Description

Note: $ in this writeup refers to CAD.

GFL is the fourth largest trash collection company in North America.  It’s managed by founder Pat Dovigi who has most of his net worth invested in the business and is clearly focused on per-share value creation.

This is a very stable industry that typically grows topline organically by 4-5%/year, mostly from price.  That sort of long-term pricing power seems reasonable to me given the barriers to entry in local markets and the fact that the big four all are publicly targeting the same sort of pricing trend.  In Dovigi’s own words, “At the end of the day, the luxury of our business is with the lion’s share of our accounts between $200 and $500 a month… so even if they’re getting high single-digit price increases, I mean, it’s not a material amount for them.”  That also leads to some operating leverage over time, so earnings should grow organically by 5-6%/year.  Waste Connection’s CEO a couple years back summarized it well, “We’ve always talked about this being kind of a 4% to 6% price plus volume growth business, especially in that 2.5% type underlying CPI… if it’s price-led, ought to drive EBITDA growth and free cash flow growth on a dollar basis, slightly above that.” 

The big four (WM/RSG/WCN/GFL) also have long runways to deploy capital through tuck-in acquisitions at very attractive IRRs. The collection business is very fragmented despite benefitting significantly from economies of scale.  The three largest companies in Canada and the US only have 30% and 50% market share, respectively.  The remainder is a collection of thousands of small mom and pop or regional businesses providing a long runway to roll-up these businesses and realize significant synergies.  GFL deploys substantially more capital into M&A than its peers do as it operates with greater leverage (4-4.5x debt/EBITDA vs 2.5-3x). Given how attractive tuck-in M&A is and how stable the industry is, I think this is the optimal capital structure for this business and is the reason GFL has grown so much faster than it's peers. This is how a former President of one of GFL’s peers described the economics of a tuck-in acquisition to me:

“On true tuck-ins, the way it works is you've got 18 routes in an area, you buy someone with 5 routes, the day you close he moves his trucks to your yard and closes his facility and back office.  Within 30-90 days you take the 23 routes (18+5) and cut it down to 20 by cutting out the overlap and you get rid of 3 drivers and trucks and keep the revenue the same.”

GFL has made 100+ acquisitions since 2007 that have been “generally at an average adjusted EBITDA multiple of 7.0x, excluding platform acquisitions.”  Management has since reiterated numerous times that for the small tuck-in program a 6.5-7.5x EBITDA (pre-synergy) multiple is where they’ll be transacting.  They’ve also indicated they’ll do 25-30 tuck-ins each year of businesses with $1-10MM of EBITDA.  My understanding is that true tuck-ins can typically be bought at 5-6x post-synergy multiples.  Needless to say, when you can pay that multiple financed with 4-4.5 turns of leverage, the IRRs are quite high.  The way I think about it, the NPV of $1 invested in true tuck-in M&A is $2-3; you’re paying 5-6x EBITDA for what the market values at 12.5-17x EBITDA (WM/RSG/WCN multiple range).

Management recently laid out a bridge to a 2023 exit FCF run rate of $970M and EBITDA of $2B that you can find on their most recent quarterly earnings presentation.  As with each similar bridge they’ve provided since being public, I expect them to easily exceed this guidance because it has very conservative volume growth assumptions coming out of COVID, conservative M&A expectations relative to their past history, and does not factor in $45-75M in annual FCF that will come from low-risk RNG projects that will not be built out until shortly after the end of the bridge period.     

So, what’s the right multiple on this business at the end of 2023 when it is run rating $2B of EBITDA and $970M of FCF?  WCN and WM trade at 16.8x and 13.5x NTM EV/EBITDA, respectively.  I think there’s no reason GFL should trade at a discount to WCN.  It has a highly aligned founder with a similar organic growth profile, but has a more optimal capital structure that will result in much more M&A value creation.  On an absolute basis, WCN’s multiple seems like a reasonable valuation for GFL.  16.8x EV/EBITDA on the 2023 exit run-rate would be equivalent to 26.6x FCF at that time.  At that multiple, assuming a constant debt/EBITDA ratio and 5%/year organic EBITDA growth, GFL could return 5.3%/year annually to shareholders while growing 5%/year.  That’s without M&A.  If they can deploy 1/3 of their distributable cash flow into M&A (which seems conservative to me), that would likely add 3-4% to the IRR.  Therefore, I think a shareholder paying WCN’s NTM EV/EBITDA multiple on the 2023 exit run-rate for GFL is likely to earn a low to mid teens IRR from that point over a long holding period in a very stable business.  There is also long-term optionality should there be additional consolidation amongst the big four (RSG/WM/GFL/WCN). 

Saying this is worth 16.8x a 2023 run-rate $970M of FCF is way to precise for how I actually think of this investment.  I plan to hold this long-term given the attractive industry structure, M&A opportunity, and reasonable valuation; but I just wanted to lay out some napkin math to quantify my view that in the short-term (the next two years) management will execute as they’ve laid out (or better) and doing so will likely lead to a re-rate more in line with WCN.  That would result in ~75% upside over the next 2 years. 

Catalyst

1) Volume recovery and margin expansion.

2) M&A.