Waste Management (WM +1.10%) released earnings for its fourth quarter and fiscal year on Thursday, Feb. 14, and it wasn't a very exciting valentine. Very slight improvements in trash volumes and pricing led to an increase in revenue of 0.8%, but earnings per share fell around 17%, largely due to asset impairments, costs associated with the company's ongoing restructuring plan, and the acquisition and integration of Oakleaf, a waste and recycling logistics provider that matches customers to third-party waste operators.
Good news for dividend lovers (and if you don't love dividends, Waste Management's probably not for you), the board raised the dividend for the 10th year in a row, nudging it up by 3% to $1.46 per share for an annual yield around 4%. Management offered guidance that the dividend would continue to rise along with earnings, and that earnings would rebound in 2013 by 20%-25%, as pricing begins to recover along with the U.S. economy and the company continues to execute its restructuring effort.
Waste Management's restructuring effort is aimed at improving performance and lowering costs by creating a more streamlined, more responsive organization. The first stage of this plan, led by new CFO Jim Fish, was to cut 100 basis points out of selling, general, and administrative expenses by flattening the leadership structure and eliminating unnecessary layers of bureaucracy, which Fish said the company was "on track" for, with a 90 basis point reduction already achieved.
Investors should continue to watch the success of this plan, which has the potential not only to generate more cash for investors but also make Waste Management a more formidable competitor as it seeks to consolidate the highly fragmented waste industry. In 2013, Fish and the team are focused on getting 100 more basis points by creating a more efficient routing and logistics program and focusing on operating costs. To achieve this goal, management has set incentive programs that are 50% dependent on improved operating costs for field operators. With the pieces in place for the company to manage this feat, failing to do so would be a red flag.
Treasure-hunting in trash piles
Throughout fiscal year 2012, Waste Management had affirmed its dedication to sustainability by focusing on recycling, mining the waste stream for reusable commodities. It followed up its acquisition of Oakleaf with the purchase of Greenstar, one of the nation's largest private recyclers. Greenstar's annual 1.5 million tons of recycled materials bring Waste Management's total recycled commodity stream up 18% to approximately 9.5 million. The company also continued to generate clean energy through its 22 waste-to-energy plants in the U.S. and joint-enterprises in China.
Waste Management wants to be in the recycling and waste-to-energy business because, more than ever, customers are demanding sustainability minded waste solutions – Waste Management can see which way the wind is blowing. It's potentially a very lucrative position to get paid to take away someone's trash, and then get paid to sell that trash to someone else.
So far, however, Waste Management is getting hammered for its good behavior due to low commodity prices. With rock-bottom natural gas prices depressing the cost of electricity in the U.S., and slower growth in both China's economy and the U.S. housing market hurting commodity prices, Waste Management's contracts have become deeply unprofitable. In 2012, recycling commodity and electricity prices dragged earnings down by $0.25 per share, over 14% of earnings. Management doesn't expect these activities to be profitable in 2013, either.
A change is gonna come
It's not all bad news forever. Waste Management can expect some big growth catalysts that I regard as basically inevitable. First, a continuing economic recovery should lead to more consumption, which in turn leads to higher waste volumes and better pricing for the company as households and municipalities get their budgets in order. Second, increased activity in the housing market will generate much higher volumes for construction waste and special waste. Finally, the eventual expiration of current commodities and electricity contracts and their renewal at more favorable prices should turn Waste Management's recycling and waste-to-energy operations from the big drain on earnings they are now to a solid contributor to profitability.
All three opportunities basically just depend on continued economic recovery, even if modest, and all three should create a lot of value for shareholders. Given the likelihood of these developments, shares look undervalued today, probably because while it's fairly certain that the economy will recover fully, it's entirely uncertain when that will happen. It's true that management offered modest guidance for 2013, and will still be pursuing its reorganization strategy in 2014. A lull in the recovery could set the company's plans back a year or more, leading to a scenario in which Waste Management's stock price doesn't move for years.
