Waste Management: A Great Dividend Grower For A Watch List (NYSE:WM) (2024)

One of the characteristics that I prefer from a prospective investment is an easy-to-understand, profitable business model. Why do I put so much stock into this quality from a business?

The answer has to do with the investment philosophy of the legendary former Fidelity Magellan Fund manager, Peter Lynch. Under his direction, the fund generated a blistering 29% annual total returns from 1977 to 1990. Paraphrasing Lynch, it is preferable to own businesses that even an idiot can run. This is because sooner or later, probability dictates that a foolish management team will eventually run a great business. The idea is that although not ideal, foolproof business models can stand up to the misdirection of fools in the C-suite.

Waste Management (NYSE:WM) is a business that I believe fits this description to a tee. The company's business model is very simple: Waste Management is North America's largest provider of waste management environmental services. The company collects trash, transfers it to company landfills, and recycles it into clean, renewable energy.

To be clear up front, I think the company's present leadership team is very well-qualified. A look at their experience and accomplishments throughout their respective careers can easily support the argument that this is a quality management team.

But more to the point of this article, here's what I hope to accomplish: I will discuss Waste Management's fundamentals and valuation for the first time since July 2019 to explain why I am reiterating my hold rating for now.

Waste Management's 1.6% dividend yield probably won't win much favor from more income-oriented investors. But it is still marginally above the 1.4% yield of the S&P 500 (SP500).

Additionally, the 47% EPS payout ratio is well below the 60% EPS payout ratio that rating agencies prefer from the waste management industry. Waste Management's 67% debt-to-capital ratio is above the 40% industry-safe guideline that rating agencies like to see. As I'll discuss later, though, the company's leverage profile appears to be rather sustainable.

This is how Waste Management still has an A- credit rating from S&P on a stable outlook. That implies the risk of going bankrupt in the next 30 years is just 2.5%. In other words, Waste Management won't be going to zero in 39 out of 40 scenarios that could play out in the coming 30 years.

Taking these elements into consideration, the company's dividend is at just a 1% risk of being cut in the next average recession. Even if the next recession was severe, that probability rises to a still manageable 4%.

As seems to especially be the case lately, high-quality businesses like Waste Management aren't exactly bargains right now. Based on the historical dividend yield and P/E ratio, shares could be worth $153 apiece. Relative to the $184 share price (as of January 22, 2024), that suggests Waste Management is 21% overvalued.

To be fair, Waste Management could continue on its track record of outperforming the S&P, albeit at a narrower margin. If the company grows as expected and reverts to historical fair value, here are the annual total returns that it could deliver over the next 10 years:

• 1.6% yield + 10.9% FactSet Research annual growth consensus - 1.8% annual valuation multiple contraction = 10.7% annual total return potential or a 176% 10-year cumulative total return versus the 9.8% annual total return potential of the S&P or a 155% 10-year cumulative total return

The Long-Term Outlook Remains Promising

Waste Management's results were a mixed bag in the third quarter ended September 30. The company's total operating revenue grew 2.4% year-over-year to $5.2 billion during the quarter, which narrowly missed the analyst consensus by $70 million.

In response to strength throughout much of the business, the company raised its prices. Due to the essential nature of Waste Management's services, customers were largely tolerant of these increased rates. That was what contributed to 6.6% core price growth for the third quarter. That was an estimated 100 basis points higher than the company's inflationary cost increases, which demonstrates that Waste Management can grow its business faster than inflation.

The company's core price growth was partially offset by weakness in the recycling business and higher intercompany revenues. That is how Waste Management's topline grew below the rate of its core price growth in the third quarter.

The company's adjusted diluted EPS edged higher by 4.5% over the year-ago period to $1.63 during the third quarter. For perspective, that beat the analyst consensus by $0.02. Cost optimization and efficiency gains per CEO Jim Fish's opening remarks during the Q3 2023 earnings call helped the non-GAAP profit margin improve by nearly 10 basis points to 12.8% for the quarter. Along with a lower share count, that is how adjusted diluted EPS growth outpaced operating revenue growth in the quarter.

Looking ahead, Waste Management has growth catalysts. According to Fish, the company's seventh renewable natural gas plant will be operational this month. Additionally, another four facilities are on pace to be completed later in 2024. These include Fairless in Pennsylvania and Orchard Hills in Illinois, which are two of the bigger projects in its growth project portfolio.

Waste Management also completed technology and automation upgrades at two recycling facilities in the third quarter. The benefits of these upgrades should begin to bear fruit in the quarters to come.

Finally, Waste Management's financial position is just fine. The company's leverage ratio was 2.7 as of the third quarter, which was squarely within its targeted ratio of between 2.5X and 3X per CFO Devina Rankin. Waste Management's exposure to higher rates is also quite limited, with just 9% of its total debt at variable interest rates.

Free Cash Flow Easily Covered The Dividend Despite Increased Capex

The recent 7.1% increase in Waste Management's quarterly dividend per share pushed it up to $0.75. For context, that's up 46.3% from the $0.5125 quarterly dividend per share paid throughout 2019 - - a 7.9% compound annual growth rate. Moving forward, I anticipate dividend growth to remain as strong.

The company's emphasis on renewable natural gas plants and technology and automation upgrades at recycling facilities is consuming more capex as of late. Thus, the company's free cash flow dipped a bit to $1.5 billion through the first nine months of 2023.

Even so, the $855 million in dividends paid during that time equates to just a 57.6% free cash flow payout ratio (details sourced from page 4 of 100 of Waste Management's 10-Q filing). That allows Waste Management to retain the capital necessary for share repurchases, to keep its debt under control, and to grow the dividend by between 7% and 8% annually in the years to come.

Risks To Consider

Waste Management has the potential to keep compounding at a solid rate in the years ahead, but even its business model has risks.

The company's increased capex in technology and automation should improve its efficiency and overall profitability. But if these investments don't pan out as the company anticipates, that could end up weighing on shareholder returns to an extent.

Regulatory risks are another threat to consider. Waste Management's investments in renewable natural gas facilities face uncertainty. If the U.S. government were to scale back the recently expanded federal tax credits for renewable natural gas production, that could hurt the company's growth prospects.

Technologically, Waste Management faces the risk of disruption to operations and compromised data if its IT network were meaningfully breached. That could not only impact financial results in the near term but also lead to a loss of trust from customers and litigation. Such a development could materially impact Waste Management's fundamentals.

Summary: A Business I Want To Buy (At The Right Price)

Waste Management is unsurprisingly not cheap (it rarely is). Per FAST Graphs, the company's historical P/E ratio is 21.3. However, I believe that the last 10 or 11 years are more representative of the valuation multiple that the company will command in the future.

If Waste Management can match the growth consensus and returns down to its 11-year normal P/E ratio of 25.9, 10% cumulative total returns could be in store through 2025. That would be better than the 5% cumulative total returns forecasted for the SPDR S&P 500 ETF Trust (SPY) through 2025.

But for my interest to be piqued enough to start nibbling on Waste Management and rating it a buy, I would need to see it at around 25X the $6.77 EPS forecast for 2024. Until the stock dips back below $170 again, I am maintaining a hold rating.

Hi, my name is Kody.I run Kody's Dividends. As you might guess, this is a blog primarily documenting my journey towards financial independence using dividend growth investing as the means to transform the dream of financial independence into a reality.I am forever indebted to this community because it helped me transition from simply being an investor to being a full-time analyst beginning in June 2021. Aside from my five to six articles a week here on Seeking Alpha, I am also a contributor to Dividend Kings and iREIT on Alpha.