I've been intrigued by the possibility of investing in the country's biggest trash hauler, Waste Management
The reason I mention this, of course, is that Waste Management reported its 2004 earnings last week. Much like the cargo that Waste Management transports on a daily basis, the report was a mixed bag. Let's separate it out into the good, the bad, and the ugly. (For ease of reading, though, we're going to mix them up a bit.)
The bad: Investors who rely on price-to-earnings ratios in choosing their purchases should be wary of investing in Waste Management based on its trailing P/E ratio of 18.5. While that number compares favorably with the S&P average P/E of 19.8, it doesn't take into account Waste Management's considerable debt.
The ugly: Waste Management has a fair amount of cash on its books, but far more debt than cash. With a total of $8.2 billion in net debt, the company is better viewed as being a business with an enterprise value (market capitalization plus long-term debt minus cash) of $25.4 billion than a $17 billion company. And when you compare its free cash flow (FCF) to the enterprise value (EV), its EV/FCF ratio comes to a pricey 26.4.
The good: Just as the company's enterprise value belies the accuracy of its "price," so too does the company's cash generation prowess belie its GAAP profits. While the latter came in at $930 million in 2004, free cash flow was noticeably stronger than that: $960 million. What's more, year over year, Waste Management increased its free cash flow even faster than it did its GAAP earnings -- by 32% in fact.
Either valuation can be used to argue that Waste Management is a bargain. Its P/E of 18.5, divided by its 29% growth rate, gives the company a PEG of 0.64 -- a bargain, some might say. Others can point to its 26.4 EV/FCF, divide that by the 32% growth in free cash flow, and conclude that Waste Management is also a bargain at the 0.82 ratio that results. Both arguments, however, have to predicate themselves upon the assumption that this trash hauling business can grow its profits and/or cash generation at roughly 30% per year over the long term. In this Fool's opinion, that assumption simply fails the smell test.
Fools of a feather don't always fly together. For an alternative view of Waste Management's invest-ability, read Nathan Slaughter's "Consider Some Trash for Your Portfolio."
Fool contributor Rich Smith holds no position in Waste Management.