2023-04-20 05:18:31 ET
Summary
- The waste management industry is expected to continue growing.
- GFL Environmental's aggressive growth strategy makes it tricky to value.
- GFL has a higher leverage ratio than its peers.
GFL Environmental Inc ( GFL ) is one of the largest diversified environmental services companies in North America. We believe the company to be an aggressive bet on the waste management industry relative to its peers. As a result, we are neutral on the stock.
Industry Analysis
We recently analyzed Waste Connections ( WCN ), where we go into more detail about the overall Waste Management industry. It also includes a quantitative comparison of GFL to some of its competitors. As a result, we suggest having a look in order to see a deeper industry analysis. However, we will go over some key points in this piece.
The waste management market is projected to grow at a compound annual growth rate [CAGR] of 6.2% from 2022 to 2030, going from US$989.20 billion in 2021 to US$1,685.5 billion . This growth is driven by two key factors :
- The growth and development of cities and industries.
- A growing awareness of renewable waste management systems and the need to reduce carbon dioxide emissions.
In addition, waste management companies enjoy natural monopolies in the areas where they operate. Natural monopolies arise typically due to the high start-up costs or powerful economies of scale, which can result in significant barriers to entry for potential competitors. A company with a natural monopoly might be the only provider of a product or service in an industry or geographic location.
Valuation
GFL is a little tricky to value due to its aggressive acquisition strategy. Given that the firm spends more on acquisitions than it earns in free cash flow, it has a fairly high leverage ratio compared to its peers, with a net debt to EBITDA ratio of 5.7x.
Since acquisitions are a major part of the company's growth strategy, we will need to subtract the money spent from free cash flows since this is money that doesn't go toward investors. However, this makes reasonably forecasting free cash flows after acquisitions basically impossible.
Nevertheless, we could value the business in its current form without acquisitions by looking at its organic growth rate, which management pegs at a range of 6.4% to 7.3% during fiscal year 2023.
Therefore, to value GFL, we will use the H-Model, which is similar to a three-stage DCF model. The H-Model assumes that growth will decelerate linearly over a specified period of time. We believe this is a reasonable assumption as companies gradually slow down as they mature.
The formula is as follows:
Stock Value = (CF(1+tg))/(r-tg) + (CF*H*(hg-tg))/(r-tg)
Where:
- CF = Free cash flow per share which we adjusted for acquisition integration costs
- tg = terminal growth rate
- hg = high growth rate
- r = discount rate
- H = half-life of the forecast period
For GFL, we used the following assumptions:
- CF = C$1.11 per share
- tg = 3.79% (used 30-year U.S. Treasury yield as a proxy)
- hg = 6.85% (based on the organic growth guidance at the midpoint)
- r = 10%
- H = 5 years (we are assuming it will take 10 years to reach terminal growth)
As a result, we estimate that the fair value of GFL is approximately $18.12 under current market conditions when excluding acquisitions. This doesn't mean that we think the price will fall that low, but it could be considered as the baseline value for the stock. If the company continues to make good acquisitions or reduce costs to maximize profitability, then the intrinsic value would be higher. Nevertheless, it remains tricky to identify.
Risks
Since acquisitions are a big part of GFL's growth strategy, they also pose a large risk. Indeed, there is always the possibility of acquiring underperforming companies. If management lacks diligence or overestimates synergies, that could result in value destruction.
In addition, rising interest rates could impact the firm's profitability since it is highly leveraged relative to its peers. However, it's worth noting management expects to bring down its leverage ratio to the low 4x range by the end of 2023.
Insiders Have Been Net Sellers
Insiders are the people with the most knowledge about the operations of a company. As a result, it's not a bad idea to keep track of what they're up to. Interestingly, insiders have been net sellers, offloading $2.2 million worth of shares in the past three months. As a result, insider sentiment is currently rated as negative.
Final Thoughts
GFL is an aggressive bet on the waste management industry due to its high leverage. However, it does provide a service that is essential to the well-being of society by keeping communities clean, which allows it to take on more debt with more confidence. Nevertheless, its aggressive growth strategy makes it difficult to value, which is why we remain neutral on the stock.
For further details see:
Navigating The Waste Management Landscape: An Analysis Of GFL Environmental