Republic Services, Inc. (RSG), together with its subsidiaries, provides non-hazardous solid waste collection, transfer, and recycling and disposal services for commercial, industrial, municipal, and residential customers in the United States and Puerto Rico. The company has paid dividends since 2003 and has increased them for ten years in a row.
The company’s last dividend increase was in July 2013 when the Board of Directors approved a 10.60% increase in the quarterly annual dividend to 26 cents /share. The company’s peer group includes Waste Management (WM), Waste Connections (WCN), and Veolia (VE).
Over the past decade this dividend growth stock has delivered an annualized total return of 9.90% to its shareholders. The largest shareholder with an approximate 25% stake is Bill Gates, through his holding vehicle Cascade Investment LLC.
The company has managed to deliver a 6.40% average increase in annual EPS between 2003 and 2012. The company is expected to earn $1.87 per share in 2013 and $2.01 per share in 2014. In comparison, the company earned $1.55/share in 2012.
The company is the second largest provider of waste management services in the US, after acquiring Allied Waste in 2008.
I like the economics of the waste management business, and believe that Republic Services has a few ways to grow revenues over time.
First, the nature of its business is to provide an essential service that is relatively recession resistant. Over time, I would expect that the amount of trash volumes to only increase, as a factor of increasing population and level of industrial and societal output.
Second, the company benefits from economies of scale, as of 12/31/2012 it owned 191 landfills, 195 transfer stations and 71 recycling centers. Trash collection services generate over three quarters of revenues ( 35% municipal and residential, 40% commercial & 25% industrial), while transfer services and landfill generate about one-sixth. Recycling services generate the majority of any remainders. Landfills are difficult to set up and operate, and require companies to go through a lot of government red tape to obtain proper permits/licenses. In addition, landfills require high costs in setting up, monitoring etc. Thus landfill ownership could be viewed as a competitive advantage.
Third, the company can grow through acquisitions, especially those that complement its geographic presence in a certain part of the country. Currently Republic Services and Waste Management (WM) generate approximately 60% of revenues in the industry combined. Through acquisitions, the company can leverage its economies of scale, and generate synergies such as reductions in capital requirements and in personnel. If you have relatively fixed costs in terms of landfills, transfer stations and truck fleet, any marginal increases in volumes can result in much higher increases in earnings. In addition, the company seeks to achieve a high rate of internalization by controlling waste streams from the point of collection through processing or disposal.
Fourth, a large portion of the company’s contracts also include price hikes tied to inflation. In addition, it could contain costs by standardizing the truck fleet it operates, and switching it from diesel to natural gas. The company operates under one – five years contracts with municipal, commercial and industrial customers.
Fifth, the company can also increase earnings per share through regular share repurchases. Between 2003 and 2008, shares outstanding decreased from 240 to 192 million. After the acquisition of Allied Waste in 2008, the number of shares outstanding has decreased from 381 million in 2009 to 363 million in 2013.
The company can also leverage its existing position to generate new revenue streams. Examples include recycling centers as well as using trash to generate energy. These are existing operations, which could potentially generate extra money for shareholders. Currently, 35% of trash is recycled, and this percentage is expected to increase.
While to compete with Republic Services requires a lot of capital, and there is limited pricing power. Contracts are due for renegotiation every few years or so, and subject to competitive bidding. If a competitor wants to gain market share, they can potentially lower prices to gain key contracts. Given the scale and vertical integration of Republic’s operations the chances of that are low, since it can probably outbid most of the smaller rivals in the industry. The company is also number one or two provider in 90% of the markets it operates in.
The second risk involves potential for environmental liabilities. The company needs to be really good at managing environmental issues, particularly as it relates to its landfills. After a landfill is filled up with trash, the company has to monitor it for at least 30 years.
If management does not do a very good job of continuously monitoring risks related to an environmental contamination on a systematic basis, the results could be terrible for communities affected and shareholders. Again, the possibility of this actually happening is likely low, but it is something to think about.
The third item is that I do not expect future growth in earnings per share might not exceed 5-6%/year over say the next 5 – 10 years. Therefore, the opportunity cost of owning Republic Services is missing out on a stock that yields 3% but grows distributions by more than 6%/year.
Republic Services increased Returns on Equity from 5.70% in 2003 to over 21% by 2007. There was a big drop during the financial crisis, and currently the ROE is standing at 7.40%. Based on forward earnings, I expect this ratio to increase above 10%. I generally want to see at least a stable return on equity over time. I use this indicator to assess whether management is able to put extra capital to work at sufficient returns.
The annual dividend payment has increased by 12.80% per year over the past five years, which is higher than the growth in EPS. This has been achieved mostly due to the expansion of the dividend payout ratio.
A 12% growth in distributions translates into the dividend payment doubling almost every six years on average. Future dividend growth would have to track growth in earnings per share, and would likely be in the high single digits.
The dividend payout ratio has increased from 9% in 2003 to almost 59% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 56%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
Currently Republic Services is attractively valued at 18.50 times estimated 2013 earnings, yields 3% and has a sustainable distribution. The company has stable revenues, which are relatively recession resistant. However, growth has been a little slow in the past five years. If earnings per share grow by 2 – 3%/year based on organic growth (such as growth in population) and acquisitions, and 2-3%/year due to share repurchases, this could translate to total growth of 4 – 6%/year. Given the high dividend payout ratio, I am not sure if long-term dividend growth would be higher than 6%/year over the next 5 - 10 years. This is not too bad of course, given a starting yield of 3%. However, if I find a stock that yields 3% and expect it to grow distributions above 6%/year, I would likely buy that stock, rather than Republic Services.
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