Waste Connections

Waste Connections posted a good set of results in the second quarter as adjusted EPS came in at $1.50 per share, 16% higher on a year-over-year basis. Strong core pricing, acquisition volume, and fuel surcharges led to continued strength in margins for the quarter. 

Why it matters: Organic solid waste revenue growth during the quarter came in at 3.6%, with a 4.6% contribution from average yield and 1.1% contribution from fuel surcharges, which were partially offset by a negative 1.9% contribution from volume decline and 0.2% headwind from recycling. Adjusted EBITDA margins continue to outperform and came in at 32.8% during the quarter, up 10 basis points year over year. Impressively, underlying margins expanded by 70 basis points, overcoming cost pressure from fuel costs and ongoing drag from lower commodity values. Management said that it is spending about $100 million in artificial intelligence-related technologies and expects about $100 million of annual EBITDA impact from benefits related to pricing, AI-driven routing, and customer service.

The bottom line: We increased our fair value estimates for the wide-moat-rated firm to USD 162 (CAD 228) from USD 156 (CAD 213) to reflect the time value of money and slightly higher margin projections.

Between the lines: The firm has continued to trade pricing for volume in its markets as unit volumes were down 1.9%. The consolidated drop in volume is despite 1% volume growth in its exclusive markets, which constitute about 40% of the footprint and where there is no competition. This shows that the firm continues to bleed market share in competitive markets, especially within the residential segment, to private competitors that operate at a much lower margin profile. We are impressed with the firm's margin performance, but our midcycle margin assumptions are guided by the belief that the competitive dynamics put a cap on how much margins can improve from the current level.

It looks like 2026 is turning out to be another strong year from an inorganic growth perspective. One of the main reasons for the firm's outperformance in the past decade has been its execution on the inorganic growth front. We think Waste Connections has built an impressive bolt-on acquisitions engine that is value-accretive to shareholders. Management anticipates another outsize year of acquisition activity based on its pipeline and deal visibility, with aggregate annualized revenue from acquisitions to hit the USD 100 million mark around the end of the second quarter. The upbeat guidance on acquisitions was another reason for the market's positive reaction.

The strength and the resilience of Waste Connections' business model are evident from its performance during periods of economic or geopolitical turbulence. For instance, management expects the firm to be largely insulated on an EBITDA basis from most of the effects of higher fuel costs caused by the current geopolitical turmoil. This is due to a mixed impact on the company from a variety of factors. First, the firm will benefit from any pickup in exploration and production waste activity due to higher oil prices, and higher commodity prices will also be beneficial for the recycling business. Second, on the cost side, the firm is somewhat insulated from the hedges that it has in place for diesel prices. Third, the firm should be able to pass on its increased cost to customers in the form of fuel surcharges.

We are impressed by the firm's margin performance in its core business. Management highlighted that its artificial intelligence-driven pricing tool has already yielded approximately 20% improvement in customer retention and pricing effectiveness while maintaining core pricing strength. While the firm's technology initiatives are beneficial at the margin, we are not convinced about a structurally higher margin profile due to technology implementation. Technology and automation investments should boost efficiency for all the large players in the industry, and the margin profile for the industry is partly a reflection of competitive intensity. In our opinion, tech will improve efficiency, but there is a cap to margin expansion. We project midcycle adjusted EBITDA margin of around 34% for Waste Connections, higher than for peers.

We are slightly increasing our fair value estimate for the New York Stock Exchange-listed shares to USD 162 per share from USD 156 per share, reflecting the latest results. Our fair value estimate equates to around 29 times our adjusted EPS estimate for 2026 and a forward EV/adjusted EBITDA of around 15 times. Our weighted average cost of capital for the firm is 6.9% based on a 7.5% cost of equity, a 24% long-term tax rate, and an 82% equity weighting.

Between 2021 and 2024, Waste Connections' annual revenue increased by double digits each year, driven in part by heavy M&A activity. The firm has achieved strong pricing growth in the last four years. Average yield was especially strong during 2022 (9.2%) and 2023 (9.0%) as inflation reached levels last seen in the 1980s. In our view, Waste Connections' ability to pass on pricing increases exceeding inflation reflects its pricing power, which is afforded by its wide economic moat. While pricing has remained resilient, volume has been more bumpy. Volume rebounded strongly after the pandemic in 2021 but has been subdued in the last four years as higher interest rates have impacted industrial production and construction activity.

Between 2026 and 2030, we assume the firm can post average annual organic top-line growth of about 5%-6%, amid a steady economy and persistent pricing power. We forecast average collection and disposal yields of around 4.0% annually, with slightly higher recycling yields as commodity prices recover. Our annual core pricing assumption for Waste Connections is higher than its larger peers, WM and Republic Services, because of the firm’s favorable market mix. We project volumes to remain under pressure until 2027 and then recover to a growth of around 0.5% on average in the next three years. Additionally, we forecast another 200 basis points of average annual growth from tuck-in acquisitions.

We forecast Waste Connections' adjusted EBITDA margin will average around 34% over the next five years, which is a higher level of profitability than the firm’s historical average. Our EBITDA margin forecast assumes that the company can preserve many of the efficiencies it’s gained over the past five years, leveraging more-favorable customer pricing arrangements, and successfully extract cost synergies from future acquisitions. We estimate a normalized mid-cycle margin level in the final year of our stage one forecast to prevent our fair value estimate from being based on cycle-high or cycle-low profitability. We temper our EBITDA margin expansion expectations in 2029-30 to our view of a midcycle level of profitability (that is, roughly 34.5%). Our midcycle gross margin and SG&A margin (SG&A % of revenue) expectations for the firm are 43.8% and 9.5%, respectively. Our midcycle margin assumption accounts for industry cyclicality and potential margin headwinds from lower landfill volumes driven by greater adoption of landfill alternatives, dilutive acquisitions, commodity volatility, and so on.

