Republic Services Inc. (
) is the second largest collector and disposer of trash in North
Seven Year Average Annual EPS Growth Rate: 6.2%
Seven Year Average Annual Dividend Growth Rate: 20%
Current Dividend Yield: 3.34%
Balance Sheet Strength: Quite Leveraged
Republic Services is quite leveraged, but the stable cash flows
from this dominant position in an essential industry lead me to
conclude that while the current valuation is not excellent,
investing in the company should result in reasonable long-term
returns for investors.
The current price of $28/share looks fair.
Republic Services Inc. is the second largest collector and
disposer of trash in North America, with a market capitalization of
over $10 billion. Throughout the last decade, and continuing after
the large acquisition of Allied Waste Industries, the company has
built a good track record of paying
In 2011, 75% of company revenue came from collection services. The
company utilized its 334 collection operations to collect trash in
39 states. For collection services, 40% of revenue comes from
commercial customers, 35% comes from municipal and residential
customers, and 25% comes from industrial customers.
Transfer stations serve as the intermediate step between collection
sites and landfills, and Republic Services owns or operates 194
transfer stations. For the most part, this is for internal company
use, but the company also charges other trash hauling businesses to
dispose their trash collection here as well, which accounts for 5%
of total company revenue.
Republic Services owns 194 active landfills and is responsible for
130 closed landfills. The company disposes of collected trash here,
and also generates 13% of company revenue by charging fees for
other companies to dispose trash in these landfills.
Republic Services generates additional revenue through the 74
materials handing facilities that it owns or operates. Commodity
costs can substantially affect profitability for this segment of
(click to enlarge)
(Chart Source: DividendMonk.com)
The jump in revenue in the chart is due to the acquisition of
Allied Waste Industries. In 2008, Republic Services (the third
largest trash collector in the country) acquired Allied Waste
Industries (the second largest trash collector in the country), and
kept the Republic brand. Republic Services had to use considerable
share dilution to make this purchase.
As can be seen in the chart, revenue growth was pretty solid,
but then after the recession and the acquisition, revenue went
fairly flat. Waste Management has similar flat business
Trash hauling is a recession-resistant business because it's
such a necessary service. However, economic recessions can result
in less construction and less industrial output, which decreases
Earnings and Dividends
(click to enlarge)
(Chart Source: DividendMonk.com)
EPS grew at a rate of 6.2% over this period. During this time,
RSG diluted the share base to make an acquisition, dealt with the
financial crisis and recession, and paid a regularly growing
dividend. So all things considered, EPS growth has been quite
The dividend grew at a almost 20% per year over this period, but
much of that growth occurred early. The most recently announced
annual increase was 6.8%. The dividend payout ratio is under 60%,
which is lower than that of Waste Management.
Approximate Historical Dividend Yield at Beginning of Each
The current yield of 3.34% is higher than it has been
historically, with exceptions for dips in late 2008 and early 2009
where the yield was temporarily higher than it is currently.
Republic Services regularly performs
as well. In 2011, the company had $830 million in free cash flow,
and spent $420 million on net share repurchases and $309 million on
dividend payments to shareholders. The company bought back around
4% of its market cap in shares and paid a dividend of a bit under
3% for that period. Looking over the 10 year history, the number of
shares outstanding decreased substantially until the Allied Waste
acquisition, when the share count radically increased. The number
has been declining again as the company has resumed these
Republic Services has a total debt/equity ratio of 90%, and
there's more goodwill on the balance sheet than there is total
equity. Total debt/income is over 12, meaning that at current
levels if RSG directed all net income towards debt repayment, it
would take roughly 12 years to pay off. The interest coverage ratio
is around 3.5, which is a bit low for my liking.
When it comes down to the balance sheet, I view trash collectors
in the same group as utilities. They're companies that generate
very consistent cash flows and they own assets that are very hard
to replicate (landfills), but they require considerable assets and
leverage. So while Republic Services is rather leveraged, it is
considered investment grade. The balance sheet is a bit of a weak
spot, and a bit more leveraged than competitor Waste Management,
but still in reasonable territory. Debt maturities are nicely
The waste industry is a highly fragmented industry save for the
two dominant companies,
) and Republic Services. Combined, these companies account for
comfortably over half of all U.S. trash revenue, with no other
competitors coming anywhere close to those numbers.
