Thursday, October 29, 2009

Waste Management - Stock Analysis for Dividend Growth

Waste Management Inc. (WM) provides integrated waste management services in North America. The company is engaged in collection, transfer, recycling, disposal, and waste-to-energy services. WM is neither a dividend aristocrat nor a dividend achiever. In fact, WM has started showing some dividend growth trends in last five years. While I am presenting and showing data from last 10 years, I am only using last five years of dividend data. My objective here is to understand if WM has any potential to be a dividend achiever.

Trend Analysis
Since WM has recently started growing dividends, I am looking at trends for past 5 years of corporation’s revenue and profitability. The parameters should show consistently growth trends. The trend charts is shown in image below and for background reference I have plotted data for past 10 years.

  • Revenue: Overall stable and consistent revenue in last 5 years. The average revenue growth for last 5 years is 3.2% (with 3.1% std. dev). While it shows stability, it shows company facing growth challenges.
  • Cash Flows: Relatively increasing trend for operating cash flow. The corporation has a consistently higher operating cash flow, two times the net income or free cash flow.
  • EPS from continuing operation: In general, the EPS also has an increasing tread since year 2003 with average growth rate as 9.8% (17.5% std dev). Most of that growth is coming in 2004 and 2005. After that is more or less constant. With relatively flat revenues, the EPS growth is most likely coming from operational efficiencies and share buybacks.
  • Dividend per share: Dividends per share are consistently growing for the last 6 years, including the most recent 2009 dividend increase.

Risk Parameter Calculation
Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. The risk number for risk-to-dividends is 2.00. This is a medium risk category as per my 3-point risk scale. The factors that are making it medium risk-to-dividends are increasing payout factor and high variability in EPS.

Quality of Dividends
This section measures the dividend growth rate, duration of growth, consistency over a period of past ten years.

  • Dividend growth rate: The average dividend growth (9.6%) is very much similar to average EPS (9.8%) growth rate. However, the EPS has a very high variability (sometimes negative growth).
  • Duration of dividend growth: Dividends have continuously grown for the last 5 years. Before 1998 in its pervious incarnation, before WM, the corporation has consistency paid dividends for more than 25 years. However, not a consistently growing dividends.
  • 4 year rolling dividend growth rate for past ten years: No
  • Payout factor: In the recent past 5 years, it has been consistently less than 50%. This provides little flexibility and room to grow dividends.
  • Dividend cash flow vs. income from MMA: Here, I analyze how the dividend cash flow stacks up against the income from FDIC insured money market account. The baseline assumption is (a) stock is yielding 3.8%; and (b) MMA yield is 2.4%. Considering the average dividend growth rate of 9.6%, the stocks dividend cash flow at the end of 10 years is 2.9 times MMA income. If we assume my average expected growth rate of 3.2%, then the dividend cash flow is only 1.70 times MMA income.

Fair Value Calculation
This section determines what price I should pay to buy a given stock

  • Net present value (NPV) price based on 15 year DCF: $15.35
  • Average high yield price calculated based on past 10 years: $39.8
  • Pricing based on past 10 year relative price-to-earnings ratio. $44.0
  • Pricing based on price-to-earnings ratio of 12: $26.1
  • Graham number: $9.9

The range of fair value is calculated as $19.1 to $26.7.

Qualitative Analysis
The strength of WM business is its well established distribution network and existing market share of approximately 30%. The closest competitor has half of that market share. Putting this in context of economic environment, it has opportunity to grow due to its pricing ability and leveraging existing distribution network.

  • This quantitative analysis shows that, in last 5 years WM has been able to bring in some level of stability in revenues, profitability, and operating margin. While the corporation is able to maintain consistent operating cash flow, it facing challenges in growing that cash flow. The EPS also has high volatility. Due to its low payout factor, corporation has been able to grow dividends for last 6 years.
  • Assuming that the corporation’s existing trends in profitability and growth continue ‘as is’, I expect dividend growth to slow down relative to its 5 year average.
  • The company expects to continue to maintain its cash flow.
  • The company plans to use its free cash flow for debt reduction, dividends, and share buyback.

Conclusion
WM raised its annual dividend for 2009 from $1.08 to $1.16 per share. This increase shows corporation’s confidence in its free cash flow. For 2009, I believe this increase is ably supported by its cash flow. The stocks risk-to-dividend number is 2.00 (medium risk category). The current pricing of $30 is very close to my fair value range. I would be open to adding WM in my portfolio as long as my asset allocation allows. I expect WM to provide long term value and sustainable current dividends (and slow dividend growth).

Full Disclosure: No position at the time of this writing.

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