Bloomberg published an article identifying Waste Connections (WCN, Financial) as the "MVP of Garbage" while being traded at a good premium compared to its peers.
The $16 billion waste management company reported its first-quarter fiscal 2017 results this month. The formerly Texas-based company delivered an impressive 112% sales growth to $1.09 billion and a whopping 66.8% profit decline to $14.9 million – 1.4% margin vs. 8.7% in the year earlier quarter.
In review, Waste Connections recently underwent a $2.67 billion reverse merger deal with Canada-based Progressive Waste Solutions. As a result, Waste Connections is now Canada-based and logged higher overall sales and expenses – especially "Impairments and other operating items" that jumped to $141.7 million in the first quarter from $236,000 in first-quarter 2016.
"2017 is off to a great start with 15% same-store landfill tonnage increases, better-than-expected contribution from recent acquisitions, increased E&P waste activity, and higher recycled commodity prices all driving results above our outlook for the first quarter. Adjusted EBITDA margin was 50 basis points above our expectations, and most importantly, adjusted free cash flow was $237.5 million, putting us well on our way to our full-year adjusted free cash flow outlook of $725 million.
"We are extremely pleased with our first-quarter performance and encouraged by both continuing strong solid waste fundamentals and the notable ramping of E&P waste activity and related margins. In addition, we are proud of our proposed three-for-two stock split also announced today, which, if approved by our shareholders, will be the fourth such split in our almost 20-year history." – Ronald J. Mittelstaedt, chairman and CEO
The company sees its full-year adjusted free cash flow* outlook of $725 million compared to $550.9 million in 2016.
*Waste Connections (10-K): We define adjusted free cash flow as net cash provided by operating activities, plus proceeds from disposal of assets, plus or minus change in book overdraft, plus excess tax benefit associated with equity-based compensation, less capital expenditures for property and equipment and distributions to noncontrolling interests. We further adjust this calculation to exclude the effects of items management believes impact the ability to assess the operating performance of our business.
Waste Connections shares rose 4.01% at market close the day after the earnings announcement.
Valuations
Bloomberg was on point with Waste Connections’ valuations. Meanwhile, the company had a trailing price-earnings (P/E) of 71.9 times vs. the industry median of 20.2 times, a price-book (P/B) value of 2.9 times vs. 1.8 times and a price-sales (P/S) ratio of 3.8 times vs. 1.3 times (GuruFocus data).
Waste Connections had trailing dividend yield of 0.71% with 38% payout ratio.
Waste Connections had multiples of 3.6 times and 29.8 times when current market capitalization was applied to average 2017 sales and earnings-per-share expectations.
Total returns
Waste Connections has outperformed the broader Standard & Poor's 500 in the past decade whereby the company had provided more than twice the return of the index at 16% total gains vs. 7.15% (Morningstar data). In the past year alone, the company provided 37.5% total gains vs. the index’s 17.9% total return.
Waste Connections
Waste Connections was founded in 1997. According to filings, Waste Connections is the third-largest solid waste services company in North America, providing waste collection, transfer, disposal and recycling services in mostly exclusive and secondary markets in the U.S. and Canada.
Through Waste Connections’ R360 Environmental Solutions subsidiary, the company also is a leading provider of nonhazardous exploration and production, or E&P, waste treatment, recovery and disposal services in several of the most active natural resource producing areas in the U.S.
Waste Connections also provides intermodal services for the rail haul movement of cargo and solid waste containers in the Pacific Northwest through a network of intermodal facilities.
In January 2016, Waste Connections and Canada-based Progressive Waste Solutions entered into a $2.67 billion reverse-merger agreement were the new entity, still named Waste Connections, would be based in Canada and 70% owned by Waste Connections shareholders.
The merger agreement helped reduced Waste Connections’ tax rate to 27% from 40% (Bloomberg). In 2016, Waste Connections derived majority or 69.7% of its sales from solid waste collection, 21% from solid waste disposal and transfer, and the rest from recycling, E&P waste treatment, recovery and disposal and intermodal and other services.
In 2016, Waste Connections derived 12% of its revenue from Canada and the remainder from the U.S.
As of Dec. 31, 2016, Waste Connections delivered services from operating locations grouped into six operating segments: Southern, Western, Eastern, Canada, Central and E&P (1).
Southern
Southern segment services customers located in Alabama, Arkansas, Florida, Louisiana, Mississippi, southern Oklahoma, western Tennessee and Texas.
In 2016, sales in Southern jumped by 379.7% to $809.9 million or 21.1% of total company sales and delivered a segment EBITDA* margin of 20.2% vs. 21.2% in 2015.
*Waste Connections (10-K): The company defines segment EBITDA as earnings before interest, taxes, depreciation, amortization, impairments and other operating items, other income (expense) and foreign currency transaction gain (loss). Segment EBITDA is not a measure of operating income, operating performance or liquidity under generally accepted accounting principles and may not be comparable to similarly titled measures reported by other companies. The company’s management uses segment EBITDA in the evaluation of segment operating performance as it is a profit measure that is generally within the control of the operating segments.
Me: denominator used or segment sales figure excludes any adjustments.
