WM NYSE: WM Recommendation: Buy · 2019-05-24 · Investment Thesis 2 Recommendation: Waste...

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WMNYSE: WM

Recommendation: Buy

Christopher Smith

Investment Thesis

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Recommendation: Waste Management, Inc. (NYSE: WM) is undervalued in the market with substantial long-term upside, therefore I am recommending a buy.

Rationale: WM has consistently offered investors constant growth while increasing dividends and buying back shares. WM’s ability to make acquisitions and investments offers flexibility in a shifting marketplace. I believe WM is a great investment for the following reasons:

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Barriers to entry limit the threat of new entrants and encroachment

Sustainability Initiatives

Future and present M&A offers flexibility and growth prospects

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Price Target: $125.82

34.8% upside to current price of $93.32

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Long-term contracts provide stable revenues and recession-resistant profitability

Company Overview

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Company Profile Historical Stock Chart

Revenue Breakdown Revenue Breakdown ($ in millions)

§ Incorporated in 1987 in Oklahoma

§ WM is North America’s leading provider of comprehensive waste management environmental services

§ Owns and operates 146 material recovery facilities, 293 landfills and 346 transfer stations

§ Owns over 300 subsidiaries, some of which are in countries such as China, England, and India

$14,485

$13,609

$12,961

$13,996$13,983

$13,649

$12,000.00

$12,500.00

$13,000.00

$13,500.00

$14,000.00

$14,500.00

$15,000.00

201720162015201420132012

Annual Revenue

1% CAGR

$0

$20

$40

$60

$80

$100

$120

Oct-91

May-93

Dec-94Jul-96

Feb-98

Sep-99

May-01

Dec-02

Aug-04

Mar-06

Oct-07

Jun-09

Jan-11

Aug-12

Mar-14

Nov-15

Jun-17

0.530.19

0.09

0.08 0.1

Revenue Breakdown by Service

Collection Landfill Transfer Recycling Other

Industry Overview

4Source: Company 10-K. 4

• Cost of fuel – most equipment is diesel-powered• Very Cap-Ex heavy industry; rising interest costs

hurt companies• Cost of commodities

• China’s regulations on imported recycling• Sorting and processing of recyclable

• Population has a growing focus on eco-friendly and sustainable solutions

• Zero Waste Goals

Demand for waste removal will never go away, but top companies are focusing on sustainability to drive future growth.

• Waste Collection and Hauling• Hazardous waste collection• Recyclable materials collection, hauling, and

processing• Removal and hauling of rubble, construction

and demolition debris• Waste transfer station operation

Industry Services Trends

Cost Drivers/Trends Market Share

25.2%

17.6%

7.6%

49.6%

Waste Collection Services Market Share

Waste Management Inc. Rebublic Services Inc.Waste Connections Inc. Other

39.447.8 49.8 51.8 53.4 51.1 52.4 55 56.7 57.9 60

0.10.20.30.40.50.60.70.

2000 2005 2006 2007 2008 2009 2010 2011 2013 2015 2016

U.S Solid Waste Industry Revenue 2000-2016

Revenue in billion U.S. dollars

High Barriers to Entry

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Contracts

High Capital Requirements WM Positioning

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Landfill Regulation

• All solid waste management companies must have access to a disposal facility• Third parties pay fees to use WM’s

disposal and transfer facilities• High costs associated with planning to meet

agency requirements for various facilities

• Location restrictions• Liner requirements• Leachate collection and removal system• Frequently compacting and covering• Groundwater monitoring Closure and post-

closure care• Corrective action• Financial assurance• Disposable waste dependent on permit

• Contracts increasingly focused on reduced environmental impact

• 30% of revenue comes form contracts greater than one year• Weighted average remaining contract life

of four years• Largest Client accounts for 1% of total revenue• 2017: New York Department of Sanitation

• $3.3 billion contract, 20-year deal• 2018: Seattle contract

• $425 million, 10-year deal

• Economies of scale• Extensive transfer station and landfill network

allows WM to better cater to large contracts• NY contract involves use of transfer station

railway network to move waste• Investment in truck fleet and natural gas

collection• Powered by natural gas• Key in Seattle contract

High Barriers to Entry

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1

Long-term Contracts

71Difference in revenue is due to rounding.

