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Morningstar | WCN Updated Forecasts and Estimates from 20 Feb 2019

Traditional solid-waste services specialist Waste Connections grew fourth-quarter consolidated revenue 3.7% organically, slightly ahead of our forecast on a better-than-expected contribution from core solid-waste segment pricing. Relative to the same period last year, organic revenue growth continues to stem from favorable pricing conditions across the traditional solid-waste industry, 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 expanded 30 basis points to 31.5% and was mostly in line with our expectations. Excluding the dilutive impact acquisitions, margins were up 80 basis points, as leverage from solid-waste pricing and higher E&P activity comfortably offset recycling headwinds and operational cost inflation.

Since our midcycle revenue and margin assumptions remain mostly intact, we don’t expect to make material changes to our $60 fair value estimate. That said, we will be incorporating full-year 2018 financials into our DCF model and that could drive minor adjustments, which would likely prove upwardly biased. The shares are trading in 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 overly optimistic midcycle revenue and margin assumptions.

Internal growth for the solid-waste operations (including collection, disposal and transfer, and recycling) grew 3.5%, as another strong 4%-plus contribution from core pricing overcame flattish waste volume and a 1% headwind from weakness in the recycling unit. Solid-waste segment volume was largely flat due in part to continued shedding of low-margin and “unsafe-to-service” Progressive Waste contracts, though this is slightly better than the 1% average decline posted in the first three quarters of 2018. Year-over-year solid waste segment internal growth accelerated from the 2% posted last quarter on stronger pricing trends and easing recycling comparisons.

Recycling revenue declined 24% (down 42% for the full year) on the back of lower average recycled commodity prices, particularly old corrugated cardboard, or OCC, which has been hit hard by import restrictions into China. Average OCC prices are currently in the area of $85 per ton, down 15% from the $102 average seen in 2018. Management expects recycled commodity values to remain near this level in 2019, which points to the potential for greater stability. Aside from the solid-waste division, E&P-waste segment revenue was up a solid 20% on the back of improved activity with customers in the Permian basin.

In terms of 2019 guidance, management expects total revenue of $5.31 billion, which compares with previous Consensus estimates of about $5.34 billion. This includes solid waste division organic growth near 4% and an elevated level of incremental revenue from deals. The firm anticipates 30 basis points of adjusted EBITDA expansion to 32.1%.