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Morningstar | Solid Collection Volume Gains Persist in Waste Management's 4Q

Wide-moat waste services leader Waste Management’s fourth-quarter organic revenue growth was about 7%, mostly in line with our forecast on a workday-adjusted basis. Relative to the same period last year, internal top-line growth came from a continued healthy core pricing backdrop and ongoing volume growth across the traditional solid waste collection and disposal operations, despite a tough comparison with late 2017 hurricane-related business. Similar to previous quarters, these factors were only partly offset by recycling division headwinds linked to anemic commodity prices for key materials the firm extracts and sells, namely recycled fibers. Adjusted operating profitability was mostly in line.

Because our midcycle revenue and operating margin assumptions are mostly intact, we don’t expect to make material changes to our $75 fair value estimate. That said, we will be incorporating full-year 2018 financials into our discounted cash flow model, and that could drive minor adjustments, which would probably prove upwardly biased. The shares are trading in modestly overvalued territory relative to our longer-term expectations for top-line, profitability, and free cash flow growth. Several industry leaders are seeing very healthy trends in their traditional solid waste operations thanks to U.S. macroeconomic tailwinds, and this dynamic hasn’t escaped investors. Waste Management is a very well-run and highly profitable waste hauler, but we think the stock price is baking in slightly overoptimistic midcycle revenue and margin assumptions.

Total organic revenue increased 7%, reflecting an approximate 4.7% increase in total average internal volume (4% workday adjusted) and a 2% rise in average yield. Collection and disposal organic revenue once again expanded nearly 6% on solid 2.3% yield gains and 3.5% volume growth; commercial collection volume stood out, rising 4% year over year. Service increases continued to outpace service decreases, with help from positive macroeconomic tailwinds, including solid housing starts over the past year or so. Internal recycling commodities revenue posted roughly a high-single-digit decline on the back of markedly lower average commodity prices, particularly for old corrugated cardboard, which has been hit hard by import restrictions into China.

We estimate total adjusted EBIT margin rose by 30 basis points, to 18.8%. Overall, we suspect leverage from healthy traditional solid waste revenue growth overcame recycling headwinds, higher third-party transportation costs, and heightened internal investments aimed at optimizing productivity and efficiency. Clean margins remain well above the 17% five-year average.