1

Creating anInvestment

Recommendation

SpeakerPosition

Company

smartwomansecurities

© 2010 Smart Woman Securities. Materials are for SWS members’ use

only. All rights reserved.

Date

2

Announcements

• Please enter any SWS related announcements here.

3

Last Seminar Recap• EPS and P/E are a crucial part in understanding how to

come to the value of a stock

• Ratios help us compare different companies and compare a specific company across time

• Financial metrics also help us determine the future earnings and earnings quality for a company.

• Be careful about comparing companies in different industries, as many ratios cannot be universally applied.

• Continue to research financial metrics that may be relevant to the industry that you are interested in.

4

Tonight’s Agenda

• Putting it All Together

• Stock Pitches

• Example Stock Pitch

5

This Week’s Seminar• After this, you should be able to:

– Synthesize the information from previous seminars to come up with an investment idea

– Understand what are the important parts of a an investment story

– Take what we have learned and apply it in practice so that you can invest in stocks

– Understand how to pitch your stock

6

Market Update

• Have speaker comment on what happened in the markets for past week.

• We encourage speakers to create a slide of important occurrences (see next slide for example).

7

Market Update Example Slide

• There were mixed technology results as Apple & Microsoft posted solid positive third quarter earnings; raising concerns about semiconductor valuations

• Merrill Lynch wrote down $7.9b in losses from subprime losses, which adds more wariness around the health of the housing market.

• Bank of America announced 3,000 job cuts, which adds concern to the state of the economy.

• Crude oil futures climbed above $92; analysts expect it to surpass $100, a strong sign for the economy.

• S&P500 gained 2.3% on the week; DJIA was up 2.1% while the NASDAQ was up 2.9% as investors seemed less concerned about risks in the credit markets.

8

Putting it all Together

9

Recap of Last 3 Weeks• Finding stock ideas

– Finding stocks that seem interesting (based on trends, Lynch/Buffett’s principles, your own observations)

– WSJ, Financial Times, Economist

• Qualitative Analysis– Going to their websites, reading reports, etc.– Think about what industry it belongs in, who

are major competitors?– Think about if recent success/difficulties

company is facing are likely to persist– Good framework is Porter’s Five Forces

10

Recap of Last 3 Weeks Cont’d

• Fundamental Analysis– Look at income statement, balance sheet,

statement of cash flows – Revenue growth, EPS growth, profit margins,

ROE, ROA

• Valuation Analysis– P/E, Discounted Cash Flow >> is all the good or

bad news reflected in the stock price?

• Creating an Investment Recommendation

11

Stock Pitches

12

Stock pitch

• Every stock pitch needs to communicate 2 major points:

#1: IS THIS A GOOD BUSINESS?

#2: WILL THIS BE A GOOD STOCK?

13

Is This a Good Business?

• Company Overview– What does the company do? Brief company &

mgmt history. – Characteristics of the business:

• Size of company and market share• Is it a growing business or more stable (or declining)?

• Industry Analysis – Define the industry the company competes in– How fast is the industry growing? – Competitive landscape. What is your company’s

market share?– Porter’s Five Forces analysis

Note: sources for this info are in the 10K & Annual reports: MD&A, Company Description

14

Is This a Good Business? (cont’d)• Financial Statement Analysis

– Tie #s to your statements/observations – Revenue growth, EPS growth, profit

margins• From income statement

– ROE, ROA• From balance sheet and income statement

– FCF generation • From statement of cash flows

• Economic Landscape– What external macroeconomic factors

will affect the stock?

15

Will this be a Good Stock?• Opportunities and Risks

– Future growth prospects & risks

• Valuation– Stock price history (if it blew up, figure out why)– Valuation tools:

• P/E vs. growth rate of EPS• P/E across different companies

• Investment Recommendation– What type of investor should invest, time horizon,

what the target price is expected to be, etc.

