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Waste Connections (WCN) Stock | NYSE: WCN | TSX: WCN.TO

Recycling Capital to Fund Growth

Waste Connections (“WCN”) is a provider of solid waste services, non-hazardous exploration and production (“E&P”) waste services, and intermodal services of cargo and solid waste containers. WCN operates solely in North America, with facilities and networks across 43 US states and six Canadian provinces. It differentiates itself from large peers in the solid waste services industry by focusing on niche markets and underserved regions through organic growth opportunities and acquisitions. 

The solid waste services industry is highly commoditized. To combat this, WCN recognizes the benefit of acquiring high market share in smaller markets where it will have more pricing power and face less competition than urban areas. Asset positioning and establishing vertically integrated operations have been the primary focus of management since day one, and this strategy formed the third largest player in the industry today.

Growth

68

Valuation

84

Quality

58
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Where Are We Now

Updated on: 11/7/2021

Conviction Score

7

Waste Connections may be a boring waste collection business, but its growth profile certainly isn’t. We like Waste Connection’s small- to mid-size market focus for expansion opportunities and its vast North American reach. We also think Waste Connection shares will perform well over a long holding period.

  • Waste Connections is still posting revenue growth around 15%. We think this is quite impressive in a mature industry like waste collection that grows far slower.

  • Waste Connections’ services are sticky as the company is a great operator. Adding to that is that most cities and companies would prefer to contract with the same waste disposal company over and over.

Investment Thesis

  1. WCN is the third largest solid waste services provider in North America, but its margin profile is superior to the #1 and #2 industry players. Its strong margins can be attributed to its focus on niche markets and underserved regions where returns are higher, and competition is sparse.

  2. WCN’s moat is a result of its competitive positioning - About 40% of WCN’s revenues are generated via exclusive agreements in dense markets while the balance of WCN’s revenues come from underserved and niche markets. Additionally, it is a capital-intensive business, and it executes well on placing infrastructure and collection networks close to their customers, making it difficult for competitors to steal share from WCN-penetrated markets.

  3. Risks to WCN include rising input costs, cyclicality in the core solid waste business and oil / natural gas production, acquisition execution risks, volatile recycling material and Renewable Identification Number (“RIN”) pricing, and regulatory risks.

  4. WCN will be riding two major secular trends this decade – (1) stable rise of waste production as the economy expands and population grows, and (2) ESG (stands for Environmental, Social, and Governance) as a company that recycles and recovers materials and manages waste.

  5. The solid waste services industry is fragmented and ripe for consolidation. As a world-class capital allocator, WCN aims to acquire regional players in attractive markets to grow out its footprint, spur cost efficiencies, and gain market share.

The Basics

WCN is a provider of integrated waste services, mainly the collection, transfer, disposal, recycling, and resource recovery – a process used to extract materials or energy from solid waste for use as an input material for new goods – of solid waste. WCN also performs non-hazardous natural gas and oil E&P waste treatment, recovery, and disposal services for customers, along with intermodal services of cargo and solid waste containers in the US Pacific Northwest (“PNW”).

WCN provides services in 43 states across the US and six provinces in Canada, serving over 7 million residential, commercial, and industrial customers. WCN operates mainly in exclusive and secondary markets.

The former refers to whole or partial markets where WCN has exclusive agreements (i.e., primarily franchise agreements, municipal contracts, and governmental certificates) to be the sole provider in a specific market. The latter refers to smaller, non-urban markets where WCN has an “edge” to capture greater market share as opposed to saturated urban areas where market share is significantly more difficult to grab absent any exclusive agreements. 

Where WCN Operates on a mapSource: 2020 WCN Annual Report

WCN’s focus on smaller markets has treated the company well – it is the third largest solid waste services company in North America by market capitalization, behind Waste Management (“WM”) and Republic Services (“RSG”). Collectively, these three businesses control about 30% of the waste services industry.

Despite sitting in third place, WCN is an extremely efficient operator, consistently at or above WM and RSG's margin readings.

The company owns and operates 91 landfills, of which about 66 are municipal solid waste (“MSW”) landfills, 13 are non-MSW landfills, and the remainder are E&P landfills. Completing WCN’s ecosystem of infrastructure and operations are another 300+ solid waste collection operations, 180+ transfer stations, and 68 recycling operations owned and operated by the company.

