Republic Services Closing Competition Gap Through Aggressive Expansion

Summary

• Republic Services has a growing addressable market and is maintaining its market relevance through aggressive expansion.
• Improved its operating efficiency and received strong guidance from its management.
• According to management, RSG's sales volume is correlated with GDP growth, which can help investors determine their risk appetite.
• This stock is trading at a discount to its competitor at 35.52x earnings, but at a premium to its five-year average of 27.12x earnings.

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As one of the world's largest producers of waste, the continuous issue of waste management is one of the US's most significant concerns today. From improper disposal, increasing trash collection costs and rising pollution levels that contribute to climate change, it is no wonder why waste management is a major industry in the country.

Source 1: Republic Services

Republic Services (NYSE:NYSE:RSG) offers environmentally responsible bin collections, recycling transfer, disposal, and other environmental services. It has a total of $87 billion addressable market and has successfully penetrated 41 states across the US. The company is currently expanding in order to boost revenue growth organically through acquisitions and it continues to capitalize on landfill gas potential, with 17 projects now in the pipeline. Republic Services established their first solar powered compost facility in California to help meet community demands.

Source 2: Seeking Alpha, prepared by the Author, amounts in Millions

At this time, RSG's TTM cash acquisition of $1,515.9 million is already up 97% from 2020. Compared to its peer, Waste Management (NYSE:WM), which only boosted its cash acquisition by 0.20% to $4,093 million in 2020, this is an outstanding percentage rise.

A global waste management problem has been around for a while, which has been further exacerbated by the pandemic. One of the current reasons why people in the US refuse to handle garbage, which has an impact on the recycling sector as a whole, is a fear of contracting Covid through surface transmission. This has given RSG's revenue growth a negative impact, particularly in its 2020 figure, as illustrated in the graph below:

Source: Seeking Alpha, prepared by the Author, amounts in Millions

RSG's performance is correlated with the economy's overall performance, which presents a major problem. Further waves of Covid-19 variants could wreak havoc on its business operations in the future. The following image was provided by management to show how their volume growth compares to the growth in housing starts and GDP growth.

Source: Republic Services

Goldman Sachs (NYSE:GS) has lowered its forecast for economic growth in the US in 2021 and 2022, from 5.7 percent and 4.7 percent to 4.4 percent to 4 percent, respectively.

On the brighter side, RSG’s TTM revenue has already outperformed both its 2019 and 2020 figure, thanks to its cash acquisitions and increasing sales volume of 4.3 percent compared to -3.4 percent the same quarter last year. This snowballed to the company's bottom line, which saw a complete rebound from its 2019 and 2020 figure, as demonstrated in the graph below:

Source: Seeking Alpha, prepared by the Author, amounts in Millions

2021 Bullish Guidance, Despite Slowing GDP Forecast

RSG's management provided a guidance for the full calendar year of 2021, highlighting:

• An estimate of more than $1 billion acquisition.

• 4.01 to 4.04 diluted earnings per share, up by an average of 33% from the previous year's 3.02.

• $1.8 billion shares repurchase authorization as of Q3 2021.

• Adjusted free cash flow of $1,475 to $1,500 million.

Valuation: Better Upside In a Drop

Source 3: Prepared by the Author

When comparing the current price of RSG to its average fair price of $139.2, it will provide investors a 3 percent upside potential. RSG is trading at 35.32x earnings a bit cheaper than WM of 38.89x earnings, but overvalued when compared to its 5 year historical data. A drop will provide a better entry point to improve upside potential.

Source: Prepared by the Author

I completed my 5-year DCF model with the help of an analyst's revenue forecast. The total revenue of RSG is expected to reach $14,500 million by the end of the model, with a compound annual growth rate (CAGR) of 7.38 percent from 2020 to 2025. This is feasible, in my opinion, given RSG's acquisition strategy and improved gross margins as shown below.

Source: Seeking Alpha, prepared by the Author

RSG is also more efficient compared to WM which only has 38.47 percent TTM gross margin. I also predicted that by the end of the model, its gross margin would have risen to 20.1%. The company can benefit from digitizing their sales offering, which can result in future synergies and cost savings, particularly during times of full recovery from the pandemic.

Source 4: Seeking Alpha and Yahoo Finance, prepared by the Author

Above are the assumptions I made and the WACC value I used as my discount rate. Additionally, I added its five-year historical data, which aided me in completing my DCF model.

Balance Sheet: More Cash Acquisition, Less Matured Debt

Source: Seeking Alpha, prepared by the Author, amounts in Millions

RSG has a relatively low cash and cash equivalent balance amounting to $40.1 million compared to the start of the trend analysis. This is due to the aggressive expansion discussed above as well as paying off its debt. The graph below illustrates its long-term debt schedule; it has successfully paid off all of its substantial debt maturing over the next three years.

Source: Republic Services

In 2023, RSG will have a long-term debt due amounting to only $305.1 million. However, looking at the image below, its free cash flow shows a different trend.

Source: Seeking Alpha, prepared by the Author, amounts in Millions

Its TTM free cash flow amounted to $1,490.60 million outperforming its historical data. It is also worth noting that the company has $381.5 million in deferred revenue on its current liabilities. In my opinion, RSG is still liquid with a current ratio of 0.64x and flat debt to equity of 1.02x.

Dividend Yield: 1.37 percent

Source 5: Seeking Alpha Dividend Tab

RSG has a 44.56 percent pay-out ratio and a 13.31 percent TTM ROE. Currently, it has a dividend yield of 1.34 percent and a forward dividend yield of 1.37 percent. A decline in the stock's current price could be used to enter at a higher dividend yield.

Price Action: All-Time High, Potential Pullback

Source 6: TradingView

RSG is currently at an all-time high and a healthy consolidation above its simple moving average will provide investors a high quality pullback set-up. While the MACD indicator continues to indicate positive sentiment, the price appears to be already over-stretched.

Additional Key Points

RSG expanded significantly over the years through cash acquisitions, but this growth has also been accompanied by the accumulation of goodwill.

Source: Seeking Alpha, prepared by the Author, amounts in Millions

RSG is prone to significant impairment losses if management mishandles operations; nevertheless, investors can rely on the company's track record of being resilient in the face of economic downturns and enhanced operational efficiency. Despite the risks, RSG has caught up to its peer, WM, in terms of operational efficiency and market share penetration in the US.

RSG's management believes that its expansions will fully benefit the company next year, and revenue growth is something that investors should keep an eye on to see if it is improving or already outperforming WM. RSG remains liquid and has no material obligation to hinder further expansion for the next three years. This stock is a buy on the dip, but as always, manage your risks.

Thank you for reading and happy November everyone. Good luck to us all!

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.