The trash business is basking in the sweet smell of success as investors swoop down on a sector that is generating enormous amounts of cash and thick profit margins. But are we approaching peak garbage?
Some of the biggest names in the sector have seen their share prices rally virtually without pause over the past few months, to fresh record highs in a few cases.
Toronto-based Waste Connections Inc. (WCN-T), North America’s third-largest player in the space, rocketed to a record high above $220 on the Toronto Stock Exchange this week after the company reported upbeat fourth-quarter financial results and delivered a promising lookahead. The stock is up 22 per cent over the past 12 months.
It’s by no means alone with this strong performance, which points to broader interest in the sector as it crushes major benchmarks.
GFL Environmental Inc. (GFL-T), another Canadian player, has rallied 31 per cent since the end of November.
Texas-based Waste Management Inc. (WM-N) and Republic Services Inc. (RSG-N), based in Arizona, rallied to record highs this week after releasing their own financial results. The stocks are up 30 per cent and 42 per cent, respectively, over the past year. Their performance easily beats the tech-stock-fuelled Standard & Poor’s 500 Index over the same period.
The sector used to appeal to investors for its utility-like performance. It was relatively immune to recessions because of long-term garbage-hauling contracts, reliable generation of waste and high barriers to entry because of tough regulations on landfill sites.
In the past few years, though, this performance has moved up a notch. Waste-management companies that had been delivering steady growth of 4 to 6 per cent, on average, are now increasing their revenues by as much as 10 per cent through consolidation, improved operational logistics and strong pricing power.
“The garbage industry is not afraid of inflation, because they can pass it through on price,” Michael Hoffman, an analyst at Stifel, said in an interview.
As well, he added, companies have ramped up automation and improved their routing systems to become more efficient.
Waste Connections this week gave investors a lesson on how these attributes are feeding into financial results. In the fourth quarter, the company’s revenue increased by 8.9 per cent from last year, and net income increased by 53 per cent. For the full year, it generated US$2.1-billion in operating cash flow, up from about US$2-billion last year.
Another standout metric: Already fat profit margins expanded further.
The ratio that compares EBITDA – earnings before interest, taxes, depreciation and amortization – with revenue expanded by two percentage points, year over year, to 32.2 per cent. The company expects margins will expand by another 1.2 percentage points this year, which implies EBITDA growth of 13 per cent in 2024.
“In this business, those are big numbers,” Chris Murray, an analyst at ATB Capital Markets, said in an interview.
Investors who want to join the rally, though, aren’t exactly early to the trade. In addition to record-high stock prices, valuations are reflecting strong growth that could limit share-price gains.
Key stocks in the sector now trade at 42.2 times analysts’ consensus earnings estimates for 2024, on average, which is rich for garbage-hauling. Similarly, the stocks trade at nearly 32 times free cash flow, up from a multiple of about 25 just one year ago.
Mr. Murray believes that the gains ahead for Waste Connections will be more muted. He raised his target price on the stock, or where he believes it will trade within a year, to $235 from $220. However, he downgraded his recommendation to “sector perform” from “outperform” – the equivalent of moving to “hold” from “buy” – based on an expected return of just 6.5 per cent.
Still, he’s not trashing trash. The inflationary pressure of the past couple of years, he argued, will generate better pricing for Waste Connections in 2024, given that 40 per cent of its operations are linked to the consumer price index.
Similarly, Mr. Hoffman called the sector’s recent rally “a heck of a move.” But he believes that long-term investors are now latching on to waste-management companies for their reliability – most revenue isn’t tied to volume, but rather based on contracts – as many forecasters predict subsiding economic activity.
“In the face of all the things you worry about, the one thing you know about the garbage business: The garbage people show up everyday and pick it up,” Mr. Hoffman said.
David Berman