Best Ideas portfolio holding Republic Services (RSG) is a dominant player in the US non-hazardous solid-waste services industry. For those that may not be as familiar with the trash taker, the company is a powerful force within the industry thanks to its significant landfill ownership, the value of which continues to increase over time due to a variety of structural factors from citizen’s group opposition (Not-In-My-Back-Yard) to increasing regulatory and environmental hurdles. Waste Management (WM) and Waste Connections (WCN) round out the solid-waste industry’s oligopolistic, landfill ownership structure.
During the fourth quarter, results released February 12, Republic Services generated annual revenue of $2.23 billion, up 3.9%, and exceeded consensus expectations by a couple pennies per share on an adjusted basis. Revenue growth in the quarter was comprised of a variety of factors, but we were particularly encouraged by the pace of pricing expansion, which represented 1.7 percentage points of the growth (adjusted core pricing expansion in the quarter was 3.2%). Volume increases accounted for 1.6 percent points of the sales growth in the quarter as the rubbish handler continues to benefit from the strengthening economy. Acquisition-related revenue, fuel-recovery fees and recycled commodities accounted for the balance of top-line growth.
Earnings performance in the fourth quarter could have been better. Even after excluding a hefty charge related to its Bridgeton Landfill, net income for the three months dropped to $178 million from $193 million in the year-ago period. Earnings before interest taxes, depreciation, depletion, amortization and accretion (adjusted EBITDA) fell to 625 million from $648 million, revealing more than a 2 percentage point drop in its EBITDA margin. Though adjusted earnings per share came in better-than-consensus, increases in expenses related to labor and related benefits, transfer and disposal costs, and maintenance and repairs overwhelmed any benefit related to plunging diesel fuel prices. The company could have controlled costs better, in our view.
Looking ahead to 2015, Republic Services expects revenue to advance at a 2.5%-3.5% pace and diluted earnings per share in the range of $1.98-$2.04 per share. Management is planning to hit the range in adjusted free cash flow of $710-$740 million, which compares to reported levels of traditional free cash flow of $672 million and $667 million during 2014 and 2013, respectively. The forecasts exclude the company’s pending acquisition of Tervita, an environmental services company that serves oil and gas producers in the US. Transaction details weren’t readily available, but dislocations in the energy market likely lubricated the deal.
All-in, Republic Services is a fantastic company. Much like Waste Management and Waste Connections, we like the company’s strong free cash flow generation, and the oligopolistic structure of landfill ownership in the US is a key, sustainable positive for the entrenched players. We don’t plan to make any changes to the company’s position in the Best Ideas portfolio, but we continue to cast a cautious eye on Republic Services’ balance sheet. At the end of 2014, the firm held just $75 million in cash against a ~$7 billion debt load. Massive debt obligations may not weigh down returns to equity holders in the near term, but such an overleveraged position will eventually come home to roost.