Waste Connection | From trash to treasure
admin | March 13, 2020
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
With the equity indices all down sharply over the last month and the Bloomberg Barclays Us corporate index hitting a year high recently, nothing seems insulated from the fallout of COVID-19. Relative safe havens such as packaged food have seen widening of 50 bp or more in the 30-year part of the curve. Waste collection servicers may prove to be the fallout shelter, in particular, WCNCN.
In recent days, WCNCN equity was relatively flat year-to-date. Furthermore, its 30-year bond, which priced on March 4 at +150 bp, is only out about 10 bp since pricing. Over the same time frame, Waste Management (WM), one of WCNCN’s closest peers, has witnessed roughly 37 bp of widening in its 30-year bond.
Exhibit 1: Waste Services Peer Comparison
Source: Company Filings; APS
WCNCN boasts the strongest margins in its peer group, which reflects the company’s strategy of focusing on secondary markets where population growth is higher and competition is limited. Currently 70% of WCNCN’s top line comes from commercial and residential markets, which are not as cyclical as industrial markets. Exclusive contracts from these markets account for more than 40% of WCNCN’s top line. This enables the company to maintain pricing power without the risk of increasing customer churn. WCNCN has maintained pricing growth above the rate of inflation, leading to solid margin growth. At year end 2019, WCNCN’s EBITDA margin was 32.1%, which compares favorably to WM’s EBITDA margin of 29.9% and Republic Services (RSG) margin of 28.7%. Drilling down to the free cash flow line, WCNCN’s free cash flow/sales ratio was a strong 16.2%, nearly 300 bp above WM’s ratio and more than 500 bp better than RSG’s. From 2016-2019, WCNCN’s revenues have increased 59.6% while free cash flow grew 94.1%.
Managing leverage for growth
WCNCN manages leverage in the 2.5x-3.0x range. The company has noted on multiple occasions that this leverage metric provides for strong investment grade ratings as well as flexibility to pursue acquisitions for growth. Given that the waste services business is highly fragmented, acquisitions are typically of the tuck-in nature. Management’s commitment to IG ratings is underscored by its common practice of reducing share buybacks to build cash on the balance sheet for acquisitions.
WCNCN ended 2019 with leverage of 2.4x. While the company has tapped the debt market twice in 2020, a 10-year issued late January ($600 million) and the aforementioned 30-year ($500 million), both deals were used to repay outstandings under the credit facility and its term loan. That said, both deals were essentially leverage neutral. While no filings have been released since the deals launched, as of 12/31/19 $916 million was outstanding under the revolver and $700 million under the term loan. The revolver should be largely repaid, and just over $500 million is outstanding on the term loan.
At a time like this when liquidity is very valuable, WCNCN’s liquidity is quite strong. Assuming the revolver is fully repaid, that leaves roughly $1.45 billion of availability after slightly more than $100 million of LOCs. Add to that the $327 million of cash on the balance sheet, and that puts liquidity at $1.77 billion. WCNCN’s debt maturity profile is very manageable with nothing maturing this year and $225 million maturing through 2022. The term loan comes due on 3/28/23 and WCNCN has done a good job so far repaying it. The initial tranche size was $1.64 billion and we estimate that just over $500 million is outstanding. Furthermore, WCNCN should generate nearly $1 billion of free cash flow this year. While WM’s cash position is a strong $3.56 billion currently, we note that a majority of the cash will be used to fund its acquisition of Advanced Disposal Services which is expected to close by the end of 1Q20.
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