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