Aug 15 -
Summary analysis -- Waste Connections Inc. ------------------------ 15-Aug-2012
CREDIT RATING: BBB/Stable/-- Country: United States
Primary SIC: Sanitary
Mult. CUSIP6: 941053
Credit Rating History:
Local currency Foreign currency
01-Jul-2011 BBB/-- BBB/--
29-Jun-2007 BBB-/-- BBB-/--
The ratings on Folsom, Calif.-based Waste Connections Inc. reflect the company’s “satisfactory” business risk profile and “intermediate” financial risk profile, according to Standard & Poor’s Ratings Services’ criteria definitions. The company is a major regional provider of solid waste management services, an industry we consider to have generally favorable characteristics, and benefits from efficient operations, in our opinion. The ratings also incorporate management’s demonstrated commitment to maintaining moderate financial policies, as well as the company’s solid operating performance and credit measures.
Waste Connections, which generated revenues of $1.6 billion for the 12 months ended June 30, 2012, 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.
Waste Connections’ demonstrated operating strength reflects the company’s unique business strategy, including a focus on secondary markets and significant operations under exclusive franchise contracts, which supports its credit quality. The company generates about half of its revenues and more than half of its cash flows under exclusive contract arrangements; it derives the balance from competitive markets. 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. Waste Connections also benefits from the significant remaining life of its landfills and limited asset retirement obligations, given that few sites are scheduled to close during the next 10 years.
The essential nature of Waste Connections’ services, its leading presence in a number of growth markets, and the benefits expected from 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 relatively limited exposure to more cyclical industrial markets somewhat mitigates these concerns.
Waste Connections has expanded rapidly in the past several years, primarily through acquisitions, and took advantage of the fragmented nature of many markets in the western U.S. Recently, the company acquired Hudson Valley Waste Holding Inc. in 2011 for roughly $300 million, as well as certain solid waste collection and recycling assets in Alaska in the first quarter of 2012 for roughly $133 million (exclusive of a $4 million contingent payment). Growth via acquisitions remains a key focus; the company has stated that it intends to acquire $40 million to $60 million of revenue on a normalized, yearly basis. We expect management to maintain its prudent and successful track record of acquiring and integrating numerous small solid waste operations. In addition to acquisitions, internal growth is a meaningful and important component of earnings, in part because of attractive demographics. The company’s entry into selected markets in Midwestern and Southwestern states has broadened its geographic diversity and is consistent with its strategy of having a leading market share or fully integrated operations in all markets served. Waste Connections’ positions in higher-growth markets should support reliable internal growth once economic recovery is more pronounced. Waste Connections has used a combination of debt, equity, and internal cash flow to finance its growth.
The company’s impressive adjusted EBITDA margins of 33% are the highest among the companies we rate in the industry, despite the relatively modest scale of its operations compared with those of larger industry participants. This reflects Waste Connections’ exclusive contract arrangements, low-cost structure, and high level of service integration (waste internalization tends to average 66%). The company was able to raise prices throughout the economic downturn despite fluctuations in fuel prices, and profitability has remained solid.
Waste Connections has consistently performed well in the periods following the recession, outperforming its larger peers on pricing and volume. Since the first quarter of 2010, the company has maintained steady core price increases of about 2.5%-3% while volume reductions were less pronounced than those of its peers. Recently though, while the company’s pricing has held up well, volumes have started to soften, as they were down 2.2% in the second quarter. The company chose to forego lower-priced disposal volumes at one of its landfills and saw reduced special waste volumes. The company has also been beset by the headwinds from lower recycled commodities prices in 2012, as overseas demand for recyclable commodities has decreased.
The company’s attractive profitability and solid cash flow generation in combination with management’s disciplined growth strategy support the intermediate financial risk profile. Credit measures are appropriate for the rating, with funds from operations (FFO)-to-total debt (adjusted for capitalized operating leases) at 36% for the 12 months ended June 30, 2012, and free operating cash flow-to-total adjusted debt of 22%. Although we expect Waste Connections to use free cash generation and some borrowings under its revolving credit facility for acquisitions and share repurchases, earnings growth should enable credit measures to hold steady or gradually strengthen. In March of 2012, the company issued a follow-on public offering of 12 million shares of common stock, which it used to repay revolving facility borrowings, which had increased because of the acquisition of the Alaska waste assets. We expect FFO-to-total adjusted debt to average about the appropriate level of 30% and free operating cash flow-to-total adjusted debt to exceed 15%. We adjust total debt to include capitalized operating leases and asset-retirement liabilities at landfills (final capping, closure, and postclosure) on a tax-effected basis. The company has fully funded its pension and postretirement obligations.
The company’s liquidity is “strong,” with strong and consistent internally generated free cash flows and good availability under its revolving credit facility. 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 1.5x.
-- Even if EBITDA declines by 30%, 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 30% drop, in our view.
-- In our analysis, we assume liquidity over the next 12 months of about $1.2 billion, mainly consisting of availability under the credit facility and funds from operations. We estimate that the company will use approximately $380 million during the same period mainly for capital spending, dividends, and stock repurchases.
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. Revolving facility borrowings of $325 million are substantial, though these have been reduced from $519 million at Dec. 31, 2011. Debt maturities are manageable for the next several years and, in addition to the revolving facility borrowings, include 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, with respective headroom levels of more than 45% and 60%, and should remain comfortably compliant in future periods.
Waste Connections benefits from good free cash generation. Adjusted free operating cash flow to total adjusted debt was roughly 22%, which is exceeds the median for the rating. 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. We expect Waste Connections’ capital spending to be about $145 million for 2012, which is in line with the $142 million it spent in 2011. We expect the company to use free cash generation mainly for acquisitions and share repurchases. The company has authorization from its board of directors to repurchase up to $1.2 billion of common stock through December 2014. As of June 30, 2012, the remaining maximum dollar value of shares available for repurchase under the program was $429 million.
The outlook is stable. The company’s leading positions in most of its markets, strong liquidity, consistent free cash generation, and disciplined growth strategy support credit quality. Profitability held steady through the recession and has improved since. We expect the company to continue to generate solid profitability in 2012 despite potentially lower commodities pricing, slightly negative volumes, and high fuel costs. We expect management to maintain its prudent and successful track record of acquiring and integrating numerous small solid waste operations while maintaining appropriate credit measures.
However, we could consider a negative rating action if Waste Connections’ cash flow generation declines. This could occur if the company’s liquidity deteriorates, if its share repurchases become overly aggressive, or if it faces weaker-than-expected volumes, pricing pressures, or contract cancellations. We estimate that if the company’s adjusted EBITDA margins were to decline by 10 percentage points from the current 33% mark, then its FFO-to-debt ratio could drop to approximately 25%, which could prompt a review of the ratings. Although the company has resumed its share repurchase program, we believe that management will adhere to financial policies that result in credit measures appropriate for the rating.
Though less likely, we could raise ratings modestly if the company meaningfully strengthens its business risk profile or adopts more conservative financial policies, uses cash flow to reduce outstanding borrowings, and maintains an FFO to debt ratio of about 45%, which we would consider in line with a financial risk profile assessment of “modest.”