16

Making a Recommendation

• One-year time horizon

• Target price (estimated EPS x P/E)

• Buy, sell, or hold recommendation

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The following stock pitch is recommended, but speaker may wish to use his/her own

investment report

18

Example Stock Pitch:

Waste Management (WM)

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Stock Pitch• This stock pitch was created in summer 2008, so

all references are from that time period.

• Looking at a previous stock pitch allows you the benefit to see what’s happened since the original recommendation with 20/20 hindsight.

• It is also valuable to pay attention to what happened in the broader market and economy. For example, within months of this recommendation, the United States was in the largest financial crisis in history.

20

Snapshot: WM• Ticker: WM• Current Stock Price:

$35.44• 52 Week High:

41.19• 52 Week Low: 27.57

• Recommendation: Buy

• Target Price: $45• Upside: 27%• Time Horizon – 1

YearPlease note that the ticker for Waste Management changed from WMI to WM in fall 2008. As a result, there may be some reference to both and stock charts may make it appear that the company started trading in 2008, while in reality, it has been public since the 1980’s.

21

Company Overview: WM• WM is a national integrated waste provider with

collection and disposal services (landfills and recycling).

• Company has $12B in revenues and is the largest US waste provider.

• Mgmt for WM is considered some of the best in the business and David Steiner, CEO, is respected as very knowledgeable on waste business.

• Steiner has been with company for since 2003 and has led way in turning around industry through sophistication of business practices.

22

Investment ThesisInvestment Thesis: Solid waste industry stocks are a BUY as

pricing power is a secular story that should continue to drive performance.

Pricing: Pricing 50-150 basis points above CPI is sustainable long term and has been achievable in spite of volume and fuel headwinds.

Volumes: Volumes will continue to be a headwind (-3%) through early 2009, but should recover without hurting the pricing story.

Margins: Margins should expand 100-150bps over the next 12-18 months driven by increased pricing and stabilizing fuel, while offset slightly by higher third party disposal fees.

Economic Cycle: Stocks have outperformed relative to the market during recessions (+22%) and the pricing story should drive performance coming out of the down cycle.

Valuation: Stocks are trading at 7.3x 09 EV/EBITDA, slightly below historical average of 7.8x. With continued improvement in ROIC, multiple expansion is warranted and should occur.

23

Industry Overview

24

Industry Overview

Public Co. Collection33%

Private Co. Processing2%

Public Co. Processing6%

Municipality Processing4%

Public Co. Disposal19%

Private Co. Disposal4%

Municipality Disposal11%

Municipality Collection11%

Private Co. Collection10%

Collection55%

Processing12%

Disposal34%

Solid waste is a $52B US industry with integrated operations and growing 4-5% annually.

25

Industry Overview: Collection

Collection Segment• 55% of Market ($29B)• Top 3 Control 47% of Market• Low Barriers to Entry• High Variable Costs• EBITDA Margins ~15%

Residential Construction, 5%

Nonresidential Construction, 5%

Residential, 30%

Commercial, 40%

Manufacturing, 17%

Special Waste, 5%

Industrial, 30%

WMI27%

Municipalities27%

RSG6%

Other Public Companies

9%

Private Companies

19%

AW12%

Allied Waste (AW) and Republic Services (RSG) the #2 and #3 players merged in fall 2008.

26

Industry Overview: Disposal

Disposal and Processing Segment• 45% of Market ($23B)• Top 3 Control 67% of Capacity• High Barriers to Entry• High Fixed Costs• EBITDA Margins ~60%

Recycling24%

Composting8%

Waste-to-Energy12%

Landfill56%

WMI36%

CVA4%

Other Comps and Munis

25%

AW22%

Veolia4%

RSG9%

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Porter’s Five Forces

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Porter’s Five Forces

• Barriers to Entry • Collection segment – very low b/c any

small mom and pop can buy trucks, equipment, etc. and get into the industry.

• Disposal segment – very high b/c it is very difficult to get a landfill sited and environmental compliance is very costly.

