Recession-proof; lack of competition; depth and breadth. You can never have it all. Or can you?
Waste Management (WM -0.68%) is a classic Peter Lynch-style company that makes up for its lack of glamour with strong fundamentals. But it can be hard to buy a company when it keeps going up, which had been the recent case for Waste Management. However, coronavirus concerns and a slowing economy have knocked Waste Management off its seemingly unstoppable, upward trajectory. And even though its valuation remains high, Waste Management is an industrial stock you'll want to buy and hold forever.
Competition is a core threat to most companies, but less so to Waste Management, which has the largest waste collection, transportation, and disposal business in the United States. Its transition from diesel to liquefied natural gas (LNG) and compressed natural gas (CNG) for its trucking fleet, its conversion of waste into energy, and its status as the largest recyclables collector make it a company that's beneficial to the environment as well.
From an environmental and efficiency perspective, handling waste is the kind of business that is better run by a large corporation. That's not to say that Waste Management doesn't face competition from large and small waste companies as well as the public sector in the form of county and city programs. The company notes the risks of smaller public and private players undercutting its prices. But the extent of Waste Management's integrated value chain from pick up, to transportation, to the handling of that waste makes it a compelling choice for many local governments and businesses interested in the long-term benefits of responsible waste management. That is why, in addition to high barriers of entry, Waste Management has a sizable and protective moat. The company's planned acquisition of Advanced Disposal will further expand this protection.
Recession-proof companies are those where demand for their products and services is not affected by a recession. Companies selling consumer staples, healthcare companies, and arguably some tech companies make this list. Although Waste Management isn't as recession-proof as consumer staples companies, it is about as recession-proof as you can get for an industrial.
And trash has been a growing business. A growing population means more waste and an environmentally conscious population means a greater emphasis on recycling, sustainability, biofuels, and landfill efficiency.
On the industrial side, Waste Management's business grows as the economy grows, which could be a double-edged sword. The company's vulnerability to the coronavirus-induced economic slowdown will be something investors will want to watch. Worry about the slowdown is the most likely reason why the stock has sold off. Slowing construction projects, less industrial production, and fewer people working all mean less waste, which could impact Waste Management's commercial and industrial sectors, which together, made up 70% of collection revenue and 46% of total revenue in 2019.
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Waste Management has been an investor favorite thanks to its tailwinds and lack of competition. The company has outperformed the S&P 500 and downright trounced industrial ETFs over the past five years. As such, its valuation had gotten pretty high, with its P/E ratio topping 30 and price to free cash flow (FCF) topping 25 for a time. As of this writing, the P/E has fallen to 25, and price to FCF is at 20.
The biggest challenge for Waste Management's stock will be justifying its premium valuation in the face of slowing commercial and industrial revenue. This challenge comes on top of flat Q4 2019 revenue that snapped a five-year streak of consistently higher YOY quarterly revenue.
For that reason, a short-term decline in the price of Waste Management's stock is, arguably, justified. The unknown is a scary thing, and until Waste Management announces a coronavirus-impacted quarter, the uncertainty is even more acute. But when you consider that it's only certain aspects of Waste Management's business that are vulnerable, and if you believe things will return to normal eventually, then Waste Management is a better buy than it was a month ago.
It's also important to ask what is really at risk here. To me, the fundamental fabric of America's consumer-based economy, industrial might, and economic strength are not affected by this virus. What is affected, heavily, is consumption and production in the near term.
At the end of the day, Waste Management benefits from many high-probability tailwinds like an increasing overall population, an increasingly industrializing population, and pro-environmental sentiment toward the handling of waste. These tailwinds combined with the company's industry-leading position overpower the short-term risks of a slowing economy.
Financials and dividend
Waste Management's balance sheet and financial leverage are average when compared to other industrials. The company's debt and debt to capital (D/C) ratio have been on the rise the past five years, yet are still within an acceptable range. This rise would be concerning if Waste Management's business was more vulnerable to an economic slowdown or competition, but it remains something to watch.
On the dividend side, the company's FCF easily covers dividend obligations, meaning Waste Management's dividend is safe and sound. The company has increased its dividend for 17 years. The yield had been below 2%, but as a result of the sell-off, the yield is now a decent 2.4%.
Buy and hold forever
It's undeniable that the wide-ranging effects of the coronavirus are unknown, meaning it takes some confidence to invest in the stock market amid all this uncertainty. Waste Management is the kind of stock that can provide some peace of mind through its reliable core business and attractive tailwinds. It's the kind of company that is truly worth buying and holding forever for anyone that believes Waste Management's industry and firm-level strengths outweigh the near-term risks of an economic slowdown. A balance between home and business and devotion to the environment make Waste Management a sound way to take advantage of the present uncertainty and get a dividend while doing so.