Months after the coronavirus pandemic struck, some industries are still trying to get back on their feet. Business has been so slow that even an essential service provider like Waste Management (WM 1.60%) isn't finding enough trash to dump into its landfills. That could end up as repulsive sales numbers this year, at a time when the company's debt pile is also about to get bigger. So are you better off avoiding Waste Management stock right now?
How is Waste Management dealing with COVID-19?
Even as the coronavirus lockdown hit demand for Waste Management's trash collection services, the company also discontinued nonessential services like collection of bulk goods and yard waste as a protective measure. The results showed up on Waste Management's second-quarter numbers, with revenue and net income falling 10% and 19%, respectively, year over year. Waste Management reported core pricing -- which includes price increases and fees -- of only 1.3%, compared with 4.2% in Q2 2019. The company expects full-year revenue to fall 4% to 5%.
It can be unnerving to see sales declines from a company that's into a resilient business. After all, investors fall back on such businesses during recessionary periods.
I'm not too worried, though. Waste Management's Q2 core price was certainly a dampener, but the temporary suspension of some fees and price increases in the wake of the COVID-19 pandemic hurt pricing. Management says it remains "committed to its pricing programs." I too believe that Waste Management's pricing power is intact, given its massive network of 250 landfills that are even used by rivals for a tipping fee.
As for volumes, they should pick up slack as the economy gets up and running since Waste Management has a hugely diversified customer base: The public sector contributed 23% to its total sales in 2019 while the rest came from diverse several sectors and industries, including retail trade, manufacturing, real estate, construction, healthcare, and offices to name a few.
Moreover, Waste Management has proved its mettle time and again, and it should be no different this time around.
But high debt can be troublesome when earnings come under pressure. As of June, Waste Management had nearly $13 billion in debt. Now the entire waste management process, from hauling to disposing of and recycling trash, requires significant investments in assets such as a fleet, transfer stations, and landfills, so high leverage isn't really surprising. But Waste Management is about to add least $1.8 billion in debt as it acquires Advanced Disposal (ADSW). So what we have here is a bigger company in the making, but at what cost?
A blockbuster deal?
Waste Management's impending $4.6 billion acquisition of Advanced Disposal includes Advanced's debt worth $1.8 billion. To top that, Waste Management intends to finance the deal using debt.
Sounds worrisome? It's not necessarily.
First, Waste Management should easily be to access low-cost funds given its strong credit rating and liquidity. Second, its operating income currently covers its interest expenses comfortably, as its 12-month interest-coverage ratio of 5.43 indicates.
In short, some amount of additional debt shouldn't hurt the company. What matters more is what Waste Management is getting in return: It's bagging the fourth largest waste management company in the United States. That's certainly not a bad deal, and it looks even more promising when you get to know these important facts about Advanced Disposal:
- Advanced Disposal operates in 16 states across the Midwest, South, and East regions.
- It has 2.7 million residential and more than 200,000 industrial and commercial customers.
- It owns or operates 41 landfills with an average remaining life of roughly 37 years.
- It has 18 landfill gas-to-energy conversion facilities.
- It runs 20% fleet on natural gas.
- It generated $1.6 billion in revenue in 2019.
So Advanced Disposal's acquisition should expand Waste Management's reach, asset base, and green fleet, thereby further solidifying its leadership position in the industry.
With management also expecting the acquisition to be immediately accretive to adjusted earnings per share and cash flow from operations, there's a lot of value to be unlocked in the long run.
So does that make Waste Management stock a buy?
The acquisition has been in the works for more than a year now, which is one reason Waste Management shares shot to all-time highs in March before crashing with the broader market. But with the stock bouncing sharply from its April lows and barely 10% away from its 52-week high, its trading at a price-to-earnings multiple of 30 and price-to-book value of 7, both of which are above respective five-year averages.
So you might want to want to wait for a dip to buy Waste Management shares, but don't miss it then. It's a safe, reliable stock that also pays a dividend: It has increased its dividend annually for 17 consecutive years and currently yields 1.9%.