It's not just the size of their operations; it's what they own.
Landfills are a competitive advantage for both companies against
smaller competitors. Opening a landfill is tricky business in terms
of how much capital is needed and how much red tape must be moved
through. By owning these long-lasting undesirable assets, Waste
Management and Republic Services are vertically integrated. Smaller
competitors often pay these businesses to dispose waste into their
The industry itself has faced some headwinds. The weak economy
has resulted in stagnant trash volumes. In addition, because
residents and businesses are becoming more sensitive to the
environmental effects of their disposed materials, or because they
wish to save money by going through less material, there has been
more creativity associated with avoiding trash volume or recovering
useful materials. More recycling, more reuse, and more efficient
original use of materials, can all detract from trash volumes.
For a trash company that does not make use of this trend, it can
hurt the bottom line. Both Waste Management and Republic Services
have strong recycling operations. In addition, Waste Management has
large operations associated with turning waste into energy for
powering the equivalent of over a million homes. Republic Services
faces these headwinds of flat trash volume but also has
opportunities for expanding what it can do with the trash it
The company has some other areas of growth or cost savings as
RSG is consolidating/standardizing its fleet of vehicles to
operate what it calls "one fleet". The more standardized its
fleet is, the more money it can save with repair, maintenance,
parts inventories, automation, and so forth.
RSG is consolidating call centers.
RSG is expanding recycling capabilities.
RSG is gradually repositioning its fleet to run on natural
RSG can perform small tuck-in acquisitions to increase the
density of its trash collecting routes, which can improve
RSG's core industry of trash is always going to be necessary,
but the company does face risks.
The company is susceptible to energy prices for powering its
vast army of vehicles and operations. The company hedges against
this to cover much of the risk, but not all of it. According to the
company's June 2012 presentation at the Global Industrials and
Basic Materials Conference, a $0.10 increase in the cost of fuel
results in a decrease of $0.01 in EPS.
Changes in other commodity costs can affect the bottom line of
RSG's recycling operations.
While RSG is in a conservative industry, it is still susceptible
to economic weakness because trash output decreases during times of
economic recession. Focuses on environmental sustainability, and
business initiatives to produce less trash, can also potentially
reduce volume for the company.
Republic Services also faces risks in the form of contract
losses to competitors if it doesn't manage its business well.
Conclusion and Valuation
In conclusion, I view RSG as a leveraged and currently flat
investment, but one that operates in a very necessary industry as
the #2 competitor, way ahead of all other competitors.
In a fairly mild scenario, where the company grows revenue by 2%
over the long-term, and where margins are static, the net income
would also grow by 2%. If the company buys back 3-4% of its market
cap each year, then EPS could grow by 5-6% over the long-term. If
the dividend payout ratio remains static, then dividend growth
would approximately match this rate.
Using these estimates in a dividend discount model, and using a
10% rate of return as my target, I calculate that the stock is
worth less than $24/share, meaning the current price of over
$28/share is more than 16% overvalued. However, if the target rate
of return is dropped to 9% to account for the relative safety of
this kind of business, then I estimate that $31/share is fair,
implying that the current price is undervalued by around 10%.
Now, this is a fairly conservative scenario. Due to dividends
and share repurchases, 6% or 7% of the annual returns are internal,
and don't rely on any growth. They just rely on maintenance of the
current position and revenue/profit numbers. The 2% revenue growth
used for this estimate is fairly pessimistic; it could imply 0%
volume growth and 2% pricing growth to keep up with inflation, or
could imply 2% volume growth and 0% pricing growth (meaning price
deterioration after inflation is accounted for). Or around 1% of
each. If volume picks up a bit, and if pricing remains consistent
with inflation, revenue growth could exceed this figure and lift
the EPS growth and fair value up.
Overall, the downside looks fairly mild, the current stock price
of a bit over $28/share looks reasonable for high single digit
returns, and there is potential upside if trash volume picks up for
A solid approach for investors interested in this industry may
be to buy both Waste Management and Republic Services. That reduces
some of the risk associated with losing or gaining customers
between the two. Together they represent more than half of the
industry, are far and away larger than their competitors, and offer
decent dividend income.
Full Disclosure: As of this writing, I have no position in RSG
or WM. You can see my
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