A Member of Pat McKeough’s Inner Circle recently asked for his advice on a waste management company that made a major acquisition in 2022.
Pat likes the firm’s rising revenue and earnings over the last five years, a trend that’s continued to the latest quarter. However, he notes that the company’s habit of growth by acquisition carries significant risk in today’s market.
Republic Services Inc. (Symbol RSG on New York) is a leading U.S. waste management business. It is the largest or second-largest waste management business in 95% of the markets where it operates.
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The company has spent over $5 billion on acquisitions in the past five years. Bill Gates, through his investment vehicle Cascade Investment, owns more than 34% of its stock.
On May 2, 2022, Republic completed the acquisition of US Ecology Inc. (symbol ECOL on Nasdaq) for $2.2 billion.
US Ecology is the largest hazardous waste landfill operator by volume in the U.S. In addition, its operations team has the technical expertise needed to accelerate Republic’s growth in this area.
In the 12 months ended September 30, 2021, US Ecology reported $968 million in revenue from nine specialty waste landfills (five of which are hazardous waste landfills); 16 transfer, storage, and disposal facilities; seven wastewater treatment facilities; and more than 80 environmental service field locations.
Republic’s revenue increased 12.5% between 2017 and 2021, from $10.0 billion in 2017 to $11.3 billion in 2021. Excluding one-time items, earnings rose 61.8% as the company moved into more profitable markets, from $822.2 million, or $2.43 a share, in 2017, to $1.33 billion, or $4.17 a share, in 2021.
Meanwhile, in the quarter ended March 31, 2022, Republic’s revenue increased 14.4%, to $2.97 billion from $2.60 billion a year earlier. Revenues rose in all its operating segments. Excluding one-time items, the company earned $360.7 million, or $1.14 a share, in the quarter. That was up 21.4% from $297.2 million, or $0.93.
Growth by acquisition adds risks, especially with acquisitions as big as US Ecology. Republic aims to offset some of that risk by buying related firms it believes it can integrate smoothly to generate cost savings. Still, the company has a leading market share in most of its geographic locations, so it will need to keep making acquisitions to show significant growth.
The stock is now close to all-time highs and is trading at 27.0 times forecast earnings of $4.70 a share. The shares yield 1.6%.
Inner Circle: A warning about growth by acquisition
Using a growth by acquisition strategy may work for some waste management stocks but is inherently risky. Indeed, it’s a little like buying new stock issues.
These acquisitions generally come on the market when it’s a good time to sell. That may not be, and often isn’t, a good time to buy. Insiders and managers at the selling company know a lot more than the buyers about the company itself, and its business strengths and weaknesses.
Some takeovers work out well for the buyers, of course. This doesn’t diminish the inherent risk. More importantly, risk multiplies as takeovers become a habit.
Takeovers are more likely to succeed when the buyer is already a successful company and is under no pressure to buy anything. That way, the buyer can take its time and wait for a truly attractive, low-risk opportunity to come along.
The lesson here is that major, successful, well-managed companies do succeed in growth by acquisitions. But they use them as a tool for pursuing a core business, rather than making acquisitions the core of their business.
Recommendation in Pat’s Inner Circle: Republic Services Inc. is a hold.