Description

I am recommending Waste Connections (WCN) as a long. WCN is the third largest solid waste company in North America with industry-leading EBITDA margins and free cash flow conversion. Among the major waste companies, WCN is the most deliberate with market selection. It avoids more competitive urban markets and instead targets secondary or rural markets where it attains leading market shares either through exclusive contracts (100% market share) or vertical integration (owning the only landfill in the region). In 90% of its markets, WCN operates in a monopolistic or oligopolistic market structure. WCN is not cheap, but it is an all-weather investment that should compound over several years. WCN trades 16.3x 2025 EBITDA with a 3.6% FCF yield. I believe the growth algorithm for the core waste business over the medium term is as follows: 7-8% revenue growth (0% volume + 5% core pricing + 2-3% tuck-in M&A) / HSD % EBIT growth / low teens % FCF per share or EPS growth.

Decades of consolidation in the waste management space have driven more rational competitive dynamics, leading to increased pricing discipline. The top four players now control ~56% of the collections and landfill volumes in the US. The businesses are highly recurring, driven by weekly lift fees, container rentals, and landfill gate fees. Within collections, ~40% of WCN’s business are franchise agreements, where WCN is the sole provider of waste management services for residents and businesses in a given region. These are 10-20 year contracts, and they rarely change hands given the incumbent has invested significant capital to efficiently service the region. For 50% of the business, WCN is the leading player within secondary or rural markets, where they might be only a handful of meaningful competitors. In these markets, WCN is vertically integrated, in most cases owning the only landfill in the region. This allows WCN to exercise greater pricing discipline in these markets on the collection side. Even if WCN loses collection volume to a competitor, inevitably those waste volumes will be disposed of at its landfill. The remaining 10% would be represented by large, urban areas that contain a larger number of competitors. A little less than half of their large urban exposure is NYC, which WCN acquired as part of its merger with Progressive Waste in 2016. Despite NYC being a hyper competitive market, WCN has dramatically improved this business from breakeven towards 20% EBITDA margin. In addition, NYC is in the process of transitioning to more of a franchise market, where only 3 competitors are permitted to service a given zone. WCN was the only major to win a contract and won the right to collect commercial waste in 12 commercial zones. The new market structure could make NYC a highly profitable market and provide another platform upon which to execute M&A. With NYC’s new market structure, ~95% of WCN’s exposure is in monopolistic or oligopolistic market structures.

The pricing dynamic within waste management is very favorable. For WCN, 60% of volume is subject to open market pricing, where it contracts directly with residents and businesses and has full discretion on when/how much to flex pricing. The absolute $ fee for service is quite low: ~$40/month for residents (weekly pick-up) and $300/month for businesses (very wide range), which suggests there is ample runway to continually compound price increases. Given the low cost and the “necessary but don’t want to think about it” nature of the service, all residents and businesses care about is reliability and predictability of service. So long as an operator is reliable, price rarely becomes an issue. WCN’s customer retention is in the low 90% range. The other 40% of collections (mainly tied to franchise agreements) has pricing tied to an index, such as CPI.

Thesis Points:

Highly recurring, essential service with limited disruption risk

The solid waste management industry is resilient throughout economic cycles as the business provides non-discretionary services. Waste generation is largely dependent on population and household growth, GDP, industrial production and levels of employment. In a downturn, the most volatile component of the industry is construction and demolition waste, where WCN has limited exposure (well less than 10% of revenue). In 2020 (affected by COVID), revenues were +1% and EBITDA -1%. The business benefits from a highly diversified and segmented customer base, providing services to the entire cross section of the U.S. economy without any disproportionate exposure to a certain industry or region. ~80% of revenue has an annuity-type profile, driven by weekly lift fees, container rentals and disposal gate fees. Revenue streams excluded from the calculation include fuel surcharges, temporary large container rentals, disposal services for E&P waste and commodity-oriented recycling revenue. In addition to highly recurring revenue streams, WCN enjoys a low 90% customer retention rate. Lastly, in a world increasingly concerned about disintermediation risks stemming from artificial intelligence and machine learning, it is hard to imagine a scenario where waste management operators are disrupted, given the enormous amount of physical infrastructure required to collect, treat and dispose of various waste streams. Other long-term disruptive risks such as autonomous driving should arguably be a net positive to the industry.

