Waste Management (WM 0.33%) reported its fourth-quarter earnings on Feb. 2, and the results were met with mixed reactions. The company delivered revenue and net income in line with analysts' estimates, but that represented stronger growth than normal. Revenue was up 15% year over year to almost $4.7 billion, while the company's net income grew 16% to $506 million, driven by stable increases in its trash volume. But as with many other businesses, it faced margin pressure from increases in commodity prices due to inflation.
Where the company stood out, however, was in its spending forecast for the coming years. Waste Management is looking to invest heavily in recycling and renewable energy projects in 2022 and beyond, signaling management's vision for the company's future. This news was interpreted differently by various stakeholders, but long-term investors should see this as a positive indicator. Here's why.
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A forward-looking process
Waste Management has noticed that becoming a more sustainable and recycling-focused company is not only better for its public image but also for its profitability. As a result, the company is planning on spending over $1.6 billion by 2025 on scaling up its recycling and renewable energy businesses. The company's capital expenditures for the fourth quarter were also up from $394 million to $774 million -- the primary source of this increase being the early stages of its spending on these projects.
Specifically, the company will be investing in collecting renewable energy from its landfills and a new automated recycling process. Currently, just four of Waste Management's landfills produce renewable natural gas (RNG), but the company expects to reach six by the year's end. Looking further ahead, Waste Management has a goal of getting 21 RNG plants operational by 2026. This would produce roughly seven billion kilowatt-hours of energy -- enough energy to power over 650,000 U.S. homes for one year -- which it will use to fuel its RNG transportation trucks.
This energy creation will allow the company to be both more sustainable and more capital-efficient. The company's investment in expanding its recycling footprint also helps its profitability. Waste Management expects these investments will be paid back fully in six years, and by 2026, they will generate an additional $180 million in EBITDA. Not only does this help Waste Management financially, but it also reinforces the company's role as a leader in the trash and recycling industries.
Trash is still a goldmine
Of course, with over $1.6 billion being spent over the next four years, free cash flow is going to take a hit. Investors have already seen this in the latest report where free cash flow declined from $1.2 billion in the year-ago quarter to just $243 million. The company expects this trend to continue: It is guiding for free cash flow of approximately $2.1 billion this year, down from about $2.7 billion without the investments.
While cash flow might be taking a hit, it is not going to make much of a dent in the company's relative cash generation. Even if Waste Management only generates $2.1 billion of free cash flow in 2022, that's still good for a free-cash-flow margin of 11% for the year based on the midpoint of revenue guidance. Additionally, these investments don't look like they will affect the company's dividend and stock buyback program.
The company maintained its stock buybacks, approving $1.5 billion for future repurchases. The company also increased its dividend 13% to $2.60 -- marking the 19th consecutive year of payout growth. With a payout ratio of 53%, Waste Management has plenty of cash to continue supplying investors with an impressive quarterly payout even after factoring in the new spending.
The big picture looks bright
All in all, this push into recycling and renewable energy is a bullish development for long-term investors. It is clear management does not want to sit back on its heels when it comes to sustainability, seeing it instead as a major opportunity. While the expenses to fuel this shift will be costly in the short term, they will not affect the company's ability to return capital to shareholders, nor will they permanently crimp impressive cash-flow margins.
Waste Management might be a "boring" stock at first glance, but under the surface lies a cash-generating machine with a management team looking toward the future.
