At the end of September last year, I recommended Waste Management (NYSE:WM) as a long-term investment. I was not expecting the stock price to rise so quickly. In fact, I was of the view that the stock price will remain flat in the short-term at least. However, since I last wrote about the company, it has gained more than 15%. This trend has been present in Waste Management stock price in the last three years and the market seems to be quite happy with the company. I still believe that the stock is a long-term investment due to the excellent income growth possibilities through dividend. Waste management has a wide moat and the massive capital outlay means the competition is not intense.
A look at the fundamentals explains why the market has been so responsive to the company’s policies. I have updated the table since we now have full year 2016 results and these numbers explain the possible reason behind the stock price movement.
Data sourced from SEC filings and Morningstar.com. Calculations by the author
Gross margin has been steadily rising in the last three years but in 2016, it jumped sharply. Keep in mind that solid waste management is a stable and mature industry. This industry does not offer stellar growth prospects. In these conditions, A jump of 115 basis points in gross margin is impressive. This shows that the company has been able to implement its price initiatives and the cost of services has been managed efficiently. The business is now generating more for every dollar spent. Impressive growth in top line has also been converted into a better operating margin. OP margin has also gone up by 109 basis points. The effect of this increase can be seen in EBITDA as well. EBITDA has also recorded a healthy jump of more than $300 million. However, the net margin was the key metric as it went up by more than 288 basis points. The trend in these margins explains the reasons behind the stock price movement. The market has realized that the business is able to drive growth even from a partly saturated industry. Waste Management has been implementing new pricing initiatives, and the market seems to have realized that the company is getting considerable success in its new plans.
Rising EBITDA has resulted in strengthening the credit profile of the company. The leverage ratio has come down below 2.5x. It is still not an investment grade ratings worthy leverage ratio but Waste Management should not be worried about its credit profile at the moment. The scale of operations, predictable cash flows and stable growth in the industry will mitigate any threat to its credit profile. Free cash flows also went up by more than $350 million. At the moment, per share free cash flow is $3.65. This is another good news for shareholders as it further enhances the dividend growth prospects. In order to achieve this, Waste Management did not need to compromise its capital budget. In fact, the capital expenditure for 2016 was more than the last year. Operating cash flows showed strong growth of over $460 million.
The company will likely continue to grow at a reasonable rate in the short-term at least due to the increased construction activity and the demand for solid waste management services. In addition to the growth opportunity in the industry, Waste Management’s operations are capital intensive. Especially the landfills side of the business. Waste Management has an advantage in this area and they will extract value from these assets as well. The potential for power generation and re-sale of recycled material is another factor which should be kept in mind while evaluating its future growth prospects.
The company is not just planning, it is delivering on its promises. The strategy is quite clear and they are leveraging their wide moat to their advantage. Its nationwide reach gives it an advantage over its competitors and allows the company to have a unique pricing power. This sort of control over pricing is not common in this industry. The fact that Waste Management is able to do this is a testament to the strong market position it has achieved. I still believe it is a solid long-term investment. The company is growing its margins impressively and there is more potential for growth. Wide moat and high barriers to entry will protect it against the competition. Total return in the next 4-5 years can be substantial for Waste Management shareholders.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.