|Shares Out. (in M):||380||P/E||18.9x||16.5x|
|Market Cap (in $M):||10,566||P/FCF||14.3x||14.6x|
|Net Debt (in $M):||6,420||EBIT||1,516||1,520|
After its December, 2008 merger with Allied Waste, Republic Service, Inc. (RSG) is the second largest solid waste collection company in the U.S. after Waste Management (WM) with approximately 17% market share. Together, RSG and WM control the majority of landfills in the U.S. RSG offers a very basic service, hauling trash, which produces strong and predictable cash flows of approximately 7% of revenues.
The keys to this investment thesis are that 1) waste collection is a relatively stable business most of the time, and 2) RSG in particular is deleveraging and improving margins after its merger with Allied. As free cash flow increases going forward, the company will reduce debt, repurchase shares and pay dividends all of which will increase shareholder value.
Regarding the first point, landfills, or dumps as most people call them, are extremely difficult to create due to problems in obtaining permits. Nobody wants a dump in their neighborhood, yet transportation costs require that dumps be located as close as possible to population centers, making existing landfills highly valuable assets to control.
The waste collection business is driven by volume and price. According to a recent article in the NY Post, an esteemed publication near the pinnacle of all newspapers in journalistic integrity, accuracy, and fact-checking, "Every year since 1960 Americans have created more solid waste than the year before. The amount of trash we produce has tripled since 1960 - while the U.S. population has gone up only about 90 percent." The latter point may well be true, but according to RSG, volumes fell around 9.5% last year. In spite of this drastic fall in volumes caused by the worst financial/economic crisis since the Great Depression, RSG managed to raise prices by 3.0%, and projects further increases of 2% to 2.5% in 2010. That, in my opinion, indicates very strong pricing power. Approximately 50% of revenues are tied to index based pricing, which tends to lag CPI movement by 6-12 months. Just over 50% of RSG's revenue is derived in states with above average population growth. The company isn't providing guidance for 2010 with regard to volumes, but my assumption is that volumes will either stabilize or the decline will reach close to zero for the year. One's view on volumes is really a macro issue - will commercial construction pick up, will residential accounts start to pick up again, etc. Personally I think we will survive but be poorer, and perhaps our trash production will not grow as fast as it used to, but it will grow over time with population growth. One thing is certain, trash has to go out. I challenge any reader to either 1) completely eliminate their production of garbage or 2) allow their garbage to pile up in the kitchen or backyard. Three or four days of this regime should convince anyone that RSG is in a stable line of business.
Regarding point #2 above, RSG currently has $6,420 in LT debt after repaying $740m in 2009, and will continue to prioritize repayment of debt until leverage reaches 2.5x ebitda (FY 10E $2,570m). This target should be reached in 2010, thereafter management has stated that share repurchases will resume. RSG will generate around $700 to $725 in FCFE in 2010, which is 6.6% to 6.9% on today's market capitalization of $10,566. Holding all things constant but using 100% of the FCFE to repurchase shares, RSG could take itself private in just under 15 years, and if prices and volumes were to increase during this time, the time-to-private could be significantly shorter. The company currently pays a 2.7% dividend, or about $289m annually.
Last but not least, Cascade Investment (Bill Gates' investment company) owns 14.6% of RSG according to Bloomberg, and is represented on the board. Also, Berkshire Hathaway more than doubled its stake to 8.29m shares (2.2%) in the last quarter.
Market recognition of annuity-like FCF with moderate organic growth, debt pay-down + share repurchases, dividends.