Fitch Assigns Initial 'BBB' IDR to Waste Connections; Outlook Stable

CHICAGO--()--Fitch Ratings has assigned an initial Issuer Default Rating (IDR) to Waste Connections, Inc. (WCN) of 'BBB'. In addition, Fitch has assigned ratings of 'BBB' to WCN's senior unsecured revolving credit facility, senior unsecured term loan and senior unsecured notes. The Rating Outlook is Stable.

Fitch's ratings cover a $1.2 billion unsecured revolving credit facility, an $800 million unsecured term loan and $600 million in senior unsecured notes. A full rating list follows at the end of this release.

KEY RATING DRIVERS

WCN's ratings are supported by its strong free cash flow, adequate liquidity and moderate leverage, all of which provide the company with significant financial flexibility. The company's strategy of eschewing highly competitive urban markets to focus on maintaining strong competitive positions in smaller, secondary markets has led to consistently strong profitability and cash generation. Consistent with its secondary market focus, WCN derives a notably higher proportion of its revenue from franchise markets compared to its larger competitors, which provides the company with more predictable revenues and profitability tied to these franchise contracts.

Rating concerns include WCN's exposure to the more volatile petroleum exploration and production (E&P) sector and the company's ongoing focus on acquisitions. With its 2012 acquisition of R360 Environmental Solutions, Inc. (R360), WCN significantly increased its exposure to the E&P waste sector. In 2014, 14% of the company's revenue and 21% of its EBITDA was derived from its E&P segment, both significantly higher percentages than most other integrated waste companies. The E&P segment is highly sensitive to oil prices, and WCN's exposure to the segment will likely result in increased volatility in financial performance going forward.

Since its founding in 1997, WCN has grown significantly through acquisitions. The U.S. waste industry is highly fragmented, and consolidation is common in the industry. Similar to those of other large integrated waste companies, most of WCN's targets are relatively small bolt-on acquisitions that provide the company with increased scale or customer contracts in a specific location. However, the company has, at times, made larger acquisitions, including the $1.4 billion R360 acquisition in 2012. Although borrowing associated with acquisition spending could drive an increase in WCN's leverage, Fitch expects any acquisition-related increase in leverage would be temporary, as the company has consistently used free cash flow in the past to reduce incremental leverage relatively quickly.

Other rating concerns include the possibility of significant cash costs related to potential environmental liabilities at landfills, volatile recycling commodity revenues and significant cash returns to shareholders. However, most of these concerns are generally consistent across the environmental services industry and are not necessarily specific to WCN. Also, the company has been disciplined in balancing its shareholder-friendly activities with its desire to maintain balance sheet flexibility.

Fitch expects conditions in WCN's traditional collection and landfill business to remain favorable over the intermediate term as modest U.S. economic growth leads increased waste volumes. The company's strategy of avoiding competitive urban markets has provided it with the ability to steadily increase both price and volume, which Fitch expects will continue to benefit revenue and profitability over the intermediate term. However, declining demand in the higher-margin E&P segment will be a headwind on both revenue and profitability, at least in the near term, as E&P linear feet drilled (which directly influences the volume of E&P waste) is expected to decline by 45% to 50% in 2015. Beyond 2015, Fitch expects revenue and margins to grow at a higher rate as the E&P business stabilizes and the traditional waste business continues to grow.

WCN's credit profile is relatively strong for the waste services sector, and its free cash flow (FCF) margins are the strongest in the waste services industry. This provides the company with significant financial flexibility. Based on Fitch's calculation of FCF, which incorporates dividends and distributions to noncontrolling interests, WCN's FCF margin was a very strong 12.1%, well above the low- to mid-single-digit FCF margins typically produced by investment-grade waste services companies. WCN's FCF totaled $255 million including $247 million in capital expenditures and $61 million in dividends, in the period. Funds flow from operations (FFO) was a robust $563 million (including distributions to noncontrolling interests) in the 12 months ended March 31, 2015, while working capital was a modest use of $0.3 million in cash. Fitch expects WCN to continue produce relatively strong FCF over the intermediate term despite the potential for increased dividends and capital spending as the company continues to grow.

EBITDA leverage (debt/Fitch-calculated EBITDA) at March 31, 2015 was 2.7x, around the midpoint of the company's target range of 2.5x to 3.0x, with $2 billion in debt and 12-months Fitch-calculated EBITDA of $734 million. The company's EBITDA margin (as calculated by Fitch) was 34.9%, about 700 to 1,000 basis points higher than typically seen at its investment-grade peers. Funds from operations (FFO) adjusted leverage was 3.1x at March 31, 2015. The company's liquidity position is adequate and included $16 million in cash and cash equivalents and $573 million in availability on its $1.2 billion unsecured revolver after accounting for $554 million in borrowings and $73 million in letters of credit. Debt maturities in 2015 total $179 million, including $175 million in senior unsecured notes due in October 2015.

Going forward, Fitch expects leverage to generally remain within the targeted 2.5x to 3.0x range, although it could temporarily rise above 3.0x if the company borrows to funds an acquisition. As noted above, however, if leverage rises above 3.0x, Fitch expects the company will look to de-lever fairly quickly to bring leverage down to its targeted range. On the other hand, over the longer-term, WCN could increase debt somewhat if the natural de-leveraging effect of increased cash flows drives leverage below 2.5x for an extended period.

KEY ASSUMPTIONS

Fitch's key assumptions within its rating case for WCN include:

--U.S. economic conditions continue to improve at a modest pace over the intermediate term, leading to higher volumes and pricing in WCN's traditional collection and landfill business;

--In WCN's E&P business, declining drilling activity in 2015 leads to lower volumes, partially offset by the positive impact of new E&P facilities recently opened, while after 2015 E&P volumes stabilize, but growth in the sector remains weak;

--Profitability improves over the intermediate term on higher overall volumes as WCN benefits from operating leverage in its traditional collection and landfill businesses;

--Capital spending declines somewhat from the relatively high level seen in 2014, but remains consistent as a percentage of revenue with the levels seen several years ago;

--The company continues to make modest to moderately-sized acquisitions over the intermediate term;

--Dividends increase on an annual basis;

--Leverage remains near the year-end 2014 level over the intermediate term;

--WCN maintains an ongoing cash balance in the $15 million $25 million range;

--Cash not used for dividends or acquisitions is targeted toward share repurchases.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

--A significant decrease in the proportion of the company's business tied to E&P waste.

--Reducing leverage (Total Debt/Fitch-calculated EBITDA) to below 2.5x for an extended period;

--A sustained increase in the company's cash liquidity to above $50 million.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--A change in financial policy that results in leverage increasing above 3.25x for a sustained period;

--A steep decline in the FCF margin to below 3%;

--An adverse environmental development at a landfill that leads to significant liquidity pressure.

Fitch has assigned the following ratings to WCN with a Stable Rating Outlook:

--IDR 'BBB';

--Unsecured revolving credit facility 'BBB';

--Unsecured term loan 'BBB';

--Senior unsecured notes 'BBB'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=984048

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Contacts

Fitch Ratings
Primary Analyst
Stephen Brown
Senior Director
+1-312-368-3139
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Eric C. Ause
Senior Director
+1-312-606-2302
or
Committee Chairperson
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Stephen Brown
Senior Director
+1-312-368-3139
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Eric C. Ause
Senior Director
+1-312-606-2302
or
Committee Chairperson
Craig D. Fraser
Managing Director
+1-212-908-0310
or
Media Relations
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com
Elizabeth Fogerty, +1 212-908-0526
elizabeth.fogerty@fitchratings.com