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Republic Services (NYSE:RSG) shows that a great operator in the garbage industry does not have to be a garbage investment. Republic Services over time has grown to become a huge, nationwide and integrated provider of such environmental services, providing great value to investors along the way.
While investors have had a great run, and there are still many consolidation opportunities in the future, I fear that the risk-reward at these valuations is simply not compelling enough for me here.
An Overview
Republic Services provides essential environmental services in what is a huge and growing service industry which measures more than $90 billion according to the company itself. This huge market opportunity and fragmented operations provide for continued opportunities for the business to consolidate and build further scale.
The predictability of the business is impressive, driven by a sticky revenue base with 80% of the business being an annuity-like business. The business itself is hugely diversified as well. Small containers make up nearly a third of sales, residential and transfer & landfill each make up 20% of sales, as environmental solutions, recycling, and temporary and recurring large containers make up the remainder of the business.
The company holds leading positions in the markets in which it operates, is highly vertically integrated, as solid operating processes result in great service and efficiency, despite the scale of the business. Besides the garbage business, the company plays a huge role in sustainability efforts, as the company operates numerous recycling services and is involved with large renewable energy projects.
Valuation Thoughts
Being able to buy a reliable and predictable operator does not come cheap. The company generated $11.3 billion in revenues in 2021, up 11% on the year before. The company is incredibly profitable as it posted operating earnings close to $2.1 billion on which net earnings of $1.3 billion were reported. These earnings are equal to $4.05 per share based on a share count of 318 million shares, with adjusted earnings coming in close to the same number at $4.17 per share.
With shares trading at $135 by the end of 2021, the company was awarded a $43 billion equity valuation, a number which rises to nearly $53 billion if we factor in net debt of $9.5 billion (as that even excludes some environmentally related costs). The net debt load (based on financial net debt) was equal to roughly 3 times EBITDA of $3.2 billion. Needless to say, valuations were high at 32 times adjusted earnings posted in 2021. Based on the 2022 earnings guidance of $4.58-$4.65 per share, multiples came down to roughly 31 times earnings.
Needless to say that these are high valuations. Based on the enterprise valuation, the company was valued at 4.7 times sales, more than 16 times EBITDA, 32 times earnings and a slightly lower forward earnings multiple. A near $2 per share dividend provides for a modest dividend yield, as Republic is not about dividends, but more about continued consolidation of this fragmented market.
A Big Deal
Like the rest of the market, shares fell to the $115 mark in February amidst concerns about the economy and inflation, but by now shares have recovered and trade near their highs again at $135 per share.
As a matter of fact, it was the day before the release of the 2021 results when the company announced the intention to acquire US Ecology (ECOL) in a deal valued at an enterprise valuation of $2.2 billion. The deal is relatively small as the purchase price equals 4% of the enterprise value of Republic Services, as the deal gives the company greater exposure to treatment, recycling, and disposal of both hazardous and non-hazardous goods.
The deal is set to add $968 million in revenues, revealing that just a 2.3 times sales multiple was paid. On the other hand, the business is much less profitable with EBITDA of $156 million working down to a 14 times multiple, as this comes after Republic paid a big premium for US Ecology.
Based on these multiples, the deal looks fair, as that is before factoring in $40 million in synergies which are easily worth half a billion in value, if they are to be realized. Yet the overall deal is relatively small for Republic, so no major reaction is seen in response to the deal of course. Pro forma net debt will jump to $11.7 billion, as leverage ratios increase to 3.4 times based on the pro forma EBITDA numbers of the combination.
Concluding Remark
Amidst all these moving parts, I cannot help to feel the urge to be cautious, despite the long-term track record and future growth opportunities. Republic trades at 29 times forward earnings, is a steady growth play and carries quite some leverage, but this is outdone by the fact that this is a predictable business with steady cash flows.
Nonetheless, in this rapidly rising interest rate environment, I am very cautious to pay multiples with a high twenty handle. Therefore, I think that I still regard Republic as a great and long-term value creating play, but the valuation multiples here leave no compelling risk-reward for me to initiate a position just yet.
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