Long Term Contracts and Margins Collection Customer Classification Mic

Rev, EBITDA Margin graph

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CARG: 20.8%

• Residential contracts typically last from 3-8 years

• Commercial and industrial contracts typically

have a three year service agreement

• Larger contracts often have longer terms such as

NY’s 20-year and Seattle’s 10-year agreement

40%

27%

28%

5%

Commercial Residential Industrial Other

13,388.0 11,791.0 12,515.0 13,378.0 13,649.0 13,983.0 13,996.0

12,961.0 13,609.0 14,485.0

22.0%

23.0%

24.0%

25.0%

26.0%

27.0%

28.0%

0 2,000.0 4,000.0 6,000.0 8,000.0

10,000.0 12,000.0 14,000.0 16,000.0

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Annual Revenue and EBITDA Margin

Total Revenue EBITDA Margin %

Future and Present M&A

81Difference in revenue is due to rounding.

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Historical Annual Acquisition Spending

Return On Investments

0 100.0 200.0 300.0 400.0 500.0 600.0 700.0 800.0 900.0

1,000.0

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Mill

ions

Cash Acquisitions

11.3% 11.8% 12.3%

7.0%8.0% 7.7%

6.4% 6.2% 6.9%

0.00%2.00%4.00%6.00%8.00%

10.00%12.00%14.00%

2015 2016 2017

Industry leading Return on Invested Capital

WM RSG WCN

M&A Activity

§ 2013: Greenstar, LLC for $210 million§ 2013: RCI Environmental, Inc. for $481 million§ 2015: Deffenbaugh Disposal, Inc. (“Defenbaugh”)

for $400 million§ 2016: Acquired Southern Waste Systems/Sun

Recycling (“SWS”) for $525 million§ 2018: Updated fleet of trucks

Sustainability Initiatives4

Adapting to shifting sentiments

• Increased production of natural gas at disposal sites• Currently enough to power 1.2 million

homes• Goal of 2 million by 2020

• Upgrading recycling capacities with single stream while maintaining recycling quality

Sustainability products and initiatives

• NY by 2030• San Francisco by 2020 (Likely will not reach goal)• Santa Monica by 2030• San Diego 75% by 2020, fully by 2040• Minneapolis 50% by 2020, 80% by 2030• Oakland by 2020• Washington D.C. City Council prioritizing

recycling

Zero Waste Commitments

Future Biogas Projections

• Solar powered trash compactors• Natural gas fueling stations

• 2017:• Opened 100th natural gas fueling

station• Operating 6000 natural gas trucks,

largest in North America• High recycling rates with construction clients

obtain LEED credits

Waste Management’s innovative sustainability strategy allows us to be the most attractive offer for customers who are increasingly concerned with recycling and sustainability

28.43 30.14 31.95 33.87 35.9 38.05 40.33 42.74

0.

10.

20.

30.

40.

50.

2017 2018* 2019* 2020* 2021* 2022* 2023* 2024*

Global Outlook on Waste to Energy market Value

Market value in billion U.S. dollars

Key Risks

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ü Certain regulations serve as a barrier to entry and positively benefit WM

ü Over the last several years WM has restructured our recycling contracts by removing floor pricing and adding contamination and processing fees

ü Sustainability expertise mitigates risk of shifting contract terms

ü Increased reliance on natural gas reduces risk of increased diesel prices

ü Increased ability to generate natural gas from landfills reduces risk of increasing natural gas prices

ü Vertical integration reduces risk of third parties raising rates

û Increased regulation raising the cost of operations

û China continues ban on imported key commodities

û Changes in oil and gas prices and drilling activity, and changes in applicable regulations, could adversely affect WM’s EES organization