Demonstrated ability to price above inflation

Decades of consolidation in the space and the industry’s increased discipline on pricing have driven more rational competitive dynamics. The top four solid waste players now account for 56% of US landfill industry volumes compared to 38% in 2008, with a very similar improvement in collection market share. Generally speaking, pricing behavior within the industry inflected in 2013 as industry players sought to recoup lost price/cost balance post the GFC. Industry participants point to a slow volume recovery coming out of 2009 and lagging CPI-based pricing mechanisms as drivers of weak industry pricing. Starting in 2013, pricing actions have accelerated across the industry, driving core price increases above 3%. The pricing actions have been a mixture of the major players reducing exposure to brokers (middlemen who interface with customers and sell aggregated “volume” to the waste management operators) and price-sensitive national account customers, along with improving index-based pricing terms. Across the industry, volume growth has been muted (flattish to slightly down). In addition to a flattish economy, all the major players attribute some of the volume softness to “purposeful shedding”, where the operators are happy to forego certain volumes given their inferior margin profile. Index-based contracts generally relate to what is referred to as restricted pricing contracts, or longer-term contracts with municipalities where price increases are formulaic. It is also very helpful for the industry that CPI has been running at 3% or above for the past few years, as it is far easier for them to generate a positive price to cost inflation spread at these levels. The other arrangement is open market pricing, where waste operators can, at their discretion, raise prices to residents and businesses. For WCN, 40% is under restricted pricing and 60% is open market pricing.

For open market pricing arrangements, the low, absolute cost of waste service gives me comfort there remains a long runway for continued price increases. The average monthly charge for a resident is $30-40, or <$10 per weekly pick-up. For the typical business, the monthly charge would be $300. Waste management fees would represent less than 1% of its customers’ cost structures, with security monitoring and pest control as the only expense items that are less costly. Simply put, if a waste operator provides reliable and predictable service (pick up my trash every Monday in the late morning), pricing is never a gating item. 

The favorable pricing dynamic is similar with landfills. On a national basis, the top 4 players account for 56% market share. The US landfill industry is even more consolidated at the micro level. Per Goldman Sachs, in the markets where the major players participate, the top two hold ~75% share within a 50 mile radius of where the waste is produced. Landfills are driven by local market dynamics, as indicated by a broad range of pricing disparity across the US based on the availability of permits, real estate value, and local market structure. Trucking costs range from $0.15-$0.25 per ton-mile, which means an extra 50 mile trip adds $10/ton. This would represent roughly 30% of the gate fee of the average landfill. Limited permitted landfill capacity, transportation constraints and rising maintenance costs of open (and closed) landfills suggest that the industry will increasingly push pricing, particularly amid increased consolidation.

In my view, WCN will continue to realize price increases above cost inflation. In a world with CPI averaging 3%, I expect WCN to generate core pricing growth in the 5% range (a delta of ~200 bps). This is exactly the average spread that WCN has achieved over the past 12 years.

Continued tuck-in M&A opportunities

There remains ample opportunity for further consolidation within the collection and landfill markets, with ~45% of the market remaining with private or local municipal players. The M&A value in this industry is beyond pricing, with tangible opportunities for increased operating efficiencies. In a market served by a single player, the cost of waste and recycling can run $30 per home compared to $40 per home in a non-consolidated market, all while generating 5-10% higher margins. The key value driver is route consolidation – when a collections company acquires a peer in the same market, it significantly reduces duplicative routes and therefore costs. For this reason, collections acquisitions are the highest ROI when an operator has existing collections and/or landfill assets in the region. The cover price for a small tuck-in deal could be 10x, but pro forma for synergies, the purchase price can be reduced to 5x. When entering a new market, WCN requires a low double digit % unlevered IRR. Underwriting assumes no synergies and the same entry/exit multiples. This generally solves for a purchase price of ~10x EBITDA. Realized synergies most often come from price optimization and better risk management (safety measures significantly reduce incident rates). These measures take out at least 1x of the entry multiple. The newly acquired operation then serves as a new platform for continued tuck-ins.

