WMI – Stock Analysis for Dividend Growth Portfolio

Waste Management, Inc. provides integrated waste management services in North America. The company is engaged in collection, transfer, recycling, disposal, and waste-to-energy services. WMI is neither a dividend aristocrat nor a dividend achiever. In fact, WMI 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 data. My objective here is to understand if WMI has any potential to be a dividend champion.

Trend Analysis

This section I look at trends for past 10 years of corporation’s revenue and profitability.  The parameters should show consistently growth trends. The trend charts and data summary are shows in images below.

  • Revenue: Overall a stable and consistent revenue in last 5 and 10 years. The average revenue growth for last 5 years is 3.2% (with 3.1% standard deviation). 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. The one concern I have is the free cash flow is more or less similar to net income.  What this means is that perhaps, almost all of the corporations net income is being distributed in the form of dividends.
  • 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.
  • Dividend per share: Dividends per share are consistently growing for the last 6 years, including the most recent 2009 dividend increase.

WMI - Trends

WMI - Trends

WMI Data Summary

WMI Data Summary


Risk Parameter Calculation

Here I use the corporation’s financial health to assign a risk number for measuring risk-to-dividends. I have discussed this in more detail at Dividend Tree. The risk number for risk-to-dividends is 2.14. This is a high risk category as per my 3-point risk scale. The factors that are making it high risk-to-dividends are increasing payout factor, historically high yield, 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). Therefore, there is inconsistency between growth rate of dividend and EPS.
  • Duration of dividend growth: Dividends have continuously grown for the last 5 years. Before 1998 in its previous incarnation, before WMI, 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 4.5%; and (b) MMA yield is 3.4%. Considering the average dividend growth rate of 9.6%, the stocks dividend cash flow at the end of 10 years is 4.5 times MMA income. If we assume my average expected growth rate of 3.2%, then the dividend cash flow is only 1.30 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 20 year DCF: $14.35
  • 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: $8.9

The range of fair value is calculated as $17.7 to $25.8. This determined by taking average (for high value) of above five parameters and then subtracting it with half the standard deviation (for low value).

Qualitative Analysis

The strength of WMI business is its well established distribution network and existing market share of approximately 30%. The closest competitor is quite far at 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 WMI 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.
  • Notwithstanding the stable operating cash flow, the recession driven slow down is likely to affect its EPS. The corporation has already acknowledged the adverse effect of (1) reduction in commodity prices; and (2) slow down in residential business sector which is one third of its revenue.
  • Assuming that the corporation’s existing trends in profitability and growth continue ‘as is’, I expect dividend growth to slow down relative to its historical growth.

Conclusion

The Company raised its annual dividend for 2009 from $1.08 to $1.16 per share. This increase shows corporation’s confidence in its operating cash flow. For 2009, I believe this increase is ably supported by the stable operating cash flow. However, the stocks risk-to-dividend number is 2.14 (high risk category). In addition, the dividend cash flow is also 1.30 times the MMA income based my expected dividend growth of 3.2%. At current pricing of $25.47, the risk/return characteristics does not justify starting a new position. The risk/return characteristics become favorable at the price of $16.50 at which the MMA income is more than 3 times the MMA income.

Investors looking for value plus sustainable current dividends (and not necessarily dividend growth) will find WMI attractive.

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

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