August 28, 2010 Waste Not? Why Not?
August 28, 2010 Waste Not? Why Not?
I am really excited about the blog today as Saturday morning I had the chance to spend sometime with a beam of light into the next generation of investors. I have spent time with my son and my daughter explaining the basics of how to use money to make money. Today I got to work with someone who is not my child, but definitely part of the extended family. They just graduated and have landed a nice position at Waste Management.
There are a lot of people in this person’s age group who would scurry through the paperwork of medical care choices, direct investment opportunities and 401 K options. This person chose to seek out advice and I was honored to be one of their pools of experience to draw from.
They also happen to be in the envious position of graduating without debt (Thanks Mom and Dad-occasional readers) and have a couple of bucks to put into play in this crazy game of investing.
In the course of sharing some insight with this person, I suggested that if they really want to be responsible with their investment money and to be sure the advice they were getting was sound that they might consider investing an hour a week for each stock they own doing homework. They immediately said they were up to that challenge, but then asked, “What kind of homework?”. That is a great question, and I am surprised more of the Mad Money Audience does not challenge Jim Cramer with that question since I basically stole the time commitment from him.
So I though it might be beneficial, first of all to me, then to the person I was working with and perhaps to a few regular readers to know what I do as part of the regular homework on an equity I own or are considering buying. (I know a few of you are already headed to the end of the blog to see what kind of crazy caption I came up with today, and that is fine. For those of you wishing to hang out, I will do my best to entertain as well as educate.)
It would make sense to use a living breathing example so in the spirit of making this relevant to at least one person, let’s look at Waste Management.
Rule one of investing, and these are not my rules, they are Cramer’s Rules, William J. O’Neil’s Rules (Founder of Investor’s Business Daily), and go all the way back to the Rosetta Stone of value investing Graham and Dodd’s “Intelligent Investor”, (Actually you can go back to Security Analysis circa 1934 where Graham and Dodd use three forms of analysis of securities and the first is the descriptive fundamentals.), and that would be know what you buy. If you can’t easily describe what company does in 3 sentences, don’t buy the stock.
Waste Management is easy. They generate revenue collecting, transferring, disposing of, and generating energy from waste. Obviously that is not enough information to make an investment decision.
The next thing I would do would be to read the media about the company. I subscribe to The Wall Street Journal, The Financial Times, Barron’s (Great issue this weekend, more later), Investor’s Business Daily, and a slew (more than three) of other investment economic publications. I would not suggest anyone have as many subscriptions as I unless you have no life. Here is a quick way to glean what the media has to say about your possible investment.
Go to a website called FINVIZ.COM. Please take a moment and to the virtual tour. I say that as I have been using FINVIZ for about 6 months and I just learned some nice stuff about the site using the virtual tour. I’d go as far as to suggest signing up (it’s free) as I believe you get a few more bells and whistles that if you don’t including some of the best stock screener around. On the home page you will see the major indices and how they are performing intra day or at the end of the day. You will also see a cool graphical interpolation of what is going on or went on that day by sector by stock. Right now I am looking at a big green mosaic which tells me the market was up on Friday. There is one big green box in the energy sector with XOM on it. Exxon had a good day on Friday. There is a small red square with GS on it. Goldman Sach’s did not fare as well.
At the top, put in WM and click on the magnifying glass. The first thing you will see with be the 10 month chart for WM. Here it is:
From looking at this stock you can see it has some cyclical tendencies. In other words it is highly reactive to the economy. That makes sense as a growing economy makes trash. You see how the stock did well post our lows of March 2009- Late January 2010. That is when we saw some weak retail numbers and economy that was hard to read. The stock corrected with the economy. By Mid February, earning were coming in fairly strong and we read some good news into the economy and the stock went up again about 18% in a couple months only to discover we may have gotten ahead of ourselves with good news and the stock came back down again. It seems to be on the mend again since July. The light blue lines at the bottom are lines of price support. The purple lines at the top are lines of resistance or other technical chart signals; in this case what is called a head and shoulders, but we won’t bore you with that mumbo jumbo.
