As part of our process, we perform a rigorous discounted cash-flow methodology that dives into the true intrinsic worth of companies. In Waste Management’s (WM) case, we think the firm is worth just over $ 40 per share, representing nearly 30% upside from these levels.
Our Report on Waste Management
With every company in our coverage universe, we rate it on 13 unique measures. To get started, we show Waste Management’s below:
Waste Management is the largest owner of municipal solid waste landfills in the nation, a strategic position we think will only become more valuable over time. As landfills continue to be closed across the country (Not-In-My-Backyard opposition, regulatory requirements, etc.), those who own the remaining will inevitably be able to charge hefty “tipping” fees (dumping fees) from mom-and-pop collection operators that must rid themselves of accumulated trash within a given “wasteshed” (region). Long-term, we think pricing expansion in the industry will meaningfully outpace inflation, driving bottom-line improvement for landfill operators over time. We think Waste Management has a solid position to capitalize on this trend.
Waste Management’s business quality (an evaluation of our ValueCreation™ and ValueRisk™ ratings) ranks among the best of the companies in our coverage universe. The company has been generating economic value for shareholders with relatively stable operating results for the past few years, a combination we view very positively.
Waste Management has a good combination of strong free cash flow generation and manageable financial leverage. We expect its free cash flow margin to average about 9.9% in coming years. Total debt-to-EBITDA was 2.8 last year, while debt-to-book capitalization stood at 58.7%.
Waste Management sports a very nice dividend yield of about 4.2%. We expect it to pay out about 60% of next year’s earnings to shareholders as dividends.
We are considering adding Waste Management to the portfolio in our market-beating Best Ideas Newsletter.
Cash Flow Analysis
We think Waste Management is worth $ 39 per share, which represents a price-to-earnings (P/E) ratio of about 19.7 times last year’s earnings and an implied EV/EBITDA multiple of about 8.4 times last year’s EBITDA. Our model reflects a compound annual revenue growth rate of 2.6% during the next five years, a pace that is higher than the company’s 3-year historical compound annual growth rate of -2%. Our model reflects a 5-year projected average operating margin of 15.9%, which is below Waste Management’s trailing 3-year average. Beyond year 5, our valuation model assumes free cash flow will grow at an annual rate of 1.8% for the next 15 years and 3% in perpetuity. We employ a 7.9% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Future Path of Fair Value
We estimate Waste Management’s fair value at this point in time to be about $ 39 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the company’s current share price with the path of Waste Management’s expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the company’s shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the company’s future cash flow potential change. The expected fair value of $ 46 per share in Year 3 represents our existing fair value per share of $ 39 increased at an annual rate of the company’s cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Pro Forma Financial Statements
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.