WCN is the most deliberate in terms of market selection. It is solely focused on growing its presence within exclusive and secondary markets (representing 90% of the current business). The TAM (measured as annual revenue) for its focused strategy within the U.S. and Canada is $4-5 bn. Over the past 7 years, WCN has completed >$900m of acquisitions per year. I am conservatively modeling $600m going forward, which would add ~2.5% to the annual revenue growth algorithm. Based on the remaining TAM, this level of deployment offers WCN a runway of nearly two decades.

Among the 3 majors (WM, RSG, WCN), I have a preference for WCN, despite the higher valuation. The dynamics described above generally apply to all the companies, but there are slight differences with asset positioning that make WCN a higher quality business. Certain distinguishing features of WCN include:

• Greater exposure to exclusive markets and secondary/rural markets (exclusive markets are essentially monopolies and secondary markets benefit from greatly reduced competition)

• Purposefully less-integrated than RSG/WM, which leads to lower capital expenditures and landfill-related remediation and aftercare costs, leading to superior free cash flow conversion

• Growth algortihm driven more by the core business: WCN’s relatively smaller size and more limited focus on sustainability-related growth investments (downstream recycling and renewable natural gas) leads to a growth algorithm that centers more on core, solid waste (core pricing + M&A, both tuck-ins and new franchise and secondary/rural markets)

I believe WCN’s market exposures would offer better insulation in a downturn. All these companies should be resilient during a recession, but WM and RSG’s greater presence in large, urban areas with numerous competitors would create more pressure on churn and realized pricing. RSG’s recent foray into environmental services through its U.S. Ecology acquisition also makes it more tied to industrial activity. WM has been the most aggressive with investments into renewable natural gas, creating the most commodity-value exposure among the group. Its recently announced acquisition of Stericycle (medical waste) is questionable and further highlights the point that WM’s size restricts it from further solid waste acquisitions. RSG is not too far behind in that regard, and for that reason, a lot of its M&A attention will be focused on building out is environmental services platform. In contrast, WCN is solely focused on classic solid waste M&A.  

Waste Stock Performance vs S&P during the GFC

WCN’s greater exposure to exclusive/franchise markets and secondary/rural markets

WCN has a very deliberate approach with its market selection strategy. Among the majors, WCN has the highest exposure to franchise/exclusive markets. Many of these arrangements are found in the western region of the U.S. These exclusive arrangements were created during the 1920s and 1930s as an inducement for 3rd parties to commit the capital to build out infrastructure on the west coast. These arrangements grant WCN the right to provide waste services to all parties (residents and businesses) within specified areas at established rates and are long-term in nature. In essence, these are local monopolies. Some of these arrangements extend into perpetuity and others typically provide an exclusive period of 7 years or longer for a specified territory. They specify a broad range of services to be provided, establish rates for the services and can give the service provider a right of first refusal to extend the term of the agreement. Given these dynamics, these contracts never change hands and the only way to enter is to acquire them. These markets are typically held in the hands of a family, and they tend to be sold as part of estate planning. WCN has established relationships with these owners, and given WCN’s presence in these types of markets, track record in acquiring these franchises and preserving the reputation post ownership, it is often the preferred buyer for these businesses.

Pricing is tied to CPI escalators (on a lagged-basis) and offers less flexibility vs open markets, where waste operators have full discretion on what to charge (subject to competitive response). These contracts offer rate stability and projectability, and therefore protect downside but limit upside. For WCN, ~40% of its revenue is tied to CPI-based escalators and ~60% is tied to more open, discretionary pricing. The 40% tied to index-based escalators largely represents its exposure to exclusive markets.

On the flip side, incremental volume (such as a new McDonald’s that is built within the territory) inures fully to the benefit of WCN. McDonald’s has no choice but to choose WCN as its waste provider and WCN charges the list price per its franchise agreement. WCN does not need to go through the process of price discovery and compete with other collection companies for the business. There is no salesforce in franchise markets. Within these exclusive markets, incremental volume acts like the pricing lever in open markets (high incremental flowthrough). WCN does not have to worry about competitors going after its business, and its sole focus is offering reliable and predictable service to its customers.