WCN leads in two niche markets – E&P waste services and intermodal operations in the PNW. In these markets, WCN owns and operates six intermodal operations, 23 E&P liquid waste injection wells, 19 E&P waste treatment and oil recovery facilities, and 12 E&P landfills. However, these two segments are very small compared to WCN’s solid waste services.

WCN’s operating strategy boils down to the following few ideologies:

  1. Avoid large and saturated urban markets – target exclusive, small, or niche markets where market share is up for grabs.

  2. Control the entire waste stream – Target vertical operations, from initial collection to final treatment and disposal.

  3. Position assets optimally – proximate disposal infrastructure enables cost and operational efficiencies and speedy operations.

  4. Decentralized management – A localized team structure allows for local issues to be identified quickly and resolved effectively.

This strategy has translated into tremendous results for the company. WCN has experienced solid revenue growth with commensurate increases in EBITDA and FCF, alluding to WCN’s operational strength, solid strategy, and renowned execution.

Waste Connections Revenue ($M) (Q3 2021)

Competitive Advantages

The WCN Fortress

WCN’s main advantage stems from its ability keep competitors out as if it were building fortresses in each market.

Currently, WCN has exclusive rights in about 40% of the markets in which it operates. The remaining 60% are smaller underserved markets, primarily secondary and rural markets, where WCN can attain high market share using its vertical integration strategy and asset positioning expertise.

There is a massive disincentive for competitors to enter a new market if WCN has exclusive agreements in place or it vertically integrates its operations within a small market, grabbing most or all of market share in a particular municipality or region.

Contractual Agreements

Exclusive agreements with municipalities for residential services typically last between three and ten years. For commercial and industrial customers, contracts are generally shorter in length and span about three years on average. WCN does not disclose churn figures, but WM does – the average customer contracting with WM’s residential services stays with the business around 10 years (~9% churn). Given WCN’s competitive positioning and focus on niche and small markets, we would expect it to experience similar or lower churn with its services.

These contracts benefit WCN in two major ways when considered in unison with the “WCN Fortress”:

  1. Customers face severe financial disincentives to break the contract and switch to another commoditized waste services provider.

  2. Contracts with 3-year terms or more allow for stable cash flows, investment payback, and the ability to reinvest into more acquisitions or expansionary projects.

We believe both factors above contribute significantly to WCN’s pricing growth of around 4.5%, on average, recorded in the 2018 – 2020 fiscal years. This is especially true when considered with WCN’s strategy to vertically integrate markets where exclusive agreements are not in place and general asset positioning.

WCN Pricing Growth TrendSource: WCN Investor Relations

Astronomical Costs

Waste collection, disposal, recycling, and recovery services require a ton of capital to buy all the infrastructure and equipment to operate a fully integrated stack of waste services. WCN invests heavily to buy buildings, land, machinery, equipment, rolling stock, and containers.

Despite WCN’s revenues growing at a double-digit CAGR over the last decade, capital expenditures (“CapEx”) as a percentage of revenue has remained roughly the same year after year with minor fluctuations. These figures are astronomical on absolute and relative bases.

Waste Connections Capital Expenditures ($M) (Q3 2021)

We believe it is unlikely that small regional players can upend WCN’s positioning to a large extent considering WCN’s brute strength and sheer size.

Proximity

WCN recognizes that in a commoditized market, such as the one it operates in, strategic positioning of assets to capture efficiencies is imperative to establishing oneself as a market leader. Customers do not expect more than a basic level of service. Therefore, customer satisfaction is largely driven by service pricing and speed.

WCN addresses these customer demands by placing disposal capacity as close as possible to the waste stream. As customers are added in existing markets, this capacity can also be leveraged to serve new customers as well. WCN realizes operational efficiencies as customers are added in these niche and underserved markets, which are manifested into the company’s strong margin profile.

Trash or Treasure?

The solid waste services industry and all its players operate in an environment with a stable secular trend of solid waste growth. The extent of solid waste production in a region comes down to the growth of several macroeconomic factors: (1) Population (2) Economic (3) Consumption.

The US Population Growth Source: US Census Bureau

Advanced economies, like Canada and the US, are expected to grow GDP at a modest level around 2% over the long run. Population growth is somewhat slower, growing 25% between 2020 and 2060 to a population of just over 400 million, a CAGR of 0.5%.

