Why the Market Dumped Shares of Waste Management, Inc.

Waste Management (WM -0.62%) is on a short leash with Wall Street these days. With waste volumes moderating, the trash collector is in the midst of reshaping its business to become a provider of "environmental solutions". Along the way, however, analysts have remained skeptical and short-term results have suffered. In this regard, the last quarter of 2013 was no exception, as earnings fell shy of expectations and the stock declined nearly 5% during the day.

But the Houston-based services company, like true Foolish investors, is playing the long game through its diversification efforts. Meanwhile, the company's been busy streamlining its operations. With that in mind, investors can salvage a few promising takeaways from the report.

Headwinds in landfills
In recent years, Waste Management, along with competitors like Republic Services, faced shrinking trash volumes during the recession. Times were tough and households cut back on everything, including waste.

Today, waste volumes are recovering, albeit slowly. During the fourth quarter, Waste Management's total collection revenue increased 1.2% and landfill revenue increased 2.3%. These two large categories translated to modest quarterly revenue growth of 2%, while creeping costs reduced earnings by roughly 7%. As a result, the company fell short of analysts' expectations for the quarter:

In line with recent trends, the collection and landfill business remains lackluster, and the outlook for 2014 looks eerily similar to that of 2013. Waste Management said the erratic winter weather was affecting first-quarter volumes thus far, and management expects internal revenue from volumes to decline about 1% in the year ahead.

Trouble converting trash to treasure
To address the concerns over its core business, Waste Management has pivoted toward other opportunities like recycling, renewable energy, and even consulting services. These categories seem to hold promise, but so far the financial results aren't measuring up.

In the waste-to-energy business, for example, the company booked a $483 million impairment charge during 2013. Management described the somewhat dire outlook for waste-to-energy projects as follows: "[T]he Company's view that projected long-term energy prices and disposal volumes into the plants will not dramatically improve from current levels." Due to rock-bottom natural gas prices in recent years, this business is not bearing the same fruit that management once expected.

Additionally, the recycling business is facing similar headwinds, hurt by relatively low commodity prices. In 2013, recycling suffered an unexpected setback that led to a $0.12 decline in earnings per share, well beyond the $0.02 decrease predicted at the outset. Looking ahead, management plans to increase fees and put in place a tighter control process to avoid unforeseen costs, but still expects to see no impact on earnings from recycling operations.

On the whole, Waste Management is struggling to turn trash into treasure through either waste-to-energy or recycling, which explains the uninspired response from the market.

Where's the silver lining?
Still, in the midst of all the rubbish, investors have a few reasons to remain optimistic. First off, one of Waste Management's primary goals for 2013 was to boost free cash flow, and the company delivered by generating $1.23 billion, an increase of almost 60% compared to 2012. The impairment charge, for instance, was a non-cash expense that is a one-time burden on the bottom-line.

Secondly, Waste Management's strength lies in breadth and pricing power, and margins in solid waste ticked up from 40 to 140 basis points largely due to evenly spread price improvements.

Finally, Waste Management is in the process of building a diverse waste business that offers an entire spectrum of services. As of now, the ancillary businesses are an impediment to robust growth, but the long-term payoff could be handsome as Waste Management distinguishes itself as a one-stop shop for clients.

Foolish takeaway
Despite slightly disappointing results, Waste Management still towers over the competition in this dirty but necessary industry. This sheer size advantage pays off in an industry with mostly recurring revenue streams. Tack on a healthy dividend of more than 3% and investors should feel confident about the future in spite of the ebbs and flows of the quarterly earnings game. Over the long haul, the opportunity for a new approach to trash is tremendous, and Waste Management will continue to chip away at the edges. 

Source: Waste Management