So you see what the chart looks like. Still not enough information to make a buying decision. Take a look further down the page and you will see all the relevant news about the company from mostly well vetted sources. NOTE, I said mostly. The first one I can see is an article from Motley Fool, (great website) that questions, “Is this the time to Short WM?” For my new trader investor, to short a stock means to sell shares in a company you don’t own in the hopes of buying them back at a lower price. You get to keep the money. I do not suggest this to any new players in the market. Save that for us experienced stupid investors. Actually there are great investment trading strategies that utilize short selling, but that will be a lesson for another day. More importantly, I want to know the reason why Motley thinks Shorting is a good idea. In other words why do they think the stock is going to drop?
Well I read the article and must say it was great. I encourage this new investor to read the article not only for the sake of understanding why WM might be a candidate for shorting, but to help identify when other stock might be over valued. The short of it is there are a lot of put options in the market place compared to call options for the stock which means more people are betting on the stock to go down then go up. While Jeremy Phillips does a great job of explaining the underlying fundamentals of why WM MIGHT be over valued, investor pessimism right now plays a large role in some of the put options market. From the financial fundamental stand point Phillips points out some possible weakness (compared to competitors Republic, Covanta, and Stricycle) in the area of future growth, debt, and Price per earnings growth. This is a great article to illustrate why, if you are going to do the homework, why it might take you an hour per equity.
The next article, ironically enough is also by Motley Fool.com and they show how to use their CAPS stock screening tool to decide why WM is a good investment. And you wonder why consumer can’t think of anything better to do with their investment money but pay down the Master Card Balance? (You can’t tell by reading, but I took a break to get Devin’s car washed. She does read this occasionally but thought I could make some brownie points. My bet is she has skipped and went looking for the picture of the day.) But I digress.
The next article is from seekingalpha.com, another great website. They go on to explain the healthy yield on the dividend at 3+ %. They go on to explain if they paid out more of their free cash flow the yield could be as much as 7%+. That won’t happen but the point is made, they have a good cash situation.
That is important to me as an investor/trader (I’ll explain the difference in a second.) As an investor, you are looking for a company that has a good value and future growth. You look for a company that has a solid management team. You look for that management team to improve shareholder’s value. The best thing a management team can do is to generate enough profit to generate enough cash to do any combination of four things:
1. Pay down or eliminate long term debt. If we look at the matrix right below the WM chart, you will see a box labeled Long Term Debt to equity. Long term debt is any obligations the company has that extend beyond twelve months. These could be corporate bonds, leases on property or equipment, payable royalties with base line covenants, lines of credit in use, loans from banks, to name a few. The higher the LTD/Eq ratio is the more aggressive a company has been in financing its growth and operation via obligations. Some industries by nature have a large LTD/Eq ratio. Waste Management happens to be one of those companies in one of those industries. Garbage trucks are expensive, they are usually leased as a fleet transaction, landfills are bought like a mortgage usually, scrap metals facilities have huge capital expenses. (A Typical Mag Crane, you know those magnets that pick up the Soprano’s competitors cars and squish them in the compactor) cost in the neighborhood of 700,000 dollars. The compactors are not cheap either. So by nature a 1.2 long term debt to shareholder’s equity ratio is not out of line for that industry. I would look to see if WM is using Free Cash Flow (The monies left over after paying all of their current expenses and short term obligations.) to pay down long term debt. To do this we look to another website. Go to Morningstar.com. If you haven’t already done so, sign up for access to some more bells and whistles on this website. The subscription service is well worth the money if you have a decent sized portfolio. I am using the basic for this illustration. At the top of the page enter WM in the symbol box. You will see the basic quote page for Morningstar. It has a lot of great information about WM. Right now we are worried about their debt level, free cash flow and net income. A little ways down the page you’ll see a box called Key Stats. Take a quick look at it. MS simplifies things for you using red and green lines. If the stat has a green bar that means it is doing well in that category compared to other in the same sector. Red, well I’ll let you figure that out. Total debt to equity is a little higher than the rest of the industry. Not terrible surprising since WM and Republic are the two largest in this category. Another thing to keep in mind is that WM expands their growth threw acquisitions. If you acquire another company to grow it is always good to do with other people’s money if you can, that also creates long term debt. Below the key stats page is Financials. Go to the right of Financials and look at the little word more. . . and click on it. It should bring up a five year history of financials starting with the income statement. Note you can look at annual or quarterly. When doing my first glance I like to look at Net Income before Taxes for the last 5 years, listed here as Income before taxes. As you can see, they made 1.4 billion in net income in 2009. Keep that number in mind, or jot it down as we will look at another number. Click on Balance sheet at the top of the financials page. Here you will get a 5 year history of their balance sheets. Go down the list and look for long term debt. Got it? You can see they run about 8 billion a year in LTD. Personally I like a company that can pay off their LTD from Net income in under 5 years. This puts WM a little beyond that but again they seem to be best of breed in a capital intensive sector. I am not overly concerned.