The growth of solid waste production in North America follows these macroeconomic trends closely, growing from 289 million tonnes produced in 2016 to a projected 396 million tonnes in 2060, a CAGR of 1%.

Projected Waste Production over TimeSource: The World Bank

Industry growth is rather low and implies that the average player in an industry like solid waste services will grow organically at a sub-5% annual rate. Therefore, it is imperative that companies focus on differentiation factors to drive pricing growth and remain competitive.

WCN is one such company – its focus on underserved and niche markets allows it to increase prices between 3% - 5% per year while it also expands its operations. 

In the short run, the US solid waste industry could benefit from the Biden Administration’s proposed infrastructure bills. These plans would substantially benefit smaller communities around the US, overhauling highways, bridges, aging water pipes, and other infrastructure. This process would create large amounts of solid waste and WCN could expand capacity in these regions to allow for an efficient solid waste disposal flow.

WCN may also benefit from the exodus of people from large metro areas to smaller cities and rural areas, where the company dominates over peers. Cities such as New York City, Chicago, and San Francisco lost many movers, while markets in less populous states such as South Dakota, North and South Carolina, and Idaho gained movers.

As these markets expand, WCN can take advantage of exclusive contracts and market share up for grabs as it can roll out extra capacity rather quickly using its massive balance sheet. If the solid waste industry continues to expand, we expect WCN to perform well. Additionally, If the “work from anywhere” movement continues unscathed, we would expect WCN to perform even better.

Map of Movers in the US

ESG – Not a Cost, But an Opportunity

ESG = Environmental, Social & Governance

A concept that has been gaining ground amongst the media and broad investor community is ESG. To many companies, implementing green initiatives represents a cost with little to no benefit to the bottom line. To WCN, ESG is an opportunity. 

Recycling Tonnage Over 60 yearsSource: Environmental Protection Agency

According to the Environmental Protection Agency (“EPA”), recycling tonnage in the US has more than quadrupled since 1960. However, growth of recycling tonnage has moderated since 2010.

This may seem like a risk for a company like WCN, who provides recycling and recovery services. However, this is an opportunity. Recycling rates for glass and plastics are still low – 25% and 9%, respectively. In fact, paper – the largest recycled material by a longshot – recycling rates are still below 70% and present an opportunity for growth.

Recycling Breakdown by YearSource: Environmental Protection Agency

WCN can capture this opportunity as the US and Canadian federal, state / province, and municipal governments push to increase recycling capacity and rates, reduce greenhouse gas emissions, and recover more materials and biogas from solid waste and E&P waste. In fact, the EPA recently called for a 50% recycling rate by 2030, a figure it believes is certainly achievable with the right amount of capacity, environmental incentives, and government regulation. For reference, the recycling rate in 2018 was around 32%. 

WCN has implemented ambitious 15-year ESG targets to expand biogas recovery, increase resource recovery, and build out larger recycling capacity to take advantage of these trends while also being proactive to enable an efficient flow of solid waste through its ecosystem. The company has committed $500 million in capital to achieve these targets on top of its regular CapEx program.

WCN is set to benefit from its own targets as well as the societal shift towards greener processes around solid waste. Recovering and recycling more materials means WCN can increase revenues from resale of these materials to a various types of manufacturers.

The company has already committed to building out capacity, especially in smaller and niche markets where this capacity is less likely to be robust. We believe WCN will be a major beneficiary of the move towards a greener world as it will be on the “frontline” of this major secular shift.

WCN is set to benefit from its own targets as well as the societal shift towards greener processes around solid waste. Recovering and recycling more materials means WCN can increase revenues from resale of these materials to a various types of manufacturers.

The company has already committed to building out capacity, especially in smaller and niche markets where this capacity is less likely to be robust. We believe WCN will be a major beneficiary of the move towards a greener world as it will be on the “frontline” of this major secular shift.

WCN Percentage Targets over TimeSource: WCN Investor Relations

Big, But Not Big Enough

The solid waste services business is a highly fragmented one containing thousands of small, regional players and few large incumbents. On the surface, it appears this environment may be a difficult one to compete in. The reality is the opposite – for large players like WCN, the market is ripe for consolidation as the number of small industry players is in the thousands.

WCN is active on the merger and acquisition (“M&A”) front. Over the past three fiscal years, it conducted 20 or more M&A transactions per year, expanding its capacity and network in smaller markets where it can obtain high market share and generate superior returns over peers.

