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Summary

  • RSG is a decent business with a decent dividend but it is too expensive right now.
  • Shares are overextended on a technical basis and sideways or downward price action looks likely in the short term.
  • The company's inferior dividend in comparison to its largest competitor makes shares an "avoid" right now.

Republic Services, Inc. (NYSE:RSG) is a large waste collection and disposal service operating in the US. The company has grown itself into a respectable dividend payer in the mold set by Waste Management (NYSE:WM). Shares, as you can see below, have taken off in the past several months and now stand at all-time highs. As a dividend investor, should you chase shares higher on expectations for future results or is it time to give RSG a break? In this article we'll take a look at RSG's prospects and its dividend in order to determine if it has a place in your portfolio.

(click to enlarge)

To do this we'll use a DCF-type model that you can read more about here. The model takes inputs such as earnings growth rates, which I've sourced from Yahoo!, dividends, which I've set at 5% growth per year, and a discount rate, which I've set at the 10 year Treasury rate plus a risk premium of 6.5%, reflecting the nature and stability of RSG's business.

2013

2014

2015

2016

2017

2018

2019

Earnings Forecast

Prior Year earnings per share

$1.97

$1.97

$2.16

$2.35

$2.55

$2.77

x(1+Forecasted earnings growth)

0.00%

9.60%

8.63%

8.63%

8.63%

8.63%

=Forecasted earnings per share

$1.97

$2.16

$2.35

$2.55

$2.77

$3.01

Equity Book Value Forecasts

Equity book value at beginning of year

$22.09

$23.02

$24.09

$25.29

$26.63

$28.13

Earnings per share

$1.97

$2.16

$2.35

$2.55

$2.77

$3.01

-Dividends per share

$1.04

$1.09

$1.15

$1.20

$1.26

$1.33

=Equity book value at EOY

$22.09

$23.02

$24.09

$25.29

$26.63

$28.13

$29.81

Abnormal earnings

Equity book value at begin of year

$22.09

$23.02

$24.09

$25.29

$26.63

$28.13

x Equity cost of capital

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

9.00%

=Normal earnings

$1.99

$2.07

$2.17

$2.28

$2.40

$2.53

Forecasted EPS

$1.97

$2.16

$2.35

$2.55

$2.77

$3.01

-Normal earnings

$1.99

$2.07

$2.17

$2.28

$2.40

$2.53

=Abnormal earnings

-$0.02

$0.09

$0.18

$0.27

$0.37

$0.47

Valuation

Future abnormal earnings

-$0.02

$0.09

$0.18

$0.27

$0.37

$0.47

x discount factor(0.09)

0.917

0.842

0.772

0.708

0.650

0.596

=Abnormal earnings disc to present

-$0.02

$0.07

$0.14

$0.19

$0.24

$0.28

Abnormal earnings in year +6

$0.47

Assumed long-term growth rate

3.00%

Value of terminal year

$7.91

Estimated share price

Sum of discounted AE over horizon

$0.63

+PV of terminal year AE

$4.72

=PV of all AE

$5.34

+Current equity book value

$22.09

=Estimated current share price

$27.43

As we can see shares have been assigned a fair value of $27.43 according to my model, given the inputs I described above. Since this is a long way down from the nearly $39 shares are currently trading for, we should investigate why in order to determine if RSG is expensive here or if the gap is justified.

We must first understand that the model produces a fair value and not a price target. The model is saying the fair value of the company's future earnings stream, adjusted for dividends received, is around $27. A price target would be somewhat higher depending on your views on the company but right now, shares appear to be expensive on an earnings basis.

Indeed, at 18 times next year's earnings, I'd say they look pretty expensive. Businesses like RSG are often assigned premium earnings multiples due to the predictability of their business and, very importantly, their dividend payments. RSG has a decent yield at 2.7%, much higher than the market yield, but significantly lower than Waste Management's yield of 3.3%. In my view, RSG shares are expensive on both a value basis and with its dividend.

If we look at the chart above, we see that the current rally has taken shares ~$4.50 above the 50 DMA, a difference that was rectified last time we saw it by a period of choppy trading that eventually allowed the 50 DMA to catch up to the price. I suspect that the best case for the current period of overextension is another period of sideways action and the less desirable case is a pullback towards the 50 DMA. Either way, I don't see a lot of reason to buy right now.

In addition, RSG is currently slated to grow earnings at ~9% for the foreseeable future and I'm wondering where this growth is supposed to come from. This is a company that has posted miniscule increases in revenue in recent years and has actually seen gross margin contraction during that time. In other words, I think any earnings growth is going to be somewhat of a challenge, let alone rapid growth such as what is being forecast. I think there is a lot of downside risk to the company's earnings forecast and that will lead to a multiple contraction at some point in the future. I had similar fears with WM but they are much more muted for RSG's competitor; it was a case of "maybe" with WM but with RSG, it seems more like a certainty. There just isn't a way that I can see that this company can grow earnings that quickly.

With RSG you've got a company whose shares are overextended to the upside, an expensive valuation, unrealistic growth expectations and an inferior dividend yield compared to its largest competitor. RSG simply doesn't offer anything that you can't get from WM but with much better prospects. I'm not saying RSG isn't a decent business because it is; what I am saying is that its shares aren't as attractive as its largest competitor. If you want to own a stock in the waste management space, you're better off with WM.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a short position in RSG over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Republic Services, Inc.: Why You Should Avoid Shares Right Now