This article originally appeared on Seeking Alpha. Please view disclosures: https://seekingalpha.com/article/275873-waste-management-looks-undervalued-boasts-attractive-yield
At Valuentum, we employ a discounted cash-flow model to arrive at a fair value estimate for every company within our equity coverage universe. In the waste industry, using a discounted cash-flow model is the best tool for valuation, given the robust cash-flow characteristics of participants. We outline below our forecasts and fair value estimate for Waste Management and offer up our model template to investors if they are interested in using it to value any operating (non-financial) company they wish. This model template can be found at the following location: DCF Valuation Model.
But before we dive into the numbers on Waste Management, we’d like to invite investors to take a read of a waste-industry primer, which goes into detail on the competitive dynamics, growth expectations, and business trends in the domestic municipal solid waste sector, which includes Republic Services, Waste Connections, and Casella Waste. In all, we view this group to be defensive with solid cash-generation qualities that should hold up during the worst of economic times.
For those unfamiliar with Waste Management, the firm 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 that 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.
Valuation Summary
Based on our forecasts, we think Waste Management’s shares are worth over $40 each. We reveal our valuation summary below.
Key Financial Statements
We display below the historicals and our projections for Waste Management’s business in the years ahead. To view them, please click on the picture.
Income Statement
Balance Sheet
Cash Flow Statement
To close out our assessment of Waste Management, we wanted to provide a glimpse into the firm’s returns on invested capital. In addition to striving to find firms that are undervalued–both on a DCF basis and versus peers–and are strong cash flow generators, we at Valuentum also look for firms that have a solid track record of creating economic profits for shareholders with reasonable risk. In Waste Management’s case, we’re forecasting returns on invested capital greater than the firm’s cost of capital for each of the next five years. This economic profit spread (return on invested capital less the firm’s cost of capital) means that Waste Management is creating value for shareholders.
We show our calculation of return on invested capital for Waste Management below. To view, please click on the picture.
In all, Waste Management has an attractive position in the municipal solid-waste sector, largely due its large landfilling network. We believe the trash taker’s equity is undervalued and find its 3.7% dividend yield attractive given current corporate bond rates. Should the firm’s dividend yield breach 4% (providing a sufficient margin of safety, in our opinion), we may consider adding it to our Best Ideas list.