The company hopes that restructuring corporate overhead will help it truck into 2015. Source: Waste Management.
Waste Management (WM -0.52%) today reported third-quarter 2014 net income of $270 million, versus $291 million a year ago. The company posted $0.62 in earnings per diluted share, compared to $0.58 in the prior year. Waste Management attributed its performance gap to approximately $66 million of after-tax corporate restructuring and legal reserves charges. CEO David Steiner communicated in the company's earnings release that the restructuring expenses should save the waste hauling and recycling giant roughly $100 million per year -- once the cost-cutting activities are fully implemented in 2015. Below, we'll walk through highlights from the earnings report and harvest the takeaways for investors.
Revenue continues on a weak trend
For several quarters, Waste Management has struggled to increase its top line. In our earnings preview, we presented a table with data from the last four reported quarters to illustrate recent revenue weakness. The trend indicated that this quarter's revenue might head south. Below, we've updated the table to include the third-quarter 2014 numbers:
| Quarter | Reported Revenue | Prior-Year Quarter | Percentage Change |
|---|---|---|---|
| Q3 2013 | $3.62 | $3.46 | 4.62% |
| Q4 2013 | $3.50 | $3.43 | 2.04% |
| Q1 2014 | $3.40 | $3.34 | 1.80% |
| Q2 2014 | $3.56 | $3.53 | 0.85% |
| Q3 2014 | $3.60 | $3.62 | (0.55%) |
Source: SEC Filings. All dollar figures in billions.
In today's earnings release, management stated that revenues would have been positive if not for $12 million of foreign currency translation effects and $24 million of lost revenue from divestitures of operations. Yet even if we spot management the benefit of these add-backs, the net result translates to revenue growth of less than 0.5%.
It's not clear that revenue will accelerate any time soon. Waste Management has recently prioritized pricing over volume. For example, it's elected to lose a handful of marginally profitable national accounts in 2014 rather than cut profitability to the bone for the sake of keeping the revenue associated with these contracts. The company's overall near-term focus appears to emphasize optimizing profitability over new sales. It's pruning out the volatility in some of its business lines (hence the sale of Wheelabrator), and cutting unnecessary costs, as discussed directly below.
Restructuring charges provide insight to the profit-and-loss statement
The company described its $66 million charge against earnings as a restructuring of corporate functions and an expansion of legal reserves for litigation matters. An analysis provided in the earnings release shows that the corporate restructuring accounts for roughly two-thirds of this total.
The restructuring is of interest because, as corporate overhead, the savings will most likely improve the sales, general, and administrative portion of the company's income statement going forward. That the cost-cutting was focused on overhead rather than cost of goods sold in this quarter indicates that management's productivity improvements over the last few years are producing satisfactory results.
Indeed, Waste Management posted a yield of 2.3% on collection and disposal activities during the quarter, the latest of several quarters above the company's target of 2%. Core pricing, a measure of Waste Management's price increases and fees (outside of fuel surcharges) increased 3.8%.
The benefits of optimizing operations
If Waste Management is partial to price over volume in its contracts, and as an overarching near-term strategy favors profitability over revenue growth, what is the benefit to shareholders?
One answer is found in the company's cash flow, which continues to exhibit strength relative to earnings. In the third quarter, Waste Management realized cash from operations of $1.8 billion. This covered the company's net investing activities of $576 million, provided for Waste Management's generous dividend (currently yielding 3.1%), and funded $600 million of share repurchases.
Thus, because of Waste Management's well-oiled cash conversion cycle, and despite the charges to net income, ending cash on the company's balance sheet actually increased by $125 million in Q3.
Summing up the quarter
Given the unexpected charge against earnings, what should investors take away from this report? Those seeking stock price appreciation may be disappointed, as a key driver for stock price growth -- climbing revenue -- does not appear to be in the cards for the next few quarters.
However, for total-return aficionados, management's recent actions, and this quarter's results, support the proposition that Waste Management is a fairly steady, profitable, and moderate growth company with attractive cash flow. The company's bent toward shareholder-friendly resource allocation is an enticement to hold the shares and remains a bonus for longer-term shareholders.
