Waste management stocks are likely to continue to outperform the overall market in 2023, as their defensive operations should shield them from the multiple uncertainties raging in the markets these days. Today, we are looking at Waste Management (NYSE: WM) and Republic Services (NYSE: RSG) because they are the most dominant payers in the industry.
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Their unique qualities, including high-quality cash flows, predictable and diversified revenue streams, and growing capital returns, should result in the two stocks withstanding any further potential market sell-off. Both stocks have historically produced low-volatility returns.
This was the case through 2022, with Waste Management and Republic Services declining by just 4.6% and 6.2%, compared to the S&P 500 (SPX), which declined by a much more substantial 19.4%.
With 2023 already predicted to be a tough year for global markets amid lasting macroeconomic uncertainty, let’s go over why the two stock’s outstanding attributes are likely to result in further outperformance ahead.
High Barriers to Entry
The waste management industry is extremely capital-intensive, with high startup expenses and costly infrastructure requirements. This makes it difficult for new potential competitors to enter the market and contest with established companies. This is why Waste Management and Republic Services essentially operate in an oligopoly.
Specifically, Waste Management and Republic Services, along with municipalities, have captured a combined market share of 75% of the landfill volume managed in the United States. An oligopolistic industry comes with multiple advantages, including strong pricing power, lack of meaningful competition, and easy long-term planning amid reduced uncertainty.
Economies of Scale
With high barriers to entry and dominating market shares come easy economies of scale. This basically means that Waste Management and Republic Services can offer their services more efficiently at larger volumes, resulting in expanding margins. The two companies featured gross margins of around 35% at the end of 2014. They have now expanded to roughly 37% and 40%, respectively.
Recession-Proof Business Model
Waste Management and Republic Services can be considered “recession-proof” because waste management is an essential service that is required in all communities and is not as likely to be impacted by economic downturns, which is the case with most other industries.
People and businesses generate waste regardless of economic conditions, and the demand for waste management services is relatively stable. Both Waste Management and Republic Services recorded revenue growth during the Great Financial Crises and the COVID-19 pandemic.
Quality Cash Flows and Secured Rate Increases Over Time
Waste Management & Republic Services usually sign long-term contracts with municipalities and other organizations, which result in them enjoying stable revenue streams. These contracts can last an extended period of time, such as five or 10 years, and usually include provisions for charging increases based on inflation or other factors. Besides ensuring that the waste management companies enjoy predictable sources of income, this also contributes to them easily planning for the future.
In the case of Republic Services, for instance, about 80% of its revenues have an annuity-type profile, while about 50% of its contracts have CPI-based increases or are linked to an alternative inflation index or increase at a fixed rate of 3% or greater each year.
Consistently-Growing Capital Returns
All the factors mentioned above have allowed Waste Management and Republic Services to consistently grow their capital returns regardless of the underlying state of the economy.
In particular, Waste Management has increased its dividend per share annually for 19 consecutive years, with its 10-year CAGR standing close to 6%. Republic Services displays an equally remarkable dividend-growth track record, counting 18 years of consecutive annual dividend hikes. Its 10-year dividend-per-share CAGR stands close to 7.7%, not that far from Waste Management’s past-decade dividend growth pace.
According to Waste Management’s and Republic Services’ consensus earnings-per-share (EPS) estimates of $5.71 and $4.80, the two companies feature payouts ratios of about 45% and 40%, respectively. Given their low payout ratios and aforesaid traits and earnings growth drivers, I feel confident that both companies can be relied upon when it comes to their dividend-growth prospects. Both companies also have a long history of strong stock buybacks.
What Do Analysts Make of WM and RSG Shares?
Regarding Wall Street’s sentiment toward Waste Management, the stock has a Moderate Buy consensus rating based on five Buys and seven Holds assigned in the past three months. At $172.75, the average Waste Management stock forecast implies just 8.8% upside potential.
As far as Republic Services goes, the stock also has a Moderate Buy consensus rating based on five Buys and five Hold ratings assigned in the past three months. At $148.70, the average Republic Services stock forecast implies 16.2% upside potential.
The Takeaway – Rock-Solid Picks for an Uncertain 2023
Overall, the combination of resilient cash flows, oligopolistic industry structure, and other qualities, as discussed earlier, Waste Management and Republic Services, can be attractive investment options in the face of the multiple uncertainties that are likely to endure through 2023. Both stocks are modestly pricy. However, given their unique characteristics and safe dividends, they are likely to retain their premium valuation multiples.
