Hot Stock: Waste Management

Garbage has to go somewhere.

If there’s one industry that likely doesn’t get much discussion around company water coolers, it’s the garbage sector. But waste management, as its more tastefully called, is big business. There isn’t a city in the world that doesn’t need to get its waste shipped from one place to another, and while some locales handle the removal themselves, more and more are turning to private companies to ship out their soiled stuff.

One operation that has analysts buzzing is The Woodlands, Tex.-based Waste Management Inc. (NYSE: WCN). It focuses on smaller urban and rural areas rather than large city centres and also has a budding exploration and production (E&P) segment that hauls away waste from natural gas sites.

On July 8, Stifel analyst Jeff Osborne maintained his buy rating on the stock and increased his 12-month target price from $44 to $47. He likes the stock because of its focus on secondary markets. “It can capture stronger pricing with better visibility than its larger peers,” he wrote on April 25, when he initiated coverage on the company.

He’s also bullish on its E&P prospects. It has a stronger growth profile than its solid waste division, which is growing at about 2% a year. While it’s a more volatile business, over the long term it should be a big revenue driver. In his July 8 note, Osborne said the company plans spend about $40 million to $60 million a year on acquisitions, with about $10 million to $20 million of that going to E&P related buys.

Stuart Scharf, an analyst at S&P Capital IQ, also has a buy rating on the stock, in part because he expects to see 18% total revenue growth this year. Gross margins will also expand, he says, from 42.4% in 2012 to 45.5% this year. “(This) reflects better core pricing and a more favourable mix due to oilfield waste margins,” he wrote on July 6.

Both analysts are also keen on its ability to generate free cash flow. The company’s projected free cash flow is $300 million this year, up from $276 million in 2012. Osborne predicts that Waste Management will increase its dividend—it’s paying a 0.94% yield today—in the coming years as its payout ratio is only around 16%. Other companies, he notes, have a payout ratio of 50% or higher.

While a slowing housing market and higher fuel costs could slow the company’s growth, Scharf is optimistic that its prospects will only get better form here. “We believe strong cash flow will continue to be targeted for strategic acquisitions, further debt pay downs and to return to shareholders,” he says. “Leverage remains below historical levels, and we expect favorable return on invested capital potential as Waste Connections targets new markets.”

The stock is trading at about $42.50, but a number of analysts think it could reach between $45 and $47 dollars within the year.

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