While to compete with Republic Services requires a lot of capital, and there is limited pricing power. Contracts are due for renegotiation every few years or so, and subject to competitive bidding. If a competitor wants to gain market share, they can potentially lower prices to gain key contracts. Given the scale and vertical integration of Republic’s operations the chances of that are low, since it can probably outbid most of the smaller rivals in the industry. The company is also number one or two provider in 90% of the markets it operates in.
The second risk involves potential for environmental liabilities. The company needs to be really good at managing environmental issues, particularly as it relates to its landfills. After a landfill is filled up with trash, the company has to monitor it for at least 30 years.
If management does not do a very good job of continuously monitoring risks related to an environmental contamination on a systematic basis, the results could be terrible for communities affected and shareholders. Again, the possibility of this actually happening is likely low, but it is something to think about.
The third item is that I do not expect future growth in earnings per share might not exceed 5-6%/year over say the next 5 – 10 years. Therefore, the opportunity cost of owning Republic Services is missing out on a stock that yields 3% but grows distributions by more than 6%/year.
Republic Services increased Returns on Equity from 5.70% in 2003 to over 21% by 2007. There was a big drop during the financial crisis, and currently the ROE is standing at 7.40%. Based on forward earnings, I expect this ratio to increase above 10%. I generally want to see at least a stable return on equity over time. I use this indicator to assess whether management is able to put extra capital to work at sufficient returns.
The annual dividend payment has increased by 12.80% per year over the past five years, which is higher than the growth in EPS. This has been achieved mostly due to the expansion of the dividend payout ratio.
A 12% growth in distributions translates into the dividend payment doubling almost every six years on average. Future dividend growth would have to track growth in earnings per share, and would likely be in the high single digits.
The dividend payout ratio has increased from 9% in 2003 to almost 59% in 2012. Looking at estimated earnings for 2013 however, the forward dividend payout ratio is 56%. A lower payout is always a plus, since it leaves room for consistent dividend growth minimizing the impact of short-term fluctuations in earnings.
Currently Republic Services is attractively valued at 18.50 times estimated 2013 earnings, yields 3% and has a sustainable distribution. The company has stable revenues, which are relatively recession resistant.
However, growth has been a little slow in the past five years. If earnings per share grow by 2 – 3% per year based on organic growth (such as growth in population) and acquisitions, and 2-3% per year due to share repurchases, this could translate to total growth of 4 – 6% per year. Given the high dividend payout ratio, I am not sure if long-term dividend growth would be higher than 6% per year over the next 5 – 10 years. This is not too bad of course, given a starting yield of 3%.
However, if I find a stock that yields 3% and expect it to grow distributions above 6% per year, I would likely buy that stock, rather than Republic Services.
Full Disclosure: None