Waste Management (NYSE:WM) is the largest residential recycler in North America and has extensive developments planned. It will continue to dominate its competitors in scale by opening eleven new material recovery facilities in 2012, operating 42 single-stream plants, and now processing 50,000 tons per month of recyclables. In doing this, it is giving the investment community a signal that it wants to be the leader in providing recycling services to residential, commercial, and industrial customers. Furthermore, by the year 2020, Waste Management expects to increase the amount of materials they manage to more than 20 million tons per year.
However, sometimes too much of a good thing can also inhibit success. This significant increase in volumes led to a subsequent increase in operational costs, leverage, and has made the firm vulnerable to risk of reduced commodity prices. A majority of these "headwinds," or negative impacts, are related to low commodity prices but are not limited to them. Unexpected headwinds also appeared to be caused by rollbacks on tip fees, working capital, under recovery of fuel surcharges, compensation or SG&A expenses, and litigation settlements. These headwinds are typical, especially when they are subsequent to economic downturns, but can they be mitigated?
Dissecting the Blows
In order to really understand the impact and risks that recycling operations have on Waste Management, we should review the year-over-year impact it has had on earnings per share since 2011.
|Metric||Q2 2013||Q2 2012||Q2 2011|
|Impact on Diluted EPS||($0.02)||($0.07)||-|
|Revenue From Recycling Operations||$366 million||$369 million||$419 million|
|Closed Stock Price (July month-end)||$42.03||$34.40||$31.49|
The impact on diluted earnings per share actually decreased when comparing the second quarter of 2012 to the second quarter of 2013. However, revenues from recycling operations decreased by -0.81%. It is hard to tell whether this type of headwind alone had a large impression on investors' outlook and caused the stock to trade at $34.40.
Now, let's see if there's any correlation with Waste Management’s return on equity during these respective periods.
|Metric||Q2 2013||Q2 2012||Q2 2011|
|Net Earnings||$244 million||$208 million||$237 million|
|Return on Equity||37.5%||32.1%||35.7%|
Despite the 17% growth in net earnings and 16.8% growth in return on equity from 2012 to 2013, the second quarter of 2012 also appears to be negatively affected. The overall company's earnings per share was greatly affected by $0.07 per share headwinds--primarily due to commodity prices.
Per the second quarter 2012 transcript, CEO David Steiner reported that the company's average recycling commodity prices during the second quarter were 20% lower year over year. Therefore, headwinds related to recycling operations have the potential to substantially impact earnings and should not be dismissed. These headwinds will only continue as commodity recycling remains at low levels and should continue to weigh on overall company performance during the remainder of 2013. Other risks to earnings are the significant increase in fuel and other costs, a severe downturn in the U.S. economy, a continued drop in energy and recycling commodity prices, and the inability to raise gross margins and prices enough to meet return on assets (ROA) goals.
If Waste Management can prove that it can keep its recycling operational costs low and not saturate the commodity market with its increasing recycling volumes, I believe that the firm will be able to lower its long-term risk. Metrics such as internal revenue growth from recycling operations and headwinds from unanticipated lower commodity pricing will be less of a concern for shareholders and executive management.
Tinia Pina has no position in any stocks mentioned. The Motley Fool recommends Waste Management. The Motley Fool owns shares of Waste Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!