2023-12-04 20:16:44 ET
Summary
- GFL is a waste management business that has grown rapidly through acquisitions, but heavy debt accumulation raises concerns about its financial health.
- Increasing interest rates and tightening capital markets could leave GFL vulnerable and slow down its growth through acquisitions.
- GFL’s current cash flow does not provide an acceptable margin of safety over its fixed costs.
- The company must improve its financial health before investors consider buying shares.
All figures discussed are in millions of Canadian dollars, unless stated otherwise.
GFL Environmental ( GFL ) is a vertically integrated waste management business headquartered in Toronto Ontario. The company offers environmental services to municipal, residential, commercial, industrial, and institutional clients. The business has grown rapidly over 16 years while completing close to 200 acquisitions. The business currently has 20,000 employees and a market capitalization of $15 billion.
The company’s success has come from identifying a fragmented industry, but heavy debt accumulation questions whether GFL is creating a well-integrated platform that can generate organic growth or is empire building at the expense of investors. While top line growth has been impressive, the debt taken on to fund it could prove financially damaging for investors. Increasing interest rates and tightening capital markets could leave GFL vulnerable. Growth through acquisition could begin to slow if M&A markets freeze up as capital become scarcer with increasing economic headwinds. For these reasons, we are rating the stock a "sell" at current valuations.
Businesses with rich access to capital can often drop the ball on integration and focus instead on growth through further acquisition. Strong access to capital lined up serendipitously with GFL’s accurate assessment of a niche market ripe for a roll up. Its ability to manage the acquisition strategy will be tested in a different economic environment and will likely show the company’s inadequate integration and willingness to overpay for acquisitions.
Company Background
Green for Life Environmental Inc. was founded in 2007 by current CEO and President Patrick Dovigi, after a falling out with his prior business associate, Romeo DiBattista Sr. Promptly after launching GFL, Dovigi began setting out to roll up a segment of the waste management market he thought was under attended to by the larger players.
Dovigi identified that significant volumes could be achieved by acquiring “mom-n-pop” waste service providers who represented a significant portion of the total market. In 2010, $6 billion of the waste service sector in Canada was represented by over 1,700 companies in the small to medium size. Dovigi thought rolling up this segment of the market could create a platform of considerable size, while avoiding head-to-head competition with industry heavy weights.
GFL has grown into the largest industry player in Canada and is top ten largest waste management businesses in North America. It is rapidly expanding into the US market and creating notable brand recognition with their bright green trucks. Dovigi has built an environmental services and industrial giant, predominantly through strategic acquisitions, but can the company sustain its growth and create economies of size, or will the debt burden reduce returns for shareholders?
Growth Through M&A
Much of GFL’s growth to date has come through acquisitions. In under two decades the company has completed over 200 acquisitions of varying sizes, with its busiest year coming in 2021 with 43 purchases . From 2018 through Q3 2023 GFL has spent $15.8 billion on acquisitions.
GFL Financial Statements
GFL’s largest acquisitions were for the Waste Management assets , WCA Waste Corporation , and Terrapure Environmental Ltd . Financial data for some of these businesses is not readily available as they were privately owned, however, the data that is available shows possibly rich valuation for GFL’s largest purchases.
The Waste Management assets were acquired in June 2020 for $835MM USD, and generated revenue of approximately $345 million USD, representing a 2.4x revenue multiple. WCA was acquired one month later for $1.212 billion USD and was estimated to have $400 million USD in sales at the time, representing over a 3x revenue multiple. Terrapure Environmental was purchased by GFL in March of 2021 for an aggregate purchase price of $927.5 million with revenue estimated at $365 million, or a 2.54x revenue multiple.
Limited information available on the details of the acquisitions makes it difficult to judge value, and whether GFL is overpaying. The strategic benefit of the assets could justify overpaying, but what is evident from the data available is that GFL is not purchasing at a discount. GFL currently trades at 1.93x its TTM revenue, 20-30% below what it paid for its three largest acquisitions. A notable premium considering public market multiples generally trend above private multiples.
While GFL has raised a sizable sum of capital through equity issuances, the lion’s share of the company’s acquisitions has been through debt. With the company possibly overpaying for its largest acquisitions, shareholders should take careful consideration if the company can service the debt it has accumulated.
