We have upgraded our recommendation on Waste Management Inc. (NYSE:WM - News) from Underperform to Neutral. The company is the largest provider of comprehensive waste management services in North America.
Waste Management recorded a 15% increase in EPS to 63 cents in the third quarter from 55 cents in the year-ago quarter. Revenues increased 9% to $3.52 billion. Both results beat Zacks Consensus Estimates.
Waste Management recently acquired Oakleaf Global Holdings and its primary operations for $425 million. The combination will provide North American customers with unprecedented access to waste and recycling solutions by pairing the largest network of directly owned hauling, recycling, diversion and disposal assets with the largest managed third-party network.
The integration is on track. The company expects to generate a minimum of $80 million in EBITDA on an annualized basis.
2010 marked the seventh consecutive year of an incremental quarterly dividend. With the current dividend rate of 34 cents per share, the current dividend yield came in at 4.3%. Backed by its strong cash flow, Waste Management is expected to announce another dividend hike this year.
Waste Management’s cost cutting efforts helped to maintain its profits despite weak volumes. In the recently reported third quarter, the company witnessed a $28 million benefit from its cost reduction initiatives. Management stated that it remains focused on its cost control measures.
On the flipside, Waste Management has incurred huge startup costs for growth initiatives in the medical waste business and for its first ever retail product Bagster. These investments have not as yet generated the expected returns. We believe increasing costs from growth initiatives would weigh on the company’s margins in the near term.
Waste Management’s margins were already affected by higher fuel prices and deterioration in pricing across most business lines, particularly residential. We expect margin deterioration to continue due to the impact of the Oakleaf integration and continued customer churn.
Prices of paper commodities, namely old corrugated containers and old newsprint, have declined sharply in October, the trend continuing in November as well. Waste Management may face significant headwinds if prices continue to drop. According to management, a $10/ton drop in average price would impact EPS by about a cent for the full year. Furthermore, the fourth quarter also faces a headwind from the loss of a large contract in South Florida.
To sum up, we have upgraded our recommendation, on the stock, from Underperform to Neutral, with the rewards balancing out the risks. We intend to hold a more positive stance when Waste Management’s cost cutting and growth initiatives bear fruit.
Waste Management is the largest provider of comprehensive waste management services in North America. The company provides collection, transfer, recycling and resource recovery, as well as disposal services to nearly 20 million residential, commercial, industrial and municipal customers. It competes with Republic Services, Inc. (NYSE:RSG - News) and Casella Waste Systems Inc. (NasdaqGS:CWST - News). Waste Management currently maintains a Zacks #3 Rank (Hold) on its stock for the short term.
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