Waste Management (WM 0.30%) gave some key insights into its core business drivers during its second-quarter earnings call. Here are the highlights of the call, as well as how the trash titan intends to create value for long-term investors.
1. A best-in-class landfill network gives Waste Management pricing power
Another big area of focus is maximizing return on our disposal network. We have the best-positioned landfills and transfer stations in the industry, and we've started to see increased volumes being disposed at our facilities. We believe that is due to a strong economy, and benefits in volumes from third-party haulers choosing our close-in disposal sites. We see an opportunity to leverage the logistical benefits of our disposal network, and increase the returns in our large investment in that network.
-- CEO James Fish
Waste Management's wide economic moat is built upon its nearly irreplaceable collection of landfills and waste processing facilities. Massive regulatory hurdles and intense homeowner opposition make it difficult for competitors to encroach on Waste Management's turf.
In turn, Waste Management continues to win new business even as it raises prices. Service-increase requests from existing customers exceeded service decreases for the 18th straight quarter, and new customer gains exceeded lost business for the 13th consecutive quarter. Moreover, commercial volumes rose 3.2% despite a 6.6% increase in prices, while industrial volumes improved 3.1% despite a 10.9% price hike.
This powerful combination of volume and price increases led to a $47 million gain in collection income from operations and a $56 million rise in operating EBITDA in the second quarter. Better still, these strong results prompted Waste Management to raise its 2018 guidance for adjusted earnings per share to between $4.05 and $4.10, up from a prior estimate of $3.97 to $4.05.
2. Yet recycling remains a challenge
While our strong performance from our traditional solid-waste business is propelling us forward, as demonstrated by this EPS guidance increase, we continue to see pressure from our recycling line of business, as commodity market challenges persisted in the second quarter. During the quarter, EPS from recycling declined by $0.07 when compared to the second quarter of 2017, largely due to lower demand for recycled materials following China's import ban. And we are no longer assuming a second-half recovery in recycled commodities prices.
Waste Management expects its recycling business to have a negative impact of approximately $100 million on its full-year EBITDA and $0.17 to $0.20 on earnings per share. Still, Fish said that more than 75% of this impact has already been incurred, and the company is taking action to improve profitability in this segment.
In addition, Waste Management's operating EBITDA margin increased 40 basis points to 28.4% in the second quarter, even after accounting for a 40-basis-point negative impact from recycling. In turn, management is confident that Waste Management will achieve its full-year EBITDA and free cash flow forecast, despite the ongoing struggles of its recycling operations.
3. Cash flow generation is at record levels
The strong core price in collection and disposal volume growth that we saw in the second quarter, combined with disciplined focus on controlling costs and optimizing working capital, drove $975 million of cash from operations. This is the best single-quarter cash from operations we have ever achieved.
-- CFO Devina Rankin
Waste Management's Q2 operating and free cash flow both rose more than 19%, driven by its strong operating results and the benefits of tax reform. Notably, this free cash flow growth comes even as Waste Management is investing aggressively to modernize its landfills and vehicle fleet, which should support further increases in long-term profit and cash flow.
In all, Waste Management produced $621 million of free cash flow in the second quarter, and the company expects to generate a total of about $2 billion in 2018.
4. And management plans to pass this cash on to investors
We remain committed to a capital allocation plan that prioritizes return of value to our shareholders and accretive growth through acquisition. In the second quarter, we paid $200 million in dividends and bought back $300 million in shares. We've allocated over 90% of our 2018 free cash flow to dividends and share buybacks in the first half of the year. In the quarter, we completed another $21 million in accretive tuck-in acquisitions, bringing the total for the first half of the year to $269 million. This represents about $200 million of annualized revenue acquired in 2018.
Waste Management uses its robust free cash flow to create value for shareholders in multiple ways. The first is via acquisitions; Waste Management consistently acquires smaller competitors that help to steadily increase its revenue and profits. The company also repurchases its own stock, which tends to increase the value of its remaining shares, since its profits are then divided among fewer shares.
Best of all, Waste Management has increased its cash dividend to investors for 15 consecutive years. And with its dividend payments currently accounting for only about 40% of Waste Management's free cash flow, shareholders can expect more dividend increases in the years ahead.