Waste Connections Isn't Getting Equal Credit For The Current Environment
- Waste operators like Waste Management and Republic Services reported great figures that imply an enormously robust economy and waste ecosystem.
- Waste Connections had less optically appealing financial statements due to its recent acquisition activities. In truth, the company shed the revenue many quarters ago. Real-time markets are doing great.
- The two other stocks have each jumped +6% and +10% on recent earnings, but Waste Connections got little credit for being in the exact same environment.
- A few unprofitable contracts are still being divested, but once that is completed, Waste Connections will grow at the pace of peers again, although with superior markets and management.
- Waste Connections is expecting a monster 2019, and its acquisition pipeline is strong. The company should be receiving the same treatment as its peers.
In my article on the volume, price, yield, and churn figures from the Q2-18 reports from Waste Management (WM) and Republic Services (RSG), I covered how the recent figures underline how robust and strong the current waste environment is. Low customer churn and high pricing indicates a stable outlook, while volume trends were more moderate. Waste operators are able to pass on wage increases to customers consistently, while expanding margins and growing sales on volume. Nearly everything but residential is bounding ahead.
As a result of these stable and strong results, the stocks of most waste operators jumped on the good news from WM and RSG.
Each posted volume and price trends that resulted in sales growth in excess of 2.5% organically, in addition to an overflowing amount of acquisition spending and capital return.
On the other hand, Waste Connections (NYSE:WCN) "only" grew 4%.
Optically, the reason was quite simple. Whereas peers had organic volume growth of ~1% on average and total organic sales growth of approximately 2.8-4%, Waste Connections had volume growth of -1.5%. This also led to total organic growth (on great pricing, 3.6% yield) sitting at roughly 2.0%.
Volume Fully Expected and Underlying Growth Moderate
The interesting point (to me, at least) was that the negative volume was quite obviously temporary. Divestitures accounted for roughly 85 basis points, and a few other temporary comparison issues should sunset pre-2019.
Waste Connections expects sequential improvement of 50-100 basis points, but for me, the real interest is in its 2019 guidance and the misinterpretation of the company's corporate strategy.
The management team of Waste Connections has largely been competent and consists of seasoned people. Let us break down the 2019 guidance comment from Ron Mittelstaedt, CEO of WCN, given to a Goldman analyst:
So what we said on 2019 is that, we expect price and volume to be in the 4% to 6% range with pricing being the majority of that. So pricing probably in that 3.5% to 4% [...] volume being the differential bridge between 4% and 6%. We said that based on deals done already, deals that we expect to do over the balance of the year, that, that rollover impact should – could be up, up to 3% to 4%.
So the company expects 4-6% overall organic growth with a layer of acquisition growth that also amounts to ~3%. The 4-6% organic growth is largely pricing which is better for margin status.
So it sort of gives you between 7% and up to 9% to 10% top line growth before contribution from any deals may be done in 2019. And we said from that with recycling anniversarying as well as purposeful shedding anniversarying at the end of the third quarter, that we see margin expansion of 50 basis points to 75 basis points going into 4/19 as we sit here today. [...]
So total top line growth of 7-10% in the near term, pre-acquisition activity. That is tremendous and at least equal to, if not greater than, expectations most peers have.
[...] Again, I think it’s important to note that this is not volume loss, it’s occurring on a realtime basis, this is volume loss that occurred as we shed that volume a year ago, three to four quarters ago, now coming into the fourth quarter in this third quarter, and is just in the reported number, which is why we gave that number and said what the underlying volumes are doing.
As previously stated, most should have expected this level of negative volume, or at least negative 100 basis points.
We do think that it was probably - we’re going to round 30 basis points to 40 basis points of lighter than expected volume in Q2, that was due to special waste projects that were delayed. I know it seems a while ago sitting here in July, but we were having severe snow events throughout many parts of the U.S., all the way up into May and certainly, in Canada, into late May. So we did not really begin - we only really got about one month contribution of special waste that we would typically see more like a full two months beginning in May.
While there were a few unexpected headwinds, they were seasonal. While management teams have a tendency to blame the weather for almost everything, the team at WCN has generally been a good steward of capital. At the same time, management teams at other waste firms have shared the same weather-related sentiments (specifically, Advanced Disposal Services (ADSW)):
[...] the last part of your question was a more typical 1% to 2% volume growth, Brian. I would expect that in this GDP environment, and as you look at a full year, that we should return to that as we go into 2019 and certainly, as we get into the second half of 2019, there are still some nominal lingering effects of some of the contracts that we have opted to walk away from. But the underlying should be in that 1% to 2% range even at a 4% type price. Obviously, as you push pricing, you start to get up into that range, there is some offset to volume. So that mutes it a little bit, but I think that’s where we would expect to be.
- Ron Mittelstaedt, CEO (Q2-18 Earnings Call Transcript)
The major point is this final one. There is nothing inherently different in the markets Waste Connections serves. The only reason is the company's divestment of its Progressive Waste lines, which is entirely according to plan.
The second point is that long-term volume doesn't even need to amount to peers.
Waste Connections' Corporate Strategy and Churn
In my old article on WCN, "Waste Connections: What Is The Secret Sauce Worth?" I explained that the company's corporate strategy differs materially from those of WM and RSG in a few key aspects. Namely, the focus on exclusive markets and the focus on profitability (i.e., not taking a route for later price and volume increases). These two attributes make the income stream of Waste Connections vastly safer and its margins much greater than those of peers, but it does change what parameters matter the most.
Traditional waste managers need a combination of volume and price because their contracts are relatively cut-throat. On the other hand, Waste Connections gets less volume growth but has superior long-term pricing power.
Volume shouldn't be at the level of peers necessarily, but pricing power should be superior. Right now, WCN is seeing single-digit churn.
Exclusive and integrated markets mean that there is less competition. That means volume is often based on the underlying economics and not lost/won contracts. Excluding intentional shedding the volume of WCN is not apt to change materially from what underlying GDP growth and regulation will drive.
Conclusion and Summary
Waste Connections stock reacted less on a great environment than peers due to optical issues. Once the optics are over, the management team expects a magnificent 2019, but even if volume is still lacking, it is of less importance than it would be for peers. Pricing and profitability are everything for WCN's corporate strategy.
When I originally wrote up WCN, it traded at $65 per share. My fair value estimate at that point in time was roughly $75 per share. With the incredibly robust environment, I believe that the fair value could easily be ~$80, but Waste Connections (and the other firms, for that matter) remain less of a bargain than when I initially wrote it up.
On a comparative basis, I still prefer Waste Connections for its high-quality markets and M&A pipeline, and the stock could see a material bump if 2019 guidance is hit.
For now, I sit on the sidelines with an eye on the stock if it hits $70. It would be my vehicle of choice for a stable environment. If this environment continues, I would prefer Advanced Disposal Services.
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