Our forecast assumes that capital expenditure will grow slightly lower than revenue growth in the next five years as the firm moderates some of its additional investments in recycling and energy projects. We expect midcycle capital expenditures margin (capital expenditures as a percentage of revenue) to stabilize at around 11%, resulting in strong free cash flow generation. We expect free cash flow to the firm (before acquisitions) of around USD 1.7 billion in 2027 and USD 2.2 billion in 2030.

The second stage of our valuation model assumes that Waste Connections can generate an average of 20% return on new invested capital and 6% earnings before interest growth (that is, a 30% reinvestment rate) for 15 years after our five-year explicit forecast period. The second- and third-stage assumptions in our DCF model imply a terminal EV/EBITDA multiple of 13 times.

We believe that Waste Connections deserves a wide moat rating stemming from intangible assets associated with its ownership of landfill assets and cost advantage emanating from route density. A network of well-located landfills is an extremely scarce resource in the US that is almost impossible to replicate for a new entrant in the industry, leading to an intangible asset moat source. Cost advantage comes from the sheer magnitude and advantageous location of the network of landfill assets, which leads to lower disposal costs for the company and an industry-leading route density in waste collection, leading to higher utilization of the capital base and efficiency.

Together, these two moat sources create a high barrier to entry and protect excess returns for the firm. 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. The industry has consolidated significantly over the past few decades, and the moats for the largest players in the industry have only become wider. The pricing power of the firm and relatively recession-resilient characteristics of the industry, coupled with high visibility of future cash flows, give us confidence in our wide moat rating.

Industry Dynamics: The industry has gone through continuous consolidation over the past several decades, leading to better competitive positioning for the larger incumbents. The scale advantage inherent in the business can be seen in the higher gross margin profile of the large publicly traded players in the industry. We think the difference can be explained by having denser route disposal networks that make it more cost-effective for one garbage truck to take care of an entire location, higher internalization and tech adoption, and better landfill assets.

Waste Connections has differentiated itself from its two larger peers by focusing on "franchise" markets (defined by long-term, exclusive contracts rarely rebid) and "secondary" markets (nonfranchise rural and small suburban markets), rather than on more competitive urban markets. Approximately 85% of the firm’s revenue comes from markets with fewer than 500,000 people. In secondary markets, competition is limited, with Waste Connections often having the only landfill in the vicinity. There are far fewer collection companies to contend with in secondary markets. In more-populous urban markets, hosts of small waste haulers can drag down collection pricing and pit landfills against one another, especially during downturns. Waste Connections' core pricing growth has consistently been stronger than its larger peers because of its favorable footprint.

Landfills Are a Scarce Commodity: The regulatory intangible assets stemming from irreplaceable landfill footprints are at the heart of our argument and are the firm’s primary and most durable moat source. Federal and state regulations and not-in-my-backyard (NIMBY) activism have continued to make it very costly to operate and close landfills and extremely difficult to receive approval for new landfills. The regulatory burden has increased continuously, and more regulations disproportionately favor larger, established players in the industry, with capital and expertise. Since disposal costs are a significant expense for waste haulers, owning strategically located disposal assets (landfills and transfer stations) can yield a cost advantage in local markets over smaller competitors (with low internalization) that transport waste over longer distances.

A significant number of landfills in the US are expected to close in the next 15 years, which further strengthens the pricing power of operating landfill assets. Industry sources estimate that 400 landfills are expected to close in the next 15 years, leading to 150 million tons of capacity going offline. Strategically located landfills will become scarcer, and regulatory approvals for newer landfills are only getting more difficult to obtain. The weighted average remaining landfill life for Waste Connection’s landfills is estimated at approximately 31 years after considering remaining airspace, expansion airspace, and projected annual disposal volume.

Efficient Scale Characteristics: Even if regulations and NIMBY opposition was 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, adequate 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 Enhances Cost Advantage: Waste collection is like other route-based businesses, where superior route density is a meaningful cost advantage over smaller competitors and would-be new entrants. 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) relative to smaller providers.

Recycling and Energy Businesses: Recycling and renewable energy segments are essentially a no-moat business. Both these business segments lack pricing power or a maintainable cost advantage due to the final product being largely a commodity. We see these businesses as essential projects that the company has to undertake to burnish its sustainability credentials and to increasingly comply with stricter regulations. On a relative basis, we like the energy business more than the recycling business, given the return characteristics of landfill gas-to-energy projects.

Waste Connections enjoys strong pricing power, a feature of its wide economic moat and favorable market mix. This should allow the firm to defend profit margins during difficult macroeconomic environments.

The firm’s long-running focus on serving secondary (rural and suburban) markets helps minimize exposure to price competition.

Waste Connections generates industry-leading EBITDA margins and has a record of extracting mutual benefits and applying its operational know-how to improve the profitability of acquired businesses.

More US municipalities are gradually pushing for greater solid waste reduction and recycling, which could temper the level of higher-margin waste entering Waste Connections’ landfills over the long run.

At Waste Connections' current size, acquisition activity may need to ramp up considerably to maintain historical growth levels, which could bring the temptation to overspend on a large deal.

Waste Connections' premium valuation relative to peers may narrow if acquired growth slows and/or margin expansion falls short of management's target.