Every once in a while I think it’s important to get some balance into our thinking… we can’t obsess over growth every day, so now that the world is opening up and inflation expectations have people in a little bit of a growth-stock panic again, I thought I’d take a look at something, well, more boring.
And right there in my inbox is a good candidate — Dividend.com is selling their Premium service ($149/yr) by pitching an “environmental services pick” that they say “continues to thrive during pandemic times”… so what is it?
Here’s a little taste of the ad:
“Trash isn’t exactly glamorous, but what it lacks in excitement, it makes up for in steadfastness. Despite shifts in how we work and play, trash hauling remains a lucrative business and provides plenty of cash flows/dividends for investors. And our Best Dividend Stocks List pick in the sector was one of the main beneficiaries.”
OK, we’ve looked at trash stocks before, from time to time, and we know that they generally took a pretty good hit last summer when offices and restaurants closed… sure, we generated a lot more trash at home, but they lost a lot of good customers. Which one is Dividend.com pitching? Let’s check out the clues…
“Thanks to rising industrial activity and the re-opening of the economy, trash volumes have already started to rise. Our pick has been quick to capitalize on the change. Moving forward, this new normal creates an interesting environment where both residential and commercial demand is higher…
“… management at our pick estimates that for the full year, revenues will grow by more than 12.5%. That’s pretty impressive tech-like growth for a garbage company.”
And apparently they’re prepared to lever that with some improved margins…
“Thanks to aggressive cost cutting, investments in technology and continued price improvements, margins have boosted significantly. As a result, earnings jumped by more than 14% during the first quarter of 2021, while cash flows surged by 44% year-over-year.”
Other clues? They have “over $10 billion in annual revenues,” and we’re told that the dividend was increased by “nearly 6%” last quarter, with a payout ratio of 52% and current yield of 1.56%… and they had “more than one billion in free cash flows” in that quarter, while earnings grew by 14%, and cash flow by 44%.
Sounds fairly decent, no? That’s not a huge dividend, but dividend growth is our friend. So what’s the stock?
In some ways, those clues could point us toward either of the two largest US trash companies, Waste Management (WM) and Republic Services (RSG). WM is the larger player, with revenue of about $15 billion (RSG $10 billion) and a market cap of $59 billion (RSG $35 billion), and WM tends to get a slightly higher valuation than it’s second-place competitor, but they are extremely similar. Just to give you a little context before we dig into which one matches these clues better, here’s the 5-year chart for both (That’s WM in blue, RGS in orange, and the S&P 500 in red):
So it’s frankly a little bit silly to work really hard to distinguish among the two, they’ve both done extremely well, have similar management strategies and balance sheets, and have similar outlooks and valuations…. it’s perhaps a little easier for RSG to grow faster, given its slightly smaller size, but it’s also a business where network effects and large asset bases (like landfill ownership) make a big difference, so there’s also some advantage in being larger. Both companies reported strong first quarter results as commercial wasge volumes started to pick up, and both raised their forecasts for the year. Ready to split hairs?
About two weeks ago, WM reported $1.1 billion in “operating EBITDA” and $865 million in free cash flow, and posted 14% growth in adjusted EPS in the first quarter, and their revenue growth guidance was 12.5-13%. They use lots of different kinds of ‘cash flow’ in their announcements, but their “net cash from operating activities” did go up by close to 44%, that line had 46% growth year over year. Their dividend was raised from 54.5 cents to 57.5 cents in February, so that’s an increase of 5.5% and a current yield of 1.59%. WM’s payout ratio (dividend divided by adjusted earnings) was 54% last quarter and last year, with current analyst estimates of $4.86 in 2021 earnings it would be 47% this year.
RSG reported last week, announcing 24% growth in adjusted EPS in the first quarter and 62% growth in “adjusted free cash flow”. They’re a a bit smaller, so the free cash flow can’t really get close to $1 billion in a quarter to match that clue (they’re guiding to just $1.34 billion in adjusted free cash flow for the full year). Their last dividend increase, from 40.5 cents to 42.5 cents, was just under 5%, and their current dividend yield is 1.56% (they do their annual dividend increase in July, so that will likely change). RSG’s payout ratio last quarter was 46% (dividend/adjusted earnings per share), 2020 came in at 47% and 2021’s earnings guidance of $3.74-79 means the current 42.5 cent dividend would be 45%. RSG did not provide specific revenue growth guidance like WM does.
So given the slightly better match on the growth and free cash flow numbers, Thinkolator sez this is another pitch for Waste Management (WM), which we also covered during the heat of the downturn last year because Dan Ferris over at Stansberry was pitching the stock (with the appropriate line, “pandemic or not, the trash trucks keep coming.”)
Will it be a winner this year? Um… probably? As you can see from that chart I included above, they’ve certainly both been pretty consistent winners in past years as they’ve gradually gobbled up hundreds of small local landfills and trash/recycling haulers, and they both have fairly steady profits over time from both their regulated businesses (landfills and municipal waste contracts, which are often priced with built-in growth on long-term deals, kind of like utilities) and their market-price services handling trash pickup from residences and businesses.
Both had slightly weak years in 2020 thanks to the slowdown in commercial business, though RSG was slightly weaker than WM and has been a little bit less steady on the revenue growth front over the years. Both have had a couple years when revenues came in below the prior year in the past, but with a 2% drop in revenues and 10% drop in net income for both of them in 2020, it was at least their worst year in about five years. The bounceback is likely to be stronger for WM than for RSG, partly because of their acquisition of ADSW that went through last year, but both are bouncing back (revenue growth from 2019 to 2021, skipping the 2020 down year, should be 11% for WM and 5.5% for RSG).
Both companies, despite that soft year, continued to buy back shares (albeit less than in prior years), and raise their dividends (last year had their lowest increase in a decade, when the average dividend increase was more like 7-8%… but again, that’s splitting hairs and an increase is an increase)… so they clearly managed through the business challenges reasonably well, and this year they’re benefitting both from reopening businesses and restaurants and a general boost in the economy and from a little recovery in the prices they can get for recycled commodities.
What happens with inflation? Well, it might be that investors begin to think that a 1.6% dividend yield isn’t enough, so dividend payers can certainly be hurt if inflation takes off… but operationally, they should be in very good shape. Their contracts are generally built with annual price increases that are either fixed and relatively high (over 3%) or track with the CPI or with some other index of trash and utility pricing, so the protection there is similar to what a lot of utilities and REITs might offer during times of rising prices.
So these are solid companies, but we should pay a little attention to that potential “rising interest rates” risk. One of the major drivers of these companies has been multiple expansion over the years, just like with a lot of other steady dividend growth companies — investors demanded a 3-4% dividend yield to buy WM or RSG a decade ago, and now they’re willing to accept 1.5-2%, almost exactly mirroring the decline in rates for the 10-year treasury note yield, so if that changes abruptly, for whatever reason, it could have a meaningful impact on the share price.
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And there you have it — I promised “boring,” and I think I may have delivered. Interested in the big trash haulers for that bounceback growth and some continued strong dividend compounding? Have other dividend growth ideas you prefer? Let us know with a comment below.