Outside the shimmer and shine of hypergrowth companies lies the stable and stodgy realm of dividend stocks. What they lack in flair is made up for with consistent earnings growth and steady payouts.
As the largest waste and recycling services provider in North America, Waste Management (WM 0.79%) has developed a reputation for being a best-in-breed income stock. Its business may not be glamorous, but its returns certainly have been. The stock is up 21% year to date, reaching a new all-time high on Wednesday and handily outperforming its industrial sector peers as well as the S&P 500. Let's dive into Waste Management's numbers and growth potential to determine if the stock is a buy despite its higher valuation.
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Proven recession resilience
Waste Management's performance during the COVID-19 pandemic was a textbook example of its ability to navigate foggy business climates. The company generates revenue by collecting trash and recycling, then transporting it and disposing of it in landfills and recycling facilities. If you live in a big city, there's a good chance that a Waste Management truck picks up your waste.
That's the residential side of collection revenue. The other 70% comes from a mix of commercial and industrial customers. As business slowed during the pandemic, residential business picked up as folks spent more time at home. But many industrial and commercial customers simply weren't producing as much waste, which impacted Waste Management's results. However, the company was able to overcome this challenge thanks to its long-term contracts and diversified revenue streams from various industries in both the public and private sectors. Its commercial and industrial customers tend to have three-year service agreements and stick with the company for 10 years, although Waste Management also offers temporary services and subscriptions.
All said and done, revenue was down less than 2% while net income and free cash flow (FCF) declined in the low- to mid-double digits. Waste Management -- yet again -- proved its mettle during uncertain times.
WM Revenue (Annual) data by YCharts
History of dividend raises and share buybacks
Waste Management's history of dividend raises and share buybacks is backed by ample FCF and net income generation. Even in the down year of 2020, it generated $1.5 billion in net income and $1.8 billion in FCF, which was plenty to cover its $1.3 billion in share buybacks and dividend payments.
The company recently announced a new share repurchase plan that could mean up to $1.35 billion in buybacks, as well as a new annual dividend payout of $2.30 per share. The company's ability to consistently raise its dividend and support expenses with earnings from its operations rather than debt is a core virtue of many successful dividend stocks.
Growth potential
Waste Management estimates it captures around 20% of the annual $75 billion waste and recycling industry in the U.S. However, the sector as a whole tends to grow in the mid-single digits, meaning Waste Management has to get creative if it wants to deliver outsized returns. Aside from reducing costs and driving efficiency, Waste Management boosts its performance by raising prices or buying out competitors, which it recently did through its acquisition of Advanced Disposal Services.
Long term, it sees potential in the burgeoning sustainability industry. Annual ESG reports are now the norm for large corporations. Aside from transitioning to renewable energy, one of the best ways for food and beverage companies to reduce their carbon footprint is by lowering their waste output, which includes everything from sustainable plastics and packaging to converting more trash to recycling. Waste Management is positioned to help these companies accomplish their ESG goals by reducing the environmental impacts of their waste. Outside of food and beverage, other industries, such as chemical companies, are looking to make sustainable products from waste.
In a recent interview at WasteExpo 2021, Waste Management CEO Jim Fish talked about the potential of the emerging sustainability industry but stressed that the economic aspect is just as important as the environmental benefits. In many cases, companies can't afford the added costs of sourcing sustainable materials without passing along those costs to consumers (who, in many cases, are not willing to pay a premium). Similarly, trends toward autonomous driving are great, but it's a lot harder to mass produce 32-ton driverless garbage trucks than passenger cars.
To help the company implement real solutions that can make a profit, it promoted longtime executive Tara Hemmer to Senior Vice President and Chief Sustainability Officer. Investors can monitor her team's progress to determine if Waste Management is achieving measurable results or just talking for the sake of positive PR. Despite the potential and interest from upper management, the company has yet to prove it can profit from sustainability (outside of recycling).
The bottom line
Waste Management's industry-leading position, reputation for dividend raises, and relatively stable business model make it a great dividend stock, especially for retirees. Given that so much of America's waste passes through the company's channels, it stands to reason that Waste Management is positioned to benefit nicely if it can prove it can profit from sustainability, but it will take imagination and time for this new growth outlet to evolve.
The stock's rise calls its valuation into question. The company has a price-to-earnings ratio of 39 and a price-to-FCF ratio of 34, which are its highest levels in five years. It's becoming increasingly harder to justify buying the stock at its higher price given the company's low growth and a dividend yield that is now just 1.6%. Waste Management remains a great long-term industrial stock, but investors will have to pay a much higher premium now than in years past.