û Developments in technology could trigger a fundamental change in the waste management industry

û Weak economic conditions may negatively affect the volumes of waste generated and demand for post-consumer fiber and metals processed

û Diesel fuel price increases or diesel fuel supply shortages may increase their expenses and restrict their ability to operate

û Failure to pass on recycling costs in future contracts

Key Risks Mitigants

Final Recommendation

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Recommendation: Waste Management, Inc. (NYSE: WM) is undervalued in the market with substantial long-term upside, therefore I am recommending a buy

Base Case

Price Target: $125.82Upside: %34.8

Upside Case

Price Target: $145.72Upside: %56.2

Downside Case

Price Target: $90.92Downside: %2.6

Appendix

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Valuation – Comparable Companies Analysis

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Market Enterprise EV / Revenue EV / EBITDA Price / EarningsCompany Ticker Capitalization Value 2017A LTM 2017A LTM 2017A LTMRepublic Services, Inc. RSG $24,726 $32,895 2.9x 3.3x 10.6x 11.7x 28.6x 18.0xWaste Connections, Inc. WCN 21,133 24,645 4.5x 5.1x 14.5x 16.2x 53.9x 29.1xCasella Waste Systems, Inc. CWST 1,330 1,843 2.9x 2.9x 15.0x 15.7x 30.8x 33.5xAdvanced Disposal Services, Inc. ADSW 2,177 4,050 2.7x 2.6x 10.3x 10.6x 43.9x 45.0x

Waste Management, Inc. WM $40,452 $50,385 3.1x 3.4x 11.3x 12.2x 27.7x 17.9x

Low $1,330 $1,843 2.7x 2.6x 10.3x 10.6x 28.6x 18.0xMean 12,341 15,859 3.3x 3.5x 12.6x 13.5x 39.3x 31.4xMedian 11,655 14,348 2.9x 3.1x 12.6x 13.7x 37.4x 31.3xHigh 24,726 32,895 4.5x 5.1x 15.0x 16.2x 53.9x 45.0x

Operating StatisticsRevenue Revenue Growth EBITDA EBITDA Margin

Company Ticker 2017A LTM '16-'17A LTM 2017A LTM 2017A LTMRepublic Services, Inc. RSG $10,042 $10,071 7.0% 2.1% $2,770 $2,804 27.6% 27.8%Waste Connections, Inc. WCN 4,630 4,818 37.2% 6.6% 1,449 1,524 31.3% 31.6%Casella Waste Systems, Inc. CWST 599 637 6.1% 7.6% 115 118 19.2% 18.5%Advanced Disposal Services, Inc. ADSW 1,508 1,548 7.3% 4.9% 390 383 25.9% 24.7%

Waste Management, Inc. WM $14,485 $14,724 6.4% 3.0% $3,996 $4,139 27.6% 28.1%

Low $599 $637 6.1% 2.1% $115 $118 19.2% 18.5%Mean 4,195 4,269 14.4% 5.3% 1,181 1,207 26.0% 25.7%Median 3,069 3,183 7.1% 5.7% 919 953 26.7% 26.3%High 10,042 10,071 37.2% 7.6% 2,770 2,804 31.3% 31.6%

Valuation – WACC

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Capital StructureDebt-to-Total Capitalization 20.1%Equity-to-Total Capitalization 79.9%

Cost of DebtCost of Debt 4.0%Tax Rate 23.0%After-tax Cost of Debt 3.07%

Cost of EquityRisk-free Rate(1) 2.8%Market Risk Premium(2) 6.0%Levered Beta 0.7

Cost of Equity 6.75%

WACC 6.01%

Valuation – DCF (Base)

