2023-11-01 10:51:42 ET
Summary
- Republic Services is a compelling dividend growth stock with consistent outperformance and lower volatility than the S&P 500.
- RSG operates in the environmental services sector, focusing on sustainability and growth through acquisitions.
- Despite a premium valuation, RSG has strong financials, a history of dividend hikes, and a recent buyback program, making it a "Buy" with a consensus price target of $167.
Introduction
As most readers know by now, I love investments in industries with high entry barriers that come with business models that are critical to our everyday lives.
This includes oil companies, transportation companies like railroads, companies producing farm equipment, consumer goods producers, healthcare companies, and real estate.
One segment I love that I haven't added to my portfolio yet is waste management. Very recently, I wrote an article covering the company with the same name as its industry, Waste Management ( WM ), where I made the case that it's one of the best dividend growth stocks money can buy, thanks to safety, consistent growth, and an attractive low-volatility profile, among other reasons.
In this article, I want to discuss its smaller peer, Republic Services ( RSG ) , which has a lower dividend yield of 1.5% but an even better total return profile.
The company is on my watchlist, next to RSG, as I want to own one of the two over the next 1-3 quarters, depending on the valuation.
In this article, I'll walk you through my thoughts and explain what makes RSG such a wonderful dividend growth stock.
So, let's get to it!
An Almost Perfect Total Return Profile
The market is (somewhat) selling off, inflation is elevated, and people need cash. I get it when investors flock towards high-yield investments. In prior articles, I have mentioned that I believe in a new investment era where a big chunk of the future total return may come from dividends.
However, I also believe that it is a mistake to avoid stocks purely because they come with a low yield.
Historically speaking, dividend growers have the highest total return and the lowest standard deviation.
In other words, you get a higher return while taking lower risks!
While I may sound like a snake oil salesman right now, it's completely backed by evidence.
Here's another chart. Between 1973 and 2022, dividend growers have turned a $100 investment into more than $13,000! Dividend payers (that's where high-yield stocks are a part of) turned $100 into $8,000.
That isn't bad either.
The equal-weighted S&P 500 turned $100 into $4,000.
Hartford Funds
RSG confirms this.
- Since 1999, RSG has returned 12.4% per year, turning a $10,000 investment into almost $180,000.
- The S&P 500 returned 7.0% per year during this period.
- WM returned 7.3% per year.
With that in mind, it gets better. RSG is now a much more mature business, which has lowered its standard deviation (volatility)
- Over the past ten years, RSG has returned 18.1% per year. Over the past five years, that number is 16.3%.
- Over the past five years, the standard deviation was 19.0%. That's in line with the S&P 500! That's incredibly impressive, as we're comparing a single stock to a diversified basket of 500 stocks!
These numbers are obviously no guarantee of future results, but as I will explain in this article, RSG is doing very well and still benefitting from high entry barriers and secular long-term tailwinds.
The RSG Dividend
As I already briefly mentioned, RSG does not have a juicy dividend yield.
The Seeking Alpha dividend scorecard gives the stock a big fat D+ for its yield.
However, that's where the bad news ends. The company scores As on safety, growth, and consistency.
The company has hiked its dividend every single year since it started rewarding investors through direct distributions. That's 20 years in a row.
Over the past five years, the dividend has been hiked by 7.5% per year. The dividend is protected by a sub-40% payout ratio and a balance sheet with a BBB+ rating. That's one step below the A-range.
In the third quarter, the company reported a total debt load of $12 billion, with total liquidity at $2.3 billion and a leverage ratio of 2.9x (EBITDA) at the end of the quarter.
It also has limited debt maturities over the next few years and a low average cash interest rate on its debt.
On July 28, the company hiked its dividend by 8%. It also announced a $3 billion buyback program on October 27, which translates to 6.4% of its current market cap.
Over the past ten years, the company has bought back roughly 13% of its shares, which has contributed to its stellar stock price performance.
Having said that, its recently announced buyback program is certainly something to get excited about, as it shows the company's confidence in its business.
This brings me to the next part of this article.
Republic Services Is Doing Tremendously Well!
