Given the increased focus on environmental concerns and regulations in North America, the barriers to entry in the waste management industry have increased.
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With this regulatory barrier, Waste Connections (TSE: WCN) is well positioned to succeed into the future. Waste Connections is the third-largest solid waste services company in North America.
The company provides non-hazardous waste collection, transfer and disposal services, as well as recycling and resource recovery in the U.S. and Canada. In other services, the company also provides non-hazardous oil and natural gas exploration and production, or E&P, waste treatment, recovery and disposal services in several areas across the U.S.
As of December 2020, Waste Connections operated in 43 states in the U.S. and six provinces in Canada. The company has six main segments of revenue which are Collection (63% of FY 2020 revenue), Landfill (18%), Transfer (12%), E&P (3%), Recycling (1%), and Intermodal and Other (2%).
Within the Collection segment, majority of the revenue comes from Commercial (41% of FY 2020 revenues), followed by Residential (38%), and Industrial and Construction (21%). (See Insiders’ Hot Stocks on TipRanks)
Waste Management Industry
The waste management industry in North America has seen consolidation over the past few decades due to increased regulations and cost of operations. That has resulted in three large companies in the industry today, which are Waste Management (WM), Republic Services Group (RSG), and Waste Connections.
The industry has experienced structural changes in recent years, such as a shift to privatization, increased regulation, increasing the size of waste networks with transfer stations, and vertical integration.
Two notable acquisitions in the industry are the acquisitions of Advanced Disposal Services by Waste Management in October 2020, and the acquisition of Progressive Waste in June of 2016.
Since waste companies require large assets such as landfills, trucks, and sorting facilities, there are high barriers to entry.
Secondary, Rural Markets
A key differentiator for Waste Connections is that it targets secondary and rural markets (which are known to be less competitive) to have higher local market share. This results in lower customer churn, and improves financial performance.
Waste Connection’s revenues are quite diversified with the largest geography being Southern (25.2% of FY 2020 revenue), followed by Eastern (24.5%), Western (21.1%), and Central United States (16%). The remaining 13% is from Canada.
One key beneficiary of targeting secondary and rural markets is the ability to maintain higher EBITDA margins. Waste Connection’s five-year average EBITDA margin is 30.6%, considerably higher than Waste Management and Republic Services Group, which have 27.8% and 28.2%, respectively.
This is a structural advantage for Waste Connections as it allows it to have higher pricing power due to the lower competition in rural areas, as apposed to Waste Management, which is largely concentrated in major cities in North America.
Vertical Integration
Owning landfills is a strategic competitive advantage in the industry, as barriers to opening new landfills have increased over the years due to regulations and competitive factors.
As of December 31, 2020, Waste Connections owned 66 municipal solid waste landfills (MSW), 12 E&P landfills, and 13 non-MSW landfills (only construction, demolition, and other non-putrescible waste).
Revenues at landfills are generated through a tipping fee based on volume and the nature of the waste. As landfills are the end of the value chain in waste management (waste is usually transferred from the location to a transfer station and then ultimately to a landfill), it holds pricing power for Waste Connections. It may charge higher prices to third-party waste companies who choose to dump in its landfills, enabling higher local market share and margins.
Acquisition Strategy
As the industry continues to consolidate, Waste Connections plays a key role as it aims to expand through acquiring waste companies in existing or adjacent markets. Waste Connections has a strong track record of “tuck-in” acquisitions. The company has demonstrated success with 21 acquisitions in 2020 (net fair value $481.6 million), 21 acquisitions in 2019 (net fair value $837.7 million), and 20 acquisitions in 2018 (net fair value $1 billion).
Waste Connections has generated an average return on equity (ROE) of 12.5% over the last five years, and has maintained a net debt (debt – cash) to EBITDA ratio below 3x over the last five years.
In addition, Waste Connections provides a growing dividend that has a current yield of 0.62%.
What Analysts are Saying about WCN Stock
From Wall Street analysts, WCN earns a Strong Buy consensus rating, based on eight Buy ratings. Additionally, the average WCN price target of C$176.79 puts the upside potential at 9%.
Bottom Line
Waste management companies have inherited strong competitive advantages. Waste Connections represents a safe and unique investment opportunity in the waste industry, with a focus on secondary and rural markets, a strong portfolio, and a long-term growth strategy through acquisitions.
Disclosure: The author works as a manager at National Bank Financial and had no position in any of the companies discussed in this article.
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