OK you probably need a break now so here is some art to go along with your reading:
2. Issue dividends. We can evaluate the WM dividend situation in Morningstar or back in FINVIZ.COM. Let’s got back to FINVIZ. In the first column of the WM matrix you will see Dividend %. That is the dividend yield which is the annual dividend divided by the current price of the stock. Lately you have been hearing Jim Cramer pontificate about AHY’s, Accidental High Yielder. Those are stocks with decent fundamentals whose depressed stock prices are creating impressive dividend yields. A dividend is cash paid to the shareholder just because they are a shareholder. When evaluating a stock, it is important to determine if they pay a dividend and what the yield is of that dividend. Here we see WM paying a yield of 3.75% annually. Is that good? Well the US Treasury 10 year note is yielding 2.65% right now so 3.75% for a sound equity like WM look really sexy. Now is that dividend sustainable. A few weeks ago I did a whole schpiel on dividend yields and sustainability so for a change I am going to steal from myself, “In essence, ‘buy the dividend’ is at the heart of value investing. Just watch the cash flow on stocks that pay a high yield (We consider a high yield as anything above the current 10 year treasury yield, currently at 2.6%) to make sure it is a sustainable dividend and not a sucker bet. A quick check for sustainability would be to look at the payout ratio which compares earnings per share to dividends per share. The lower the better as it is a good indicator that they can continue to pay that dividend. For example one stock you mention is VZ Verizon. If my numbers are correct they are paying a 6.3% dividend yield, but the payout ratio is an obscene 733%. (Please check my numbers). However having been a holder of VZ and VOD, I kind of get the convoluted relationship between Vodafone, Verizon, and Calico (sp) Partnerships. This is a cash rich arrangement. VOD has a nice 5.4% yield and only a 50.6% payout, but the incestuous relationship should cover VZ ability to pay dividends.” If we go to the fourth set of number below the chart almost to the bottom you will see the payout ratio for WM. It is 57.75% which is a little high but very doable. I prefer to see PO ratios below 40%, but this again is a capital intense sector.
3. Stock buybacks. This is usually a good sign when a company thinks its stock is undervalued and buy some of it off the street. There are few places to check for stock buy backs, but I found a cool website that is free and they give a graphical interface for seeing stock buy backs, dividends, free cash flow and a whole bunch of other metrics. Go to ycharts.com. On the home page type in WM and select Waste Management. That will bring up a series of little charts. The first one will be price. Click on that chart which will make it bigger. Once it is bigger, at the top of the chart, change the drop down menu to show Free Cash Flow. You should see a chart that indicates as of June 10th (the last SEC filing by WM) they had free cash flow of $260 million. At the top of the chart you can choose another attribute to compare FCF to, choose Stock buybacks. You will see that WM is inconsistent with buybacks although they are retuning to their buy back program as of a year ago. We will discuss SEC filing in a moment, but that is where you find the size and timing of the buy back as they must be Board approved and report to the SEC.
