2024 Should Be Another Year of Outsize Acquisition Activity for Waste Connections

Sector Director

Brian Bernard

As a fully integrated waste hauler, Waste Connections leverages its large network of collection routes that bestows significant control over the waste stream, funneling trash from commercial, industrial, and residential end markets into its valuable landfill assets. Waste Connections' secondary and rural market strategy faces less competition and delivers higher profit margins relative to larger, urban-focused competitors Waste Management and Republic Services.

In 2016, Waste Connections (the third-largest integrated waste hauler at the time) merged with the fourth-largest provider, Progressive Waste, essentially doubling in size. The deal afforded Waste Connections the opportunity to apply its top-tier operational know-how and pricing discipline to bring Progressive’s profitability up to par with its own. Waste Connections also gained entrance into new geographic regions, most of which fit its differentiated focus on less-competitive secondary markets—a strategy that’s contributed to its industry-leading profitability. 

Waste Connections was enjoying the fruits of a successful merger integration and tailwinds from healthy US macroeconomic expansion heading into 2020, but the covid-19 pandemic threatened to interrupt the firm's strong performance record. However, Waste Connections persevered, shining a light on the resiliency of its business model. Indeed, 2020 adjusted EBITDA and free cash flow were not far off from the firm's 2019 performance. Since 2020, EBITDA margin has averaged over 31% and adjusted free cash flow has grown at a 17% compound annual rate, with $1.2 billion of free cash flow in 2023).

We expect Waste Connections to continue its tuck-in acquisition strategy, and its ability to raise core price on acquired volume (thanks to its vast ownership of landfills, a preferred asset) should support free cash flow growth. But considering the firm's growing revenue base, we think it will become more challenging for acquisitions to move the needle.

Business Strategy & Outlook

We assign Waste Connections a wide economic moat rating because we have very high confidence in the firm's ability to generate excess returns over the next 10 years, and we think it's more likely than not that excess returns will persist over the next 20 years. Waste Connections has a large amount of goodwill on its balance sheet from its 2016 merger with Progressive, and this dynamic has resulted in a relatively tight spread between the firm's return on invested capital and its cost of capital. However, considering the firm's competitive advantages, we're confident this spread will persist. Furthermore, if we look past the goodwill generated from this merger, Waste Connections' ROICs are around 10%.

We believe that intangible assets stemming from its irreplaceable landfill footprint is Waste Connections' primary and most durable moat source. Federal and state regulations and not-in-my-backyard activism have made its very costly to operate and close landfills and extremely difficult to receive approval for new landfills. As such, the number of landfills has fallen from approximately 10,000 in 1980 to only about 1,500 today. Small landfill owners couldn't afford to implement environmental requirements such as plastic linings and leachate and methane recovery equipment and were replaced by large regional landfills. Today, we estimate that public companies own or manage 60% of municipal solid waste landfills, including life-of-site agreements to operate municipal-owned landfills. While Waste Connections' landfill footprint is much smaller than Waste Management (263) and Republic Services (207), we think it is appropriately scaled for the firm's smaller market share compared with the larger public players. Landfill scarcity has supported pricing power for Waste Connections with annual core price increases consistently exceeding inflation. Furthermore, the company can generate profits (through tipping fees) from competitors that don't own landfills or own landfills that are located too far away to be cost-competitive. 

Because disposal costs are the most significant expense for waste haulers, owning well-placed disposal assets (landfill and transfer stations) can yield a cost advantage in local markets over competitors that transport waste over longer distances. However, cost advantages related to the proximity of disposal assets wouldn't persist without the presence of intangible assets. Transfer stations (which require permits to operate) are extensions of landfills that consolidate and compact waste into high-volume transfer vehicles. Transfer stations can reduce disposal costs, but significant waste volumes are needed to yield favorable economics.

The largest public waste collection and disposal businesses have been able to expand existing landfills, but regulations and Nimby make it difficult for even the largest, most powerful players to construct new landfills. However, if regulations were relaxed and landfill construction costs decreased, we think that there would still be limited incentives for new entrants because waste disposal has most of the characteristics of an efficient scale market—mature demand, excess capacity (existing landfills have long useful lives), commodity products, inelastic demand, and high sunk costs—and new entrants would lower the industry's returns below the cost of capital. 

