Waste Management Is The Perfect Stock For My Dividend Portfolio (NYSE:WM) (2024)

Introduction

I have to admit that I'm writing this article with bittersweet feelings.

On the one hand, I love how well Waste Management (NYSE:WM) is doing, as it's one of my favorite defensive dividend growth stocks. On the other hand, I don't own it, and I have been looking for an entry for a while.

Now, the stock has rallied after reporting stellar earnings and solid guidance.

While it confirms my thesis and it's great news for its investors, I'm not in it.

After writing an article titled Waste Management Is A Superior Dividend Stock - I Want In on August 21, it's time for an update, using its just-released quarterly earnings and key statistics showing why the company behind the WM ticker is such a great long-term investment.

So, let's get to it!

Low-Volatility Dividend Growth

As I wrote in my prior article, WM is a very defensive company operating in an industry with high entry barriers and anti-cyclical demand (although a stronger economy results in faster trash growth).

Waste Management's landfill network, consisting of 259 sites across the United States and Canada, is the foundation of its operations.

These landfills are built in compliance with strict regulations and designed with environmental safeguards, making them an essential part of North American waste management.

As a result, the company has a significant competitive advantage in the industry despite the risk of competition.

Thanks to pricing power, anti-cyclical demand growth, and high entry barriers, the company has been a wealth machine, albeit with initial difficulties.

Going back to 1992, WM has returned 8.9%, turning $10,000 into more than $150,000. That's good but less than the 9.7% performance of the S&P 500.

The good news is that this is mainly due to starting difficulties. WM was founded in 1987 as USA Waste Services, which means it was very young in the early 1990s, leading to an unfavorable risk/reward, at least compared to more consistent stocks with more mature business models.

Over the past ten, five, and three years (see the lower part of the chart above), the stock has outperformed the S&P 500 by a wide margin, on a very consistent basis, and with a very favorable volatility profile.

• Over the past ten years, WM shares have returned 16.5% per year.
• The five-year CAGR is 13.0%, more than 300 basis points above the annual S&P 500 return.
• The standard deviation is roughly 300 basis points above the S&P 500 volatility, which is very attractive. After all, we're comparing a single stock with historically outperforming returns to a well-diversified basket of 500 stocks.

On top of that, it has a fantastic dividend history. Although the stock yields just 1.7%, which is too low for most income-oriented investors, it has a sub-50% payout ratio, a 5-year CAGR of 8.6%, and a history of consistent dividend growth - in any economic environment.

The company also enjoys an A- credit rating, one of the best ratings on the market.

In the third quarter, WM returned $855 million to shareholders through dividends and repurchased $990 million of its stock. The leverage ratio at the end of the quarter was 2.73x, within the target range of 2.5 to 3x.

So, based on these factors alone, I want to own WM, as it would add anti-cyclical and consistent dividend growth to my portfolio.

Even if we were to enter a new Great Financial Crisis, I would have zero doubt that WM would continue to pay a dividend, service its debt, and even grow its business in key areas.

This brings me to the next part of this article, as the just-released earnings allow me to emphasize the company's earnings power and financial stability.

Waste Management Is Firing On All Cylinders

The company's third-quarter earnings confirm by thesis, with adjusted operating EBITDA growing by over 6% and margins expanding by 100 basis points to 29.6% compared to 3Q22.

This allowed the company to generate adjusted EPS of $1.63, beating estimates by $0.02.

The company's strong results were primarily powered by its solid waste business, where organic revenue growth in the collection and disposal business was in line with expectations.

Regarding pricing power, core prices increased by 6.6%, reflecting robust pricing performance across all lines of business.

Commercial waste volumes turned positive, and special waste growth improved from the previous quarter.

Collection and disposal volume grew by 0.7% on a workday-adjusted basis, with special waste driving most of the volume growth at 11.1%.

In other words:

• The company's prices beat inflation.
• Volumes were up despite economic weakness.
• Margins are improving.

Furthermore, with regard to higher margins, the company's focus on managing the middle of the P&L (Profit and Loss) has been successful. They have continued to drive SG&A (Selling, General, and Administrative Expenses) leverage and gained momentum in operating cost optimization and efficiency improvements.

According to Waste Management, it has leveraged attrition and technology to reduce headcount by 1,650 positions since January 2022.

Their long-term goal is to eliminate 5,000 to 7,000 positions through attrition and technology over 4 to 5 years. This focus on cost control has resulted in strong operating leverage, although I'm not a fan that it will cost jobs, but that's expected in an industry that's still very capital and labor-intensive.

Additionally, one reason why I have often praised WM is its ability to exploit a very underappreciated revenue stream: Renewable energy.