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FYE December 31, FYE December 31,($ in millions) 2014A 2015A 2016A 2017A 2018E 2019E 2020E 2021E 2022E 2023E 2024ETotal Revenue $13,996.0 $12,961.0 $13,609.0 $14,486.0 $14,843.3 $15,285.1 $15,728.4 $16,118.7 $16,478.9 $16,750.9 $16,968.6

Revenue Growth (7.4%) 5.0% 6.4% 2.5% 3.0% 2.9% 2.5% 2.2% 1.7% 1.3%

ExpensesCOGS 9,002.0 8,231.0 8,486.0 9,021.0 9,202.8 9,430.9 9,673.0 9,913.0 10,134.5 10,301.8 10,435.7

Gross Profit $4,994.0 $4,730.0 $5,123.0 $5,465.0 $5,640.5 $5,854.2 $6,055.4 $6,205.7 $6,344.4 $6,449.1 $6,532.9Gross Margin 35.7% 36.5% 37.6% 37.7% 38.0% 38.3% 38.5% 38.5% 38.5% 38.5% 38.5%

SG&A 1,481.0 1,343.0 1,410.0 1,468.0 1,451.7 1,494.9 1,538.2 1,576.4 1,611.6 1,638.2 1,659.5D&A 1,292.0 1,245.0 1,301.0 1,376.0 1,409.9 1,451.9 1,494.0 1,531.1 1,565.3 1,591.1 1,611.8

Operating Expenses 3,045.0 2,654.0 2,711.0 2,844.0 2,861.6 2,946.8 3,032.2 3,107.5 3,176.9 3,229.4 3,271.3Operating Income (EBIT) $1,949.0 $2,076.0 $2,412.0 $2,621.0 $2,778.8 $2,907.4 $3,023.2 $3,098.2 $3,167.4 $3,219.7 $3,261.6

EBIT Margin 13.9% 16.0% 17.7% 18.1% 18.7% 19.0% 19.2% 19.2% 19.2% 19.2% 19.2%Income Tax Expense (23%) 413.0 308.0 642.0 242.0 639.1 668.7 695.3 712.6 728.5 740.5 750.2

EBIAT $1,536.0 $1,768.0 $1,770.0 $2,379.0 $2,139.7 $2,238.7 $2,327.8 $2,385.6 $2,438.9 $2,479.2 $2,511.4

Cash FlowPlus: D&A 1,292.0 1,245.0 1,301.0 1,376.0 1,409.9 1,451.9 1,494.0 1,531.1 1,565.3 1,591.1 1,611.8Plus: Stock Based Compensation 65.0 72.0 90.0 101.0 103.5 106.6 109.7 112.4 114.9 116.8 118.3

Discretionary Cash Flow $2,893.0 $3,085.0 $3,161.0 $3,856.0 $3,653.1 $3,797.2 $3,931.5 $4,029.1 $4,119.1 $4,187.1 $4,241.5Less: Increase in NWC (73.0) (14.0) 305.0 7.4 9.6 13.4 1.1 1.0 0.8 0.6Less: CapEx (1,151.0) (1,233.0) (1,339.0) (1,509.0) (1,662.4) (1,589.7) (1,572.8) (1,531.3) (1,565.5) (1,591.3) (1,611.8)Less: Cash Acquisitions (35.0) (554.0) (611.0) (200.0) (400.8) 0.0 0.0 0.0 0.0 0.0 0.0

Free Cash Flow $1,707.0 $1,225.0 $1,197.0 $2,452.0 $1,597.4 $2,217.2 $2,372.1 $2,498.9 $2,554.6 $2,596.6 $2,630.3Free Cash Flow Growth -- (28.2%) (2.3%) 104.8% (34.9%) 38.8% 7.0% 5.3% 2.2% 1.6% 1.3%

Unlevered Free Cash FlowWACC 6.01%Discount Period 0.25 1.25 2.25 3.25 4.25 5.25 6.25Discount Factor 0.99 0.93 0.88 0.83 0.78 0.74 0.69

