Our view: The merger of Secure and Tervita combines the two largest third party crude processing and waste management providers in the WCSB. In our minds, the transaction unlocks value through enhanced operating scale, FCF generation capability, and ultimately investor attention. We maintain our Outperform rating with an unchanged $8.50 price target.
Key points:
Transaction closed. Secure and Tervita closed the merger on July 2. Secure assumed Tervita's ~$740MM debt and issued 148MM shares to Tervita shareholders. We see the combined market cap and enterprise value of $1.3BN and $2.4BN, respectively. We expect the combined entity to generate $450MM EBITDA in 2022 as the company works to realize $75MM in annual cost savings from the transaction.
SES will continue to address Competition Bureau's concerns. The Competition Bureau's application to the Competition Tribunal seeking to prevent the transaction from closing was denied. In its ruling, the Tribunal noted it does not have the jurisdiction to issue the specific interim and unprecedented relief sought by the Commissioner. That said, the parties will continue to address the Bureau's concerns. Potential remedies may involve minor asset sales which could help reduce absolute debt, though may not be completed on a leverage-accretive basis.
Tuning up estimates to reflect earlier close date. We have adjusted our 3Q21 estimates to reflect a July 2 close date. We expect cost reduction synergies to be modest until 4Q21 and to reach the targeted $75MM run rate by YE22. Our 2022 EBITDA estimate of $450MM remains relatively unchanged and is 5% above street consensus.
FCF outlook strong. In 2022, we project Secure to generate $153MM FCF net of our assumed $105MM capital expenditures, mapping to a 12.5% FCF yield. We see maintenance capital for the combined entity at approximately $40-45MM and our $60MM growth capex assumption reflects a return to normalized expansion capital expenditures as the company optimizes its expanded footprint, though we note this amount is discretionary.
Net debt reduction should continue through 2022. The company plans to focus primarily on debt repayment until leverage reaches the 2.0x-2.5x range, which it expects to reach within 12-18 months. We estimate Secure's 2022 net debt/EBITDA ratio at 2.0x (ex. IFRS leases). Secure's issuance of $200MM senior unsecured notes should also reduce its annual interest cost outlay by about $5MM.
Maintaining Outperform rating and $8.50 price target. Our price target is based on an 8.0x multiple of our 2022 EBITDA estimate. We believe Secure is well positioned given its exposure to recurring revenue and increasing mix of longer-term revenue contracts, strong corporate EBITDA, and FCF margins. Our price target supports an Outperform rating.