Or, to put it differently, turning trash into cash.

During its earnings call, the company mentioned that its investments in renewable energy and recycling business are on track.

Their seventh renewable natural gas plant, part of a growth program consisting of 20 facilities, is expected to be in service in January.

Four more facilities are set for completion in 2024, including significant projects in Pennsylvania and Illinois.

In the recycling sector, technology and automation upgrades at facilities have led to lower labor and processing costs, higher throughput, and improved material quality. This positions the company for further growth opportunities.

Earlier this year, the company noted that renewable natural gas demand is set to grow by 4-5x by 2030.

Results for recycling and renewable energy in the third quarter were in line with expectations. Growth was down, but that was mainly due to much lower energy prices compared to last year. This is not an indication that long-term growth in this segment is in trouble.

Operating EBITDA in the Company's renewable energy business declined by $13 million compared to the third quarter of 2022, which was in line with expectations and primarily driven by decreases in the value of energy prices and renewable fuel standard credits. - WM 3Q23 Earnings Release

Adding to that, the company's recently automated recycling facilities are delivering strong results.

Sustainability growth projects are on track, and operating EBITDA expectations for the year remain within the range provided in the previous quarter.

With one quarter remaining in the year, the company is confident about achieving the 2023 financial outlook, including a 6% growth in adjusted operating EBITDA at the midpoint and a margin run rate of about 29% by year-end.

This outlook is supported by 62% operating expenses as a percentage of revenue and 9% SG&A as a percentage of revenue.

Valuation

The valuation is the reason why writing this article was bittersweet. As I briefly mentioned in the intro, a lot of stocks are currently selling off, offering attractive opportunities.

WM isn't one of them.

After rising 9% from its 52-week low, WM is up 3% year-to-date.

Since 2021, WM shares have held up very well despite general market weakness.

Unfortunately, as much as I love WM, the risk/reward isn't great.

Over the past two decades, WM has traded at a normalized P/E ratio of 21.3x, as displayed by the blue line in the chart below. This valuation has "guided" the company's stock very well until the pandemic caused a disconnect.

Currently, WM is trading at a 27.3x blended EPS multiple.

The good news is that EPS growth is expected to remain very high (also displayed in the chart above).

• Next year, EPS is expected to grow by 13%.
• In 2025, EPS is expected to grow by 12%.

If we assume that the company returns to a 21.3x multiple while incorporating these growth rates, we get an implied annual return of 1.7% through 2025.

That's not a lot.

While this is just a theoretical calculation using a realistic growth path, a lot of good dividend growth stocks are trading at much higher discounts, with annual return expectations north of 15%.

For example, Hershey (HSY), as we can see below.

I'm not bringing up Hershey to push you into that stock. I have no position in HSY. I just wanted to show that I'm dealing with so many buying opportunities that it's hard for me to dedicate a lot of cash (which I need to start a new position) to WM.

I can also buy undervalued industrials, beaten-down real estate stocks, cheap basic materials, you name it.

The current consensus price target of WM is $181, which is 12% above the current price.

Given the company's strong financials and high likelihood of elevated growth on a prolonged basis, I will stick to a Buy rating. If WM were a cyclical industrial stock with higher economic risks, I would give it a neutral rating.

With all of this in mind, WM is on my watchlist. It's even on my physical watchlist, next to my computer screen. It's highlighted, so I actually see it every day.

While I'm not at all rooting against the company (obviously), I'm hoping to see some weakness in its stock price.

I would love to get a shot at buying this stock between $140 and $150, which is a price it has seen a few times since 2021.

We could see $140, but I doubt it's possible without the Fed doing serious damage to the economy, causing some panic selling. So, that remains a long shot.

In other words, WM remains a high-conviction case of "buy-on-weakness," which I hope to do over the next few quarters.

Takeaway

Waste Management continues to stand out as a compelling long-term investment. This company's low-volatility dividend growth, driven by high entry barriers and anti-cyclical demand, has proven to be a wealth-building machine.

While it had a slow start, recent years have seen it consistently outperform the S&P 500 with attractive returns and low volatility.

WM's solid financials, including a strong dividend history and A_ credit rating, make it a reliable addition to any portfolio.

Its focus on cost control and investments in renewable energy further bolster its growth potential.

While WM may be an appealing choice for investors, its current valuation presents a dilemma. In a market full of buying opportunities, this reliable company is not currently being offered at a discounted price. Although the prospects for future growth are promising, there are other stocks available at more attractive discounts.

For now, WM remains on my watchlist, with the hope of a potential entry point during a market downturn. It's a high-conviction "buy-on-weakness" case that I'll be closely monitoring over the coming quarters.

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