TEXT-S&P cuts Waste Connections rating to 'BBB-'

Fri Oct 19, 2012 4:08pm EDT

Overview
     -- U.S.-based Waste Connections Inc. plans to issue a term loan and
incur revolving facility borrowings to fund its proposed acquisition of R360 
Environmental Solutions Inc. 
     -- We are removing our corporate credit rating on Waste Connections from 
CreditWatch and are lowering it by one notch to 'BBB-'. 
     -- The stable outlook reflects our view that the company will achieve and 
maintain credit measures that are appropriate for the rating during the next 
two years.
Rating Action
On Oct. 19, 2012, Standard & Poor's Ratings Services lowered its corporate 
credit rating on Woodlands, Texas-based Waste Connections Inc. by one notch to 
'BBB-' from 'BBB'. The outlook is stable. We are removing the rating from 
CreditWatch, where we placed it with negative implications on Sept. 17, 2012, 
following the company's announcement of its plans to acquire non-hazardous 
oilfield waste services provider R360 Environmental Solutions Inc. for $1.3 
billion. 

The purchase price represents an EBITDA multiple of roughly 6.5x, in our view. 
We expect the acquisition to close in the fourth quarter of 2012, subject to 
certain closing conditions, including the receipt of regulatory approvals.
Rationale
The one-notch downgrade reflects our view that the additional debt incurrence 
needed to finance the $1.3 billion acquisition will hurt Waste Connections' 
financial risk profile to some extent, though we still view it as an 
"intermediate" risk. We believe the company intends to issue a sizable unrated 
term loan and to borrow a substantial amount on its unrated revolving 
facility. At the outset, we estimate that the company's pro forma funds from 
operations to debt ratio and its free operating cash flow to debt ratio will 
be 21% and 12%, respectively. In comparison, these figures were 36% and 22%, 
respectively, as of June 30, 2012, having benefitted from the issuance of $370 
million of equity and associated debt reduction earlier this year. We believe 
that the company will stay committed to maintaining investment-grade financial 
policies and will use its free cash flow primarily to reduce debt over time, 
but we also believe that it is likely to remain acquisitive. Therefore, we 
think the company is unlikely to return credit measures to levels appropriate 
for the former rating  within a two-year time horizon.

Waste Connections' acquisition of Houston-based R360 is a larger-than expected 
transaction, a major departure from its core business, and a bold move into 
the field of oil and gas production-related waste services. We believe this 
will have a mixed effect on our view of the company's "satisfactory" business 
risk profile. Revenues from these services are less stable and predictable 
than those from Waste Connections' core essential services of solid waste 
collection and disposal, as market volatility in oil prices tend to govern the 
demand for services. With the addition of R360, we believe that the proportion 
of the company's sales from oilfield waste services will rise to over 15% from 
2%, and that EBITDA from such services will exceed 25% of total EBITDA. On the 
other hand, R360's profit margins are very good at present, and are supported 
by a difficult-to-replicate network of permitted disposal sites, transfer 
stations, and saltwater injection wells. R360's operating site and geographic 
diversity is solid, as it operates 26 facilities in many active oil-rich shale 
basins including the Williston, Permian, and Eagle Ford. 

The use of unconventional hydraulic fracturing to extract natural gas, natural 
gas liquids, and oil from shale deposits has increased rapidly in recent 
years, but as of late the supply-demand imbalances and low natural gas prices 
have resulted in declining rig counts and lower activity in certain dry-gas 
concentrated areas. Consequently, many oilfield services companies and 
environmental companies have re-mobilized assets to more oil-rich areas, 
creating greater competition. R360's assets are positioned in areas with more 
exposure to oil and natural gas liquids, which are currently performing well. 
However, if oil prices were to drop to a low level, then oil exploration and 
production could slow, potentially causing lower demand for oilfield waste 
logistics and disposal services, which could result in revenue declines and 
some margin compression.

Waste Connections provides collection services (64% of revenues through the 
first six months of 2012), disposal and transfer services (29%), and 
recycling, intermodal, and other services (7%) in mostly secondary (non-urban) 
markets. The company serves more than two million residential, commercial, and 
industrial customers in 30 U.S. states, primarily in the western and 
southeastern regions.

The company's demonstrated operating strength reflects its unique business 
strategy, including a focus on secondary markets and significant operations 
under exclusive franchise contracts. The relatively high proportion of 
exclusive arrangements is an advantage for the company, as higher customer 
retention affords Waste Connections greater ability to maintain solid pricing 
and reduces volume erosion during recessionary periods. 

The essential nature of Waste Connections' services, its leading presence in a 
number of growth markets, and the benefits expected from recently completed 
acquisitions enhance the company's earnings prospects. However, the solid 
waste management industry is mature and competitive, which results in some 
pressure to pursue acquisitions to promote growth and to contain costs. The 
company's still relatively limited exposure to more cyclical industrial 
markets somewhat mitigates these concerns. 

We characterize the company's financial risk profile as intermediate, as it 
has a demonstrated track record of maintaining prudent financial policies. We 
believe management will remain committed to sound financial policies, and will 
primarily use cash flow to reduce debt until debt leverage is lower. On a pro 
forma basis, we expect the company's funds from operations to debt ratio to 
improve to 25% by year-end 2013, which is at the low-end of the 25% to 30% 
range we expect at the current ratings. We also expect the company's free cash 
flow to debt ratio to improve to 14%, which is within the 10% to 15% we 
anticipated. We anticipate that steady operating performance and solid 
generation of free cash flow will benefit credit metrics as the company 
prioritizes debt repayments in lieu of large acquisitions or share 
repurchases. Our belief in the company's cash-generating capability and our 
view of management's commitment to using a major portion of cash flow to pay 
down debt is a critical underpinning to the ratings. 

