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Waste Management Makes Money From Hauling Garbage. But It Expects More Than Half of Its Profit Growth to Come From Something You Wouldn't Expect.

Motley Fool - Wed Jan 24, 8:30AM CST

With Waste Management(NYSE: WM) operating the largest network of landfills in the U.S. and Canada, chances are that most everyone reading this has seen one of its trucks driving by at some point.

The company generates the bulk of its revenue from hauling garbage. Through the first three quarters of 2023, collecting trash from commercial, industrial, and residential sources has accounted for 68% of revenue.

In some instances, there isn't a landfill nearby, so Waste Management takes trash to a transfer station, where it can be processed for more efficient transport to a landfill. The company owned or operated 337 transfer stations at the end of 2022, a number that will be updated when it reports results for the fourth quarter of 2023.

Waste Management owned or operated 259 sites in its landfill network at the end of 2022. All of these sites require proper permitting from various government entities, which can be hard to get initially. But once obtained, this can be a competitive advantage -- it's difficult for a competitor to come in and steal business.

The revenue Waste Management generates from collecting trash as well as operating landfills and transfer stations is the bulk of its business, as one would expect. But the company's landfills surprisingly have more value than meets the eye. And through 2026, management expects more than half of its profit growth to come from extracting this hidden value.

What exactly is that value? Read on.

Waste Management's surprising profit project

The company hauls tons of waste to landfills, where it all just sits. Well, it doesn't just sit -- it also decomposes. And as a result of the decomposition, the garbage releases what are called landfill gasses (LFGs).

LFG can be harvested to produce electricity, and that's exactly what the company has been doing. But it can also be refined into renewable natural gas (RNG) to power vehicles or sell to third parties. This is what the company is prioritizing right now.

Waste Management built five facilities between 2015 and 2022 to convert LFG to RNG. And through 2026, it's building 20 more. This is resulting in high capital expenditures for the company -- the total bill is expected to be around $1.2 billion. But the payoff is expected to be substantial. Indeed, Waste Management believes that its RNG facilities will be generating $450 million in annual free cash flow in 2026 and beyond.

Allow me to put that number into perspective. If not for all of its capital expenditures right now, Waste Management would be generating about $2.5 billion in annual free cash flow. However, management believes it can add $580 million in free cash flow once its current investments start paying off. Of this, $450 million will come from its investments in RNG.

In other words, about 78% of incremental free cash flow will come from turning landfill gasses into RNG, which is something that you might not expect at all.

Why Waste Management is a good stock to buy

Over the years, Waste Management has consistently grown its profits, leaving it with more options for creating shareholder value. Two of its most frequent decisions are repurchasing shares and paying a dividend. The chart below shows the long-term trend.

WM Average Diluted Shares Outstanding (Quarterly) Chart

WM average diluted shares outstanding (quarterly), data by YCharts.

In December, the company announced that it was increasing its dividend for the 21st consecutive year, placing it in elite territory.

As already mentioned, Waste Management's core business is rock-solid, and the company is competitively well-positioned. And it has a viable path to profit growth as it takes better advantage of something that's already at its disposal: landfill gasses. And that should boost shareholder value, making this a good stock to buy and hold today.

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Jon Quast has no position in any of the stocks mentioned. The Motley Fool recommends Waste Management. The Motley Fool has a disclosure policy.

Paid Post: Content produced by Motley Fool. The Globe and Mail was not involved, and material was not reviewed prior to publication.

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