The above table attempts to illustrate the significant differences in market dynamics within a large urban center versus a secondary/rural market. Within a typical rural market, there are only 1-2 landfills of which WCN would own one. WCN is most often the leading player within the rural markets they operate. As a 70% share player, the route density that comes with that level of share brings material cost structure advantages to WCN, much more than what a 20% share would bring to a leader within a large urban market. Owning the disposal capacity within the rural markets also affords WCN significant pricing power on the collection side. WCN has the luxury to be very price disciplined in these markets; if it loses some volume to a competitor that offered a discounted collection price, that volume will inevitably come to WCN’s landfill at incremental EBITDA margins exceeding 50%.

WCN has limited exposure to large urban markets, estimated to be ~10% of revenue, compared to 38% for RSG. WM’s exposure to large urban markets is estimated to be much higher. Given this dynamic, RSG and WM have the incentive to consolidate collection companies within their larger markets and perhaps be a bit more price competitive with collections, in order to ensure the volume goes to the landfill they own in the market. WCN believes this explains its structural EBITDA margin advantage relative to RSG and WM. WCN shares the same level of EBITDA margins for landfills (~50%), but it has superior collection margins.

Lower level of internalization leads to higher FCF conversion

WCN internalizes a lower % of its collected waste, estimated at 56% versus 65% for RSG and 68% for WM. In many cases, particularly within its exclusive markets, WCN believes that landfill ownership is not critical. In some of its exclusive markets, the landfill is either owned by the municipality or is owned by a third-party that is dependent on WCN’s collection volumes. The agreements are structured such that the landfill gate fees (i.e. the disposal costs for the collection company) are a pass-through cost item, which would automatically get reflected within the collection pricing. WCN’s western region, which contains the majority of the company’s exclusive markets, is 40% internalized. WCN’s central region, which serves as the best proxy for a “competitive” market (secondary + large urban markets), is 80% internalized. Landfills are high margin businesses (50% EBITDA margin) but require a significant amount of capex as well as remediation/after-care costs for landfills that are closed. These expenditures are reflected in the cash flow statement. The lower exposure to landfills, coupled with a slightly lower tax rate, explains the ~50% FCF conversion (FCF as % of EBITDA) for WCN vs. ~42% for RSG.

As mentioned above, WCN trades at a premium on an EV/EBITDA basis, but the metric does not capture the relatively less capital-intensive nature of its business model. On a FCF yield basis, WCN is still the most expensive but much more in-line with peers.

WCN’s growth algorithm driven more by the core business

RSG’s near-term growth algorithm included solid organic growth from pricing gains in excess of cost inflation, continued tuck-in M&A, and incremental growth from sustainability initiatives, including downstream recycling projects and RNG investments/partnerships. The sustainability initiatives are interesting as they naturally leverage the existing infrastructure and offer attractive returns on capital, but the revenue streams are inferior in quality, as they are indirectly tied to commodity values, such as natural gas prices, prevailing trading values for RINS credits, and the cost of virgin plastics. RSG is committing $735m over the next several years to these initiatives, and my inclination is that the capital commitment will increase over time, particularly with downstream recycling projects. 

WCN’s focus on sustainability projects is more subdued and centers solely on a select number of RNG projects at its existing landfills. Over the next 2-4 years, WCN has committed to 12 projects and WCN ultimately sees opportunities at 15-20 landfills over the long-term. The equity structure will be a mixture of partnerships (2/3) and WCN ownership (1/3). WCN projects a $200m investment creating a comparable amount of annual EBITDA by 2026.

Given its relatively smaller size, WCN’s main focus is on core waste M&A. WCN’s M&A strategy is highly targeted on growing its presence within exclusive and secondary markets (~90% of its exposure today). WCN has sized the TAM (measured as annual revenue) for its focused strategy within the U.S. and Canada to be $4-5b, comprised of $1.5-2bn for exclusive markets and $2.5-3bn for rural/secondary markets. Over the past 7 years, WCN has completed >$900m of acquisitions per year. I am conservatively modeling $600m going forward, which would add ~2.5% to the annual revenue growth algorithm. Based on the remaining TAM, this level of deployment offers WCN a runway of nearly two decades.

Waste Connections Footprint

Financials

Catalyst

• continued margin expansion over the next several years
• FCF conversion (as % of EBITDA) steps up in 2025/2026 once RNG investments are complete