4. Acquisitions and capital appropriating. I told you we would be getting to the SEC filing and here is where you need them. Head your browser over to http://www.sec.gov/ There you will see a box called filing and forms. Click on the little box called search for company filings, click on it. It should bring you to http://www.sec.gov/edgar/searchedgar/webusers.htm , then click on the link that says Company or fund name, ticker symbol, CIK (Central Index Key), file number, state, country, or SIC (Standard Industrial Classification) and you should end up at http://www.sec.gov/edgar/searchedgar/companysearch.html or you skip all of that crap and just save the link in you browser favorites. You will use it a lot. In the box that says “CIK or Ticker Symbol, type in WM. One of the first lines that comes up is the SEC filing 10 Q. That would be there quarterly filing dated August 2nd, 2010. Open that document by clicking on the little blue box marked document. The first line is the 10Q and it is one of the larger files. Go ahead and click on it. I encourage to look through the 10 Q in its entirety at some point in time. For this exercise, look at the table of contents and find the link to Management’s Discussion And Analysis of Current Financial. . . . And click on that link. It will take you to page 31 of the quarterly filing. That first few paragraphs are some of the general statements about the company and cautions about forward looking statements. The CEOs discussion begins on page 33. If you read that section you learn a lot about the entity. You’ll learn that some of their pricing schemes are tied to inflation benchmarks and as we all know inflation has been and should remain low, impacting their ability to bump revnue. What I was looking for was how they use Free Cash Flow and there on page 48 was the following- Net Cash Used in Investing Activities — During the first half of 2010, net cash used in investing activities was $823 million, compared with $563 million during the first half of 2009. The most significant items affecting the comparison of our investing cash flows for the six-month periods ended June 30, 2010 and 2009 are summarized below:
• Investments in unconsolidated entities — We made $161 million of cash investments in unconsolidated entities during the first half of 2010. These cash investments were primarily related to a $142 million payment made to acquire a 40% equity investment in Shanghai Environment Group (“SEG”), a subsidiary of Shanghai Chengtou Holding Co., Ltd. As a joint venture partner in SEG, we will participate in the operation and management of waste-to-energy and other waste services in the Chinese market. SEG will also focus on building new waste-to-energy facilities in China. We did not make any similar investments during the first half of 2009.
• Capital expenditures — We used $475 million during the first half of 2010 for capital expenditures compared with $583 million in the first half of 2009, a decrease of $108 million. The decrease can generally be attributed to timing differences associated with cash payments for the previous years’ fourth quarter capital spending. Approximately $145 million of our fourth quarter 2009 spending was paid in cash in 2010 compared with approximately $245 million of our fourth quarter 2008 spending that was paid in the first quarter of 2009.
• Acquisitions — Our spending on acquisitions increased from $59 million for the six months ended June 30, 2009 to $237 million for the six months ended June 30, 2010. During the second quarter of 2010, we paid approximately $150 million to acquire a waste-to-energy facility in Portsmouth, Virginia. We continue to focus on accretive acquisitions and growth opportunities that will contribute to improved future results of operations and enhance and expand our existing service offerings.
• Net receipts from restricted funds — Net funds received from our restricted trust and escrow accounts contributed $26 million to our investing activities in the first half of 2010 compared with $71 million in the first half of 2009. The year-over-year decrease in cash received from our restricted trust and escrow accounts is generally due to the timing of requisitions from our tax-exempt bond funds, which are used to support related capital projects.
That shows you how they are using their free cash flows and support the argument that they are growing their revenue by acquiring other entities.
Ok WM is looking better and better the more we read about the company. In looking in the executive suite, I did note that David Steiner CEO to over the presidency in June 2010 from Lawrence O’Donnell the III. You might know him as the boss who went undercover for WM on the CBS show Undercover boss.
