Republic Services Inc

Moat: 3.5/5

Understandability: 2.5/5

Balance Sheet Health: 4.5/5

Republic Services Inc. is one of the largest providers of environmental services in the U.S. and Canada, providing non-hazardous waste collection, disposal, and recycling services across different markets.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Republic Services (RSG) operates in the solid waste and recycling industry, providing a range of services including collection, recycling, transfer, and disposal to commercial, industrial, municipal and residential customers.

  • Revenues Distribution:
    • Collection (53.1%): This segment involves the collection of waste and recyclables from residential, commercial, and industrial customers. This is the biggest and most stable part of their revenue stream.
    • Recycling and Solid Waste (29%): This segment deals with the processing and sale of recyclable materials and the disposal of solid waste in landfills.
    • Environmental Solutions (12%): This includes a number of treatment, disposal, and alternative fuel generation.
    • Other (6%): All other revenue not classified above.
  • Trends in the Industry: The industry is characterized by a high degree of regulation and capital expenditures. Industry consolidation has been an ongoing trend with the largest players continuing to grow their presence. Growing environmental concerns and increased government pressure have made the recycling component more profitable. As well, there is a trend towards higher usage of technology in the waste management and collection process.
  • Margins: RSG has relatively stable profit margins and are not heavily exposed to fluctuations of commodity prices. In the recent earnings calls, management mentioned improving pricing and focus on better profitability (even though volumes are down), as well as focus on improving margins on all business lines.
    • A focus on pricing initiatives and streamlining operations has also boosted the company’s efficiency.
  • Competitive Landscape: The industry is highly competitive, but the largest players enjoy a great deal of pricing power. This is due to economies of scale and the regulatory barriers that exist when setting up large disposal facilities. They compete with other large national waste providers like Waste Management and smaller regional companies.
    • The main source of competitive advantage for companies in this industry lies in securing and maintaining municipal contracts. Contracts tend to have 5-10 year durations and high-switching costs for municipalities, which can lead to durable revenue streams.
  • What makes the company different? From the call, they are pushing operational optimization which is helping to drive down costs as well as using more recycled materials. Also, their focus on the environmental solutions is a growing aspect that they are pushing. All of this is helping them to increase margins without relying on just price increases.
  • Also, from their website, Republic Services is one of the first to introduce and utilize a clean-burning natural gas truck fleet.
  • They are also investing heavily into technologies like AI to optimize routes and create better operational efficiencies.
  • They also are implementing an aggressive pricing strategy, raising prices in part to offset inflation and also because they believe their value is worth more in the industry. They are also focusing on capturing the most attractive contracts and then allowing pricing increases to trickle down to those as well.

Financials Overview:

  • Revenue: Has been steadily increasing through the years. Recently, there has been a focus on improving revenue by focusing on more lucrative contracts and implementing price increases, rather than on just overall volume. While volume increases will be present with a more profitable contract.
  • Profitability: The Company has shown increasing profit margins with strong net profit margins compared to many other sectors. This is due to their ability to use their scale and contracts to keep cost down, and also their ongoing initiatives to improve performance.
  • Debt: RSG is highly levered which allows it to generate great returns in good times, however, in economic downturns, it can severely hurt them. They are heavily reliant on debt markets in their financing. Their debt to equity has consistently been above one, with their senior notes at $5.3 billion which is almost as much as the value of their shareholder equity.

Moat Analysis: 3.5 / 5.

