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Morningstar | Traditional Solid-Waste Pricing and Volume Remain Solid in Waste Management’s 3Q; No Surprises

Wide moat waste-services leader Waste Management’s third-quarter revenue grew roughly 5% organically (about 3.5% year to date), to $3.8 billion, mostly in line with our expected run rate. On a year-over-year basis, revenue growth was mostly driven by a healthy core-pricing backdrop over the past year and continued volume growth across the traditional solid-waste collection and disposal businesses. 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 with our expectations.

Our longer-term midcycle revenue and operating margin assumptions remain intact, we are maintaining our $75 fair value estimate. At roughly an 13% premium to our fair value estimate, the shares are trading in slightly overvalued territory. Recycled commodity prices are depressed, but the industry leaders are seeing strong growth within their solid-waste operations on the back of U.S. macroeconomic tailwinds, and this dynamic hasn’t escaped investors. In our view, the stock price is baking in slightly over-optimistic mid-cycle revenue and margin assumptions.

Total organic revenue increased roughly 5%, reflecting an approximate 4% increase in average volume (internal) as average yield was flattish (up slightly less than 1%) because of recycling pressure. Collection and disposal organic revenue expanded slightly more than 6% on solid 2.5% yield gains (2.4% on average year to date) and 3% traditional solid-waste internal volume growth. Residential volumes were up almost 1% year over year, while commercial and industrial volume growth remain quite healthy (both increased about 3%). New business continues to outpace lost business, driven by positive macroeconomic conditions, including solid housing starts over the past year-plus.

Recycling commodities revenue contracted 10% (down 15% year to date) because of 47% lower average commodity prices, which are under pressure from increased import restrictions in China, particularly for old corrugated cardboard. Management remains optimistic internal efforts can help stabilize this business by 2019.

We estimate total adjusted EBIT margin was roughly flat relative to third-quarter 2017 at 19%. Overall, leverage from healthy traditional solid waste revenue growth was largely offset by recycling headwinds, higher labor costs (including driver recruiting), an uptick in third-party transportation costs, and heightened internal investments aimed at optimizing productivity and efficiency. That said, this is another impressive margin showing, versus roughly a 17% five-year average.