EUR 850.00 For Business Accounts Only

Morningstar | Traditional Solid Waste Strength Picks Up Recycling Slack in Waste Management's 2Q. See Updated Analyst Note from 25 Jul 2018

Wide-moat waste services leader Waste Management’s second-quarter revenue increased 2.2% on an organic basis, to $3.74 billion, slightly below our expected run rate due to softer-than-anticipated recycling segment performance. Relative to the same period last year, the top-line increase stems from robust pricing conditions and healthy volume trends across the traditional solid waste collection and disposal businesses, only partly offset by persistent weakness in the recycling operations linked to anemic commodity prices for key materials the firm extracts and sells, namely recycled fibers. Adjusted operating profitability was mostly in line when ignoring an uptick in litigation-related accruals.

Since our longer-term midcycle revenue and operating margin assumptions are intact, we are maintaining our $75 fair value estimate. In our view, the shares are trading in modestly overvalued territory. Recycled commodity prices are quite depressed, but several industry leaders are seeing strong growth in their solid waste operations thanks to U.S. macroeconomic tailwinds, and this dynamic hasn’t escaped investors.

Collection and disposal organic revenue grew 5%, reflecting 2.3% yield gains (similar to the first-quarter trend) and 2.3% traditional solid waste volume growth. Of note, residential volume was roughly flat year over year following a string of declines over the past year. Commercial growth and industrial volume growth both remain solid (up 3%). New business continues to outpace lost business, driven by healthy macroeconomic conditions, including housing starts. Recycling commodities revenue contracted 19% (down 16% in the first quarter) due to 43% lower average commodity prices, which are under pressure from increased import restrictions in China, particularly for old corrugated cardboard. Management no longer expects a material commodity price recovery in the second half but remains optimistic that internal efforts will stabilize the business by 2019.

We estimate total adjusted EBIT margin fell 30 basis points to 18.1%, as recycling headwinds, higher litigation accruals, and higher labor costs (driver recruiting) more than offset leverage from healthy traditional solid waste revenue growth. That said, this is still an impressive showing--recall that margins surpassed 18% for full-year 2017--an all-time high for the company. Management raised its 2018 earnings per share guidance to $4.05-$4.10 from $3.97-$4.05 due to strength in the traditional solid waste operations and a lower-than-expected tax rate during the quarter.