As most readers will know, Republic Services is a major player in the U.S. environmental services sector, with substantial operations across the United States and Canada.
The company manages 360 collection operations, 246 transfer stations, 74 recycling centers, 208 active landfills, and more, with a strong emphasis on sustainability and environmental solutions.
This includes landfill gas-to-energy projects and a post-closure responsibility for 128 closed landfills. Republic Services targets the North American environmental services market with a focus on sustainable practices, digital technologies, and customer-centricity. This is a market with a total size of almost $110 billion.
As one can imagine, Republic Services aims to secure leading market positions in the sectors it serves.
The company's strategy includes both internal and external growth.
- Internally, RSG focuses on volume growth, price increases, expanding recycling capabilities, and infrastructure development.
- Externally, they pursue acquisitions and public-private partnerships to complement their business platform and deliver value to customers.
Over the past three years, the company has invested $5.2 billion in acquisitions and returned $2.2 billion to shareholders.
Having said that, the company is growing very consistently.
In the third quarter, the company achieved 6% revenue growth, with 2% attributed to acquisitions.
They also achieved 9% growth in adjusted EBITDA and expanded their EBITDA margin by 70 basis points.
The core price on total revenue increased by 7.0%, while the core price on related revenue showed an even higher increase of 8.6%.
The core price on related revenue was composed of open market pricing at 10.4% and restricted pricing at 5.7%, which shows the company's pricing power.
Bear in mind that more than half of the company's contracts are priced at open market rates. 23% is tied to CPI and similar indexes.
Unfortunately, lower commodity prices hurt the recycling business a bit.
During the third quarter, recycling commodity prices averaged $112 per ton, down from $162 per ton in the previous year.
Recycling processing and commodity sales reduced revenue by 20 basis points.
While fiber markets showed a steady recovery, plastic pricing improved from recent lows, resulting in a current average commodity price of approximately $120 per ton.
However, RSG's Environmental Solutions business saw its revenue increase by $8 million compared to the previous year. On a same-store basis, it contributed 40 basis points to internal growth during the quarter.
The company also upgraded its full-year adjusted earnings per share guidance to be in the range of $5.46 to $5.49, primarily due to the lower tax rate.
So, what about the valuation?
Valuation
This is where it becomes tricky.
Because the stock offers both growth and safety, especially in this environment, it has done quite well. Currently, the stock trades at a blended P/E ratio of 27.4x.
The normalized P/E ratio of the past two decades is 21.0x (the blue line in the chart below), which means the stock is trading at a premium.
However, it would be unfair to say that RSG is overvalued.
Using the chart and data below:
- The company is expected to maintain elevated EPS growth. This year, EPS is expected to grow by 11%, followed by 8.5% growth in 2024 and 10.4% growth in 2025.
- Despite economic weakness, analysts have upgraded the company's EPS expectations.
- Over the past five years, RSG has traded at roughly 27x earnings, which would fit its growth profile and ability to use pricing to boost revenues.
- If the company maintains this valuation, it could return 10% through 2025.
The current consensus price target is $167, which is 12% above the current price.
I agree with this.
While I have to say that RSG is trading at a lofty valuation, it's not an unreasonable valuation in my view.
Hence, I give the stock a Buy rating and will look for a potential decline to $135 (or lower) to initiate a position.
Both WM and RSG seem perfect for my portfolio, and I will likely add one of them soon, depending on market opportunities.
The mix of consistent growth in an anti-cyclical industry with high entry barriers, pricing power, consistent volume growth, opportunities in renewables, and the fantastic total return profile are reasons that these picks are perfect for my portfolio.
Takeaway
Republic Services is a compelling dividend growth stock. Despite its lower yield, RSG has consistently outperformed, with 18.1% annual returns over the past decade and lower volatility than the S&P 500.
Its strong financials, dividend history, and recent buyback program are encouraging signs.
RSG operates in the environmental services sector with a focus on sustainability and growth through acquisitions. The company's consistent performance and the potential for a 10% return through 2025 make its current premium valuation reasonable.
With a consensus price target of $167, RSG is a " Buy " in my book.
For further details see:
Republic Services: Dividend Growth Brilliance