The company is far from done – management believes WCN is well positioned to take advantage of an active M&A environment and will continue to acquire companies to expand its footprint for as long as its strong cash flow and low leverage profiles allow for it, albeit at a slower pace than in recent history.

Capital Allocation

WCN converts a large amount (i.e., over 50%) of its EBITDA (adjusted) to FCF (adjusted), which allows it to freely and frequently conduct:

  1. M&A

  2. Pay down debt

  3. Return capital to shareholders

When WCN is not making acquisitions, excess cash is used to return capital to shareholders. Share repurchases are done opportunistically, meaning that when management does not see adequate acquisition or reinvestment opportunities in the core business, or if it believes its stock is cheap, it will buy back shares to return capital to shareholders and reduce the overall share count.

WCN Free Cash Flow TrendSource: WCN Investor Relations

On a go-forward basis, management sees the opportunity for a greater portion of capital being used to fund CapEx and share repurchases and dividends. If the lower M&A allocation does not diminish WCN’s competitive positioning, shareholders will be benefit from a growing dividend and frequent buybacks because of WCN’s financial strength.

When WCN is not making acquisitions, excess cash is used to return capital to shareholders. Share repurchases are done opportunistically, meaning that when management does not see adequate acquisition or reinvestment opportunities in the core business, or if it believes its stock is cheap, it will buy back shares to return capital to shareholders and reduce the overall share count.

On a go-forward basis, management sees the opportunity for a greater portion of capital being used to fund CapEx and share repurchases and dividends. If the lower M&A allocation does not diminish WCN’s competitive positioning, shareholders will be benefit from a growing dividend and frequent buybacks because of WCN’s financial strength.

WCN Capital Allocation by YearsSource: WCN Investor Relations

Risks

Cyclicality

WCN can experience fluctuations in its revenue profile due to several macroeconomic factors, such as slowing population growth, a weak economy decreasing consumption, and lower E&P oil production reducing E&P waste. 

Input Costs

WCN incurs high costs for insurance, diesel, and compressed natural gas for its fleet of collection trucks. Although WCN enters fixed-price fuel purchase contracts, it leaves the company vulnerable to paying above-market prices in times when fuel prices are falling. As an industrial company, WCN could also incur significant liability on a covered insurance claim that results in out-of-pocket expenditures to pay for potentially uncovered portions and /or result in larger insurance premiums going forward. These could reduce margins more than expected and hurt WCN’s share price.

M&A Execution Risk

WCN’s business and growth models rely heavily on mergers and acquisitions. Poorly identified strategic opportunities, dilutive deals, lack of acquisition opportunities, and unwillingness on the part of regional incumbents to sell their businesses could result in lacklustre growth that hurts WCN significantly over the long run.

RIN and Recyclable Commodity Prices

In providing recycling and recovery services, WCN creates and captures recycled materials and renewable fuels. The former is subject to volatile swings in market prices, which could reduce WCN’s revenues. The latter is subject to the regulations of the Renewable Fuel Standards, which require refiners to (1) blend renewable fuels into transportation fuels or (2) purchase renewable fuel credits called RINs, which are attached to renewable fuels for sale to blenders. The prices of RINs have been volatile historically, which could dually affect WCN’s financials by reducing revenues and increasing RIN costs.

Diagram of the Renewable Identification Process Source: Environmental Protection Agency

Regulatory Risk

A substantial portion of WCN’s operations is subject to government contracts and regulation, posing risks of municipal annexation of unincorporated areas potentially heightening demand for a competitor’s services at the expense of in-place contracts with WCN, lawsuits, and bringing light to anti-monopoly regulations as the large industry incumbents grow larger via M&A.

Bottom Line

WCN is a steady compounder with a sustainable competitive advantage through its focus on vertically integrating and superior asset positioning in niche markets and underserved regions. The company enjoys a stable flow of cash given the relevance of its services in our daily lives. The business may be boring, but it is strong, reliable, and rewards its shareholders well.

Luckily, growth opportunities are still ripe. WCN can grow by innovating in ESG-friendly waste services, such as recycling and recovery. It can also continue doing what it has always done – buy smaller industry players and grow inorganically.

This has been a winning strategy for WCN and we believe the trend will go unabated in the foreseeable future. WCN is a consolidator, a growth machine, and certainly not trash.

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