  • Switching Costs (High): Customers, especially municipalities and large commercial accounts, face high switching costs due to contractual obligations, the integration of waste management systems, and the time and effort involved in changing providers. This provides a degree of revenue stability for Republic Services.
  • Economies of Scale (Moderate): The large scale of operations allows them to achieve efficiencies in collection routes, processing, and disposal facilities, which leads to cost advantages. However, new smaller competitors can enter with a specific niche in smaller communities if they can be more cost effective.
  • Regulatory Approvals (Moderate): Landfills require environmental permits and authorizations, which create a barrier to entry for new competitors. While they do create a barrier to entry they can also be a source of a vulnerability if any of their permits are rejected.
  • Brand (Low to Moderate): A company’s brand name and relationship with municipalities are important, but they are not extremely hard to replicate or compete with. This provides them with some pricing power and name recognition, but is not seen as a primary advantage.
  • Scale (Moderate): Due to the regional nature of the market, they are also able to lock up some geographical monopolies in their region.
  • Overall: While RSG possesses strong, durable cost advantages, and sticky contracts, but there are limited structural advantages that will allow them to greatly and indefinitely expand on these already stable returns, therefore, the moat is not seen as a wide moat, but more of a solid narrow moat.

Risks:

  • Regulatory Changes: Changes in environmental regulations, including restrictions on landfill use and recycling requirements, could increase costs and hurt their margins.
  • Economic Downturns: Reduced industrial activity can reduce demand for waste collection, and lower consumer spending may hurt retail waste. Downturns can result in both lower revenue volumes and pricing pressure on existing contracts.
  • High Leverage: High amounts of debt increase their risks, as they can be more vulnerable to interest rates increase, or liquidity risk of they have a difficult time refinancing.
  • Disruptive Technologies: While they are invested in new technologies, if a more efficient technology enters the market it may disrupt their business.
  • High Labour Costs: Their business is heavily reliant on its labour force, and a labour shortage or unionization could hurt their bottom line.
  • Acquisition Risk: They have been expanding rapidly by acquisitions and integration of new businesses. This creates integration and synergy risks. If they acquire too many bad businesses, it will drag on their overall performance.

Business Resilience:

  • Their business is very resilient because they are providing a necessary and vital service to the community. The waste management industry is also extremely stable, despite changes in the global economy, people will still need to dispose and recycle.
  • This means that the need for waste management is relatively constant, and doesn’t fluctuate much due to consumer spending and patterns.
  • Their business operations and services are also somewhat limited by locality. Since waste is not cheap to move, companies can benefit from regional monopolies.

Understandability: 2.5 / 5

  • The business is generally easy to understand- everyone understands the need for waste management and recycling services and what that process looks like.
  • However, the business’s financials and strategies are complex and require a deeper dive to understand fully, as they contain different streams of revenue, different accounting rules, and have non-standardized language in their documents.

Balance Sheet Health: 4.5 / 5

  • While their net debt is quite high, and their interest is also significant, their cash flow is large enough to meet their current and short-term obligations.
  • As mentioned, there are not many assets that are used, their debt to asset is quite significant, also they do rely heavily on debt financing.
  • They also are focusing more on organic expansion, and reducing their overall debt load.
  • Therefore, the balance sheet is reasonably healthy, but there are certain aspects that must be kept in mind when assessing the company’s finances.

Recent Concerns and Management Insights

  • Inflation: Like other companies, RSG is also struggling with inflationary and high energy costs. They are focused on offsetting this effect through pricing power and improving operational efficiency. This can cause fluctuations in their margins.
  • Labour Shortages: They are experiencing labour shortages, particularly for truck drivers, as well as rising labour costs. They have taken actions like increasing employee pay, and improving the working environment to retain workers.
  • Acquisitions: There are questions on how they are managing their recent acquisitions, and how to improve the margins from those new acquisitions.
  • Guidance: Their guidance for the short-term has increased to around $5.05 to $5.10 per share. This was largely done through improved operating income, while also accounting for higher expenses. This shows the company is trying to meet its short and long-term targets.
  • Share Repurchase Program: The board recently authorized a share repurchase program worth $2.0 billion. This is a sign of confidence in the current valuation and the company’s prospects. It also should help to offset any dilution that may have happened because of stock option exercises.

Therefore, while there are some risks to the business and concerns regarding their high debt load, their ability to maintain margins, use their scale and contracts to maintain a narrow moat, and strong leadership, makes this a reasonably safe and worthwhile investment for a long-term investor.