Ballooning Debt and Lackluster Cash Flow
GFL has been a strongly funded business taking in large sums from institutional investors. To end the third quarter of this fiscal year, GFL has over $757 million of funds on hand, made up of $174 million in cash and $583 million in revolving credit . GFL has grown its debt by 40% in the past 5 years, issuing over $16 billion in notes.
Covenants require that total net funded debt to Adjusted EBITDA not exceed a 6:1 ratio on a trailing twelve-month (“TTM”) basis for the four quarters following a material acquisition and 5.75:1 ratio during all other times. As can be seen below, GFL from 2020 onwards has maintained a debt level that pushes this upper bound. It should be noted that these calculators are the authors, and the company’s bank reported figures (which are not public) could have adjustments that change the ratios. To date GFL has been in compliance with all its covenants.
GFL Financial Statements
Growth through debt is not necessarily bad when used appropriately. However, it can become a drag on the business if cash flow is siphoned away from operations. To avoid these pitfalls management must find synergies and create organic growth amongst the purchased businesses. This is especially the case if management overpays for its acquisitions. It is imperative that the purchased assets compensate for the debt burden and create growth to manage future debt payments, increase equity returns, and compensate for the risk assumed.
GFL’s second debt covenant is an interest coverage ratio requiring the company to maintain an Adjusted EBITDA to interest of 3:1 or higher. Interest has averaged $126 million per quarter since 2020, this would require the company to maintain an Adjusted EBITDA of $378 million per quarter. The company has managed this covenant since beginning in September 2021, but not by a substantial margin. If interest rates continue to rise, the company could find itself in a difficult position.
GFL Financial Statements
While EBITDA is useful as an apples-to-apples measure between companies, it fails to capture a business’s ability to turn sales into cash, an important point for capital and debt heavy businesses. A free cash flow (“FCF”) analysis shows GFL has a poor cash flow record, averaging 10% FCF to revenue quarterly since 2020. When comparing GFL’s FCF to fixed payments, one can see in normal quarters- those which GFL does not refinance larger portions of its debt- the company still struggles to cover most of its fixed costs. Even when debt repayment is removed, the businesses free cash flow still often falls short of meeting its interest expense and capital leases.
GFL Financial Statements
GFL’s impressive growth to date has been significantly funded through debt, and the businesses’ fixed costs could outpace its ability to generate cash flow. Perpetual growth is useless unless management can create synergies out of the acquisitions, especially if the company overpays for its acquisitions, it is now trying to repay debt derived from a valuation above what the company can likely return.
GFL Q3 2023 MD&A
Management has made deleveraging the business a key focus since the beginning of the year. The company has had some success to date, but still has considerable room for improvement moving forward. Long term debt has been reduced $400 million this year, but with a high CAPEX, $830 million year to date, further improvements could be difficult if cash flow becomes constrained.
Valuation and Conclusion
The stock currently trades at a 12x EV/ Adjusted EBITDA and has trended flat this year after falling 22% from its peak in early July. When compared to some of its peers, GFL paints a better value picture, and could be considered for a portfolio if one wishes to add diversification into industrials, a sector that is generally steadier during economic downturns. GFL has traded above $16 billion in recent periods, and if it trends towards that valuation again could provide a decent return for investors, but its financial health poses risks that outweigh the potential upside.
Seeking Alpha GFL Financial Statements
While the company’s historical roll up story is impressive, success to date appears largely driven by its strong access to capital and ability to continually acquire. In the M&A game, most businesses succeed or fail on integration rather than acquisition. Whether the business has been able to successfully integrate its roll up thus far will not be fully seen until the acquisition train slows to a halt. With rising debt costs and capital markets leaning towards a risk off approach, GFL could find itself with a lack of adequate prospects, and organic growth could prove insufficient to meet the rising debt service costs.
With large debt outstanding, GFL’s current cash flow does not appear sufficient to meet worsening conditions. At current valuations the company should be avoided by investors, and a reduction in value by 30-40% (with no deterioration in earnings or cash flow) may need to be realized before the stock becomes attractive. Even at depressed levels of valuation, the company’s cash flow and debt leave far too much risk to buy into common shares.
Equity investors always need to remember, debt holders have first dibs. Unless the company can prove its acquisition strategy through improved cash flow and succeed in improving its financial health, investors should avoid the stock as the risk don’t justify what potential upside there may be.
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For further details see:
GFL Environmental: An Overpriced Roll Up Strategy