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Why Investors Are Paying a Premium for Waste Management

By Daniel Foelber – Jun 7, 2020 at 10:54AM

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It's a favorite for more than one reason.

Waste Management (WM -0.31%) has the largest waste collection, transportation, and disposal business in the United States. And while that might not put it in the most glamorous line of work, there are many reasons why its business model is attractive. Here's why investors are paying a premium for Waste Management.

A man collecting trash on a beach.

Image Source: Getty Images.

Reliable revenue stream

Waste Management has traditionally traded at a premium to other industrial stocks and the company's P/E ratio and price-to-free-cash-flow (FCF) ratio signal that the stock continues to trade at a premium to the market average.

WM PE Ratio Chart

WM PE Ratio data by YCharts

Part of the reason why is because 75% of Waste Management's revenue has what the company calls "annuity-like characteristics," in that it comes from multiyear contracts with the public and private sector. These contracts are important to the stability of Waste Management's business considering its commercial and industrial sectors made up 70% of collection revenue and 46% of total revenue in 2019.

Waste Management is also partly a recession-proof stock in that there will always be a baseline amount of demand for its services. Waste Management's cash flow, net income, and stock price have remained resilient even during past economic slowdowns.

WM Free Cash Flow (Annual) Chart

WM Free Cash Flow (Annual) data by YCharts

For example, at the height of the Great Recession at the end of February 2009, Waste Management's stock was down about 27% since the beginning of 2007 compared to the S&P 500 being down 48% over the same time frame. 

Tailwinds

There's upside potential as well. Waste Management benefits from several strong tailwinds, the best of which is a rising population. There's a good chance that there's a Waste Management truck that picks up your trash, but also think about all of the waste that's related to commercial and industrial activity. GDP growth will mean more business for Waste Management.

Waste Management also benefits from an increasingly environmentally conscious population that cares about recycling instead of piling up trash in a landfill. Waste Management is the largest residential recycler, and although its recycling business has struggled to help the bottom line in years past, it's adjusting its price model to ensure that customers pay a higher price for its services. 

Simplicity

Another attractive quality is the simplicity of Waste Management's business model. Waste Management is a stock you can comfortably buy and hold forever partially because it's a business that's easy to understand. Investing in companies that are easy to understand and impact your everyday life is a classic Peter Lynch style of investing that can be a lot of fun, especially for new investors.

Risks

Risks to Waste Management's industrial and commercial revenue streams as a result of the COVID-19 pandemic include slowing construction projects, less industrial production, lower consumer spending, and fewer people working. The waste associated with people going out for leisure activities at everything from restaurants, to bars, to concerts, to conventions could also hurt Waste Management's business in the short term. That being said, the company's residential and recycling businesses could pick up as people spend more time at home. However, it's worth mentioning that the company has neglected to give any full-year guidance and has also suspended its share buyback program.

Solid dividend

Despite the suspension of its share buyback program and uncertain earnings, Waste Management is committed to sustaining its dividend, which currently yields around 2%. Waste Management has had 17 years of consecutive dividend increases and has already approved another 6% dividend raise in 2020. 

A justified premium

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. These tailwinds, combined with the company's industry-leading position, overpower the short-term risks of a slowing economy.

The company's reliable revenue, recession-resilience, and a business that everyone can understand are some reasons why investors are paying a premium for Waste Management.

Daniel Foelber owns shares of Waste Management. The Motley Fool recommends Waste Management. The Motley Fool has a disclosure policy.

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