Analysts Debate: Is Waste Management Still a Top Stock?

The Motley Fool has been making successful stock picks for many years, but we don't always agree on what a great stock looks like. That's what makes us "motley," and it's one of our core values. We can disagree respectfully, as we often do. Investors do better when they share their knowledge.

In that spirit, we three Fools have banded together to find the market's best and worst stocks, which we'll rate on The Motley Fool's CAPS system as outperformers or underperformers. We'll be accountable for every pick based on the sum of our knowledge and the balance of our decisions. Today, we'll be discussing Waste Management (WM 2.75%), a leader in one of the few absolutely indispensable service industries of modern life.

Waste Management by the numbers
Here's a quick snapshot of the company's most important numbers:

Source: Morningstar.

Alex's take
Before we get started, let me make clear that I don't expect Waste Management to fall apart in the foreseeable future. Trash hauling is an essential underpinning service of society, and Waste Management is the biggest player in North America. What I'm looking at in my call today is whether or not Waste Management can beat a simple index fund. There are plenty of index funds out there that offer dividend distributions, and plenty of stocks that have high yields combined with a rock-solid business position. Can Waste Management do better?

Source: YCharts. Total return (dividends included) figures used.

It shouldn't be so surprising that Waste Management thrashes the index on much longer time frames. Even the largest companies can have extremely long growth ramps that allow them to beat the indexes for decades. Over the past several years, however, the only thing supporting Waste Management's stock price growth has been a simple rise in its valuation. That's all. The company's fundamentals have not justified any investing optimism in years:

WM Total Return Price data by YCharts

Dividend payments have outpaced the stock's growth, but that's been driven entirely by management's focus on high yield. The company's free cash flow payout ratio has been consistently rising throughout its history of dividend payments. Its free cash flow? Well, you can see the chart. And here's the thing. In the last five years, Waste Management is the only major company in its industry to have declining cash flow. Although the others have zigzagged a bit, all of them are firmly in positive territory today, as compared to five years ago:

WM Free Cash Flow TTM data by YCharts

But the dividends! That's why you're investing, right? Because it's got a big payout and everyone needs someone to take out the trash? If you're looking for a rock-solid dividend, why not try Intel (INTC +13.79%)? It's even more important to a much larger global industry, and its free cash flow payout ratio is well below Waste Management's. Or why not Lockheed Martin (LMT 1.15%)? Its free cash flow payout ratio is even lower than Intel's, and it's not like the government will suddenly stop buying expensive toys to blow up sandy places. Both of those companies offer higher yields than Waste Management, and both are extremely well-placed in vital industries. Neither had significant free cash flow gains in the last five years, but both have done better than Waste Management.

I just can't see Waste Management doing any better than matching the index -- even with reinvested dividends -- going forward. I'll pass on this one.

Sean's take
Alex has done a pretty good job of dissecting Waste Management by the numbers, but I'm going to take a slightly different approach. Rather than dissect where we've been, I want to examine where Waste Management is headed on paper.

In the simplest terms, we're talking about trash -- a necessary byproduct of life. I love companies that deal with the necessities of life. There will always be a need for trash pick-up and transport, and there's an almost insatiable demand for recycling needs, as well. Waste Management perfectly fits the bill of a necessity stock.

As Alex mentioned, there are worries for Waste Management, but not so much from a past performance perspective. Industry consolidation, like the buyout of Allied Waste by Republic Services four years ago, and the purchase of Alaskan Waste Company by Waste Connections earlier this year, are truly its biggest concern. Waste Management's sheer size allows it to have pricing power and flexibility that few other waste service companies possess. As its peers grow, Waste Management may lose some of that flexibility.

Luckily for shareholders, there are plans in place to grow the business beyond just traditional trash collection. As the nation's largest recycler, Waste Management is planning to utilize its landfills in multiple ways to drive growth (in addition to reducing costs and adding to its margins). The company is currently using methane gas derived from its landfills to generate 550 MW of electricity to power 440,000 homes. By 2020, Waste Management expects to be powering approximately 1 million homes. It also generates revenue from its recycling efforts of metals within its landfills, which drive down its costs and keep harmful materials from reentering the environment.

With necessity companies like Waste Management, you're often also talking about a dividend. With Waste Management, it's not about quantity, because with a yield of 4.4%, you can easily do better by jumping ship to my Foolish colleague Brian Stoffel's garbage patch pet, Veolia Environnement (NYSE: VE), which is yielding 7.2%. Instead, you get what I consider to be the safest dividend in the waste collection sector. In 2003, it paid out just $0.01 for the entire year; now, shareholders are privy to $0.355 each quarter! With a projected payout ratio of 68% for 2012, shareholders are getting a good chunk of change back from the company without much fear that their payout will shrink, thanks to the necessity nature of garbage collection.

Have I mentioned that I really like necessity stocks? Weak metal prices may be temporarily weighing on Waste Management's recycling business, and a weak economy might be constraining its expansion efforts, but, all told, this is a story that makes a lot of sense to me over the long term, and I'd recommend bringing this trashy play into your portfolio any day.

Travis' take
The trash and recycling business isn't exciting, but that shouldn't scare investors away from a steady dividend play. As Sean said, this is an absolutely necessary business, and it'll be around for years to come.

Alex and Sean have covered the business well, so I'll focus on the main question we should have about the stock. Is it a reasonable enough value to buy right now? I ask this under the assumption that the company is no longer a growth stock, but has instead become a value steady company with a solid dividend.

Waste Management is currently trading at 17.2 times trailing earnings, and pays a 4.4% dividend. That P/E ratio isn't all that impressive considering the number of stocks with lower ratios and similar dividend yields available on the market. If we look at it through another lens, the company has an industry leading return on capital of around 10%, but it's important to note that the company has $12.2 billion in property plant and equipment. Any growth will require a lot of spending with very limited upside.

Comparing the valuation of Waste Management to our previous outperform picks, like Intel, which has a lower P/E and a higher dividend, or Seadrill (SDRL +0.00%), which pays a much higher dividend and is investing in capital equipment with a payback of three to four years, shows that there's better value elsewhere. Someone looking for a solid dividend may even want to turn to 3M (MMM 0.32%), which has paid a dividend for 96 straight years, and has increased its dividend for 54 consecutive years.

My opinion is that, if the economy goes into recession, Waste Management will likely outperform the S&P 500. Because I think that we're in for a booming economy over the next few years, driven by housing, higher employment, and more domestic energy, I believe that the index will outperform. I'd lean toward an underperform call, but with very little conviction, so I'd prefer to just stay away from this stock.

The final call
Two fence-sitters outweigh one bullish call today, so we've decided to simply avoid Waste Management. It may be steady, but it's not likely to offer any real benefit to our collective CAPS portfolio in either direction. Today, we're beating the index by 111 points over 21 picks, and we're always on the lookout for the next great stock. Waste Management might not be that stock, but here's hoping that next week's selection is more appealing.