Why I Bought Waste Management
Chad is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
When I recently made some changes to my personal portfolio, one name that kept popping into my head was Waste Management (NYSE: WM). I've read several articles extolling the virtues of the company's consistent business and attractive dividend yield. I've written before that in a direct comparison, Republic Services (NYSE: RSG) looked like a better value. However, there have been several changes since that post. Truth be told, the primary reasons I chose Waste Management had to do with the company's expected growth rate and their current dividend yield.
With Waste Management just recently reporting earnings, originally I was not that impressed with the results. However, when you look at the company's bottom-line financials, this story that I bought Waste Management for appears to be intact. In the waste and recycling industry, there are basically two rules. The first is, take care of your customers the right way the first time. The second rule is be as operationally efficient as possible.
In an industry where certain townships have different rules about waste collection, companies have to be flexible to meet the differing needs of their customers. In my county, for example, individual homeowners are allowed to contract with whomever they choose for trash and recycling pickup. However, in the county south of where I live, trash and recycling pickup are contracted through the county itself. This means 20 miles up the road in one direction, a trash collection company can market itself to individuals. In another county, the company has to present a proposal and compete against multiple other companies for the county's contract.
Given these challenges, a company the size of Waste Management has certain advantages if it chooses to exploit them. The company can spread its variable costs across a larger base, and in theory squeeze more profits out of each dollar of sales. The company has fallen behind a few of its competitors in its cost management efforts, and addressing this issue should benefit shareholders longer-term.
Just as an example, if you look at the gross margin of several of the companies in this industry you can see that Waste Management has some room for improvement. As of this earnings report, the company's gross margin was 34.66%. Compare this to Republic Services, which showed a gross margin recently of 40.62%, and Waste Connections (NYSE: WCN), which reported its gross margin at 43.03%. Since gross margin is a fundamental measure of the company's cost efficiency, it makes sense that if these two smaller competitors can achieve margins in the 40% to 43% range, Waste Management should be able to get close to this range. This is where the company's announcement of 700 job cuts and the simplification of reporting should be a good long-term move. Let's take a look at what the company reported to see how each division is doing.
Waste Management reports earnings based on their different geographic locations. As proof that the company's cost management is beginning to yield better results, look at the consistent difference between the direction in revenues and the direction and operating income. In nearly every division, while revenues were down slightly, the company managed to consistently turn the slightly lower sales into better income. While revenues were down 4.82% in their Eastern division, operating income increased 1.42%. In the Midwest, revenues decreased 2.28%, while operating income increased almost 13%. In the company's Southern region, revenues again were down 3.04%, but operating income still increased by about 0.5%. In the Western region, revenues were basically flat, but again operating income increased.
The real challenge in this earnings report was the company's Wheelabrator division, which provides waste services to energy facilities and power production plants. Revenues were down 11%, which led to operating income down over 64%. Thankfully this division represents the smallest percentage of both revenues and operating income. If none of these numbers seem terribly impressive, take a look at the company's financials and I think you'll see why I chose to buy shares.
Three different numbers sum up the investing thesis behind why Waste Management should be considered for everyone's portfolio. The first is the company's operating cash flow increased nearly 40% on a year-over-year basis. Second, the company's free cash flow was up over 60%, which led to a free cash flow payout ratio of just 49.57%. Last, the company consistently repurchases shares and year-over-year diluted shares decreased 2.52%.
Though the company's operating income in each division doesn't look particularly impressive, Waste Management is doing everything right generating free cash flow and buying back shares. When you look at the three companies that we've talked about, analysts expect the most growth from Waste Management at about 10%. Republic Services and Waste Connections are both expected to grow at a rate between 6% and 7%. When it comes to dividend yield, Waste Management wins again with an over 4% current yield. Compare this to a yield of 3.3% at Republic and less than 1.2% at Waste Connections. In short, with the highest yield, the best growth, and plenty of free cash flow, there's a lot to like about Waste Management.
MHenage owns shares of Waste Management. The Motley Fool owns shares of Waste Management. Motley Fool newsletter services recommend Republic Services and Waste Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.
