American waste services provider Waste Management (NYSE:WM) is set to release its second-quarter results on July 29. Investors would be hoping that the company exceeds analysts' earnings expectations like it did in the first quarter. Whether that happens or not we'll get to know once the figures are released, but let's take a look at what could be in store.
Improving yield in collection business could drive performance
Waste Management generates 61% of its revenue from the waste collection business. The company enters into three to six-year contracts with commercial, industrial and residential customers for collecting wastes. The industry is witnessing lower waste volumes. Waste generation is closely related with a country's economic health -- when the U.S. economy was reeling under recession, the volume of waste generated took a hit and has remained weak since then.
During the first quarter, waste collection volume declined 1.8% against the same period last year. Some part of the volume declines that we saw in recent quarters was due to the management's decision to walk away from low-margin residential and industrial businesses. Waste Management's primary focus is on growing yield, which refers to the revenue increase coming from pricing gains alone, without taking into account volume changes.
In the first quarter, the company could offset the collection volume decline with a 2.6% yield gain. We could expect to see yield gains to drive second quarter results, too. Waste Management is concentrating on the profitable commercial business, and could be a beneficiary of improvements in the U.S. construction sector. Aside from the fact that construction activities are higher during summer months, analysts believe the industry could improve through the whole of 2014.
Recycling could remain weak
The recycling business contributes about 10% toward total revenue, and the lower prices of recycled goods are weighing on the segment's prospects. In the first quarter, the segment's yield dropped 4% compared to the year-ago period on account of 1.8% decline in the average recycling commodity prices.
To counter this, Waste Management has been adding penalty clauses for contaminated wastes to contracts where it's allowed to do so. So customers pay higher rates for contaminated waste. In the short term, this would mean more revenue, and in the long run, management is hoping that there would more awareness and contaminated waste volumes would come down. This would help lower operating costs. However, we are unlikely to see any significant improvement in the segment's performance in the second quarter. For the full year, management expects recycling earnings to remain flat at 2013 levels.
Earnings and cash flow
Analysts expect Waste Management's second-quarter earnings to grow 9.3% over the same period last year to $0.59 per share on 2.5% increase in revenue to $3.61 billion. The earnings improvement is expected to come from better pricing and cost reduction efforts of the company. In the first quarter, operating expenses as a percentage of revenue was 65.7%, down from 66.2% recoded in the year-ago period. The company is using more green vehicles (running on compressed natural gas) that are helping reduce fuel cost.
But investors need to keep an eye on Waste Management's growing debt burden. In May, it raised $350 million by issuing 3.5% senior notes, payable in May 2024. Though the company repays its debt on a regular basis, it has to pay a significant amount of interest. Last quarter, it had to pay $122 million in interest, roughly $0.26 per share. The recent issue will push up interest costs further.
Thankfully, Waste Management is generating good free cash flows. It generated $484 million in the first quarter, which is its highest since 2008. The improvement was on account of efficient capital spending and a divestiture of a $166 million partnership in a Chinese waste-to-energy facility.
Waste Management divested more assets in the month of May. GFL Environmental agreed to buy the company's assets in the Canadian provinces of Nova Scotia, New Brunswick, Newfoundland, and Labrador. Additionally, Post Capital Partners along with Randy Jensen has acquired the company's Puerto Rico's solid waste operations. Though financial terms of the deals were undisclosed, there's no doubting the fact that the impact of the deal would be reflected in the quarter's cash flow.
Waste Management has been generating earnings growth through yield optimization and cost savings, and investors could expect to see similar trends in the quarter. Collection volumes could remain weak, though there could be some support from the U.S. construction sector.
ICRA Online and Eshna Basu have no position in any stocks mentioned. The Motley Fool recommends 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.