2023-05-09 15:10:49 ET
Summary
- Waste Connections reported strong pricing power in 1Q23 with an 11.8% YoY increase in core prices and expects core price growth of 10% in 2Q23.
- I believe the recent return of founder and former CEO Ron Mittelstaedt is positive news for shareholders.
- At a 32x forward PE, the stock is certainly not shouting cheap.
Overview
Waste Connections ( WCN:CA ) provides non-hazardous solid waste collection services for commercial, industrial and residential customers. The company reported strong pricing power in 1Q23, raising core prices by 11.8% year over year (including fuel surcharge). Noting that 2Q23 core price expectations are at 10% lends credence to management's FY23 core price guidance (guided at 9.5%). While volume was a little lower than expected, I anticipate things will improve as the seasons begin to shift in WCN:CA's favor. Management has noted that there has been no change in volume trend, but this metric is still important to keep an eye on. Overall, I am recommending a buy rating as I believe WCN is a solid business with very strong competitive advantage thanks to its scale, execution capability (CEO is now back), balance sheet strength, and focus on exclusive and secondary markets, which account for about 90% of the business. I expect the company to maintain its high adjusted EBITDA margin (30%+) and strong FCF generation (FCF margin of mid to high teens%) thanks to its robust pricing power. WCN:CA's ability to generate consistent cash flow gives the company a stronger balance sheet on which to launch inorganic growth initiatives and distribute earnings to shareholders.
1Q23 Earnings
WCN reported $567 million in adjusted EBITDA for 1Q23 and adjusted EPS of $0.89. While weather did have a minor impact on volume, especially on the West Coast after recent landfill acquisitions, the company showed strong pricing power with an 11% increase in core prices and a 0.8% increase in prices due to fuel surcharges. Commodity price fluctuations, however, led to a reduction in margins (160 bps), causing the adjusted EBITDA margin to drop to 29.8%.
Outlook
Management guided to 2Q23 revenues of $2 billion and adj. EBITDA of $615 million (30.8% margin). Core price growth of 10%, a 0.5% headwind from fuel surcharges, and a 1.5% drop in volumes were the underlying growth drivers. I believe there is room for a beat in 2Q23 as management seems to be very conservative on their outlook for volume, especially considering their comments regarding it. Specifically, management noted volume trends are more or less steady in recent weeks, and daily landfill tons were up nominally in 1Q23. My take is that management is simply being overly cautious given the direction of the macro economy is too uncertain at this point. In fact, management is already hinting that they are looking forward to a seasonal uptick, that is expected typically in 2Q23. In the bull case for FY23, if volume were to pick up much earlier than expected (starting from 2Q), commodity prices will start to recover (which will give a further boost to growth as it comps against a tough FY22), and management will further juice growth through M&A, I believe there is a chance that management will raise FY23 guidance, which would give a boost to the stock momentum.
CEO
WCN:CA announced a CEO transition as its founder and former CEO, Ron Mittelstaedt, took back the helm. I view this as positive news for shareholders, as Mittelstaedt previously moved to the position of Executive Chairman in 2019 for personal family reasons. With the return of this key M&A leader, I anticipate an increase in the utilization of cash to execute value accretive deals.
Risks/Concerns
While I recommend a long position, I have some reservations about the stock. To begin with, the stock is not particularly cheap at the current 32x forward PE. While it is trading close to its 5-year average, I am concerned about a reversion to the 10-year average (28x). One could argue that the 5-year average is more appropriate because the company has grown in size, which strengthens its moat. However, we should keep in mind that interest rates are currently much higher, which should reduce equity valuation. The second point of concern is the FY23 guidance. Although I am inclined to be optimistic, if we take it at face value, it does imply a more 2H23 weighted performance, which increases the uncertainty of meeting guidance (i.e., it takes longer to ensure the risk to FY23 guidance is low if we can only verify it later in the year).
Conclusion
WCN:CA reported strong 1Q23 earnings, with pricing power driving growth despite weather-related volume impacts and commodity price fluctuations. Looking forward, management's guidance for 2Q23 indicates continued growth, with potential for a beat as management appears to be conservative in their outlook. While there are some concerns about the stock's valuation and the uncertainty of meeting FY23 guidance, I recommend a buy rating for WCN given its strong competitive advantage, balance sheet strength, and potential for inorganic growth initiatives. Additionally, the recent CEO transition is viewed as positive news for shareholders, and I anticipate an increase in value accretive deals under Ron Mittelstaedt's leadership.
For further details see:
Waste Connections: FY23 Guidance Seems Too Conservative