Present Value of Free Cash Flow $393.56 $2,061.3 $2,080.3 $2,067.4 $1,993.7 $1,911.6 $1,826.8

Valuation – DCF (Base)

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DCF Sensitivity AnalysisWACC

105.64 4.0% 5.0% 6.0% 7.0% 8.0%10.6x $102.45 $95.89 $89.76 $84.01 $78.6311.6x $111.39 $104.32 $97.70 $91.50 $85.69

EV/EBITDA 12.6x $120.34 $112.74 $105.64 $98.99 $92.7613.6x $129.28 $121.17 $113.58 $106.47 $99.8214.6x $138.22 $129.59 $121.52 $113.96 $106.88

Method Weight Price UpsidePerpetuity Growth Method 80% $130.86 40.2%Exit Multiple Method 20% $105.64 13.2%

Fair Value Estimate $125.82 34.8%

Enterprise Value DCF Sensitivity AnalysisCumulative Present Value of FCF $12,334.6Terminal ValueTerminal Year EBITDA $4,873.4Exit Multiple 12.6x

Terminal Value $61,404.6Discount Factor 69.45%

Present Value of Terminal Value $42,645.4% of Enterprise Value 77.6%

Enterprise Value $54,980.0

DCF Implied Equity Value and Share PriceEnterprise Value $54,980.0

Less: Total Debt $10,030.0Plus: Cash & Cash Equivalents $83.0

Implied Equity Value $45,033.0

Implied Share Price $105.64

Shares Outstanding 426

Comps Implied Equity Value and Share PriceEnterprise Value $56,695.6






130.86 4.0% 5.0% 6.0% 7.0% 8.0%2.1% $266.14 $166.31 $117.60 $88.74 $69.662.3% $297.00 $178.45 $123.87 $92.48 $72.10

EV/EBITDA 2.5% $336.06 $192.53 $130.86 $96.56 $74.722.7% $387.06 $209.04 $138.70 $101.02 $77.542.9% $456.51 $228.69 $147.54 $105.91 $80.58

Valuation-DCF (Base Cont.)

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Perpetuity Growth Method DCF Sensitivity AnalysisCumulative Present Value of FCF $12,334.6Terminal ValueTerminal Year FCF $2,630.3Growth Rate 2.5%

Terminal Value at 2024 $76,887.28Discount Factor 69.45%


Enterprise Value $65,732.7Less: Total Debt $10,030.0Plus: Cash & Cash Equivalents $83.0




Valuation – DCF (Upside)

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Revenue Growth (7.4%) 5.0% 6.4% 2.9% 3.8% 4.5% 3.8% 3.8% 3.7% 3.6%

ExpensesCOGS 9,002.0 8,231.0 8,486.0 9,021.0 9,241.6 9,513.0 9,859.0 10,148.2 10,459.2 10,848.7 11,241.9


SG&A 1,481.0 1,343.0 1,410.0 1,468.0 1,457.8 1,496.3 1,546.1 1,586.7 1,628.1 1,668.9 1,708.8D&A 1,292.0 1,245.0 1,301.0 1,376.0 1,415.9 1,469.8 1,536.2 1,594.9 1,655.8 1,717.5 1,779.8



EBIAT $1,536.0 $1,768.0 $1,770.0 $2,379.0 $2,148.7 $2,305.6 $2,488.3 $2,664.8 $2,840.4 $2,961.5 $3,084.7


Discretionary Cash Flow $2,893.0 $3,085.0 $3,161.0 $3,856.0 $3,668.5 $3,883.3 $4,137.3 $4,376.7 $4,617.8 $4,805.0 $4,995.1Less: Increase in NWC (73.0) (14.0) 305.0 18.4 0.5 14.4 (8.0) (3.7) 17.9 20.8Less: CapEx (1,151.0) (1,233.0) (1,339.0) (1,509.0) (1,669.4) (1,609.2) (1,617.3) (1,595.1) (1,656.0) (1,717.7) (1,779.8)Less: Cash Acquisitions (35.0) (554.0) (611.0) (200.0) (205.8) (213.6) (223.3) (231.8) (240.7) (249.6) (258.7)




