Republic Services Action: Unclear Strategic Advantage (NYSE: RSG)

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Investment thesis

Republic Services, Inc. (NYSE: RSG) is one of the 2 largest players in the waste management industry, effectively forming a duopoly that owns and operates most of the largest landfills in the United States.

Being one of the duopolies means it has a “respectable” advantage over other small players outside the duopoly. However, within the duopoly, it is the smallest player and therefore is expected to face significant competition from Waste Management, Inc. (WM), who is the biggest player in the duopoly.

Waste Connections, Inc (WCN), which is a smaller player outside of the duopoly, has a business strategy that allows it to avoid directly competing with the much larger duopoly. It’s an advantage that RSG doesn’t have as they still face competition from WM.

As such, I think it is more interesting to invest in WM and/or WCN rather than RSG. In the following sections, I explain in more detail how I arrived at this conclusion.

Company presentation

Based on the company’s latest quarterly report, here’s what we can gather from the company’s operations:

  • RSG is “one of the largest environmental services providers in the United States, by revenue”. If we measure by market capitalization, RSG is second only to WM in the “Waste Management” industry ranked by Finviz.
  • The company operates facilities to provide general waste management services such as collections, transfer stations, landfills, recycling processing centers, treatment, recovery, disposal and storage facilities. These are not much different from what other waste management companies offer.
  • On May 2, 2022, RSG completed the acquisition of US Ecology, a “leading provider of environmental solutions offering treatment, recycling and disposal of hazardous, non-hazardous and specialty waste”.

The latest financial figures for the first quarter of 2022 saw the company report mostly positive results in terms of revenue and earnings, based on a year-over-year comparison between 2021 and 2022:

  • Revenue went from 2,595.9 M to 2,968.8 M.
  • Net revenue went from 296.4M to 351.9M.
  • Cash flow from operating activities increased from 661.0 M to 705.6 M.
  • Adjusted free cash flow increased from 464.2M to 530.9M.

One of the (smallest) garbage industry duopolies

According CNBC, “Two private companies, Waste Management and Republic Services, lead the solid waste management industry. Together, they own approximately 480 landfills of the 2,627 landfills across the United States.” Quantitatively, this implies that WM and Republic Services collectively own only 18% of landfills in the United States. But if we focus on ownership of only the largest landfills, we can observe how the 2 companies dominate the industry.

According to this articlewhich “ranks the 30 largest landfills in the United States”:

  • WM operated 5 landfills and managed 11.9 tons of waste per year.
  • Republic Services owns 3 of the top 10 landfills and manages 7.2 tons of waste per year.
  • ‘OC Waste & Recycling’ and ‘Rumpke’ each have 1 landfill and only manage 2.5 tons and 2.3 tons of waste per year, respectively.

Republic Services - List of Largest Landfills

List of largest landfills (Waste Today Magazine)

The 10 largest landfill handles a total of 23.9 tonnes of waste per year. That means:

  • WM manages 49.8% (11.9/23.9) of waste per year.
  • RSG manages 30.1% (7.2/23.9) of waste per year.

From this perspective, RSG is seen to manage a significantly lower proportion of waste per year compared to WM, despite the two collectively dominating 8 of the top 10 landfill owners.

As one of the duopolies in the waste management industry, while RSG enjoys a significant competitive advantage over other smaller players, it is also significantly challenged by being the smallest player in the world. within the duopoly.

Strategic comparison with WM and WCN

WM is the undisputed leader in terms of market capitalization and landfill ownership, as shown in previous sections. As one of the duopolies, it is also the biggest player. This presents a very clear competitive advantage in terms of market share dominance, as I explained in detail in one of my WM articles.

WCN, on the other hand, has a “unique” advantage of its own. In another of my WCN articles, I describe how WCN “adopted a unique strategy of serving rural customers with exclusive waste management agreements to fend off competition.” Through this strategy, WCN adds more value to customers by supporting the entire end-to-end waste stream. While I’ve noted that WCN’s strategy may not be superior to WM’s market dominance strategy, it’s still a “unique” and “identifiable” advantage in itself to protect against. of WM and RSG.

If I see RSG as one of the duopolies in the industry, despite its size advantage in big industry level similar to WM, being the smaller of the 2 players’in‘ the duopoly, it does not have a clear advantage over WM.

