Waste Connections Inc. picks up trash, but investors have been more impressed with what the company delivers: Market-beating returns, impressive cash flow and a sound acquisition strategy. Will the good times persist through rising interest rates?
The company, the combination of Texas-based Waste Connections Inc. and Toronto-based Progressive Waste Solutions Ltd. following a 2016 merger, operates in 39 U.S. states and six Canadian provinces, removing solid waste and providing recycling services for residential, commercial and industrial customers.
It also handles oil-field waste produced by shale operations in the U.S. Permian, Bakken and Eagle Ford basins.
It's a good business to be in when the economy is growing (think of all those Amazon.com boxes).
In its fourth-quarter results, released last week, Waste Connections reported a 14-per-cent increase in profit, and substantially more if you look at non-adjusted net earnings, which included a sizable U.S. tax benefit. Revenue rose 10 per cent over last year.
Yet the upbeat results, which mostly blew past analysts' expectations, failed to lift the stock from its lull over the past eight months.
Since June, the price has drifted between $80 and $90 in Toronto (the shares, ticker symbol WCN, also trade in New York), just before the Bank of Canada began to raise its key interest rate and in the midst of a rate-hiking campaign by the U.S. Federal Reserve.
This is a notable pause for Waste Connections, given that the shares rallied more than 115 per cent in the previous 18 months.
The connection between interest rates and garbage collection might not seem obvious at first glance, but tighter monetary conditions threaten the valuations the Street gives a much-watched metric – free cash flow – a factor that has been weighing on most of the stock market recently as inflation expectations rise.
However, Derek Spronck, an analyst at RBC Dominion Securities, believes that concerns over interest rates are overblown.
In a recent note, he looked at the performance of the waste sector from 2004 to 2007, which was the last period when interest rates were on the rise.
Waste stocks generated average returns of 14 per cent a year over this period, handily beating the returns for the S&P 500, which suggests the sector can outmanoeuvre central bank efforts to slow down the economy.
For Waste Connections specifically, analysts say the company has a winning combination of attributes.
Pricing power is one of them. In 2017, the company was able to raise prices by 3.5 per cent, up from price increases of 2.8 per cent in 2016. This suggests that an improving operating environment can offset rising inflation.
According to Kevin Chiang, an analyst at CIBC World Markets, "42 to 43 per cent of WCN's business is indexed to [the consumer price index] and the balance should see even greater pricing growth in excess of inflation."
He added that robust energy prices should add an additional tailwind.
Just as important, Waste Connections continues to be an active consolidator in the still-fragmented North American waste industry, squeezing costs and ratcheting up efficiencies in the process.
Earlier this year, the company added 70,000 customers in Virginia and North Carolina with its acquisition of Bay Disposal & Recycling, along with smaller transactions in New York and Texas. Combined, these deals will add about US$70-million in annualized revenues, on top of another deal in the works that should drive US$40-million in additional revenues, according to Mr. Spronck.
Management expects further acquisitions can add another US$60-million in revenue by April.
"The recent acquisitions provide for a new regional platform in attractive markets, with disposal capacity that management should be able to leverage to sop up additional collection and transfer assets in these new regions," Mr. Spronck said in his note.
The company's free cash flow is reflecting its success at integrating its acquisitions: It rose to US$708-million in 2017, more than double what it was in 2015. According to Bloomberg News, free cash flow is expected to rise another 18.6 per cent this year.
At the same time, the company is hiking its quarterly dividend – by nearly 17 per cent in October.
If interest rates continue to weigh on the share price, consider it an opportunity.