29

Porter’s Five Forces• Substitutes

• Not many, you have to get your trashed picked up, but you could “substitute” by throwing away less trash.

• Not really an issue in past.

88.1

121.1

151.6

205.2 214.3237.6

251.3

4.503.66

3.252.68

4.46 4.64 4.60

0

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1960 1970 1980 1990 1995 2000 2006

To

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Porter’s Five Forces• Rivalry:

• Fairly Concentrated competition•Waste Management (WM) - $12B national

player•Republic Services (RSG) – $3B regional

player focused in midwest and south•Waste Connection (WCN) $2B Northwest

player•Independents – lots of competitors, but

only on collection

31

Porter’s Five Forces• Buyer Power:

• Collection •Buyers are residential (you!),

commercial (like McDonald’s), and industrial (factories)

•Not concentrated• Disposal

•Buyers are independents and don’t have much bargaining power or concentration

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Porter’s Five Forces• Supplier Power:

• None – Equipment and truck providers don’t have any real power.

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Porter’s Five Forces• Porter’s Five Forces:

• Industry looks fairly favorable• Barriers to Entry – High• Substitutes – Not Many• Rivalry – Concentrated at Top• Buyer Power – Not Really• Supplier Power - None

34

Industry Trends

35

Industry Trends – Pricing Power

• Waste business is a function of pricing and volumes, i.e. mgmt can increase revenue by either raising prices or increasing volumes.

• Price cuts were the main cause of lower EPS because of the greater impact on EPS.

• Industry is finally getting pricing power after years of inability to raise prices.

36

Industry Trends – Pricing Power

• Historically, managements used to cut pricing when volumes slowed as they were compensated on EBITDA levels.

• Since 2004, the relationship has changed as managements have become disciplined and are being rational with regards to pricing.

(6)%

(3)%

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YTD2008

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Price Grow th Volume Grow th Price Grow th Forecast Volume Grow th Forecast

2 year lag

No lag1 year lag

Pricing Power

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Why Does Pricing Matter?

• Pricing and volume both drive EPS growth, but pricing has larger impact.

• Managements are rational and know that pricing is better than volumes.

4.3%6.1%

3.4%

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WMI AW RSG

EP

S I

mp

act

1% Increase in Volume 1% Increase in Pricing

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Why Now? 1) Consolidation

• Consolidation – 90’s plagued with pricey mergers and bad integration, but oligopoly emerged and set stage for price discipline.

• FUTURE: Oligopoly will become duopoly with

RSG/AW merger allowing for greater concentration

37%

58% 62%

44%

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0%

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Publicly Held Municipal Private

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2) Change in Compensation

• Compensation – New managements changed compensation to ROIC (from EBITDA levels) and pricing systems were centralized, so less incentive to cut prices to get volumes when times are tough.

• FUTURE: Sophistication of industry, improved IT systems, and disciplined management continues.

0.0%

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Industry Compensation Metric Changed to ROIC

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3) Co-opetition

• “Co-opetition” – All players are on the same pricing page, which is crucial for pricing. AW has gone from laggard to leader on pricing.

• FUTURE: Biggest threat is that someone cuts prices, but managements remain disciplined.

(2)%

0%

2%

4%

6%

2000 2001 2002 2003 2004 2005 2006 2007 YTD

WMI AW RSG WCN CPI (Y/Y % Change)

Industry is Playing Nicely with Pricing 100-

200 bps above CPI

41

4) Inflationary Cost Environment

• Costs – Inflationary cost environment makes price hikes easier because independents have tougher cost structure.

• FUTURE: High fuel prices, increased equipment costs, and high disposal fees keep small independents in line.

