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Morningstar | No Surprises in Waste Connections’ 2Q; Core Pricing and E&P Waste Tailwinds Persist

Traditional solid-waste specialist Waste Connections' second quarter top line grew about 3% on an organic basis, to roughly $1.24 billion, slightly below our expected run rate due to variability in the shedding of unfavorable accounts in the former Progressive Waste business. Relative to the same period last year, higher revenue stems from robust pricing conditions across the traditional solid-waste landscape and increased activity for the more specialized E&P waste division, only partly offset by contract optimization efforts and ongoing weakness in the recycling operations linked to anemic commodity prices for materials the firm extracts and sells. Since our midcycle revenue and operating margin assumptions remain intact, we are maintaining our $59 fair value estimate and wide moat rating. As of July 24, the shares are trading in modestly overvalued territory. Recycled commodity prices are depressed, but several industry leaders are seeing healthy growth within their solid-waste operations thanks to U.S. macroeconomic tailwinds, and this dynamic hasn’t escaped investors.

Internal growth for the solid-waste operations (including collection, disposal and transfer, and recycling) expanded roughly 1.5%, as a strong 4% contribution from core pricing was only partly offset by a 1.5% drag from lower waste volume and weakness in the recycling unit. Recycling revenue fell 47% year over year (not far off the first-quarter decline) thanks to lower average recycled commodity prices, which are under pressure from increased import restrictions in China. Solid-waste division volume declines were mostly the result of continued shedding of low-margin Progressive Waste contracts. E&P waste-treatment segment revenue was up 28% on higher activity in several U.S. natural resource basins.

Waste Connections' adjusted EBITDA margin was roughly flat with second-quarter 2017, at 31.9%. We suspect leverage from solid revenue growth in the core collection and disposal operations was largely offset by recycling headwinds and softer solid-waste volume. In terms of guidance, management now expects 2018 total revenue of $4.880 billion (previously $4.825), which compares with previous street consensus of $4.90 billion. The firm also expects an adjusted EBITDA margin of 31.9% in 2018 (versus 31.5% in 2017) and adjusted free cash flow of $860 million (previously $850 million).

Waste Connections' management is participating at the Management Behind the Moat conference held at Morningstar's Chicago office on Nov. 7-8, 2018. If you are interested in attending the conference, please reach out to your institutional sales representative.