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Introduction
I have a love/hate relationship with Republic Services (NYSE:RSG). On the one hand, it's one of the best defensive dividend compounders on the market, which I will reiterate in this article. On the other hand, it's so hard to find a good entry, which is why I am currently watching the stock go higher without having a position.
As both of these things are great for existing investors, I will use this article to dive into the just-released quarterly earnings and explain why the RSG ticker is a stock on my watchlist that I've double-highlighted to buy it as soon as an opportunity presents itself. It's really that good of a wealth compounder.
The company not only beat expectations (again) but also raised its full-year guidance, as it benefits from higher margins, strong customer feedback, and ambitious future growth plans.
During the second quarter, we delivered double-digit growth in EBITDA and expanded margins by pricing ahead of cost inflation and growing our business organically. Growth continues to be broad-based, with strong results in our Recycling and Solid Waste and Environment. - Jon Vander Ark, President and CEO of RSG
Yes, RSG Is Really That Good
SWAN (Sleep Well At Night) is a term coined by my friend Brad Thomas and something I try to apply to every single investment of mine.
Republic Services is a company where this applies for sure.
With a market cap of $48 billion, it's America's second-largest non-toxic waste collector, processor, recycler, and disposer.
Headquartered in Phoenix, Arizona, the company operates in an addressable market with a total value of $107 billion, which includes the United States, Canada, and a wide range of environmental services that require professional care.
As I wrote in May, the company has roughly 5 million daily pickups using 17 thousand trucks, 72 recycling centers, 206 active landfills, 240 transfer stations, and a network of more than 40,000 employees.
Republic Services
Not only is RSG turning waste into cash, but it is also benefitting from an anti-cyclical business profile: roughly 80% of its revenue has an annuity-type profile, while 70% of its revenue comes from the collection business.
Republic Services
In addition to that, the company has strong pricing power. Half of its contracts have open market pricing, which means the company secures price increases directly with its customers.
The other half of its contracts are tied to CPI, an alternative index, or a fixed rate of 4% or greater. Whatever better reflects the company's costs.
Republic Services
So far, the company has checked a lot of boxes that could make it a great compounder.
- It has strong and (somewhat) predictable earnings growth.
- It has a competitive advantage (wide moat).
- It has a long-term strategic focus in an industry with a bright future (trash isn't going anywhere, and recycling is getting more important).
- It has pricing power.
- It is operating in a growing market.
- A big part of its revenues is recurring.
Over the past ten years, RSG has returned 450%, beating the S&P 500 and its industrial peers (it's an industrial stock) by a wide margin.
Even better, the stock has done this with subdued volatility. While a single stock is obviously more volatile than the well-diversified S&P 500, its volatility is barely higher.
The company also has a strong dividend track record.
While its yield of 1.4% isn't something to write home about, it's backed by a 39% payout ratio and 7.5% average annual dividend growth over the past ten years.
Also, while the company did keep its dividend unchanged during the Great Financial Crisis, it has never cut its dividend.
Note that the company could pay a much higher dividend. Next year, estimates are that free cash flow could reach $2 billion, which translates to a 4.2% free cash flow yield.
This indicates a healthy 33% cash payout ratio, room for further hikes, and the ability to invest in its core business, which is one of the reasons why the stock is doing so well.
Republic Services Continues To Fire On All Cylinders
The just-released second quarter was a stellar quarter.
Key achievements included 9% revenue growth (4% from acquisitions), 10.5% adjusted EBITDA growth, and a 40 basis points expansion in EBITDA margin.
Organic revenue growth was also impressive, with increases in both price (8.8% core price on related revenue) and volume (50 basis points on related revenue), including landfill MSW yield of 6.2%, the highest level in the company's history in this category.
Republic Services
Adjusted earnings per share came in at $1.41, which beat estimates by $0.09.
Seeking Alpha
Adjusted free cash flow rose to $1.26 billion on a year-to-date basis, marking a 10% increase over the prior year.
Digging a bit deeper into pricing, 8.8% core pricing was achieved through open market pricing of 11% and restricted pricing of 5.3%. The components of core price on related revenue included small container (12.3%), large container (8.8%), and residential (8.3%) segments.
