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Waste Management -- >>> There's a Jewel to

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gfp927z   Friday, 05/03/13 10:39:26 PM
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Waste Management -- >>> There's a Jewel to Be Found in Waste

By Piyush Arora

May 1, 2013


Investing in income-growth stocks as a way to ride out market uncertainty has always been a good strategy. But investing in just any income-growth stock could be disastrous. For this kind of investing, a company needs to have a solid balance sheet, as well as ample and consistent cash flows to sustain its payouts. One such company that meets the criteria is Waste Management (NYSE: WM), and here are a few reasons why it makes a great income-growth play.

Investors’ delight

Waste Management is known to return (quite a lot of) value to its shareholders. At current prices, shares of Waste Management yield an impressive 3.8%, while Republic Services (NYSE: RSG) and Waste Connections (NYSE: WCN) yield 2.9% and 1.1,% respectively. Waste Management pays out 80% of its earnings, while the Waste Connections and Republic Services payouts are just 28.6% and 58.2% of earnings, respectively.

Naturally, Waste Management's dividend sustainability comes into question with such a high payout ratio. But since the company isn’t planning any expansions or acquisitions, its cash flow can comfortably be directed toward dividends.

Its annual dividend burden aggregates to $680.1 million, which gets entirely covered by its trailing-12-month (ttm) free cash flow of $785 million. Moreover, Waste Management has around $307 million in cash and cash equivalents, which altogether points toward sustainable future payouts.

The company also has a $500 million share-repurchase program underway. At the current price, this represents the pending repurchase of 13 million shares, which should artificially boost its dividend yield to 3.9%. But the company isn’t stopping here.

Management said that it would be focusing on improving the company's yield along with reducing operating costs and increasing its overall operational efficiency over the next couple of years. Although management didn’t quantify the dividend boosts, it’s safe to assume that Waste Management would sustain its payouts for the coming years.

Growth prospects

On Jan. 31, Waste Management announced the acquisition of Greenstar, which is one of the largest private recycling businesses in the U.S. Last year, Greenstar recycled around 1.5 million tonnes of waste, and served around 12,000 domestic customers. This acquisition is expected to boost Waste Management’s recycling capacity by around 11% and bolster its material-refining facilities by 10%. Waste Management's management aims to process around 20-million tonnes of waste by 2020, and the acquisition bodes well with its long-term prospects.

But that’s not all. Waste Management is making strides in improving its financial health. For FY13, it expects to grow its free cash flows to between $1.1 billion and $1.2 billion (around a 52% increase y-o-y) with capital expenditures between $1.3 billion and $1.4 billion. If management is able to deliver what it promises, three things can happen here.

1.) Its dividend yield gets a boost to around 5.5%; 2.) Its board can approve another share buyback; 3.) It can repay a fraction of its total net-debt of approximately $9.2 billion

Of course, the logical move would be to lower its debt/equity of about 1.6x, which would eventually increase its net earnings (due to lower interest expenses).

For the recent quarter, Waste Management reported quarterly EPS of $0.57, which missed estimates of $0.60. However, its revenue rose to $3.4 billion, up from $3.3 billion in last year’s quarter.

Peer talk

Republic Services also disappointed the Street. Its quarterly profits stood at $127 million, down from $191 million in last year’s quarter. Its revenue also remained flat, and analysts expect its annual sales to grow by just 2% to 2.5% in FY13. Additionally, analysts estimate its annual EPS to grow by a meager 3.6% over the next five years, which is discouraging for investors.

Although the company is rapidly expanding its waste recycling capacity, its debt/equity is worsening quickly. At the end of the quarter, Republic Services had total long-term debt of $7 billion with operating cash flow (ttm) of $1.5 billion and cash of $67 million, due to which its cash flow-to-debt equates to 4.5x.

Compared to Waste Management's cash flow-to-debt of 4.2x along with cash and cash equivalents of $307 million, Waste Management is in a better position.

However, Waste Connections posted impressive results. Its quarterly net income stood at $448.8 million, which rose by a whopping 18.2% and beat the Street’s estimates of $445.7 million. The staggering growth was primarily driven by the acquisition of R360 Environmental Solutions in October, which reported annual revenue of $300 million last year.

Meanwhile, EPS of $0.37 missed the estimated $0.38 but rose by $0.02 per share as compared to last year’s quarterly results. Its stellar financial performance was due to masterful execution and a result of its relatively smaller size, which allowed Waste Connections to grow at a rapid rate. But the company isn’t involved in the waste-to-energy conversion business, which is a huge drawback.

As far as its long-term strategy is concerned, Waste Connections continues to expand in regions which aren't saturated with waste-recycling solutions (suburban areas), and offer less competition. This might be beneficial over the long run, but its management affirmed that its short-term growth lies in inorganic expansions in its existing markets.

This clearly puts Waste Management ahead of its peers.

A short conclusion

I don’t like to be a broken record, but if you didn’t already guess, I’d gladly put my money on Waste Management. The company has a high yield, which seems sustainable, and its pending share repurchases will further bolster its EPS. Furthermore, its acquisition of Greenstar and cash flow improvements suggest that Waste Management is well poised for an upside.


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