Does it deserve its high valuation?

Services of the Republic (RSG) is a national supplier and industry leader in the recycling and disposal of non-hazardous solid waste. With 355 collection operations, 238 transfer stations, 198 active landfills, 71 recycling processing centers and six processing, recovery, disposal and storage facilities, among other major strengths, the company serves a significant portion of the total market.

Specifically, the company operates in 41 states and holds approximately 1/3 of the total industry market share. Its only notable competitor is the publicly traded company Waste Management (WM), which dominates the market with more than half of the market share. That said, each company has its own long-term contracts with municipalities and other customers, so they’re not directly competing against each other all the time.

I am neutral on the Services of the Republic.

Business expansion, predictable cash flow

Historically, Republic Services and Waste Management have acquired their smaller competitors, increasing their market share in a rather fragmented market. Republic’s last big acquisition was that of previously publicly traded US Ecology for $2.2 billion.

Following the acquisition, the company plans to expand Republic’s environmental solutions footprint in the United States and Canada while vertically integrating the capabilities of its environmental solutions business.

With operational efficiencies to be achieved after full integration, Republic should realize notable synergies and economies of scale. This should be an excellent catalyst for profitability growth in a context of potential margin expansion.

This has been the case for the past several years as the business has evolved, with net profit margins rising from 6.5% in fiscal 2016 to 11.4% last year.

Additionally, the garbage collection industry benefits from predictable cash flows due to its non-cyclical nature. Therefore, the company’s finances should remain resilient in times of recession or turmoil, as was the case during the pandemic.

Recent performances

Republic Services’ first quarter results once again demonstrated the company’s ability to deliver strong performance, despite underlying macroeconomic concerns. For the quarter, Adjusted EPS was $1.14, a 23% year-over-year increase, supported by revenue growth of 14.3% to $2.97 billion . The revenue increase was the result of higher pricing and acquisitions, while adjusted EPS was bolstered by margin expansion and lower share counts.

Specifically, the EBITDA margin increased by 40 basis points quarter over quarter, although it decreased by 30 basis points compared to last year. The net profit margin nevertheless increased by 42 basis points year-on-year to reach 11.86%.

Management expects to incorporate US Ecology’s contribution into the full-year outlook in July. Until then, we look at the company’s past guidance, which calls for adjusted EPS for fiscal 2022 to be between $4.58 and $4.65. Additionally, adjusted free cash flow, again excluding US Ecology, is expected to be between $1.625 billion and $1.675 billion.

Dividends and valuation

Due to the company’s cash flow facing minimal volatility, Republic Services has managed to return capital to its shareholders on a consistent basis. The company has posted 18 consecutive years of annual dividend increases, with the five-year dividend per share CAGR of 7.45%.

The latest dividend increase was 8.2% at a quarterly rate of $0.46, even suggesting a slight acceleration. In any case, these are very satisfactory dividend growth rates for such a mature company.

Based on its past frequency trend, Republic is expected to announce a further increase in its quarterly dividend in July. At the midpoint of management’s adjusted EPS guidance ($4.62), the payout ratio currently stands at 40%. Thus, the company has ample leeway to continue to pursue attractive dividend growth rates.

Adding to its total capital return is the company’s share buyback program, which has approximately $1.5 billion remaining under authorization and is due to be completed by 2023. The company repurchased $252.2 million and $203.5 million of its shares in 2021 and the first quarter of 2022, respectively. This was reflected in last quarter’s adjusted EPS growth amid falling share counts.

As for its valuation, assuming adjusted EPS of $4.62 for fiscal 2022, Republic is currently trading at a forward P/E of 28.8. On the one hand, Republic shares deserve a premium because the company has a large moat, resilient cash flow and pricing power, and consistently higher returns on capital.

On the other hand, I find the stock slightly overvalued here, especially in a rising rate environment. Even with double-digit Adjusted EPS growth, I would attribute a fair multiple to the stock closer to 25 times earnings.

The Taking of Wall Street

On Wall Street, Republic Services has a moderate buy consensus rating based on six buy ratings and three hold ratings given over the past three months.

At $146.33, the average projection for Republic Services shares implies 9.8% upside potential.

Carry

Republic Services is a quality company operating in a very mature and non-cyclical industry. The company’s performance has been consistently strong, as seen in its most recent results, while the acquisition of US Ecology should further improve internal efficiencies and margins.

Additionally, capital returns have been historically strong, with another dividend increase likely on the way. That said, stocks look fully priced at the moment, with little upside from a multiple expansion standpoint. Accordingly, I am neutral on the title.

Disclosure

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