0%

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Disposal O&M Fuel

Independent Big Three

42

Financial Statement Analysis

43

Revenue Drivers2002 2003 2004 2005 2006 2007

$ in millions Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07

REVENUE DRIVERS & SEGMENT ANALYSISInternal Growth -1.6% 4.2% 7.7% 4.5% 2.9% 0.6%

Volume -1.6% -0.2% 2.9% 0.1% -1.2% -4.5%Price 0.6% 0.6% 0.8% 2.7% 3.6% 3.3%Other -0.7% 3.8% 4.1% 1.7% 0.5% 1.8%

RevenueCollection 7598 7788 8319 8633 8837 8714Transfer and Disposal 4111 4326 4684 4845 4999 4701

Landfill 2660 2750 3004 3089 3197 3047Transfer 1451 1576 1680 1756 1802 1654

Recycling/Other 643 894 1082 1183 1074 1298Wheelabrator 789 819 835 879 902 868Intercompany Eliminations (1999) (2212) (2404) (2466) (2449) (2271)

Total Revenue 11142 11615 12516 13074 13363 13310Revenue Mix

Collection 68.2% 67.1% 66.5% 66.0% 66.1% 65.5%Transfer and Disposal 36.9% 37.2% 37.4% 37.1% 37.4% 35.3%Recycling/Other 5.8% 7.7% 8.6% 9.0% 8.0% 9.8%Wheelabrator 7.1% 7.1% 6.7% 6.7% 6.7% 6.5%

• Collection and Disposal are main segments.

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Income Statement

INCOME STATEMENTRevenues 11142 11615 12516 13074 13363 13310Cost of Operations 6880 7536 8225 8631 8587 8374Gross Profit 4262 4079 4291 4443 4776 4936SG&A 1361 1216 1267 1276 1388 1432EBITDA 2901 2863 3024 3167 3388 3504D&A 1222 1265 1336 1338 1334 1259Operating Income 1679 1598 1688 1829 2054 2245Interest Expense (467) (435) (385) (465) (476) (474)

Effective Rate 5.6% 5.2% 4.5% 5.4% 5.6% 5.7%Minority Interest (7) (4) (36) (47) (44) (46)Other Income 35 14 (160) (118) (106) (41)Pretax Income 1240 1173 1107 1199 1428 1684Taxes 422 411 302 288 454 611

Effective Rate 34.0% 35.0% 27.3% 24.0% 31.8% 36.3%

Net Income 818 763 805 911 974 1073% yoy -6.8% 5.5% 13.2% 6.9% 10.2%

EPS 1.32 1.29 1.38 1.61 1.79 2.06% yoy -2.4% 7.6% 16.5% 10.7% 15.2%

2002 2003 2004 2005 2006 2007$ in millions Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07

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Income Statement Ratios2002 2003 2004 2005 2006 2007

$ in millions Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07

OPERATING RATIOSGROWTH:Revenues 4.2% 7.8% 4.5% 2.2% -0.4%EBITDA -1.3% 5.6% 4.7% 7.0% 3.4%EPS -2.4% 7.6% 16.5% 10.7% 15.2%MARGINS:Gross 38.3% 35.1% 34.3% 34.0% 35.7% 37.1%EBITDA 26.0% 24.6% 24.2% 24.2% 25.4% 26.3%Operating 15.1% 13.8% 13.5% 14.0% 15.4% 16.9%SG&A % of sales 12.2% 10.5% 10.1% 9.8% 10.4% 10.8%D&A % of sales 11.0% 10.9% 10.7% 10.2% 10.0% 9.5%

• Revenue growth for the most part is positive and steady

• EBITDA growth is positive, so managing costs.• EPS growth is 7-15%.• Margins are improving.

