Should You Take Profits from this Large-Cap Dividend Stock?

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Shareholders of Waste Management (NYSE: WM) have enjoyed dual rewards in the form of steady dividends and a rising share price over the past couple years. Waste Management is frequently cited as a well-run blue-chip with solid financials and an attractive dividend. While those are true to an extent, there may be cracks starting to form in Waste Management’s armor. All might not be well with this company, and with shares rallying significantly recently, it might be appropriate to discuss whether it’s time to take profits. There are a few important considerations investors should keep in mind.

Dangerous debt

Waste Management is an industrial, and as such, it should not be a surprise that the company has a high level of debt. Most firms adhere to the theory that companies with a lot of long-term assets on the balance sheet will have a similar corresponding level of long-term debt to finance such assets.

However, Waste Management’s level of debt exceeds reasonable levels, even when compared to its long-term assets, and should now be considered a cause for concern. The company’s long-term debt to equity ratio is 137%. While this is not overly burdensome on the company for the time being because interest rates are at historic lows, this will not last forever. At some point, interest rates will rise, and make refinancing a daunting task. The company’s profits might take a disproportionate hit from having to service such a high level of long-term debt. Waste Management has only $194 million in cash and equivalents on the books, compared with more than $7 billion in long-term debt.

Competitor Republic Services (NYSE: RSG) has a much more comfortable level of debt. The company’s long-term debt to equity ratio is 91%. That’s still on the high side, but it’s at least manageable and it’s clear that Republic Services is in a better financial position than Waste Management.

Revenue in the wrong direction

A company can’t pay interest on its debt if it doesn’t make enough in revenues, and when a company has rising levels of debt and declining profits, investors might need to re-think their position. Waste Management’s diluted earnings per share dropped from $2.04 in 2011 to $1.76 last year, representing a 14% decline year-over-year. Meanwhile, the company’s interest expense has gone up in each of the last two years. Republic Services, on the other hand, performed measurably better than Waste Management last year, with diluted earnings per share essentially flat from the year prior.

Declining dividend growth

Naturally, it goes without saying that a company cannot continue to increase its dividend forever without the operating performance to back it up. No dividend, even from a well-known company such as Waste Management, is impenetrable. While Waste Management generates solid free cash flow, its declining revenue and high debt level are legitimate causes for concern.

Waste Management’s dividend growth has declined over the last few years along with its underlying financial performance. To illustrate, consider that in 2010 the company provided investors with a 8.6% dividend increase, followed by a 8% bump in the distribution the following year.

The company’s dividend growth has tapered off measurably since then. Last year, the company raised its dividend by only 4%, and this year delivered a scant 2.8% increase. A dividend increase of less than 3% is certainly nothing to brag about. In fact, it's more or less tracking inflation.  Much better dividend growth can be achieved from stocks with better operating performance and cleaner balance sheets.

The bottom line

Waste Management traded below $31 per share last November before embarking on an impressive run. The stock increased more than 20% to its current level near $38 per share. Waste Management currently sits near multi-year highs.

The story is much the same for Republic Services, which is also up more than 20% since last November alone. Both waste disposal stocks trade for trailing price-to-earnings ratios above 20. In the case of Waste Management, it’s rarely a bad idea to at least consider taking profits in a company exhibiting declining revenues and dividend growth that has ground to a near halt in a span of just a few years.

The decision to sell a stock is a complicated one and different for every investor. Waste Management provides a decent dividend yield near 4%, and it remains entirely possible that the company can get its operating performance going in the right direction again. However, the reality is the company has a bloated balance sheet, executed poorly last year, and offers dividend growth below the dividend growth available on many other stocks. I’ll be closely monitoring the company’s performance in the months ahead, and I would advise all my fellow Waste Management stockholders to do the same.

Robert Ciura owns shares of Waste Management. The Motley Fool recommends Republic Services and Waste Management. The Motley Fool owns shares of 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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