Think twice before buying these stocks. here’s why

Collecting and processing waste can be an extremely profitable business. Waste Management (NYSE: WM) and Services of the Republic (NYSE: RSG) have dominated the space for decades, as the two names, along with municipalities, have captured a combined 75% market share in the United States. However, due to their positive and recession-proof characteristics, both companies have attracted quite high multiples, which is languishing on their investment record. For this reason, I am neutral on both names.

What makes WM and RSG stocks attractive to investors?

With investors facing uncertainty on multiple fronts these days, companies that can produce reliable cash flow while delivering growing capital returns have attracted increased attention. Waste Management and Republic Services offer just that.

For starters, the waste management industry is very capital intensive and participants have developed strong ties with government entities and municipalities. Thus, entry into the market by smaller competitors is essentially impossible – hence the strong consolidation shown by the aforementioned market shares.

In addition, the waste business is recession proof. Regardless of the underlying state of the economy, waste should be collected. Thus, Waste Management and Republic Services benefit from secure revenues that are generally locked in by multi-year contracts entered into by blue-chip counterparties, including government entities.

Because waste collection and treatment is such an impenetrable and tightly controlled industry, both companies have managed to turn it into an added benefit for them.

For example, Waste Management uses the waste it collects to create energy, by recovering gas formed naturally when waste decays in landfills. The gas can then be used in generators to produce electricity or natural gas and even be used to power Waste Management’s own operations. Therefore, the company has designed a robust end-to-end ecosystem where value creation occurs between every phase of operations.

In the case of Republic Services, the company took advantage of its critical operations to convert about half of its multi-year contracts to contracts based on the CPI or locked to an alternative index linked to inflation, or a fixed rate of 3%. . In other words, excluding contracts locked in at 3%, which is still a respectable year-over-year increase, the company may even benefit from the current high levels of inflation, as it can raise its rates. billing an equal amount, or in some cases even higher rate.

Are WM and RSG dividends reliable?

Due to the unique qualities of Waste Management and Republic Services tied to their business models, which have historically enabled them to generate resilient cash flow in all market environments, both companies have become quite well-known and trusted among investors focused on dividend growth.

Waste Management has increased its dividend per share every year for the past 19 years, with its five-year CAGR of nearly 8%. Impressively, the latest increase was a satisfying 13%, suggesting a potential acceleration in dividend growth.

Republic Services has an equally impressive dividend growth record, with 18 years of successive annual dividend increases. Its five-year dividend per share CAGR is nearly 7.5%, similar to Waste Management.

Based on Waste Management and Republic Services consensus EPS estimates of $5.72 and $4.78, the two companies have payout ratios of around 45% and 40%, respectively. Combined with their aforementioned qualities and earnings growth engines, I am confident that both companies can be trusted when it comes to their dividends.

WM and RSG stocks look overvalued

With Waste Management and Republic Services exhibiting such attractive characteristics, particularly in terms of their ability to boost earnings and dividends during market downturns, investors tend to flock to their stocks during times of uncertainty – such as the times we are living in now. While this is reasonable behavior, it also widened their valuation multiples.

Again, based on both companies’ consensus EPS estimates for the year, Waste Management and Republic Services are trading at P/Es of around 30x.

This is a very high multiple in the current environment, although both companies continue to grow earnings in a rather predictable fashion. Overall, I think both stocks are quite overvalued, despite their unique qualities.

Are WM and RSG stocks good to buy?

With both companies trading at high multiples, it appears Wall Street analysts are also predicting limited upside for both names going forward.

Specifically, Waste Management has a Moderate Buy consensus rating based on four purchases and four reservations given in the past three months. At $172.13, Waste Management’s average price target implies only 3.15% upside potential.

On Republic Services, the stock has a moderate buy consensus rating based on seven buy ratings and three hold ratings given over the past three months.

At $154.80, Republic’s average service price target implies upside potential of 9.35%, which is also rather slim given the risks associated with its currently high valuation.

However, looking at each company’s Smart Score tells a different story. Waste Management has a Smart Score of 9 out of 10, indicating that it can outperform the market in the future – at least by this metric. Likewise, RSG has exactly the same odds.

Conclusion: strong companies with a limited advantage

Overall, Waste Management and Republic Services exhibit a number of attractive attributes, including operational excellence, a wide moat, quality customer base and excellent pricing power.

Both companies should continue to generate exceptionally strong results even if the macroeconomic landscape remains challenging going forward.

Nevertheless, with investors having taken refuge in these quality attributes, the valuation multiples of the two names have widened considerably, which could limit their upside potential.

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