46

Balance SheetBALANCE SHEETCash and Equivalents 264 217 424 666 614 348Net Accounts Receivable 1748 1811 1949 2004 1858 1892PPE 10612 11411 11476 11221 11179 11351Goodwill 5079 5220 5301 5364 5292 5406Total Assets 19856 20382 20905 21135 20600 20175

Accounts Payable 526 668 772 719 693 656Total Debt 8293 8511 8566 8687 8317 8337Other Long Term Liabilities 3209 3408 3547 3592 3615 3777Total Liabilities 14548 14780 14934 15014 14378 14383Shareholders Equity 5308 5602 5971 6121 6222 5792Total Liabilities and SE 19856 20382 20905 21135 20600 20175

ROIC 8.3% 7.5% 8.7% 9.8% 10.1% 10.4%ROE 15.4% 14.0% 13.9% 15.1% 15.8% 17.9%ROA 4.1% 3.8% 3.9% 4.3% 4.7% 5.3%Debt/Cap 61.0% 60.3% 58.9% 58.7% 57.2% 59.0%Debt/EBITDA 2.9x 2.9x 2.8x 2.7x 2.5x 2.4x

2002 2003 2004 2005 2006 2007$ in millions Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07

• ROE, ROIC, and ROA are all improving.• Debt/Cap is ~60% which is consistent with

industry.

47

Cash Flow Statement2002 2003 2004 2005 2006 2007

$ in millions Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07

• CFO – very positive, CFI – investing in future through CapEx, CFF – buying back stock

• Free Cash Flow – very healthy, mature industry

FREE CASH FLOWNet Income 822 630 939 1182 1149 1163D&A 1222 1265 1336 1338 1334 1259Chg. In WC 0 (75) (223) 74 433Other 109 31 18 94 (17) (416)

Cash from Operations 2153 1926 2218 2391 2540 2439

CapEx (1287) (1200) (1258) (1180) (1329) (1211)Acquisitions/Divesitures 13 (263) (34) 52 208 188Investments (29) (295) 122 184Other 312 379 439 361 211 78

Cash from Investing (962) (1084) (882) (1062) (788) (761)

Change in Equity (955) (498) (328) (603) (754) (1273)Change in Debt (697) (456) (386) (11) (500) (256)Dividends (6) (6) (432) (449) (476) (495)Other 70 (26) 16 (27) (73) 78

Cash from Financing (1588) (986) (1130) (1090) (1803) (1946)

FCF (OCF-CapEx) 866 726 960 1211 1211 1228FCF/Share 1.4 1.2 1.7 2.1 2.2 2.4FCF Yield 3.9% 3.5% 4.7% 6.0% 6.3% 6.6%

48

Valuation Analysis

49

• P/E ratio is currently 15.8x. • EPS growth in 2008 is expected to be

about 9.1%, so holds true to our test of P/E = 1.5-2x EPS growth

Current ValuationVALUATION AND METRICS

ValuationShare Price 35.44Shares Outstanding 495Market Cap 17529

Net Debt 8183Enterprise Value 25712

2008 2009 2010P/E 15.8x 14.1x 12.5xEV/EBITDA 7.0x 6.5x 6.2xEV/Sales 1.88x 1.8x 1.8xEV/IC 1.83x 1.83x 1.83xFCF Yield 6.1% 7.0% 8.2%

50

StockVal®WASTE MANAGEMENT INCORPORATED (WMI) Price 35.992001 2002 2003 2004 2005 2006 2007 2008 2009

ENTERPRISE VALUE/EBITDA6

7

8

9

10

11

HI 10.2 LO 6.5 ME 8.4 CU 7.4

07-27-200108-04-2008

PRICE / YR-FORWARD EPS ESTS12

14

16

18

20

22

HI 21.6 LO 13.4 ME 17.8 CU 15.0

07-27-200108-04-2008

PRICE / YR-FORWARD EPS ESTS RELATIVE TO S&P 500 INDEX WITH OPERATING EPS (SPX)0.6

0.8

1.0

1.2

1.4

HI 1.38 LO 0.67 ME 1.07 CU 1.13

07-27-200108-04-2008

•Historically, it has ranged from 13.4x- 21.6x

Historical Valuation

51

•Peers are trading at 17.9x, so WM is trading at a 13% discount to peers, which is likely unwarranted.

