Waste Management, Inc. (WM): Making Money From Trash With This Stock

Investors are always worried about a recession affecting a company’s revenue or that business ceding market share to its competitors. Picking a recession- resistant company with recurring revenue solves the problem. Waste Management, Inc. (NYSE:WM), which provides waste-management services to a variety of residential, commercial, and municipal clients in North America, is a company with these characteristics.

Local regulatory barriers keep competitors at bay

Waste Management, Inc. (NYSE:WM)’s regulatory licenses provide it with an edge for a few reasons.

Firstly, the ‘not-in-my-backyard’ mentality comes into play for the waste- management industry. Nobody will like to stay near landfills and live with the associated odors. New landfill approvals are rare to come by, favoring existing incumbents with a significant number of landfills. Waste Management, Inc. (NYSE:WM) had 264 active solid-waste landfills and five active hazardous-waste landfills as at the end of 2012.

Secondly, similar to cement, the low value-to-weight ratios of waste have an impact on the waste management business. It is uneconomical for waste to be transported long distances for the purpose of dumping.This makes foreign competition virtually non-existent in this space.

Last but not least, given that there is always a possibility of regulators changing their minds about certain things, companies regulated at the federal level have more to lose in the event of any single regulatory change. In contrast, landfills are approved at the local level, making Waste Management, Inc. (NYSE:WM) less risky in that regard.

Attractive business and financial profile

Companies operating in cyclical industries like automobiles and home building tend to see wide variations in revenue and earnings between financial periods, with their stock prices experiencing similar volatility. I prefer to invest in non-cyclical businesses with recurring revenue.

Waste Management, Inc. (NYSE:WM) provides essential ‘must-have’ services whose demand is not dependent on the health of the economy. A recession might mean less discretionary travel, but waste continues to be generated and needs to be disposed of. This is evidenced by Waste Management’s beta of approximately 0.6, which is far below 1.0. A low beta is indicative of the non-cyclical nature of a stock.

Also, Waste Management boasts of strong recurring revenue by virtue of its scale and the non-discretionary nature of its services. The customer retention rate for its commercial and industrial customers is high at above 90%, with more than fourth-fifths of its customers on long-term contracts exceeding three years. This is further supported by Waste Management’s strong financial track record, having delivered profitability and positive free cash flow in every single year for the past decade.

Future outlook

Waste Management is on track to meet full-year 2013 guidance of 4% to 6% growth in adjusted earnings per diluted share following a 5% increase in quarterly adjusted earnings per diluted share from $0.38 to $0.40 in the first quarter of fiscal 2013. Given the relatively stable level of demand, earnings growth for the company will have to come from accretive acquisitions and better cost management.

Waste Management spent $250 million and $180 million on acquisitions in fiscal 2012 and the first quarter of fiscal 2013, respectively. It even has a page on its website soliciting for solid-waste companies interested in divestiture. The fragmented nature of the market and long tenure of contracts result in acquisitions being the most viable way of gaining further market share. With respect to cost containment, its restructuring efforts announced in July 2012 are expected to contribute to a 100 basis-point reduction in selling, general and administrative expenses for 2013 and cost savings of 200 basis points to 400 basis points in the long term. About 700 employee positions were eliminated through the streamlining of back-office operations.

Peer comparison

Waste Management’ peers include Heritage-Crystal Clean, Inc. (NASDAQ:HCCI) and Waste Connections, Inc. (NYSE:WCN).

Waste Connections, Inc. (NYSE:WCN) is the third-largest solid-waste-management company in North America and differentiates itself from Waste Management by focusing on secondary markets where it has at least a number-two market position. In addition, it diversified into oilfield waste in 2010 which now accounts for about 13% of its revenue. This oilfield waste is expected to grow on the back of drivers such as increased drilling in unconventional areas and tightening environmental regulations.

It achieved a good set of results for the first quarter of fiscal 2013, growing its quarterly net income by 33% as a result of a spike in exploration and production activity. I am concerned about the increased cyclicality of Waste Connections, given its expanding oilfield-waste business.

Heritage-Crystal Clean, Inc. (NASDAQ:HCCI) is the second-largest domestic provider of parts-cleaning services and the second-largest re-refiner in North America. It is also a provider of hazardous and non-hazardous waste services to its clients. Similar to Waste Management, scale and regulatory approvals are the biggest barriers to entry for its competitors in its parts-cleaning core business. New entrants will need to devote a significant amount of effort to building a branch service and transportation network of comparable scale and obtaining the necessary environmental permits regulating parts-cleaning-units emissions.

Its used oil-collection and re-refining business has huge potential for growth, but also represents a source of instability. It registered a loss of $0.02 per share in the first quarter of fiscal 2013 largely because of negative base-oil pricing trends impacting profitability. I am negative on Heritage-Crystal Clean, as it is affected by commodity price swings and does not pay a dividend. In contrast, Waste Management sports a forward dividend yield of 3.5%.

Conclusion

I like Waste Management for its strong regulatory barriers to entry and its recurring non-cyclical nature of revenue. Despite this, it is currently reasonably valued at 17.6 times forward P/E.

Mark Lin has no position in any stocks mentioned. The Motley Fool recommends Waste Management. The Motley Fool owns shares of Waste Management.

The article Making Money From Trash With This Stock originally appeared on Fool.com and is written by Mark Lin.

Mark is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.

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