Waste Management (WM) is the largest waste and recycling company in North America and has an impressive dividend profile.
The company provides mission critical services, possesses a strong moat, and has been a consistent cash flow generator over the last decade, just like many of the best high dividend stocks here.
Its scale and essential services are advantages that have allowed Waste Management to grow its dividend consistently over the last 14 years.
Let’s take a closer look at Waste Management to learn why it is a core holding in Bill Gates dividend portfolio and see if it is attractively priced today.
Waste Management possesses the largest network of recycling facilities, transfer stations, landfills, recycling facilities, and processing plants in the industry. The company makes money by entering into contracts with customers to collect, transport, process, store, and dispose of their waste.
In just 30 years of operation, the company has built an impressive and diverse base of more than 21 million customers spread across municipal, residential, commercial and industrial segments in the U.S. and Canada. During 2016, WM’s largest customer represented just 1% of its annual revenues.
Waste Management’s revenues can be segregated into collection (54% of 2016 revenues), landfill (19%), transfer (9%), recycling (8%) and other services (10%). Commercial is the largest segment accounting for 40% of collection revenues, followed by residential (28%), industrial (27%) and other (5%) segments.
The commercial and industrial businesses are more lucrative customers for WM because they typically have multi-year contracts in place, making cash flows more predictable and stable.
The trash collection business might look easy, but it actually has substantial barriers to entry. As the largest player in the market, Waste Management also carries several additional advantages.
First, there just aren’t any viable alternatives to trash disposal today. Consumers and businesses alike need to have their garbage collected and taken off-site. With the average American generating a couple pounds of trash each day, there is a constant need for Waste Management’s services.
But why does Waste Management have such a strong market position? This is when the company’s valuable, hard-to-replicate network of assets comes into play.
Waste that is not recycled or processed into forms of energy is taken to transfer stations, which consolidate waste into larger, long distance trucks. These trucks then take the waste to disposal facilities and landfills that are usually located somewhat far away.
WM owns over 240 landfills, more than its next two largest competitors combined. The number of landfills has fallen from over 7,600 in the mid-1980s to about 1,900 in 2013. That’s over a 75% decrease in less than 30 years!
Government regulations, neighborhood restrictions, high start-up costs, and environmental concerns have all played a factor in the decline of available landfills.
While the remaining landfills are larger and more efficient than their predecessors, there are only so many places that waste management companies can park trash. As a result, Waste Management’s competitors must pay the company a “tipping fee” to deposit waste at its landfills and use its transfer stations.
Waste Management’s ownership of key assets, dense trash collection network, and tipping fees allow it to maintain a lower cost profile than its peers. The company then attracts more waste volume from customers, which results in greater route density and higher returns on its invested capital compared to peers.
In addition to the toll-taking advantage Waste Management has at its landfills, new entrants also have a challenging time winning enough business to justify the significant investment needed to construct for their own disposal facilities.
Waste Management and other players already have contracts with customers, which typically last anywhere from two to seven years.
In fact, the company has noted that more than 80% of its commercial and industrial customers have a contract length greater than three years, and the typical customer stays with Waste Management for 10 years.
New entrants have a difficult time securing the cash flow streams necessary to build their own trash disposal network, especially since they cannot compete on price.
Furthermore, Waste Management’s large network of recycling facilities, transfer stations, and landfills make its business more flexible to meet the needs of virtually any customer segment – municipalities, construction sites, healthcare facilities, commercial buildings, and many others. Generally speaking, customers prefer to contract with proven operators that can meet a variety of needs.
While Waste Management might look like a mundane business in a commodity industry, this is good from a long-term investment perspective since the company’s business model is less prone to technology disruption and possesses several hard-to-replicate advantages.
Rising environmental concerns and customer consciousness have increasingly diverted waste to other alternatives such as recycling and composting.
You can see that municipal solid waste has largely stagnated over the last decade and declined slightly on a per capita basis.
Today customers are clearly more aware and working towards reducing the amount of waste they generate. Large customers such as grocery stores and restaurants are choosing to divert their organic waste from landfills to other alternatives, for example.
With increasing awareness about recycling, product packaging has also become more efficient these days. People are going green and paperless which has cut down a lot of paper waste.
All these in turn reduce the waste that needs to be collected, processed, and stored in landfills by Waste Management. You can see that solid waste going to landfills is down slightly from 1990 while recycling and composting have experienced strong growth.
Importantly, Waste Management is the largest residential recycler in North America and has the financial firepower to invest in whatever operations are needed to maintain its moat. The company is also a leading renewable energy provider.
Waste Management’s business can also be impacted by lower levels of consumption that results from lower economic activity (i.e. less consumption of goods by consumers and businesses).
When economic activity slows, less trash is produced and Waste Management is not as busy. However, its trucks still run their routes and incur the same operating costs, somewhat crimping profitability.
The dynamics of the whole waste industry have dramatically changed over time. Though the industry has seen consolidation over the recent years, it still remains intensely competitive. Waste Management also faces strong competition from governmental, quasi-governmental and private sources.