As mentioned earlier, most sales jump came from the recent acquisition activities.
Western
Western segment services customers located in Alaska, California, Idaho, Montana, Nevada, Oregon, Washington and western Wyoming.
In 2016, sales in Western segment grew 6.8% to $1.05 billion or 27.3% of total company sales and delivered 30% segment EBITDA margin vs. 29.6% in 2015.
Eastern
Eastern segment services customers located in Illinois, Iowa, Kentucky, Maryland, Massachusetts, Michigan, New Jersey, New York, North Carolina, Pennsylvania, South Carolina, eastern Tennessee, Vermont, Virginia, Wisconsin and the District of Columbia.
In 2016, sales in the Eastern segment grew by 66% to $754 million or 19.5% of total sales and delivered a 25.7% segment EBITDA margin vs. 26.5% in 2015.
Canada
Canada segment services customers located in the provinces of Alberta, British Columbia, Manitoba, Ontario and Québec.
In 2016, Waste Connections logged $466.5 million in Canada sales or 12% of total company sales and delivered a segment EBITDA margin of 32%.
Central
Central segment services customers located in Arizona, Colorado, Kansas, Minnesota, Missouri, Nebraska, New Mexico, Oklahoma, South Dakota, western Texas, Utah and eastern Wyoming.
In 2016, sales in Central segment grew 13.3% to $634.4 million or 16.5% of total sales with segment EBITDA margin of 32.9% (highest among all segments) vs. 32.9% (same) in 2015.
E&P segment
The E&P segment services E&P customers located in Arkansas, Louisiana, New Mexico, North Dakota, Oklahoma, Texas, Wyoming and along the Gulf of Mexico.
In 2016, sales in the segment fell 41.6% to $132.5 million and delivered a segment EBITDA margin of 24.5% vs. 30.9% in 2015.
Revenue and net income
On average, Waste Connections had three-year sales growth of 20.5%, profit growth of 8%, and profit margin of 4.65% (Morningstar data).
As observed, Waste Connections actually delivered losses of $95.8 million in 2015 resulting to the energy industry downturn*.
* Waste Connections (10-K): The decline in oil prices that began in late 2014 and continued through 2015 and into early 2016, has resulted in decreased levels of oil and natural gas exploration and production activity and a corresponding decrease in demand for our E&P waste services. This decrease, together with market expectations of a likely slow recovery in oil prices, has reduced the expected future period cash flows of our E&P segment, causing the fair value of the E&P segment to decrease below its carrying value. During the third quarter of 2015, we recorded impairment charges of $411.8 million associated with goodwill and $38.4 million associated with indefinite-lived intangible assets in our E&P segment.
Cash, debt and book value
As of March, Waste Connections had $268.5 million in cash and cash equivalents and $3.96 billion in debt with debt-equity ratio of 0.7 times vs. 1.03 times in first-quarter 2016.
Waste Connections increased its share count (diluted shares outstanding) by 42.5% to 175.9 million in the recent quarter compared to 123.5 million in first-quarter 2016.
Of the company’s $11.5 billion assets nearly half – 49% – were labeled as goodwill and intangibles having had a book value of $5.65 billion vs. $2 billion in first-quarter 2016.
Cash flow
(News release)
In the first quarter, Waste Connections’ cash flow from operations improved by 74.5% to $287.5 million resulting from higher cash flow derived from loss on asset disposals and impairments, intangibles amortization, share-based compensation, interest accretion and adjustments to contingent consideration.
Capital expenditures for the period were $91.2 million leaving the company with $196.3 million in free cash flow vs. $108.1 million in first-quarter 2016; 16%, or $31.7 million, of the free cash flow was allocated as dividends and share repurchases in the recent quarter.
On average, 28.5% of free cash flow was provided as dividends and share repurchases net proceeds from option/warrant exercises, equity-based compensation and share sales held in trust. AutoNation (AN, Financial) also generated $279.8 million in debt proceeds net payments in the first quarter.
Conclusion
Waste Connections certainly made a good move when it had the reverse-merger with Progressive Waste Solutions. Overall sales grew impressive for the company in 2016 allowing it to grow its businesses while including a new segment – its Canada operations.
Nonetheless, impairment charges are still evident during the company’s first-quarter operations whereby it affected Waste Connections’ ability to deliver profits to its shareholders.
Second to this recent acquisition, the company’s debt doubled along with increase in share count. Further, Waste Connections had almost half of its assets identified as goodwill and intangibles.
Waste Connections has kept its shareholder payouts including dividends and share repurchases at a low even prior to the 2016 acquisition.
(Waste Communications share price and price-sales ratio, GuruFocus)
Fourteen analysts have an average price target of $99.86 per share – 8.5% higher than the share price of $92.02 (at the time of writing).
Using three-year P/S multiple average on average 2017 sales expectations followed by application of 20% margin would indicate a value of $11.9 billion or $67.6 per share.
In summary, Waste Connections is a pass given its high valuations.
Notes
(1) Me: I was not able to observe any data specifically per segment in first-quarter 2017.
Disclosure: I do not have shares in any of the companies mentioned.
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