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Neutral on Waste Management

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We are maintaining our Neutral recommendation on Waste Management Inc. (WM - Free Report) based on concerns regarding lower commodity prices, electricity prices and a challenging pricing scenario. Waste Management currently maintains a Zacks #3 Rank (Hold) for the short term.
Waste Management’s third quarter 2012 EPS decreased 3% to 61 cents while revenues dipped 2% to $3.461 billion. Reported EPS was a penny ahead of the Zacks Consensus Estimate but revenues fell short of the same.
The bright side of the quarter was the improvement in work-day adjusted volume for the third quarter in a row, after declining for 23 consecutive quarters. The last time Waste Management delivered two straight quarters of volume growth was back in 2005. Volumes were on the decline mainly based on weak economic environment, pricing, competition and increased focus on waste reduction and diversion by consumers. Industrial, special waste and recycling operations saw positive volume growth. Residential volumes though still lingering in negative territory, have improved over the last few quarters. Based on the improving trend, we assume slightly positive volume growth for 2012.
Waste Management’s acquisition of Oakleaf Global Holdings will provide North American customers with unprecedented access to waste and recycling solutions by combining the largest network of directly owned hauling, recycling, diversion and disposal assets with the largest managed third-party network. Post integration, the acquisition is expected to generate a minimum of $80 million in EBITDA on an annualized basis.
Waste Management recently announced certain restructuring actions, including doing away with certain management positions, consolidating some back-office functions, bringing the overall headcount down by about 700. The restructuring program is expected to generate $130 million in annual savings by the beginning of 2013, which are expected to drive margin improvement in 2013 & beyond.
On the flipside, average commodity prices have declined since the fourth quarter of 2011, which has impacted the company’s earnings. Decline in average recycling commodity prices resulted in a negative impact of 10 cents on the third quarter earnings per share and a 14 cent per share impact so far in 2012. Commodity price headwinds are expected to remain in the fourth quarter as well with a likely negative impact of approximately 4 cents on earnings per share. Waste Management lowered its 2012 EPS guidance range to $2.08 to $2.13 from its prior range of $2.15 to $2.20 on a lower recycled commodity price assumption.
During 2011, approximately 54% of the electricity revenue at Waste Management’s waste-to-energy facilities was subject to current market rates. The company estimates that nearly 56% of its electricity revenue at its waste-to-energy facilities will be realized at market rates by the end of 2012. The company’s exposure to market price volatility or electricity has increased over the last few years as long-term power purchase agreements have expired. Electricity prices declined 8% in the first quarter, 10% in the second quarter and 12% in the third quarter on a year-over-year basis. Electricity prices are expected to be at low levels in the fourth quarter as well and to be flat to slightly down annually in fiscal 2012.
Waste Management’s margins have been affected mainly due to the integration of Oakleaf and higher materials costs. Based on stabilizing volumes, the company plans to be more aggressive on pricing in the back half of the year. Overall, the pricing environment remains challenging and highly competitive due to aggressive bidding by smaller competitors. We do not expect any margin improvements until at least 2013.
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. (RSG - Free Report) and Casella Waste Systems Inc. (CWST - Free Report) .

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