Waste Connections: Best At Turning Trash To Cash

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About: Waste Connections, Inc. (WCN), Includes: RSG, WM
by: Brad Kenagy
Summary

Waste Connections focuses on exclusive and specifically selected markets.

The combination of focusing on exclusive markets and M&A activity has led Waste Connections to be able to generate substantial free cash flow.

The Waste industry is highly fragmented, which provides Waste Connections a large pool of potential acquisition targets.

In this article, I will be covering Waste Connections (WCN), which is one of the largest waste companies in North America. Waste Management (WM) usually gets the spotlight because it is the largest company in the space. However, Waste Connections has vastly outperformed Waste Management and fellow peer Republic Services Inc. (RSG). Even with this vast outperformance, it is still underfollowed even here on Seeking Alpha. Waste Management has 42.4K followers, Republic Services has 8.1K followers and Waste Connections has 4.4K followers. What makes Waste Connections superior is the fact they focus on exclusive and specifically selected markets, which gives them a competitive advantage. Because of their focus on exclusive markets, Waste Connections is able to generate sustainable free cash flow growth. Finally, Waste Connections should continue to grow going forward because they have the capacity to expand further by making more acquisitions.

Waste Connections investor conference

Sustainable competitive advantage

As referenced in the first paragraph, what makes Waste Connections special is their focus on exclusive markets and the pricing consistency that goes along. The waste industry has a built-in competitive advantage because of all the red tape and regulations that go along with waste collection, disposal and transfer. The table below shows solid waste collection, disposal and transfer accounts for over 90% of company revenues each of those segments has showed year/year growth. The ability to increase prices even when volume is near flat is a big benefit for Waste Connections. The third chart below shows 86% of revenues for Waste Connections come from the United States and the second chart shows Waste Connections was able to increase core prices by 4.1% in the United States.

Waste Connections Q4 2018 earnings release

Waste Connections Q4 2018 earnings release

Waste Connections investor conference

The reason why revenue growth for Waste Connections turns into a competitive advantage is, when compared to Waste Management and Republic Services Inc., Waste Connections is superior at turning revenues into free cash flow. The following chart shows free cash flows as a percentage of revenues for the last decade have been higher than both Waste Management and Republic Services Inc. This clearly shows Waste Connections has an advantage over other companies in the group in terms of management and for the integration of acquisitions.

Chart data from stockrow.com

Free cash flow

One of the attractive things about the waste industry is the ability to consistently generate positive free cash flow regardless of the economic conditions. The chart below shows all three of the major waste companies have generated positive free cash flows for the past decade. By dollar value, Waste Connections has the lowest free cash flow, but as you can see, Waste Connections has the most consistent free cash flow growth in the group. This can be attributed to their focus on adding additional companies through M&A as well as their focus on exclusive markets, which have lower churn rates and more consistency.

*Data in Millions

Chart data from stockrow.com

Even though Waste Connections has the lowest free cash flow by dollar value, the chart below shows they are growing free cash flows at a substantially higher rate than Waste Management or Republic Services Inc. I used 2009 free cash flows as a benchmark starting point, and as you can see, Waste Connections has really expanded free cash flows over the past decade. Specifically, Waste Connections' free cash flow is up 375.67%, Republic Services Inc.'s free cash flow is up 99.77% and Waste Management's free cash flow is up 58.58%.

*Data in millions

Chart data from stockrow.com

Growth potential

There is growth potential for Waste Connections because the waste industry is highly fragmented and there are many private operators. For example, Waste Connections just completed the acquisition of American Disposal Services in December. American Disposal Services has revenues of approximately $175 million and 400,000 customers in Virginia, Maryland, Georgia and Colorado. There is a large market for potential acquisitions that Waste Connections can make. In a recent investor presentation by Republic Services Inc., they noted that approximately 35% of waste industry revenue is from either private companies or regional companies. This large pool of potential acquisition targets should continue to be a source of future growth for targeted acquisitions by Waste Connections. The map below shows there are a number of states that Waste Connections has limited or no presence in, which means the opportunities for expansion are vast.

Waste Connections investor conference

Risks

With the focus on building the business through continued M&A, it is wise to look at debt levels as to not end up with a Valeant (BHC) type situation, where a company has been doing many acquisitions but amassed too much debt in doing so. The table below shows Waste Connections has an average debt to EBITDA ratio for the group and appears not to be an issue. Issues could arise in the future if debt levels climb significantly and/or if interest rates increase, which would make refinancing debt more expensive or make potential acquisitions paid for by debt more expensive. In addition, because many of the owners of potential M&A targets are private, there is no guarantee that Waste Connections will be continue to find companies that are willing to sell.

*Data in millions

RSG

WM

WCN

Debt (Short-term + Long-Term)

$8338

$10026

$4173

EBITDA

$2819

$4227

$1520

Debt to EBITDA

2.96

2.37

2.75

Table data from Gurufocus.com

Closing Thoughts

In closing, I believe Waste Connections is a high quality company that has a sustainable competitive advantage in both strong and weak economic conditions. In addition, Waste Connections consistently generates positive free cash flows that are continuing to grow with the potential for further growth from continued acquisitions. Shares of Waste Connections do not come cheap because they are trading near their all-time high, so it might be best to wait for a pullback before finding a long-term entry point.

Disclaimer

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in WCN over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I may purchase WCN sometime in the future.