The collection and processing of trash can be an extremely profitable business. Waste Management (NYSE: WM) and Republic Services (NYSE: RSG) have dominated the space for decades now, as both names, along with municipalities, have captured a combined market share of 75% in the United States. Due to their positive, recession-resilient traits, however, both companies have attracted quite elevated multiples, which languish their investment case. For this reason, I am neutral on both names.
What Makes WM and RSG Shares Attractive to Investors?
With investors facing uncertainty on multiple fronts these days, companies that can produce reliable cash flows while providing growing capital returns have gained increased attention. Waste Management and Republic Services offer exactly that.
To begin with, the waste management industry is very capital intensive, and participants have developed strong ties with governmental entities and municipalities. Thus, entry into the market by smaller competitors is essentially impossible - hence the high consolidation as the aforementioned market shares display.
Additionally, the trash business is recession-proof. No matter what the underlying state of the economy looks like, trash has to be collected. Thus, Waste Management and Republic Services enjoy secured revenues that are typically locked in by multi-year contracts by investment-grade counterparties, including governmental entities.
Because trash collection and processing is such an impenetrable and tightly-controlled industry, both companies have managed to make it extra beneficial for them.
For instance, Waste Management uses the waste it collects to create energy, recovering the gas formed naturally as waste disintegrates in landfills. The gas can then be utilized in generators to produce electricity or natural gas and even be used to power Waste Management's very own operations. Consequently, the company has designed a robust end-to-end ecosystem where value creation occurs between every phase of operations.
In the case of Republic Services, the company has taken advantage of its critical operations to convert roughly half of its multi-year contracts to CPI-based ones or locked into an alternative index inflation-related index, or a fixed rate of 3%. In other words, excluding those contracts locked in at 3%, which is still a respectable year-over-year increase, the company can even benefit from the current elevated inflation levels, as it can increase its charging rates by an equal, or in some cases even higher pace.
Are WM and RSG's Dividends Reliable?
Due to Waste Management's and Republic Services' unique qualities attached to their business models, which have historically enabled them to generate resilient cash flows under all market environments, both companies have become quite reputable and trustworthy among dividend-growth investors.
Waste Management has raised its dividend per share annually for 19 years, with its five-year CAGR standing close to 8%. Impressively, the latest increase was by a satisfactory 13%, suggesting a potential acceleration of dividend growth.
Republic Services features an equally impressive dividend-growth record, boasting 18 years of successive annual dividend hikes. Its five-year dividend-per-share CAGR stands close to 7.5%, similar to that of Waste Management.
According to Waste Management's and Republic Services' consensus EPS estimates of $5.72 and $4.78, the two companies feature payouts ratios of roughly 45% and 40%, respectively. Combined with their aforementioned qualities and earnings growth drivers, I am convinced that both companies can be trusted when it comes to their dividends.
WM and RSG Shares Look Overvalued
With Waste Management and Republic Services featuring such attractive characteristics, especially when it comes to their ability to grow their earnings and dividends during market downturns, investors tend to flock to their shares during times of uncertainty - like the times we are currently experiencing. While this is reasonable behavior, it has also expanded their valuation multiples.
Again, based on the two companies' consensus EPS estimates for the year, both Waste Management and Republic Services trade at P/Es of roughly 30x.
This is a very steep multiple in the current environment, even if both companies continue to grow their earnings in a rather predictable fashion. Overall, I believe that both stocks are quite overvalued, despite their unique qualities.
Are WM and RSG Good Stocks to Buy?
With both companies trading at elevated multiples, it appears that Wall Street analysts also forecast limited upside on both names, moving forward.
Specifically, Waste Management has a Moderate Buy consensus rating based on four Buys and four Holds assigned in the past three months. At $172.13, the average Waste Management price target implies just 3.15% upside potential.
Turning to Republic Services, the stock has a Moderate Buy consensus rating based on seven Buys and three Hold ratings assigned in the past three months.
At $154.80, the average Republic Services price target implies 9.35% upside potential, which is also rather thin considering the risks attached to its currently elevated valuation.
However, looking at each company's Smart Score tells a different story. Waste Management has a 9 out of 10 Smart Score rating, indicating that it can outperform the market going forward - at least according to that indicator. Likewise, RSG has the exact same rating.
Conclusion: Solid Companies with Limited Upside Ahead
Across the board, Waste Management and Republic Services feature a number of appealing attributes, including operating excellence, a wide moat, a quality customer base, and excellent pricing power.
Both companies should keep generating exceptionally strong results even if the macroeconomic landscape were to remain harsh, moving forward.
Nevertheless, as investors have found refuge in these quality attributes, the valuation multiples of both names have expanded significantly, which could limit their upside potential.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.