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Finding Lots of Cash in Trash
01/26/2009 12:00 pm EST
James Stack, president of InvesTech Research, says trash hauler Waste Management offers strong cash flow and a solid dividend at rock-bottom valuations.
Waste Management (NYSE: WMI) displays the characteristics we search for in new investments, including a distinct competitive advantage and solid financials. It is also selling at a compelling valuation.
Waste Management is the largest solid waste management company in North America. Founded in 1894, it serves nearly 20 million customers in the commercial, industrial, Municipal, and residential markets. Waste Management handles 130+ million tons of disposal each year, representing a 40% to 45% share of the waste disposal market.
Even after the recently completed merger of Allied Waste and Republic Services (which were ranked second and third in market capitalization), Waste Management remains twice as large as these two companies combined. The firm's size, market share, and vertical integration provide distinct competitive advantages.
With the nation's largest network of landfills, Waste Management has significant pricing power and can charge fees to competitive waste haulers who don't own, or have access to, their own landfills.
The firm operates 99 material-recovery facilities processing paper, glass, metal, plastics and compost, as well as six secondary processing facilities where recyclable materials are processed into raw products that can be used in the manufacturing of consumer goods.
In November, WMI warned that fourth-quarter profits would be dampened due to the falling value of recycled commodities. Also, weakness in the economy portends lower waste volumes, particularly in the residential and industrial segments. However, the strength of this company's business model has been evident in past recessions. Earnings estimates for 2009 have been reduced, but are still projected above 2008 levels.
Waste Management boasts a strong balance sheet with free cash flow of $260 million. The company has exhibited good cost control, increasing operating margins from 24% in 2004 to nearly 27% currently. Return on equity, a measure of profitability, has also improved from 13% five years ago to 19%.
While the company's debt level is a little higher than we would like at 56% of capital, it is in line with historic levels, and debt service is adequately covered with operating income equivalent to four times interest payments. The stock currently yields 3.3%, [about in line with the Standard & Poor's 500 index], and the dividend is sufficiently protected with less than a 50% payout ratio. In fact, the company has announced it will raise the dividend by 7.4% to $1.16 per share in 2009.
Waste Management is currently selling at valuation levels equivalent to those at the end of the 2000-2002 bear market. Primary valuation metrics, including price/cash flow, price/revenue and price/earnings, are all well below their ten-year medians. We believe this stock will remain fairly stable, even in a prolonged recession, and should definitely benefit from any economic recovery. (It closed Friday around $32—Editor.)
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