Big, loud trucks. My three year-old son is obsessed with them! Garbage trucks are his absolute favorite.
So you can imagine the excitement every Friday morning when the garbage truck stops in front of our house. At the first clang of the trash can, he sprints to the window. Intensely engaged, he curiously demands a step-by-step explanation of the entire garbage collection process.
Because we need them to keep our cities clean, their business is non-discretionary. As a result, many waste collection stocks show steady growth, despite economic turbulence.
Within in the waste industry, my favorite is North America’s largest garbage collection company, Waste Management (NYSE: WM).
With a 3.4% forward annual dividend, the yield tops 90% of the stocks listed on the S&P 500 ($SPX). Over the past 10 years, dividends have doubled, while payouts have increased 11 straight years.
Despite its name, the company isn’t just trash, however. It’s also a top green energy producer. In 2013, Waste Management generated more green energy than the whole U.S. solar industry!
How? Making complex science sound simple, its gas-to-energy and waste-to-energy facilities turn decomposing organic matter into methane gas and thermal energy.
Truly being green, Waste Management then uses this natural gas to power its garbage trucks. At present about 15% of Waste Management’s fleet is natural gas-powered. Within the next six years, the company plans to convert 80% of its trucks to natural gas. Waste Management also owns more than 50 natural gas fueling stations, 20 of which are open to the public.
Turning trash into green energy is an increasingly important growth driver. In the first-quarter, the company’s waste-to-energy division generated $230 million, a 12% increase from the year-earlier period. Although 80% of Waste Management’s revenue still comes from garbage collection, this figure will likely shift over time, providing a truly natural income source.
International expansion is also an important growth factor. Currently dominating North America, Waste Management plans to increase its presence in China, the country with the world’s largest population. By 2020, the trash company anticipates it will handle more than 20 million tons of Chinese waste, 67% more than in 2012. This development could help sustain future revenue growth.
That’s positive news for Waste Management because even a sure-fire business like trash faces challenges. As we become more environmentally conscious, our waste disposal is decreasing. According to the Environmental Protection Agency, in 1980, 89% of all waste produced went into a landfill. With more emphasis on compositing and recycling, this number dropped to 54% by 2012.
However, due to lower commodity prices paid for recycled goods, Waste Management’s recycling operations are also suffering. Recycling accounts for about 10% of the company’s revenues. In the most recently reported first-quarter, recycling commodity prices fell 1.8% from the year-ago period.
To make up for these losses, Waste Management has increased its garbage collection and disposal prices. In the most recent quarter, pricing for these core operations increased 4.2%. With the price hike, the company expects 2014 revenue will increase 2.2% to $14.3 billion, despite an anticipated 1% drop in waste volume.
Management is also tightly crimping operational costs. In the most recent quarter, selling general and administrative (SG&A) expenses dropped 4% from the year-ago period; management spent less money on incentives, advertising, travel and entertainment. By streamlining back office jobs, reducing operational costs, and optimizing collection routes, the company expects to further reduce SG&A costs in 2014.
Through reduced capital expenses, management projects 2014 earnings will be in the range of $2.30 to $2.35 per share, at least a 7% gain from $2.15 per share in 2013. With continued focus on cost-cutting measures, earnings growth should be sustained into the foreseeable future.
This upbeat earnings outlook is good news for dividend-seeking investors as it gives the company a solid payout ratio. The dividend payout ratio -- the percentage of earnings paid out as dividends -- is important to ensure the company can continue increasing its dividend over time. Although it varies by industry, a safe payout ratio is generally 75% or less. In 2014, management expects the payout ratio to be about 65%, showing strong likelihood of future dividend increases.
From a technical perspective, the stock looks strong. Shares are on the verge of breaking out of a multi-month basing pattern. This pattern, which looks like a large U-shape, is characterized by the November 2013 $45.21 peak, followed by the February 2014 $39.75 low, and now the stock’s re-approach of the $45.21 high.
If shares can successfully move past $45.21, they could soar with nothing in the way to cap the stock.
In fact, I calculated the measuring principle for a basing pattern by adding the height of the pattern to the breakout level. This methodology boasted a potential share price of $50.67 -- a 12.1% gain from the current price.
Actions to take -->
- To maximize potential reward, I suggest buying shares if they hit or go above the $45.21 peak, for potential 12.1% returns
- To minimize potential risk, I suggest selling the stock if it falls below $42.20
Risks to consider: Decreased waste volumes and lower commodity prices for recycled materials have negatively impacted Waste Management's revenue growth. For the company to stay an attractive long-term investment, it will need to continue developing innovative, money-making solutions in its gas-to-energy and waste-to-energy divisions. However, the company is well ahead of the curve in this respect and should continue being at the forefront of innovation, driving future growth.