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Decreasing Margins Trouble Republic Services Inc.
Posted by: Damian Illia (IP Logged)
Date: March 28, 2014 10:12PM
Republic Services Inc. (RSG) is a waste management company which provides solid non-hazardous disposal services for commercial, industrial, municipal and residential applications. Owning and operating 196 transfer stations, 191 solid waste landfills and 70 recycling facilities, Republic Services is the second-largest company among this industry, in the U.S. The residential collection is done under contract with the municipalities, while commercial and industrial operations are performed through waste containers and compactors. Recycling services represents only the 6.7% of the company’s revenue however, the increased concern towards environmental problems along with re-utilization and recycling is likely to expand the waste management firms’ interest on this service.
The company’s fourth quarter results were promising, with both revenues and earnings increasing year over year, and reaching numbers above the projected levels. Clearly positioned as a premium waste management company in the U.S., Republic Services is developing an acquisition strategy. Still, the competition among this industry is strong, and given the soft economic conditions, it is likely to pressure profitability margins.
Is the Merge Still Unreliable?
During 2008, Republic Services and Allied Waste merged to create a strong company which could compete with number-one waste management company Waste Management Inc. (WM). It is true this industry has a rather constant nature, as trash volume increases with population growth, urban construction, industrial production and commercial activity. Still, the macroeconomic context during 2008 affected the recently-merged company, having to deal with lower waste volumes and intense price competition. Nevertheless, after this bumpy beginning, the company reached a good profitability. And, although it came to sustain average growth on both gross and operating margins, this tendency has recently decelerated with this margins underperforming in 2012 and 2013.
Yet this industry has a rather high barrier to entry, as its costly structure and waste regulation rules imply high static costs for all waste disposal operations, and Republic Services in well positioned as the second largest company in this non-hazardous solid waste industry.
New Acquisitions, Improved Structure
Republic Services is a company vertically integrated, which operates controlling the flow of waste while protecting its profits. With an internalization strategy, Republic Services is trying to combine financial and legal resources with local market presence by focusing on a series of quality acquisition opportunities such as local operators, transfer stations, and recycling assets. Through this structural adjustment and new acquisitions, the company is likely to gain pricing power as well as a bargaining clout.
Besides, the company’s regional landfill in Clark County, Nev., is the one of the most dynamic facilities in the U.S., and provides the company a strong cash flow stream, rising profitability and additional volume revenue. The company’s results for fourth quarter 2013 revealed a rise in revenues and earnings year over year, due mostly to an improvement in solid waste trends. Moreover, the current effort towards increasing operational efficiency has led the company to adopt compressed natural gas collection vehicles and automated-side loaders, reducing cost and improving profitability. All of these are likely to act as catalysts for a long-term growth, giving the company capacity to increase ROICs over time.
Republic Services is not as large as Waste Management (WM), and is still exposed to diverse macroeconomic fluctuations. The firm conducts recycling operations by processing recyclable materials for sale. Yet these recycled products are subjected to market price fluctuations and commodity price volatility, resulting in a possible negative impact on earnings. Moreover, competition is always pressuring prices, and affecting profitability. Competitive markets’ disposal overcapacity might as well prevent the firm from adjusting its prices on time.
The waste management industry requires high investment and costly structure. As Republic Services’ disposal assets represent a long-term benefit, the company is likely to sustain its position amid the market. Despite the recently deteriorated gross and operating margins, the company is still likely to recover, especially due to the overall economic improvement and normalized levels of pricing and volume. Plus, increasing volumes should lead to better operating leverage, improving efficiency in utilization of disposal assets.
Analysts feeling bearish suggest ROICs have been declining since 2011, result that might indicate the merge with Allied Waste is still questionable. Nevertheless, other more bullish analysts coincide when saying that Republic Services combines strong free cash flow and manageable financial leverage which results in increased dividend payment, repurchasing shares. ROE of 7.6 is above industry average 5.4, and the company has historically promulgated a conservative balance sheet with a healthy liquidity position. Still, nearby results might show whether the company’s margin reduction problems are due to environmental circumstances or, else, derived from efficiency problems inside its business structure.
Disclosure: Damian Illia holds no position in any stocks mentioned.
Stocks Discussed: RSG, WM,