In a research report released Monday titled Growth for life, RBC Dominion Securities analyst Sabahat Khan assumed coverage of GFL Environmental Inc. with an “outperform” recommendation, touting the “combination of the company’s industry-leading growth profile, a more meaningful M&A opportunity (relative to the current scale of the base business), and relatively higher leverage vs. peers.”
“Our favorable view of GFL Environmental Inc. reflects: 1) the attractive characteristics of the North American Waste industry, where GFL is the 4th largest player; 2) GFL’s positioning as a leading consolidator and the company’s relatively smaller scale (vs. its 3 larger peers), which makes M&A a more meaningful growth driver for GFL; 3) our outlook for leverage reduction over our forecast horizon; and, 4) potential upside to GFL’s valuation (given its discount to peers) as it executes on the above-noted opportunities,” he added.
Mr. Khan’s sees the North American Solid Waste industry as “very attractive,” pointing to several factors: “1) defensive characteristics as it is an essential service (e.g., volumes only declined 8 per cent in 2009 and 4 per cent in 2020); 2) long-term contracts that drive high revenue visibility; 3) price-led organic growth that closely follows CPI; 4) barriers to entry (e.g., high fixed costs, stringent regulations, etc.); and, 5) regional oligopolies across many markets (in part due to industry consolidation).”
“These industry characteristics drive very strong profitability for the 4 Waste Majors (e.g., GFL generated an Adjusted EBITDA margin of 30 per cent in Solid Waste in 2023), which in turn leads to consistent FCF generation. For more information on the industry,” he added. “Given this setup, we view the Solid Waste market very favorably, and note that GFL (founded in 2007) has quickly scaled to become the 4th largest company in the industry. Looking ahead, we believe the company has ample opportunities to continue growing via M&A and organic initiatives.”
The analyst thinks Vaughan, Ont.-based GFL also has “the longest runway for M&A among the Majors.”
“Although GFL has acquired 267 companies since inception and has grown its revenue at a 32-per-cent CAGR [compound annual growth rate] between 2018-2023, establishing itself as the 4th largest company in the US$91-billion North American Solid Waste industry, GFL is still meaningfully smaller (approximately 5-per-cent market share) than the other Majors (45-per-cent share), according to our estimates,” said Mr. Khan. “We estimate that there are still several thousands of companies operating in the industry, with private companies holding an 18-per-cent market share and other public companies (outside of the Majors) holding a 15-per-cent share (i.e., the industry is still quite fragmented beyond the Majors). As the smallest of the Majors, we believe GFL has the longest runway of needle-moving acquisitions as the industry continues to consolidate. As such, we expect GFL to allocate the largest percentage of its capital to M&A among the 4 Majors over the medium- to long-term.”
Seeing upside potential to GFL’s valuation as its discount to peers closes over time, Mr. Khan raised the firm’s target for its shares to US$46 from US$43. The average is US$44.16.
“GFL is trading at 11.6 times our 2024 EBITDA vs. an average of 15.9 times for the other Majors,” he said. “We see potential for this discount to close over time as GFL delivers on its organic/inorganic initiatives and as the company reduces its leverage over the near-term (GFL was upgraded last week from B+ to BB- by S&P). Our US$46 PT is based on 13.0 times our 2025 EBITDA.”