However, Waste Management is in a better position owing to its No.1 position, better technology, and economies of scale. It is also benefiting from the industry consolidation trend.
Waste Management’s Dividend Safety
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at some of the most important financial factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been, and how to use them for your portfolio here.
WM has one of the safest dividend payments with a Dividend Safety Score of 98, implying extremely secure dividend payouts.
Over the last 12 months, WM’s earnings and free cash flow payout ratios were 61% and 47%, respectively. For a stable business like Waste Management, these ratios appear to be healthy suggesting enough room for future dividend growth.
Looking further back, we can see that WM’s payout ratios have increased a bit over the last decade, but not by an extraordinary amount. In most years, the company’s payout ratios remained between 40% and 60%, leaving Waste Management with plenty of dividend cushion and room for incremental growth.
It is also crucial to examine how a company performed during the financial crisis to assess the strength of its business. Though a payout ratio on the surface might appear to be safe, it may still pose danger if earnings are very sensitive to the broader economy.
WM’s sales fell by only 12% in 2009, when the economy went into a tailspin as a consequence of the Lehman crisis. The company’s sales performance was much better than others, highlighting Waste Management’s relatively recession proof business model.
The volumes of trash might have declined during the great recession, but consumers and businesses still had to consume essential goods regardless of the economic conditions.
WM’s stock ultimately gained 5% in 2008, beating the S&P 500 by 42% and reflecting its defensive qualities.
Analyzing a company’s return on invested capital can help us assess its business strength. Waste Management has consistently recorded high-single digit returns, as can be seen below.
Waste Management has a monopoly in many local markets due to its extensive infrastructure network and economies of scale. Since its business is highly capital intensive, the result is moderate but predictable returns on its investments.
Waste Management has also been an excellent free cash flow generator. A company’s ability to generate free cash flow allows it to reinvest and return capital to shareholders without resorting to external financing and thus avoiding additional interest burden.
Waste Management’s lucrative customer contracts, extensive asset network, and well-known brand name ensure that the company continues to generate free cash consistently.
A company’s capacity to pay dividend also depends heavily upon the strength of its balance sheet. Companies with too much debt could unexpectedly fall during tough times and have no choice but to suspend their dividend in order to honor their debt.
Given Waste Management’s capital-intensive nature of business, it needs a higher amount of debt. However, given the company’s consistent free cash flow, its credit risk and cost of capital are quite low.
In fact, its weighted-average cost of debt was just 4.2% with the floating rate portion accounting for 12% of its total debt portfolio at the end of 2016, protecting it nicely from rising interest rates.
Waste Management’s Dividend Growth
Our Dividend Growth Score answers the question, “How fast is the dividend likely to grow?” It considers many of the same fundamental factors as the Safety Score but places more weight on growth-centric metrics like sales and earnings growth and payout ratios. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
Waste Management’s Dividend Growth Score of 74 suggests that the company’s dividend growth potential could be somewhat above average.
Although the company operates in slow-growing markets, it has consistently increased its cash flow generation and dividends over the years. The company has a reasonable payout ratio of around 60%, but high amount of debt on the balance sheet somewhat restricts dividend growth.
Waste Management’s most recent dividend increase was 3.7%, marking its 14th consecutive year of dividend increases. The company is over halfway to joining the list of dividend aristocrats and seems likely to get their given the company’s dependable business model and leadership position in the recession proof waste business.
As seen below, WM’s dividend growth had been decelerating over the past decade. Low to mid-single-digit dividend growth seems most likely to continue, in line with the company’s future earnings growth rate.
WM’s stock trades at a forward P/E ratio of 22.4 (a premium compared to the S&P 500’s 17.7 P/E ratio) and offers a dividend yield of 2.3%, which is significantly higher than its five-year average dividend yield of 3.1%.
With an expected long-term earnings growth rate in the low to mid-single-digits, the stock has the potential to offer high single-digit annual total returns (2.3% dividend yield plus 4% to 6% annual earnings growth).
The stock’s valuation appears to be somewhat rich as investors are attracted to the company’s strong predictability in terms of revenue and cash flow and ability to deliver reliable earnings and dividend growth. The low yield environment has further made WM’s stock a sort of quasi-bond for yield-focused investors.
Though WM doesn’t appear to be cheap, the company’s impressive durability and moat make it worth holding onto for existing shareholders – especially for investors living off dividends in retirement.
I expect the company will reward shareholders with steadily improving earnings and growing dividend payments for many years to come.
Closing Thoughts on Waste Management
Waste Management has a Teflon-coated business model in an industry which is almost immune to economic cycles.
Being the industry’s largest player, it possesses strong operational and technical capabilities with economies of scale that result in significant advantages over its competitors.
From its dense network of well-placed assets to its annuity-like revenues (the average commercial and industrial customer stays with WM for 10+ years) and ownership of increasingly scarce landfills, Waste Management is a business built to last.
With that said, Waste Management’s stock does not look like a bargain today, so dividend growth investors are likely better off waiting for a 10%+ pullback to think more seriously about establishing a position.