EUR 850.00 For Business Accounts Only

Morningstar | Waste Connections’ First-Quarter Solid-Waste Volume Temporarily Softens, but Pricing Still Robust

Traditional solid-waste services specialist Waste Connections’ first-quarter consolidated revenue grew 3.1% organically, slightly ahead of our forecast on a better-than-expected contribution from solid-waste pricing--the firm has been doing an admirable job securing rate gains from customers to help offset cost inflation. Relative to first-quarter 2018, organic revenue growth continues to stem from favorable pricing conditions across the traditional solid-waste industry (aided by several years of positive U.S. economic growth), along with increased activity in the specialized E&P waste segment. These factors were only partly offset by ongoing contract optimization and persistent recycling headwinds linked to anemic commodity prices for materials the firm extracts and sells.

On the margin front, consolidated adjusted EBITDA margin fell 30 basis points to 31.0%--slightly below our expected run rate. The decline was mostly driven by weather disruption, recycling segment headwinds, and the dilutive impact of acquisitions. Excluding the dilutive impact acquisitions and recycling weakness, margins expanded 45 basis points year over year, with help from leverage from solid-waste pricing and higher E&P activity.

Since our midcycle revenue and operating margin assumptions remain mostly intact, we don’t expect to make material changes to our $60 DCF-derived fair value estimate. The shares are trading in modestly overvalued territory relative to our longer-term expectations for top line, profitability, and free cash flow growth. In short, several industry leaders are seeing very healthy trends within their traditional solid-waste operations thanks to U.S. macroeconomic tailwinds, and this dynamic hasn’t escaped investors. Waste Connections is a high-quality waste hauler but, in our view, the stock price is baking in slightly overoptimistic midcycle revenue and margin assumptions.

Internal growth for the solid-waste operations (reflecting the collection, disposal and transfer, and recycling segments) grew 2.8% year over year, as another impressive contribution from core pricing (up 5% in the quarter; it was up 4% for all of 2018) more than offset a 1.2% volume decline and an approximate 0.5% headwind from weakness in the recycling operations. Solid-waste segment volume saw an approximate 50-basis-point headwind from winter-weather disruption and another 50 basis point headwind from the intentional shedding of low margin business in the Northeast. We note management expects shedding efforts to anniversary in the second half and is guiding for flat to slightly positive volume growth in the second quarter, particularly as new special-waste projects take hold.

Recycling revenue declined 14% (it fell 42% for all of 2018), as average recycled commodity prices, particularly old corrugated cardboard (or OCC) and mixed paper, continue to march lower. OCC has been hit hard by import restrictions into China over the past year plus. Average OCC prices were near $77 per ton in the first quarter, down 24% year over year, and down 17% sequentially from fourth quarter 2018. Management doesn’t anticipate improvement this year, though that factor is baked into guidance as well as into our model assumptions. Aside from the solid-waste division, E&P-waste segment revenue was up a healthy 14% on the back of improved activity with customers in the Permian basin. Waste Connections also commenced operations at a new E&P waste landfill in Wyoming's Powder River Basin.