Valuation – DCF (Upside)

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Implied Equity Value and Share PriceEnterprise Value $67,431.1











134.84 4.0% 5.0% 6.0% 7.0% 8.0%11.6x $132.00 $123.73 $115.99 $108.75 $101.9712.6x $142.62 $133.73 $125.42 $117.64 $110.35

EV/EBITDA 13.6x $153.24 $143.73 $134.84 $126.53 $118.7414.6x $163.86 $153.73 $144.27 $135.42 $127.1315.6x $174.47 $163.73 $153.70 $144.30 $135.51

Method Weight Price UpsidePerpetuity Growth Method 80% $148.44 59.1%Exit Multiple Method 20% $134.84 44.5%

Fair Value Estimate $145.72 56.2%

Valuation-DCF (Upside Cont.)

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Perpetuity Growth MethodCumulative Present Value of FCF $12,782.9Terminal ValueTerminal Year FCF $2,977.5Growth Rate 2.5%







Valuation – DCF (Downside)

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Revenue Growth (7.4%) 5.0% 6.4% 2.9% 1.3% 1.3% 1.2% 1.2% 1.1% 1.1%

ExpensesCOGS 9,002.0 8,231.0 8,486.0 9,021.0 9,241.6 9,596.0 9,718.3 9,837.8 9,953.8 10,066.0 10,173.9


SG&A 1,481.0 1,343.0 1,410.0 1,468.0 1,457.8 1,718.6 1,740.6 1,761.9 1,782.7 1,802.8 1,822.1D&A 1,292.0 1,245.0 1,301.0 1,376.0 1,415.9 1,434.5 1,452.8 1,470.7 1,488.0 1,504.8 1,520.9



EBIAT $1,536.0 $1,768.0 $1,770.0 $2,379.0 $2,148.7 $1,811.9 $1,835.0 $1,857.5 $1,879.5 $1,900.7 $1,921.0


Discretionary Cash Flow $2,893.0 $3,085.0 $3,161.0 $3,856.0 $3,668.5 $3,351.7 $3,394.5 $3,436.2 $3,476.7 $3,515.9 $3,553.6Less: Increase in NWC (73.0) (14.0) 305.0 18.4 52.7 8.8 (8.4) (7.2) (3.3) (1.0)Less: CapEx (1,151.0) (1,233.0) (1,339.0) (1,509.0) (1,669.4) (1,570.6) (1,529.5) (1,470.9) (1,488.2) (1,505.0) (1,520.9)Less: Cash Acquisitions (35.0) (554.0) (611.0) (200.0) (402.5) 0.0 0.0 0.0 0.0 0.0 0.0




Valuation – DCF (Downside)

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Implied Equity Value and Share PriceEnterprise Value $39,363.0











69.00 4.0% 5.0% 6.0% 7.0% 8.0%8.6x $64.63 $60.13 $55.92 $51.97 $48.279.6x $72.00 $67.07 $62.46 $58.14 $54.09

EV/EBITDA 10.6x $79.37 $74.02 $69.00 $64.31 $59.9111.6x $86.74 $80.96 $75.55 $70.48 $65.7312.6x $94.11 $87.90 $82.09 $76.65 $71.55

Method Weight Price UpsidePerpetuity Growth Method 80% $96.40 3.3%Exit Multiple Method 20% $69.00 -26.1%

Fair Value Estimate $90.92 -2.6%

Valuation-DCF (Downside Cont.)

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Perpetuity Growth MethodCumulative Present Value of FCF $9,800.3Terminal ValueTerminal Year FCF $2,031.6Growth Rate 2.5%







Dividend growth for 15-years straight

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WM NYSE: WM Recommendation: Buy · 2019-05-24 · Investment Thesis 2 Recommendation: Waste...

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