The last thing to do before making a decision to buy is to decide what price you want to get in at and what would be a good return. This is a unique situation as the person entering the stock will be buying the stock as part of an employee benefit package. They will not allow the purchase to be more than 20 % of their 401 K retirement package. It will be a direct purchase so I am not sure how much flexibility there may be. Despite this, the employee will be buying in small increments over a long period of time. Not a bad plan with a cyclical stock dependent upon the economy. Going back the FINVIZ site for moment, we can see the stock closed Friday at $33.62. Looking below the matrix box you will see several analysts upgrades and down grades. The range of target prices are from 36.00 to 47.00. The target price in the matrix is 39.06. If we were going to buy more of this stock, 33.50 looks like a good entry point, and we should be looking for 37-38 by the end of first quarter 2011.
Once all of that homework is done, the weekly maintenance would be to check FINVIZ and Morning Star. Also as a Charles Schwab client tye have great equity reports updated every few days which are helpful in keeping an eye out for your stock. You can also set up text alerts for your stock so every time they are mentioned on the news, you get a text message. This saved me a fortune on BP and RIG the day of the explosion. I was out of both positions within two hours. Another interesting exercise in doing weekly homework is to go to Google News and put in the name of the company and their hometown. In this case the search would be “Waste Management” and Houston. It turns up some interesting news pieces relevant to shareholders. There was an article from an Alabama news paper indicating that WM has contracts with municipalities and BP for clean ups of oil in Texas, Alabama, Louisiana and Florida. Those revenues have not hit the quarterly reports. BTW, WM saw a nice spike in revenue and profits post hurricane Katrina. Food for thought. Along with that revenue come some EPA liability issues, but that is the risk of lucrative oil clean up contracts.
Hopefully that give our new WM employee and new investor and idea of the homework needed to stay on top of the game. There are other things like listening to the earnings call report when they come up. And reading eh annual reports as they come out. Checking in with the companies website in the investor’s relations department is also a good way of staying in touch. Hope this helps.
Now I mentioned we would discuss the difference between a trader and an investor. Most of eh homework I just described would be relevant to both. The major difference in most cases would be the timeline the person is considering. In this case we have a young person who is starting their career with a sound organization. They will probably be inching into the stock through direct purchase plans through the company. So we would be looking for a relatively long term investment. That would be an investor point of view. If I was Joe “Horse Sense” Six Pack and ran across the article about WM being contracted to do BP oil spill clean ups, I might do the same homework and say, this new business will be a nice surprise to the stock and it looks as though none of the analyst have worked this event into their forward looking estimates. Buy the stock and wait a quarter maybe two and look for the upside and get out. That would be a trader point of view.
Whether you are Joe Six Pack or our new WM employee, before we establish our position in Waste Management, we should decide when to get out of our position in WM. That would again be determined by our time line and risk tolerance. If our new employee is cognizant of the 10 year yield and is looking for at least double that yield, say 5% annually, than at 35 a share in one year or less they would have to consider taking some profit. If Joe Six pack is looking for a quick six month turn around at 10%, then when the stock hits about thirty seven, he should look at getting out or at least selling his profit. These are decisions that should be made before entering a position.
Just as important is watching the down side. For Joe, since this is a trade, he should have a firm determined downside before entering the position. If Joe does not want to loosed more than 8%, he should enter a stop limit order at $31.25 immediately after establishing the position. Since our new WM employee is accumulating the WM stock, they can be more flexible with the down side as they will be buying into those dips with intent of being in the game for a while.
The week ahead, come a little late to this post. In economic news for tomorrow, we have the consumer income and spending report. The consensus is expecting a slight uptick in income. I think both will disappoint. Instead of .3% and .1% (Income and consumption) look for .1 and -.1. This will knock the market down the 1.5 we made on Friday and a half a point for the bad news. That would be a 2% drop by days end on Monday. There is no relevant earnings news coming out on Monday so that won’t help or hurt the market.
And to quote Boz Skaggs, here is one more for the road: