 2024 and beyond, making the total year-to-date delay in sustainability capex $350 million. These delays are primarily attributed to the need to secure agreements to connect gas to the system and permitting delays. Nonetheless, WM maintains confidence in achieving its $740 million EBITDA goal for 2026.
I believe WM is set to increase the contribution of sustainable businesses like renewable energy and recycling through 2027. The company has set an ambitious target of reducing its Scope 1-2 greenhouse gas emissions by 42% by 2031. In my view, the majority of this transformation is likely to stem from the generation of renewable natural gas from harmful landfill emissions, which can be used to power their waste collection vehicles, thereby reducing diesel emissions. The remaining progress in sustainability may come primarily from automating recycling facilities and enhancing their capability to process more challenging materials like flexible plastics.
Plastics Remain an Area of Opportunity
In response to the increased demand for ecologically friendly packaging, waste management firms such as Republic Services and Waste Management are boosting their investments in plastic recycling. While plastics presently account for a tiny fraction of the materials processed by the solid-waste sector, this is anticipated to rise as more measures to encourage the use of sustainable packaging are adopted. Plastic recycling is being prioritized by consumer goods businesses as part of their larger efforts to prevent global plastic waste. Hence, with the introduction of efforts, such as extended producer responsibility legislation, which holds firms financially responsible for the whole lifespan of their products, plastic recycling may grow. Plastics account for less than 5% of all recyclable solid trash, whereas paper accounts for over 67%. Waste Management expects to generate incremental EBITDA by increasing its processing capacity, including its ability to handle new waste streams. The acquisition of a majority share in Avangard Innovative's US business in 2022 allows the company to process difficult-to-recycle materials such as thin-film plastics.
Continues to Prioritize Profitability Over Growth
An emphasis on pricing and operating discipline under Jim Fish has enabled the company to increase EBITDA by almost 50% since he became CEO in 2016. Following the acquisition of Advanced Disposal Services, Waste Management has grown to become North America's largest environmental-services firm, with sales estimated to reach $20 billion in 2023. Waste Management's revenue has consistently risen at an organic rate of 3-5%, which is in line with the solid-waste industry average. I anticipate a 5-7% improvement in EBITDA for Waste Management in 2023, which is consistent with the company's long-term objectives. The majority of this increase in EBITDA is expected to come from solid waste collection and disposal, factoring in net pricing adjustments, while the volume is may remain stable, largely influenced by limited GDP growth.
Valuation
Waste Management is currently trading at approximately 30 times the next twelve months, which is higher than its five-year average P/E of 26.6x as per Capital IQ. The current multiple is also higher than the sector median of 19x. The current elevated multiple seems to be largely driven by expectations of long-term sustainability benefits beyond fiscal year 2026 rather than immediate revenue gains in my view. I believe at this elevated multiple, any potential delays in the company's sustainability initiatives can lead to a compression in the stock's multiple. Hence, I remain cautious and assign a hold rating to the stock.
Conclusion
WM is an industry leader in the Waste Management space and will continue to drive EBITDA growth of mid-high single digits in the near-term. However, the stock's valuation remains high with it trading at around 30 times its next twelve months' earnings, which is above its five-year average P/E ratio of 26.6x. Although I hold a favorable outlook for Waste Management's future, I am currently exercising caution due to the stock's premium valuation and assign a hold rating to the stock.
For further details see:
Waste Management: Valuation Keeps Me Cautious For Now