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Why This Trash Stock Can Beat the Market

By PT Lathrop – Jun 3, 2020 at 6:11AM

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Environmental and social practices make Waste Management an enduring company.

Waste Management (WM -1.68%) is a resilient business, providing essential services by disposing of our kitchen grease and recycling our junk. Unlike many rival waste companies, its strategy of investing in people and green technology prepares the company for continued strong results in both its business and its share price.

Coming out of the financial crisis of 2009, WM stock has been a six-bagger with dividends included, absolutely crushing the market averages. But the stock is currently down about 15% from its recent February highs, as the COVID-19 pandemic struck WM alongside most other companies. In early May, CEO Jim Fish withdrew the company's guidance,citing increased costs from its COVID-19 response and declining commercial revenue -- especially among endangered small businesses. And the company is still working with regulators to finalize its merger with Advanced Disposal (ADSW)

So why should you feel confident that this company will only get stronger? Waste Management's ability to solve problems for people, communities, and the environment make it an attractive company for consumers and environmental, social, and governance -- or "ESG" -- investors who look for companies that share their values. 

Waste Management workers sort paper at a recycling plant.

Image source: Waste Management.

Waste Management is green

Waste Management has tremendous scale and resources to turn its customers' waste into environmental benefits. The company operates 147 recycling centers around the country. Its "CORe®" facilities recycle industrial food waste through water treatment plants to generate green energy. Some 124 other centers capture gas emitted from landfills, further reducing the need for fossil fuels. That captured gas and other alternative fuels power 65% of Waste Management's fleet, compared to roughly 20% at its main competitor, Republic Services (RSG -1.50%). Waste Management even turns maxed-out landfills into wildlife refuges, complete with recreation and education programs. For Waste Management, this is just the beginning. 

These practices are obviously right for the planet, but they also benefit the bottom line. Waste Management is reinventing the recycling industry to make it more economically sustainable, using new technology in its "material recovery facilities" to select for items with the highest value. And since dirty bottles, cans, and packages often can't be recycled, Waste Management's improved purification processes also drive down costs. 

Meanwhile, the company is shifting its recycling model to a "fee-for-service" approach, which makes the process much less dependent on fluctuating commodity prices. If the value of recycled goods falls, Waste Management can pass along its higher costs to the customers from whom it collects, rather than relying on selling the final product to make its money back. It's like charging for a haircut rather than just selling the trimmings. 

Collectively, these investments give WM the infrastructure, networks, and reputation that provide an enduring competitive advantage. 

When COVID-19 struck, the company put its money where its values are. The company guaranteed all full-time staff 40 hours per week of pay through the duration of the crisis. It also extended small businesses a free month of service and has helped other customers adjust and extend their payment terms. This focus on treating customers kindly helps the company retain those clients -- and leaves customers less likely to complain when Waste Management recoups its higher costs by increasing its prices. The company has been proactive in serving increased residential demand, and has called itself "ahead of the game" in passing along those costs to its customers. 

The bottom line

Waste Management makes full use of its leverage in the market, with a commanding market share of 34%. That's significantly larger than its closest competitor, Republic Services, at 20%,according to analysis from CSIMarket.com. It maintains that dominance through steady increases in revenue, EBITDA, and margins:

2017-2019 Waste Management Revenue, EBITDA, and CFO bar charts.

Image source: Company presentation.

What does the company do with this reliable cash flow? Waste Management's leadership touts the company's consistent return of capital to investors. Dividends have added more than 100 percentage points to the company's stock returns over the past 10 years, according to S&P Global Intelligence. 

Foolish investors might also like to hear that the company also prioritizes reinvesting much of its cash back into the business. Over the last three years, 47% of WM's capital went to capital expenditures, and the company plans on increasing that spend by about 10% each year. More importantly, key metrics like return on invested capital show that it's investing those funds in smarter, more profitable ways than its rivals:

Bar graphs showing WM ROIC vs. rivals.

Image source: Company presentation.

Investors might also like to see the company bring down its debt. Waste Management's debt currently equals 3.1 times its earnings before interest, taxes, depreciation, and amortization. Although that ratio equals that of rival Republic Service, smaller competitor Waste Connections (WCN -1.46%) reported a debt-to-EBITDA ratio of 2.6 at the end of 2019. Waste Management used debt to grow its business, but if its debt-to-EBITDA ratio climbs higher from here, it may crimp the company's ability to cheaply and easily obtain debt to fund future expansion.

Waste Management looks like a safe buy, but if investors want to make sure it keeps outpacing the market, they'll need to keep an eye on the continued success of its innovations and its ability to manage debt.

PT Lathrop owns shares of Waste Management. The Motley Fool recommends Waste Management. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Waste Management, Inc. Stock Quote
Waste Management, Inc.
WM
$161.91 (-1.68%) $-2.76
Republic Services, Inc. Stock Quote
Republic Services, Inc.
RSG
$137.45 (-1.50%) $-2.10
Waste Connections Stock Quote
Waste Connections
WCN
$137.03 (-1.46%) $-2.03
Advanced Disposal Services, Inc. Stock Quote
Advanced Disposal Services, Inc.
ADSW

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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