If there's one thing Americans are still good at making, it's garbage. According to the United Nations, the United States is behind only Denmark in municipal waste generated per capita. It follows that waste disposal is a huge business in America -- and an excellent opportunity for investors.
At the top of the midden heap is Waste Management (NYS: WM) , by far the largest municipal waste company in America. But buried under it is competitor Republic Services (NYS: RSG) , a company that seems to get little attention from investors. Read on to see why I've decided to give this company its due and put my CAPS "All Star" rating on the line with an outperform CAPScall.
Not like all the other trash companies
Waste Management is a Foolish favorite, without a doubt. It has a five-star rating (out of five) on CAPS and is recommended by three different newsletters and one of our Real-Money Stock Picks analysts. Heck, I'll be honest, when I started this article, I'd actually intended to write about Waste Management. But there was one problem I couldn't get past -- Waste Management just can't keep up.
A long-term comparison between the two companies is somewhat clouded by Republic's 2008 merger with Allied Waste. At the time, Allied and Republic were the second and third largest trash companies in the U.S., respectively. It was a gigantic $4 billion merger, so while Republic doubled sales soon after, it was hardly organic growth. The effects of the merger were completed throughout 2009, and since then sales have actually been flat, while Waste Management has grown about 16%.
However, the synergies from the merger generated $191 million in cost savings, far higher than the initial $150 million projection. These cost savings have allowed Republic to grow its profit margin by 200 basis points since the savings were fully realized at the end of 2010, while Waste Management's has dropped 100 basis points during the same period. As a result, Republic has grown profits by 37% while Waste Management has slowly declined.
Another effect of the merger was that Republic had to take on Allied's heavy debt load. Fortunately, Republic was able to use its strong credit rating to refinance the debt and has been paying it down. Today, the company's debt-to-equity ratio sits at about 0.93, compared to Waste Management's 1.51. While 1.51 isn't particularly worrisome for such a capital-intensive business, it has been rising over the years.
Only happy when it rains... dividends
Two oft-cited reasons for owning Waste Management are that it has a very stable business and it has a good dividend. Both are true, but not necessarily good. Over the last decade, Waste Management has only grown net income by about 12%. That's certainly stable!
Meanwhile, the dividend has been very steadily and consistently growing. But because profits are not, the dividend payout ratio has been growing instead, from about 15% of net income to a recent 70%. By consistently raising the dividend without growing profits, the company has less and less left over to reinvest in the business, compounding the low growth problem. The company has been finding cash in other places by selling non-core assets and taking on more debt, but that's a strategy that can't last forever.
It would be misleading if I didn't note that Republic is also guilty of growing its dividend faster than its profits. Its payout ratio has also been climbing over the years, but that trend is reversing as the merger has brought increased profits.
The yield is not enough
In Waste Management's defense, it is currently going through a corporate restructuring that will likely improve business efficiency significantly. And both companies are partnering with Clean Energy Fuels (NAS: CLNE) to convert some of their trash-hauling trucks to natural gas, which is currently considerably cheaper than gasoline.
But it will take a lot of improvement for Waste Management to start matching Republic's growth pace. Both companies are also valued about the same, each with an enterprise-value-to-free-cash-flow ratio of about 22. While Waste Management dividend yield is more attractive at 4.4%, I'd frankly rather have Republic at 3.3% and not have to worry about how sustainable it will be.
Waste Management and Republic Services aren't the only ones turning to Clean Energy Fuels to lower their fuel costs. The company focuses its natural gas efforts primarily on trucking and fleets, and it is poised to make a big impact on an essential industry. Read all about Clean Energy Fuels in our brand new premium research report. Just click here to get started.
The article This Company Is Taking Out the Trash originally appeared on Fool.com.
Fool contributor Jacob Roche has no positions in the stocks mentioned above. Check out his Motley Fool CAPS profile or follow his articles using Twitter or RSS.The Motley Fool owns shares of Clean Energy Fuels and Waste Management. Motley Fool newsletter services recommend Clean Energy Fuels, Republic Services, and Waste Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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