This pricing strategy enabled the company to maintain an average yield of 5.9% on total revenue and an average yield of 7.1% on related revenue.
By pricing new and existing business ahead of cost inflation, the company aims to drive margin expansion in its underlying operations.
Furthermore, the company did very well with regard to customer satisfaction. This is a topic that was addressed by a lot of comments, as fears are that consistent efficiency gains and higher prices cause customer satisfaction to drop.
In the second quarter, the customer retention rate remained over 94%, and positive trends were seen in the Net Promoter Score, which indicates improved service delivery.
However, the economic slowdown didn't ignore RSG, as the company faced a decline in the large container segment, with a decrease of 1.3%, primarily blamed on a slowdown in construction-related activity.
Additionally, recycling commodity prices significantly dropped from $218 per ton in the prior year to $119 per ton during the quarter, leading to a 1.1% decrease in revenue.
Republic Services
The company also projected that commodity prices would remain relatively flat in the second half of 2023, with an average recycled commodity price range of $110 to $115 per ton for the full year.
So far, the quarterly numbers are good, as the company was able to offset cyclical weakness, boost margins, and use pricing without risking relationships with customers.
The company also invested in new capabilities, which is something I highlighted in my prior article as well.
In its 2Q23 earnings call, the company explained that it continued to invest in differentiating capabilities to leverage sustainability for profitable growth. That's a more complicated way of saying it's turning trash into more valuable products.
For example, a joint venture with Ravago, called Blue Polymers, was announced.
Waste Dive
This partnership aims to lead in plastic circularity by utilizing recycled olefins from the company's Polymer Centers to create blended pellets for manufacturing sustainable packaging.
Four facilities are expected to open beginning in late 2024, with positive earnings contribution in 2026.
Furthermore, the development of Polymer Centers in Las Vegas and the Midwest remained on track, with the centers becoming operational in late 2023 and late 2024, respectively.
RSG also noted that demand for recycled plastics remained strong, with partnerships established with companies like Coca-Cola (KO) to supply recycled PET from the Polymer Centers for use in sustainable packaging.
Additionally, the company advanced 57 renewable natural gas projects, with four of them expected to be operational by the end of the third quarter.
Outlook & Valuation
Based on the strong results achieved in the first half of this year and positive business momentum, the company revised its full-year financial outlook.
The updated guidance included revenue in the range of $14.78 to $14.85 billion, adjusted EBITDA in the range of $4.34 to $4.36 billion, adjusted earnings per share in the range of $5.33 to $5.38, and adjusted free cash flow in the range of $1.9 to $1.925 billion.
Also, the revised outlook factored in the contributions from acquisitions completed through June 30th.
Having said that, the company is expected to boost free cash flow to roughly $2.0 billion next year, which would result in a 4.2% FCF yield. This translates to a 23.8x free cash flow multiple.
This valuation is fair but not deep value.
Unfortunately, for investors who remain on the sidelines, the stock hasn't offered any buying opportunities this year. RSG shares are up 17% year-to-date and just 3% below their 52-week high.
The current consensus price target is $160, which is 6% above the current price.
I agree with that and believe that RSG will remain a great long-term dividend compounder.
However, I'm not chasing the price at these levels. I might miss out on more upside, but as usual, that's a risk I'm willing to take. If an opportunity were to present itself, I would love to buy this stock at $130 (or lower, obviously).
Takeaway
Republic Services is a SWAN (Sleep Well At Night) investment, a defensive dividend compounder with impressive growth potential.
As the second-largest non-toxic waste collector in the US, it benefits from a wide moat, pricing power, and a strong track record of predictable earnings growth. The latest quarterly earnings confirm its strength, with revenue growth, expanding margins, and positive customer feedback.
RSG's focus on sustainability and strategic investments, such as the joint venture with Ravago, highlights its commitment to leveraging waste for profitable growth.
While the stock's valuation is fair, the lack of significant buying opportunities means patience is required for potential investors.
As a long-term dividend investor, I'll wait for a better entry point, aiming for $130 or lower before considering a position.
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