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3 Key Takeaways From Waste Management's Earnings

By John Bromels – Nov 8, 2016 at 9:47AM

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The waste hauler posted solid earnings and revenue beats in the third quarter. Here's what investors need to know.

The market doesn't seem terribly enthused by Waste Management's (WM -0.23%) Q3 earnings. Shares rose just 2% after the company reported solid earnings on Oct. 26, and there's no sign they're headed toward the record highs we saw from the company this summer. 

But even without a big share jump, there's still plenty for investors to take away from the earnings report. Here are three key points to consider.

Things are looking up, up, up

By virtually any metric, Waste Management had a great quarter. Earnings of $0.84 per share beat analysts' estimates of $0.80. Revenue also came in $40 million above expectations. Better yet, the company's performance also handily trounced its year-ago quarter:

MetricQ3 2016Q3 2015Growth (YOY)
Revenue $3.6 billion $3.4 billion 5.6%
Adjusted net income $374 million $335 million 11.6%
Adjusted EPS $0.84 $0.74 13.5%
Volumes 1.6% 1.4% 170 basis points
Net cash from operations $753 million $657 million 14.6%
Free cash flow $428 million $358 million 19.6%

Data source: Waste Management. Chart by author. YOY = Year-over-year.

The company even outperformed its year-ago quarter in metrics such as customer churn -- which fell to 8.7%, the lowest since 2014 -- and core price, consisting of price increases net of rollbacks and fees, other than fuel surcharges, which rose to 7% from 4% a year ago. 

All this led the company to raise its adjusted diluted EPS guidance for 2016. The previous range was between $2.83 and $2.86 for the year, but the company is now predicting at least $2.91, an 11% increase over 2015. The company is also predicting free cash flow for 2016 of between $1.6 billion and $1.7 billion.

With strong results like this, the market's reaction seems a bit tepid. But investors should be thrilled with the company's performance.

Recycling ups and downs

The company's recycling business has been a thorn in its side in recent quarters, as global commodity prices for recycled goods have shrunk. Because plastic is derived from petroleum, low oil prices have made it cheaper to make new plastic rather than pay to clean and recycle old plastic. Commonly recycled products such as aluminum cans and paper have also seen their prices fall, with the Chinese economic slowdown hurting sales of recycled goods to China, a major purchaser of U.S. recycled goods. In response, Waste Management sold or exited 21% of its recycling facilities in recent years. 

But this quarter, the company bucked the trend, posting a 13.6% increase in average commodity prices at its recycling facilities, along with a 0.9% increase in volumes. Of course, a single quarter doesn't mean the company's recycling woes are over, and indeed, on the earnings call, COO Jim Trevathan was quick to point out that we shouldn't expect these types of prices to continue:

You can't fall into the trap of saying, no, prices are going up, so let's go back to the old style of doing business in recycling. We absolutely will never do that as long as I'm breathing. ... When you look at the pricing, it's up, but it's not dramatically up. And it's been fairly volatile over the last few years, so we're not declaring victory; we're going to continue to go after all the operating cost that we can on the recycling side. And like I said, we won't expect to get a benefit from it in 2017.

In light of the recent issues surrounding recycling, the company has been reconfiguring its recycling contracts as they come up for renewal, and Trevathan estimates that process is about 80% complete. Hopefully, when all of the contracts have been updated, recycling will no longer be the drag on the company that it has been, but investors should be aware that this quarter's recycling performance is likely to be atypical.

Mo volume, mo problems

The one area in which the company didn't fare so well was the cost of managing the liquid that collects in its landfills. Such liquid needs to be contained so it doesn't leach into the local environment or water table. In Q3 2016, the increase in leachate cost was about $23 million, or a drag of $0.03 per share.

For this quarter, the cost was mostly offset by the company's recycling performance. But it's still an area of concern for the company. And since the recycling division isn't expected to post such stellar numbers in future quarters, it can't be relied upon to continually offset those prices.

But the company has a plan, which CEO David Steiner addressed on the earnings call:

[T]here is not a lot we can do about the volume of the leachate. When it rains, we get more leachate. But there is something that we can do on the disposal side, and that is the bigger part of that $23 million of expense. ... So we're building wastewater treatment plants; we're going to look at doing some deep well injection at various sites. ... Now, that takes a little bit of a time, so we would expect these increase leachate costs to be with us at least through mid-year of next year and probably throughout 2017. But in 2018, we ought to be able to attack it pretty well.

Investors should be encouraged that management at least has a plan to combat this recurring problem, even if the fact that a solution is more than a year away is frustrating.

Investor takeaway

Waste Management had a great quarter. Much of it was improved performance, and some of it (read: recycling) was luck. Aside from perhaps a swifter solution to the leachate issue, investors really couldn't have asked for more from this company this quarter, except for maybe a bigger jump in the stock price. Investors should feel very confident sticking with this company.

John Bromels owns shares of Waste Management. The Motley Fool owns shares of Waste Management. 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.

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