Waste Management (WM) is not widely known by dividend investors, but its moat and consistency are remarkable.
As the largest integrated waste management company in the country, WM possesses several key advantages that have enabled it to increase its dividend for 13 consecutive years.
While WM’s operating history isn’t as long as some other companies, its economies of scale, durability, unique assets, consistent free cash flow generation, and mission-critical services make the company one of our favorite blue chip dividend stocks.
WM is the biggest integrated waste management company in North America and serves more than 21 million residential, commercial, industrial, and municipal customers. The company makes money by entering into contracts with customers to collect, transport, process, store, and dispose of their waste. WM owns a variety of assets to run its business, including landfills, truck fleets, transfer stations, recycling facilities, processing plants, and more.
2014 Revenue Mix: collection 54%, landfill 18%, transfer 9%, recycling 9%, other 10%.
2014 Collection Revenue Mix: commercial 40%, residential 30%, industrial 26%, other 4%
The trash business might appear to be a commodity industry at first glance, but it actually has substantial barriers to entry. As the largest player in the market, WM also carries several additional advantages.
First, it’s worth mentioning that there really aren’t any alternatives to trash disposal today. Consumers, municipalities, and businesses need to have their waste collected and taken off-site. With the average American generating several pounds of trash per day, there is a constant need for WM’s services.
All we see is a garbage truck that picks up our garbage can and drives on, but where does our trash really go? This is when WM’s valuable, hard-to-replicate network of assets comes into play.
Waste that is not recycled or processed into forms of energy is taken to transfer stations, which consolidate waste into larger, long distance trucks. These trucks take the waste to distant disposal facilities and landfills.
WM owns 252 landfills, more than its next two largest competitors combined. The number of landfills has fallen from over 7,600 in the mid-1980s to about 1,900 in 2013. That’s over a 75% decrease in less than 30 years! Government regulations, neighborhood restrictions, high start-up costs, and environmental concerns have all played a factor in the decline of available landfills.
While the remaining landfills are larger and more efficient than their predecessors, there are only so many places that waste management companies can park trash. WM’s competitors must pay WM a “tipping fee” to deposit waste at its landfills and use its transfer stations.
WM’s ownership of key assets, dense waste collection network, and tipping fees allow it to maintain a lower cost profile than its peers. This results in more waste volumes from customers (greater route density) and higher returns on its capital.
In addition to the toll-taking advantage WM has, new entrants also have a challenging time winning enough business to justify the significant investment needed to construct for their own disposal facilities. WM and other players already have contracts with customers, which typically last anywhere from two to six years.
WM has noted that more than 80% of its commercial and industrial customers have a contract length greater than three years, and the typical customer stays with WM for 10 years. New entrants have a difficult time securing the cash flow streams necessary to build their own trash disposal network.
Furthermore, WM’s large network of recycling facilities, transfer stations, and landfills make its business more flexible to meet the needs of virtually any customer segment – municipalities, construction sites, healthcare facilities, commercial buildings, and many others. Generally speaking, customers prefer to contract with proven operators that can meet a variety of needs.
WM’s revenue growth is somewhat impacted by the amount of goods consumed by consumers and businesses. When economic activity slows, less trash is produced and WM is not as busy. However, its trucks still run their routes and incur the same operating costs, somewhat crimping profitability.
Besides economic activity, solid waste volumes are gradually impacted by more efficient product packaging and the level of recycling activity, which diverts trash away from landfills.
Landfills have also received increasing scrutiny from governments regarding their impact on the environment, further accelerating the trend towards recycling and what are known as waste-to-energy (WTE) plants, which generate electricity from waste and sell it to customers such as utilities.
Importantly, WM is the largest residential recycler in North America and has the financial firepower to invest in whatever operations are needed to maintain its moat. The company is also a leading renewable energy provider.
If anything, we think the (slowly) increasing shift towards recycling and renewables will further strengthen the market positions of the biggest players because smaller competitors are unable to make the vertical integration investments needed to compete.
Whether or not these activities will be equally profitable is another question, but WM should find a way to stay relevant with its scale and collection of assets.
Additionally, lower commodity prices are hurting WM’s recycling operations (9% of sales). While not much can be done about this in the near term, WM is structuring new contracts and renewals to help it better deal with price volatility in the future and is improving operational efficiency.
WM’s management team is focused on improving the company’s return on invested capital, and we trust them to make the best decisions possible as it relates to recycling and WTE activities, which seem to have a more volatile return profile.
The company decided to divest a meaningful portion of its WTE business in late 2014 for $1.9 billion to maximize its focus on the core business, reduce earnings volatility, and improve its returns. We expect management to remain conservative with how they run the business and adapt to evolving waste management trends.
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. WM’s long-term dividend and fundamental data charts can all be seen by clicking here.
Dividend Safety Score
Our Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more. Scores of 50 are average, 75 or higher is very good, and 25 or lower is considered weak.
WM has one of the safest dividend payments that income investors can find. The company recorded a dividend Safety Score of 97, suggesting that its dividend is safer than 97% of all other dividend stocks in the market.
Over the last four quarters, WM’s earnings and free cash flow payout ratios were 66% and 56%, respectively. For such a stable and predictable company like WM, these ratios are healthy and appear to pose little risk.
Looking further back, we can see that WM’s payout ratios have increased a bit over the last decade, but not by an extraordinary amount. In most years, the company’s payout ratios remained between 40% and 60%, leaving WM with plenty of dividend cushion and room for incremental growth.
Source: Simply Safe Dividends
Source: Simply Safe Dividends