Relative Valuation

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52

Forecasting Share Price

53

• ‘08 EPS = $2.24• ‘09 EPS growth rate = 12%, ‘09 EPS =

$2.24*(1.12) = $2.51. Why?– Revenue growth due to pricing (offsets volume

declines due to economy)– Improving margins b/c cutting costs

1. Earnings Per ShareNet Income 818 763 805 911 974 1073 1111 1200

% yoy -6.8% 5.5% 13.2% 6.9% 10.2% 3.6% 8.0%EPS 1.32 1.29 1.38 1.61 1.79 2.06 2.24 2.51

% yoy -2.4% 7.6% 16.5% 10.7% 15.2% 9.1% 11.7%

MARGINS:Gross 38.3% 35.1% 34.3% 34.0% 35.7% 37.1% 37.3% 38.5%EBITDA 26.0% 24.6% 24.2% 24.2% 25.4% 26.3% 26.8% 28.3%Operating 15.1% 13.8% 13.5% 14.0% 15.4% 16.9% 17.5% 18.3%

2002 2003 2004 2005 2006 2007 2008 2009$ in millions Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09

GROWTH:Revenues 4.2% 7.8% 4.5% 2.2% -0.4% 2.6% 2.0%EBITDA -1.3% 5.6% 4.7% 7.0% 3.4% 4.4% 7.6%

54

• Current P/E = 15.8x• Expect P/E to expand to 17x. • Why?

– Better business b/c higher ROE– More in line with peers (avg. 17.3x)– Rule says 1.5-2x EPS growth rate. (1.5 * 12%) =

18x

• EPS x PE = 2.51 x 18 = $45.18• Current Stock Price = $35.44• Implied Premium = 27%

2. P/E Earnings Ratio

55

• EPS x PE = 2.51 x 18 = $45.18• Current Stock Price = $35.44• Implied Premium = 27%

EPS x PE = Stock Price

Bear Case Base Case Bull CaseEPS 2.24 2.51 2.6P/E 16 18 20 Stock Price 36 45 52

56

Investment Recommendation

57

Investment Opportunities

• Pricing: Pricing 50-150 basis points above CPI is sustainable long term and has been achievable in spite of volume and fuel headwinds.

• Volumes: Volumes will continue to be a headwind (-3%) through early 2009, but should recover without hurting the pricing story.

• Margins: Margins should expand 100-150bps over the next 12-18 months driven by increased pricing and stabilizing fuel, while offset slightly by higher third party disposal fees.

• Economic Cycle: Stocks have outperformed relative to the market during recessions (+22%) and the pricing story should drive performance coming out of the down cycle.

• Valuation: Stocks are trading at 7.3x 09 EV/EBITDA, slightly below historical average of 7.8x. With continued improvement in ROIC, multiple expansion is warranted and should occur.

58

Investment Risks

• Deep recession leads to greater than expected volume losses and related price cuts

• Inflationary cost environment recedes dramatically

• Increased regulatory policies • Recycling rates increase more than

forecasted models

59

Investment Recommendation

• Favorable long term on WM’s ability to get pricing, which will drive EPS growth.

• Volume declines should be limited in economic downturn.

• Valuation is attractive at 15.8x P/E and could see multiple expand to 18x.

• One year target price of $45, upside of 27%

60

What Happened?

• Since WM was pitched in 2008, the price decreased 5%.

• Although this is not good absolute performance, the S&P 500 was down 15% during the same time period.

• As a result, WM “outperformed” the market by 10%.• We’ll have to continue to wait and see what

happens.

61

Seminar Recap

• An investment conclusion is based on many factors coming all together – Your assumptions, analysis, and beliefs

• Backed by sound qualitative and financial analysis

• Should be able to sum up your recommendation in an “elevator pitch”

62

Weeks 9-10:• Guest lectures/presentations

After the Seminar Series:• Continue your learning in SWS• Apply to be in a Research Team• Find a stock or two and do some research of your own!

Coming Up