Liquidity
The company's liquidity is "adequate," characterized by strong and 
historically consistent internally generated free cash flows, which are 
partially offset by a sizable amount borrowed under its revolving credit 
facility to fund the R360 acquisition. The company's sources of cash should be 
sufficient to cover its needs for the foreseeable future, even if EBITDA 
declines sharply. We base our liquidity assessment on the following factors 
and assumptions:

     -- The company has good relationships with its banks, in our assessment, 
and has a good standing in the credit markets.
     -- We expect the company's liquidity sources (including cash, funds from 
operations, and credit facility availability) over the next 12 to 18 months to 
exceed its uses by more than 1.2x.
     -- Even if EBITDA declines by 15%, we believe net sources would be 
sufficient to cover cash requirements. Compliance with the credit facility's 
total debt to EBITDA financial covenant could also survive a 15% drop, in our 
view.
     -- In our analysis, we assume liquidity over the next 12 months of about 
$800 million, mainly consisting of availability under the credit facility and 
funds from operations. We estimate that the company will use approximately 
$550 million to $600 million during the same period mainly for capital 
spending, debt repayment, and dividends.

As of June 30, 2012, Waste Connections had about $136 million in cash and $785 
million available under its $1.2 billion unsecured revolving credit facility 
maturing in July 2016. Pro forma for the acquisition, we believe that these 
figures will be roughly $15 million and $275 million. Revolving facility 
borrowings of over $900 million are substantial, though we do expect the 
company to use free cash flow to reduce this amount during the next two years. 
We anticipate the amortization on the proposed term loan and other debt 
maturities to be manageable for the next several years and believe the company 
will continue to have appropriate access to sources of capital. In addition to 
the revolving facility borrowings and proposed term loan, its debt includes 
the following privately placed debt: $175 million of 6.22% senior notes due 
October 2015, $100 million of 3.3% senior notes due April 2016, $50 million of 
4% senior notes due April 2018, $175 million of 5.25% senior notes due 
November 2019, and $100 million of 4.64% senior notes due April 2021.

Financial covenants include a maximum debt to EBITDA ratio (no more than 3.5x 
under the credit facility and no more than 3.75x under the senior notes) and a 
minimum EBIT to interest coverage ratio (no less than 2.75x). The company was 
well in compliance with the financial covenants as of June 30, with respective 
headroom levels of more than 45% and 60%, but headroom levels will likely be 
tighter at the end of the December quarter immediately following the 
acquisition because of the additional debt. We anticipate that the terms of 
the financial covenants will allow for a pro forma acquisition-related 
adjustment to EBITDA, but headroom under the debt to EBITDA covenant could 
still slip to less than 15% at the end of the December quarter before 
improving in subsequent periods as debt is repaid.
Waste Connections benefits from good free cash generation. 

Adjusted free operating cash flow to total adjusted debt as of June 30, 2012, 
was roughly 22%, which exceeds the median for the 'BBB' rating category. This 
figure has averaged 16% per year for the past five years. Working capital is 
usually a modest source of cash, and capital expenditures average 10% of 
sales. Pro forma for the acquisition, we expect Waste Connections' capital 
spending to be about $200 million in 2013. We expect the company to use free 
cash generation mainly for debt reduction and tuck-in acquisitions. The 
company has suspended share repurchases in advance of the R360 acquisition, 
and we believe management will not resume large repurchase activity until debt 
leverage has been reduced. 

Outlook
The outlook is stable. Despite the substantial addition to debt to fund the 
R360 acquisition and the potential for somewhat increased earnings volatility, 
Waste Connections' leading positions in most of its markets and its strong 
free cash generation support credit quality. Although we expect muted growth 
in the core solid waste collection and disposal business stemming from weak 
volumes, along with headwinds from fuel costs and recycled commodities prices, 
stable pricing in its legacy business and effective cost management should 
keep profitability solid. We expect management to maintain prudent financial 
and strategic policies, and to improve its credit measures.

We could raise the ratings during the next two years if the economy rebounds 
more rapidly and solid waste collection and disposal sales improve; if 
activity in oilfield waste services remains solid, and if the company adheres 
to prudent financial policies. Profitability has continued to improve over the 
years, and could be boosted by the company's enhanced position in oilfield 
waste disposal. If the company uses its free cash flow to reduce outstanding 
borrowings such that its FFO to debt ratio improves to (and then consistently 
exceeds) 30%, then we may consider an upgrade.

Though less likely, we could consider a negative rating action during the next 
couple of years if Waste Connections undertakes more or larger-than-expected 
acquisitions before repairing its balance sheet or if cash flow generation 
declines to a level we deem inappropriate for the current ratings. The latter 
could occur if market conditions prompt weaker-than-expected volumes, pricing 
pressures, or contract cancellations, or if liquidity deteriorates. We 
estimate that it could take a roughly 10% decline in the company's pro forma 
revenue to $1.8 billion combined with a marked compression in adjusted EBITDA 
margins to 27% in order to yield an FFO-to-debt ratio of approximately 20%, 
which could prompt a review of the ratings. 

Related Criteria And Research
     -- Waste Connections Inc. 'BBB' Rating Placed On CreditWatch Negative On 
Acquisition Of R360 Environmental Solutions Inc., Sept. 17, 2012
     -- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, 
May 27, 2009
     -- Corporate Ratings Criteria 2008, published April 15, 2008

Ratings List
Downgraded; Off CreditWatch; Outlook Stable
                                        To                 From
Waste Connections Inc.
 Corporate Credit Rating                BBB-/Stable/--     BBB/Watch Neg/--