If I compare RSG to WCN, although RSG is much larger in terms of size, I cannot conclude with certainty that RSG is in a better competitive position than WCN. After all, through its unique strategy described earlier, WCN is able to insulate itself from competition from WM and RSG by not directly competing with them in landfill ownership. RSG still faces significant competition from WM.

Overall, in my opinion, for the reasons above, I am more comfortable investing in WM and/or WCN due to their relatively “identifiable” competitive advantage. However, if I already hold a position of RSG shares, I will not sell them at a loss below my entry price. After all, as the 2nd biggest player, he still has a “respectable” edge in the overall industry.

Financial comparison with competitors

We’ll compare financial data with some of RSG’s peers:

  • Waste Connections, Inc.
  • GFL Environment Inc. (GFL)
  • waste management, inc.

Republic Services vs Competitors - Key Financial Ratios

Main financial ratios (Seeking Alpha)

  1. We can observe that WM and RSG are the largest players in the comparison list in terms of market capitalization. This is not surprising as they hold the current duopoly in landfill ownership as described earlier.
  2. Earlier, we discussed that RSG faced significant competition from WM’s biggest player. This is reflected in the slightly lower long-term growth rate of the RSG in terms of 3- and 5-year CAGR.
  3. As we explore gross and net profit margin figures, RSG is roughly tied to WM and WCN. This suggests that WCN’s unique strategy to fend off competition from WM and RSG appears to be working as it can still maintain roughly the same margin levels despite a much smaller revenue base.
  4. In terms of cash and leverage profiles, all of the players on the comparison list are cash positive, but they are also taking on around 10-13x more debt. We observe that all the actors are financially very indebted.

In my opinion, WM, RSG and WCN have very similar financial profiles. For GFL, its finances stand as a much smaller but fast-growing player in the comparison list. It has a much smaller gross profit and is currently not profitable in terms of net income. Despite growing much faster, it has a lot of catching up to do to stand out from the competition of other much bigger players.

Evaluation

Based on cash flow data from Seeking Alpha, RSG has a free cash flow (“FCF”) that has generally been rising steadily since 2019, suggesting that growth is likely to be sustainable over the long term. We will use the FCF of the TTM period (1,260.1M) in our intrinsic value calculation.

Republic Services generated free cash flow

Leveraged Free Cash Flow (Seeking Alpha)

We will make the following additional assumptions when assessing the intrinsic value of the business:

  1. According to Seeking Alpha’s observation on “compound annual growth rates (“CAT”)”, the growth rate of leveraged free cash flow over the past 5 years is 6.86%. This is very close to the “mean value” of the US GDP growth rate of 6.37%. As a defensive company, I think it’s reasonable to assume that RSG will grow its free cash flow at this rate of 6.86% over the next 20 years.
  2. The discount rate is estimated at 6.94%, based on the WACC value.
  3. I guess RSG may not exist beyond 20 years. Thus, the Terminal Value will not be included in the calculation of the intrinsic value.

RSG action Intrinsic value

Intrinsic value (author’s calculation)

Based on the data above, the present value (“PV”) of projected free cash flow per share for RSG is $83.16.

Intrinsic value of the services of the Republic

Intrinsic value (author’s calculation)

Taking into account the total debt and cash held by the company, the final intrinsic value is $53.49

The current price of around $120.73 implies that the stock is currently overvalued.

Investment risk

Typically, most of the waste management companies on our previously discussed comparison list incur a significant level of debt. In the current context where interest rates are rising, highly leveraged companies will suffer more due to the need to bear higher interest charges. Currently, RSG has 319.7 million in interest expense and 2,831.3 million in operating cash flow. This means that interest expense represents 11.3% of its operating cash flow, which in my opinion is considered low. Investors should monitor and ensure that this percentage does not exceed 30%.

Conclusions and key points for investors

As noted above, the waste management industry is dominated by WM and RSG in terms of landfill ownership. Despite being one of the biggest players in the industry, RSG still faces significant competition from WM.

RSG is larger than WCN, but it does not have an “identifiable” advantage as WCN, as stated earlier.

Overall, in my opinion, investors should consider investing in WM and/or WCN when they become undervalued due to their relatively “identifiable” competitive advantage, as discussed earlier. Even if investors already have a current position in RSG, they don’t need to sell it at a loss since RSG is still one of the biggest players in the industry with a “respectable” lead in terms of market share. overall.