2023-12-13 11:25:30 ET
Summary
- Republic Services reported strong third quarter results recently that showed increased earnings per share and strong cash flow from operations.
- The company's ESG initiatives, including sustainability and renewable natural gas projects, are progressing well.
- Our updated fair value estimate for Republic Services' shares is $161, with a range of $129-$193.
- Republic Services continues to turn trash into cash, and we're loving it.
By Brian Nelson, CFA
When I first started in the investment business a long time ago, one of my first roles was an equity analyst covering the garbage haulers at Morningstar. It was a blast. The garbage haulers are probably among the best-run outfits, and their business models work well within the context of a discounted cash flow [DCF] model, since their primary focus is on the cash-generation of their operations to continue to fuel dividend increase after dividend increases. Trash may be trash to some, but to me, they hold a special place in my heart.
One of our favorite garbage haulers is Republic Services ( RSG ). The company is a cash cow, and it continues to drive dividend growth as it buys back shares. We like Republic Services slightly better on a fundamental basis than Waste Management ( WM ) as the latter is spending quite a bit on sustainability initiatives that we think will ultimately serve to slow the pace of its dividend growth potential in coming years. In this article, we wanted to talk about Republic Services' most recent quarterly report, what it is doing on the ESG front, and update readers on our new fair value estimate for shares.
Latest Earnings Report
On October 26, Republic Services issued strong third quarter results that showed strong adjusted earnings per share expansion, to $1.54, up from $1.34 in last year’s period. The trash taker grew cash flow from operations to ~$2.7 billion for the first nine months of the year, up nicely from ~$2.38 billion during the year ago period, translating into strong adjusted free cash flow generation of ~$1.8 billion, which itself was significantly higher than the ~$470 million in cash dividends it paid over the same time. The board also authorized $3 billion for share repurchases. Here is what CEO Jon Vander Ark had to say on the third quarter conference call :
Pricing realization in the Environmental Solutions business remains strong, and we continue to drive organic growth through cross-selling. EBITDA margin in the Environmental Solutions business improved sequentially to 22.7% in the third quarter and expanded 390 basis points over the prior year. The results we are delivering are made possible by executing our strategy in support of our differentiated capabilities.
Organic revenue growth remained strong during the quarter, with simultaneous increases in both price and volume. Core price and related revenue was 8.6% and average yield on related revenue was 7.2%, and organic volume growth and related revenue was 10 basis points.
The company’s ESG initiatives continue to bear fruit as well, as noted on the call:
Moving on to sustainability, we believe that our sustainability innovation investments in areas such as plastic circularity and renewable natural gas are a platform for profitable growth.
Development of our polymer centers remains on track. Construction of our Las Vegas Polymer Center is substantially complete, and we expect full scale operations to begin in November. Our Midwest Polymer center will be located in India. This center will be co-located with a Blue Polymers production facility with operations expected to begin in late 2024.
The renewable natural gas projects being co-developed with our partners are continuing to advance… and we expect eight additional projects to be completed in 2024. We are making progress in our efforts to reduce greenhouse gas emissions, including our industry-leading commitment to fleet electrification.
We expect to have 12 electric vehicles in operation by year-end and more than 60 EVs to be added to our recycling and waste collection fleet in 2024. We now have 6 facilities with commercial EV charging infrastructure with more than 40 additional sites in various stages of development.
Republic Services benefits significantly from its long-term disposal assets as these operations grow more attractive as time passes thanks to the increasing regulatory nature of the waste business, as well as citizen groups opposed to greenfield sites growing in number and strength. These disposal assets, including its Apex landfill in Nevada, which is the busiest facility of its kind in the U.S., represent the material barriers to entry that give the company a large portion of its moaty characteristics. Republic operates an essential business and roughly 80% of its revenue has an annuity-type profile. It's hard to find much wrong with its cash-generating business model.
Updated Valuation Statistics
Our summary valuation statistics for Republic Services. (Valuentum)
The last time we wrote about Republic Services stock on Seeking Alpha was all the way back in September 2022, and in that article , we noted that the firm was well-positioned to ride out inflationary pressures. We continue to believe Republic Services is in a great position thanks to its pricing power emanating from its disposal facilities, and we continue to expect the garbage hauler to generate robust free cash flow in excess of cash dividends paid.
Since that last update, we've finetuned our operating forecasts. We continue to expect revenue growth in the mid to high-single digits, but we've increased our intermediate-term revenue growth forecasts on account of more sustainable pricing power, which accounts for the majority of the upward delta from our prior fair value estimate of $132 per share. We now believe a good fair value estimate of Republic Services' shares is $161.
Our valuation breakdown for Republic Services. (Valuentum)
Margin of Safety
Our fair value estimate range for Republic Services. (Valuentum)
The DCF valuation model is a fantastic tool for valuing companies, but it also comes with its share of pitfalls. The first is the sensitivity of the fair value estimate to changes in future operating forecasts, which themselves are unpredictable, to a degree. With that understanding, it is the degree of uncertainty that we seek to measure, too, and we do so by assigning a fair value estimate range to a company's fair value estimate to combat the shortcoming of false precision.
For example, if one thinks a stock is worth $100 on the basis of the DCF method, it may be more appropriate to think of valuation as a range of potential outcomes as opposed to a precise number. Said another way, it may be best to present the stock's value as somewhere between, let's say, $80 and $120 per share. In this context, while we think shares of Republic are worth $161 each, a good fair value estimate range for them might be between $129-$193, as shown in the image above.
Concluding Thoughts
Republic Services is a moaty entity with valuable disposal assets that allow it to generate tremendous pricing power and copious amounts of free cash flow. We continue to believe that Republic can handle any reasonable inflationary environment, and while it does have cyclical tendencies across its commercial and industrial operations, the firm is largely recession resistant. Optimistic investors may look to the high end of our fair value estimate range, north of $190, as potential upside. Shares are trading at ~$165 each at the time of this writing. Republic Services simply turns trash into cash, and we love it.
For further details see:
Republic Services Turns Trash Into Cash