Picking Up The Trash (RSG)

In a world that is forever becoming more crowded, available landfill space is dwindling and becoming more valuable.

As a result, tipping fees keep going higher. The industry has re-focused itself on pricing. Constructing landfills require large amounts of capital investments and long exhaustive processes for environmental permits and zoning approvals.

Republic Services Inc. (RSG) ranks third in overall landfill ownership and total disposal capacity. RSG has 59 solid waste landfills and approximately 1.8 billion cubic yards of disposal capacity.

The company has increased its internalization rate to 57% from 40% around 7 years ago. Internalization rate is the percentage of company collected waste that is dumped in company-owned landfills. This is the key to higher profitability.Also, controlling long term contracts in isolated areas allows RSG to charge steep tipping fees.

RSG has long-term exclusive franchise contracts (8-30 years) in the Sunbelt states, which approximates 67% of its revenue. A contract with Las Vegas has been locked in through 2035.

This monopolistic position should help increase waste volume growth faster than its competitors. Margins are also helped by this isolated market, as fewer alternatives leave customers with little choice but to remain customers.

However, one risk to these margins is the cost of diesel fuel for trucks. Diesel fuel accounts for approximately 8% of expenses. Any price changes in franchise contracts are linked to the CPI index. These contracts do not allow for surcharges and price adjustments lag any increases in CPI, particularly energy costs. Consequently, it is difficult to fully recover added costs when diesel fuel rises in price.

Revenues over the past 5 years have risen about 6%. Over the next 5 years, that rate of growth is expected to reach 9%. Behind solid pricing increases and stable diesel costs, operating margins are expected to improve to nearly 20% from 16%. Management assumed $2.40/gallon in 2006 for diesel fuel, which is currently at $2.46 and falling.


The company's capex is expected to remain modest, as RSG has a comparatively young fleet of trucks. Management expects that capex will remain in the range of $300-400 million per year for the next 5 years.

The returns on equity and invested capital are among the best in the waste management business, 17.5% and 10.2% respectively versus an industry average of 14.5% and 8.8%. These returns should improve as cash flow generation is expected to ramp up. This will allow RSG to increase its value to shareholders.

Since mid-2000, RSG has repurchased 29% of its outstanding shares and it is estimated that another 9% were re-purchased in 2006. The dividend, which was recently increased, provides about a 1.4% yield. Earnings estimates are for RSG to earn $2.06 in 2006 and $2.25 in 2007, a 9% year-over-year increase.

On a valuation basis, RSG sells about 18 times next years estimate and provides a 5.9% cash flow yield. As RSG reduces it share count and continues to generate a steady stream of cash, it may become attractive to private equity buyers.

Regardless of whether or not private equity buyers enter the picture, RSG is well-positioned to turn trash into cash and deliver value to its shareholders.