GFL Environmental Inc (NYSE:GFL), is the fourth largest diversified environmental services company in North America. We believe the company to be reasonably priced despite being an aggressive bet relative to its peers.
We recently wrote a piece on Waste Connections (WCN), titled, Waste Connections: A Stable Business For Uncertain Times. In that article, we go more into detail about the waste management industry with a competition analysis that includes GFL and therefore recommend you have a read to get a better understanding. Nonetheless, we will summarize some key points here.
The North American waste management market size is expected to reach $229.3 billion by 2027, from $208.0 billion in 2019, registering a CAGR of 5.3% from 2020 to 2027.
We like the industry because the business of garbage removal is a natural monopoly. Natural monopolies arise typically due to the high start-up costs or powerful economies of scale of conducting a business in a specific industry which can result in significant barriers to entry for potential competitors. A company with a natural monopoly might be the only provider of a product or service in an industry or geographic location.
Furthermore, the industry is essential with high barriers to entry. The waste management business is very capital intensive, particularly with the initial capital.
Although GFL is free cash flow positive, it's still a little tricky to determine its intrinsic value because of its aggressive growth strategy. Unlike Waste Connections, which acquires companies responsibly with the cash flow that it generates, GFL borrows aggressively to acquire companies well above its cash flow generating abilities.
Therefore, a standard DCF model of GFL would be inaccurate if we used the standard definition of free cash flow because a lot of the growth is coming from acquisitions. Acquisitions are a major part of the company's strategy meaning it's unlikely to stop soon. This is money that doesn't go towards investors and should be treated as capital expenditures.
This then presents another problem in that free cash flow would be negative during the forecast period making the company essentially worthless. A company that can generate free cash flow before acquisitions is definitely not worthless. One solution would be to try to forecast organic growth. This would allow us to use the standard free cash flow metric because we would be assuming no acquisitions and would be valuing the future potential of the current business.
However, there isn't much historical data about GFL's organic growth rate since the company IPO'd only last year. Furthermore, current organic growth numbers are likely to be distorted from the pandemic. Thus, we believe the best way to approach the company's intrinsic valuation, for the time being, would be with a single-stage DCF model that assumes no acquisitions and a reasonable perpetual growth rate.
For free cash flow, we will use GFL's guidance for full year 2021 and assume that no more acquisitions will be made from 2022 and onwards. Note, all numbers are in Canadian dollars. Using the midpoint of its guidance, free cash flow is expected to be $515 million. We estimate that future interest will be approximately $303.2 million which we calculated by doubling the interest paid in the first 6 months. Although the company refinanced its 8.5% notes which will yield an estimated $17 million in interest savings, GFL is planning to raise another $400 million which will likely cancel out those savings. With a marginal tax rate of 25%, GFL's estimated unlevered free cash flow is as follows:
515 + 303.2(1-0.25) = $742.4 million
Using a weighted average cost of capital of 6.5%, and a perpetual growth rate of 2.5%, GFL's fair enterprise value would be as follows:
742.4 / (0.065 - 0.025) = $18,560 CAD
However, it's not unreasonable to think that GFL could grow at 3% in perpetuity given the essential need of the industry. In that scenario, the intrinsic value is:
742.4 / (0.065 - 0.03) = $21,211 CAD
The current enterprise value for the company's ticker on the TSX is $21,110 million. Therefore, the company is trading below fair value if organic growth can exceed 3%.
GFL has the same risks and catalysts as Waste Connections. However, GFL has the added risk of high leverage with a net debt to EBITDA ratio of 5.4x.
The good news is that there is no material debt maturing until 2024 (the revolving credit facility) with some debt maturing as far out as 2029. Therefore, the company has time to get ready for repayment although GFL also has the option to refinance some of this debt to a further date to reduce the burden of paying back over $1 billion at most of the maturity dates.
GFL is an aggressive bet on the waste management industry due to its high leverage. However, it does seem to be reasonably priced and the overall stability of the industry should help offset some of the additional risks.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within 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.