Waste Management Is at the Top of the Heap, but Shares Look Pricey
We think the narrow-moat waste firm will generate healthy amounts of cash flow in the years to come, but the market is pricing in an overly exuberant scenario.
2016 was a strong year for the U.S. solid waste industry, and narrow-moat Waste Management finished the year firing on all cylinders. Although we’re raising our fair value estimate to $54 from $52 per share on higher assumptions for midcycle operating margins, we believe the market is pricing in quite a bit of exuberance in Waste Management’s shares at present. As such, we recommend that investors wait for a pullback before building positions.
Revenue increased 6.6% year over year to $3.46 billion in the quarter, reflecting strong internal revenue growth of 5.2%, driven by increases in both pricing and volumes. Average pricing yield reached 3.2% in the quarter, as a 16.1% year-over-year increase in recycling commodity prices added to over 2% of pricing gains in collection and disposal. In addition, volumes grew by 2% year over year; this is notable as it was the first time that contribution from volume nearly matched contribution from solid waste pricing in over five years. In addition, customer churn improved by 100 basis points to 9.1%, the lowest percentage seen since 2002, suggesting that higher pricing isn’t sacrificing customer growth. In our view, Waste Management’s recent adoption of customer acquisition tools has made a material impact on the company’s ability to attract higher-quality business, a trend we believe will support better future margins versus historical averages.