Waste Management: An Updated View On The Valuation, In Light Of The Latest Earnings (WM)

Waste Management, Inc. (NYSE:WM), through its subsidiaries, engages in the provision of environmental solutions to residential, commercial, industrial, and municipal customers in the United States and Canada. We have published already three article on Seeking Alpha about the firm, starting in July, 2022, with a bullish coverage. Later on, in October, 2022, we have downgraded the stock to “hold”, which we have maintained throughout 2023 and even until today.

The primary reason for downgrading the stock has been the perceived overvaluation. The aim of our article today is to give an updated view on the valuation, based on a set of traditional price multiples and also based on a dividend discount model. We will also highlight the key takeaways from the firm’s latest quarterly results for completeness.

Let us start with our update on valuation.

Valuation

Dividend discount model

In our previous article, we have estimated the firm’s fair value to be around $110 per share, considerably below the current market value. Today, we will review the changes in the firm’s weighted average cost of capital – WACC – and our view on the expected dividend growth rate in the near term and in perpetuity to provide an up-to-date figure of the fair value.

Previously, our required rate of return has been estimated to be 9.25%, based on the firm’s WACC back then. Now, based on the latest estimates, we reduce this number by 50 bps to 8.75%, mainly driven by the lower cost of equity. Please remember that a lower required rate of return is normally leading to a higher fair value.

Further, we have previously used a 10% dividend growth rate in the near term – in the next 5 years – with a perpetual dividend growth of 4.00% thereafter.

Today, we will take a slightly different approach and use a single stage dividend discount model. We will assume that the firm’s long term historic dividend growth rate of 6.8% will continue indefinitely in perpetuity.

Using these figures, now we get a fair value for WM’s stock of about $167 per share.

This share price is still significantly below the current market price of $212 per share. Based on our calculations, the downside is roughly 21%. Also keep in mind that the firm appears to be overvalued, even when using a 6.8% dividend growth rate in perpetuity, which is relatively aggressive.

For this reason, we believe that despite an increase in the fair value compared to our previous estimations, WM remains overvalued based on its dividends. Now to get a different view, let us take a look at the price multiples.

Price multiples

The price multiples are also telling a similar story. According to most metrics in the table below, the firm appears to be trading at a significant premium compared both to the sector median and to its own historic averages. The premium compared to the historic multiples appears to be in the range of 3% to 41%, if we take the extreme ends of the range, although most metrics are showing an overvaluation of 10% to 20%, about in line with the results of our dividend discount model.

From this valuation perspective, we also believe that the upside potential from the current price levels is limited.

Review of quarterly results

Let us see now, how the firm has been doing in the past quarter, to assess, whether the share price premium is justified or not.

In the previous quarter the firm has missed revenue expectations by $60 million, despite a growth of 5.5% year over year. Despite the revenue miss, we believe that the firm’s results are strong and promising.

1.) The firm has improved its efficiency and profitability, which we believe is a key driver of long term success. Operating expenses, as a percentage of revenue have improved by as much as 210 bps. Further, SG&A expenses have also fallen by 20 bps, resulting in 9.5% as a percentage of revenue. As a result the total company adjusted operating EBITDA margin expanded by 240 bps to 29.6%.

2.) The firm continues to expand into the recycling and renewable energy business. Two major projects have been finalized in the first quarter. Operations have begun at the firm’s upgraded recycling facility in Wisconsin and the new renewable natural gas facility in Texas has also been commissioned.

3.) The firm has remained committed to return value to its shareholders. A significant amount of $307 million has been paid in the form of quarterly dividends and $250 million has been used for share repurchases.

4.) The firm has also updated its long term outlook, and while revenue growth has been revised downwards, other key metrics have been revised upwards.

5.) Debt refinancing at higher interest rates is not likely to be a problem for WM as only a small portion of the debt is expected to mature in 2025. While interests rates are still likely to remain elevated in the coming year, we expect that the Fed will gradually cut them, which will eventually benefit WM’s business.

To sum up, we definitely like these results. We like that the firm’s profitability is gradually improving, we like that the company is expanding into new businesses like recycling and renewable energy and we also like that the firm is able to generate significant amount of free cash flow, which is more than enough to invest into potential new projects and also return value to shareholders.

Despite all this however, we do not believe that the current share price is attractive. In our opinion, all the potential growth opportunities and efficiency/profitability improvements are already priced in. For these reasons, despite the strong quarterly results, we do not believe that an upgrade from our current hold to buy is justified.

Conclusion

WM has delivered strong quarterly results, with expanding margins and increasing EPS, despite missing revenue expectations. The firm has also shown progress in its expansion to the recycling and renewable energy businesses. The firm’s outlook for the coming year has been also revised upwards, with the exception of revenue growth.

While the fair value of WM’s stock is higher based on our reviewed calculation than it was previously, it is still well below the current market value of $212 per share. For this reason, we see limited upside potential as we believe that all the potential near term growth has been already priced in. The price multiples are also telling a similar story.

For these reasons, we maintain our current “hold” rating.