Route density has the capacity to provide cost advantages for firms with significant local scale. Scale matters in route-based businesses (in this case, collection through disposal) because it provides greater utilization and leverage over a vast cost base (costs linked to landfill ownership, collection equipment, transfer facilities, and so on). In our view, Waste Connections benefits from its significant route density in the smaller markets it serves.

Waste Connections has managed to differentiate itself slightly from its two larger peers because of a long-standing focus on "franchise" markets (defined by very long-term exclusive contracts that are rarely rebid) and "secondary" markets (nonfranchise rural and small suburban markets) rather than more competitive urban markets. In secondary markets, Waste Connections often has the only landfill in the vicinity or is maybe one of two. Thus, even if it loses collection business in those markets, that same waste could end up at its landfills anyway via third-party haulers. There’s also far fewer collection companies to contend with in secondary markets. In more populous urban markets, hosts of small waste haulers can drag collection pricing down while also pitting landfills against one another, especially during downturns. In terms of mix, about 40% of Waste Connections’ top line derives from franchise markets, 50% is from secondary markets, and 10% is from urban markets. For Republic, that mix is around one third each. 

We believe the major waste management companies, including Waste Connections, face low environmental, social, and governance risk. This may come as a surprise given the dirty work these companies perform (that is, garbage hauling and disposal). However, the waste business is highly regulated, and these firms have spent billions of dollars to reduce the environmental impact from their operations. Waste Connections has committed $500 million to help achieve its ESG goals.

Waste Connections is still exposed to environmental risk as mishandling waste could result in substantial fines and remediation costs and damage community relations. However, the firm has a strong record and has mitigating controls and processes in place to minimize environmental risk from mishandled waste. 

Waste Connections also faces environmental risk tied to the greenhouse gas emissions from its landfills and large truck fleet. According to the Environmental Protection Agency, landfills accounted for 17% of US methane emissions in 2019. However, the industry continues to heavily invest in clean technology to capture landfill gas and convert it into electricity and renewable natural gas. The industry has also been replacing internal combustion engine vehicles with ones powered by electricity and compressed natural gas.

Wide

Economic Moat

Waste Connections

Waste Connections, Inc. engages in the provision of non-hazardous waste collection, transfer, and disposal services. It offers its services to residential, commercial, landfill and transfer stations, and industries such as office, apartments multi-family, construction and demolition, property management, retail, restaurant, and manufacturing. It operates through the following geographical segments: Eastern, Southern, Western, Central, and Canada. The company was founded by Ronald J. Mittelstaedt on September 9, 1997 and is headquartered in Woodbridge, Canada.

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Waste Connections reports solid Q1 results, anticipates upside from recovered commodity values

Waste Connections delivered strong Q1 results despite challenges from weather-related impacts and cost inflation. The company remains confident in its outlook, emphasizing potential upside from recovered commodity values and reduced inflationary pressures.

Waste Connections surpasses Q2 expectations, eyes strategic acquisitions and operational efficiency

Waste Connections delivered strong Q2 results, with a positive outlook for 2023 and a focus on strategic acquisitions and operational efficiency. While facing challenges in labor turnover and market dynamics, the company is well-positioned to capitalize on growth opportunities and maintain financial strength.

Waste Connections reports resilient Q3 performance and focuses on sustainability

Waste Connections delivered strong financial performance in Q3, despite facing headwinds. The company's focus on sustainability and employee engagement is evident, while challenges related to evolving landfill situations and wage increases are being addressed. Opportunities for revenue growth and investments in RNG projects are on the horizon.

Waste Connections reports robust Q4 performance and optimistic outlook

Waste Connections delivered strong financial results in Q4 2023 and full year 2023, with a focus on margin expansion, revenue growth, and operational efficiency. Despite challenges related to the landfill event, the company remains optimistic about future opportunities, including acquisitions and margin enhancement strategies.

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Waste Connections, Inc. engages in the provision of non-hazardous waste collection, transfer, and disposal services. The firm offers its services to residential, commercial, landfill and transfer stations, and industries such as office, apartments multi-family, construction and demolition, property management, retail, restaurant, and manufacturing. It operates through the following geographical segments: Western, Southern, Central, Eastern, Canada, and MidSouth. The company was founded by Ronald J. Mittelstaedt on September 9, 1997 and is headquartered in Woodbridge, Canada.

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