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Waste Connections Inc. has been turning trash into gold for the past several years, but the recent rally in the share price has left valuations looking awfully stretched amid a backdrop of slow profit growth.

In the United States, where the shares trade on the New York Stock Exchange (they trade in Toronto as well), the five-year returns are 109.4 per cent, which is more than double the gains of the S&P 500 over the same period.

The problem: The stock’s price-to-earnings ratio is 39. That’s high, and it suggests that the stock may be reflecting too much optimism.

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I last wrote about Waste Connections in February, 2018, when the shares were meandering and investors were growing concerned about the economic impact of rising U.S. interest rates. The Federal Reserve was in the midst of a rate hiking campaign last year, which weighed on stocks.

But the Fed has been cutting its key interest rate this year, contributing to a global stock-market rally. In Toronto, Waste Connections has risen 17.9 per cent in 2019.

The relationship between the economy and waste generation is a close one: The stronger the economy, the more waste generated. The North American market for waste is particularly rich. According to The World Bank, Canadian and U.S. waste per capita is 2.21 kilograms a day, or nearly three times the global average.

Waste management, in other words, is a good business. And Waste Connections has been increasing its share of it through steady consolidation.

In 2017 and 2018, the company completed 34 deals valued at a combined US$1.6-billion. In 2016, it struck a US$2.7-billion deal for Canada’s Progressive Waste Solutions Ltd. – a deal that shifted the combined company’s official headquarters to Toronto, although most executives work in Texas. It now operates in 42 U.S. states and six Canadian provinces, and hauls oilfield waste from the Permian, Bakken and Eagle Ford basins.

This acquisition strategy forms part of the attraction to the stock. But on a recent call with analysts, Worthing Jackman, the company’s chief executive, said that deals in the pipeline are relatively small. As well, he suggested that high prices are making acquisitions more challenging.

“It's hard to deliver meaningful value creation as you see multiples creep much higher,” Mr. Jackman said on the call.

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That puts more pressure on the performance of existing assets. But here, volume growth is essentially stagnant. In the third quarter, solid waste volumes were flat in Canada and increased just 1 per cent in the United States.

“We're mindful of the protracted nature of the economic recovery, which has driven increasingly challenging year-over-year volume comparisons. And therefore, we believe it is prudent to remain guarded in our outlook for volume growth,” Mr. Jackman said. Calls to the company were not returned.

A lack of profit growth is another reason for caution. Waste Connections reported a third-quarter profit of US$159.1-million or 60 US cents a share, up from 57 US cents a share a year ago – for a gain of just 5.3 per cent.

The longer-term picture isn’t any better. According to Bloomberg, analysts expect a profit of US$2.65 a share in 2019, which is down slightly from a profit of US$2.66 a share back in 2014.

But the shares trade at a premium. The price-to-earnings ratio of 39, based on reported profits, is higher than peers. Waste Management Inc. has a P/E of 26, and Republic Services Inc. has a P/E of 27.

Analysts tend to be focused on other metrics, such as EV/EBITDA (which compares enterprise value to earnings before interest, taxes, depreciation and amortization). But from this perspective, the stock still isn’t cheap. Based on 2019 estimates, its EV/EBITDA ratio is 16.7, according to Bloomberg – significantly higher than Waste Management and Republic Services, which have ratios of 13.3 and 12.7, respectively.

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Perhaps the market is betting that Waste Connections is better positioned to make smart acquisitions and squeeze greater efficiencies out of its takeover of Progressive Waste. But the share price suggests that’s a risky bet.

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