In the first week of October, Advanced Disposal Services (ADSW) completed its initial public offering. On October 31, after the required “quiet” period ended, a number of Wall Street research analysts launched coverage on the company. In this month’s edition of Business Insights, we provide a synthesis of their reports and outlooks.
The Offering Itself and Subsequent Refinancing
Advanced Disposal sold 19.25 million shares at a price of $18 per share, raising roughly $350 million. The net proceeds were used for debt paydown. In late October, ADSW commenced a debt refinancing, which lowered its interest expense and extended its debt maturities. As a result of the two actions, the company’s leverage ratio (debt to EBITDA) dropped from an estimated 5.7x to 4.8x, and its cash interest expense will drop by $32 million annually. Post the offering, ADSW’s private equity owner, Highstar Capital, still owns almost 50 percent of the outstanding stock.
Thumbnail Sketch of Advanced Disposal
ADSW, with annual revenues of roughly $1.4 billion, is now the fourth largest solid waste company in the US. It operates in three geographic regions—South (35 percent of revenues), Midwest (38 percent) and East (27 percent)—in 16 states. The company is fully integrated, with a full range of collection services, 72 transfer stations and 39 landfills. Relative to its peer group, ADSW has a smaller percentage of recycling revenues, at only 2 percent of total revenues, and it is also has minimal energy waste exposure. About 80 percent of its business is in what the company describes as secondary (smaller) or exclusive municipal markets, while the remaining 20 percent is in primary (large urban) markets, which in ADSW’s case are basically Chicago, Detroit, Atlanta and Philadelphia. The company is ably led by CEO and Director Richard Burke, a nearly 30 year industry veteran.
Growth Strategy—Both Top and Bottom Line
Like the rest of the solid waste industry, ADSW is benefiting from a number of current and prospective macroeconomic drivers. The slow but steady housing recovery should continue to benefit underlying volumes, while the prospects for stronger inflation should also aid the estimated 20 percent of the company’s business that has CPI-linked pricing. Given its strong presence in the South, ADSW is in a number of demographically favorable or high growth states, such as Florida and Georgia.
Specific to Advanced Disposal, however, the company has laid out a growth strategy whose elements fall into four main buckets. First, ADSW intends to capitalize on, expand and leverage its currently high proportion of business from its secondary and exclusive municipal markets. The company follows a vertically-integrated strategy where it prefers to own the landfill in its secondary markets or be in a disposal neutral position whereby the landfill is government owned. ADSW then works in those locations to densify the surrounding collection network by offering more services and completing tuck-in acquisitions, as well as generally pursuing geographic expansion from those landfill bases.
ADSW also intends to vigorously pursue and bid on upcoming municipal or franchise contracts, which the company has estimated may total $140 million in its markets in 2017. Traditionally, its retention rate on these types of contracts has approached 85 percent, and the company has 800+ municipal residential contracts. Second, the company intends to continue its acquisition strategy.
Although its leverage remains higher than the peer group, ADSW’s strategy is to make small, tuck-in acquisitions, typically in the range of $3 million to $5 million, primarily of collection companies that increase the densification or expand the geographic reach around its landfills. Historically, ADSW has been able to pay in the range of 5x-5.5x EBITDA and then has been able to take another one-half to one turn out through synergies, such that the acquisitions actually end up deleveraging the company.
Given ADSW’s relatively small size, only comprising about 2 percent to 3 percent of the U.S. solid waste market, it remains in the sweet spot to be able to grow more materially from acquisitions than its larger brethren. Analyst estimates generally put the larger public players’ share of the market at 40 percent to 45 percent, leaving substantial opportunity to either acquire private players (estimated at 30 percent to 35 percent the market) or pursue municipal privatization opportunities.The company targets acquisition spending of roughly $30 million per year.
Third, and similar to the majors, ADSW is looking to further control costs, or “manage the middle,” by adding CNG-powered trucks (now at 16 percent conversion) and further automating its fleet (now at 55 percent of the residential fleet). Last but not least, ADSW has distinct deleveraging goals. As previously noted, post the offering, the company’s leverage was 4.8x, and it intends to get that down to a range of 3.25x-4.25x. This will obviously dramatically improve its free cash flow profile.
Reflecting these proposed growth strategies, analysts are projecting revenue, EBITDA, margins and free cash flow growth for ADSW in 2017 and beyond. Beginning in 2015, under Burke’s leadership, the company began to cull volumes that were unprofitable or did not meet its return profile. As a result, volumes have been negative over the past year and revenues flattish from 2014 to 2016.
ADSW has also put a greater focus on pricing growth, and most recently, pricing growth improved to over 2 percent. This scenario is forecast to change in 2017, when volumes are anticipated to inflect positively and internal growth is forecast to rise anywhere between 3 percent-4 percent (depending on the analyst), driving expected higher revenue. In general, volumes are forecast to return to growth in the area of 1.5 percent, and pricing is expected to remain stable in the 1.5 percent-2 percent area.
Barring unforeseen economic circumstances, that level of growth is expected to be sustained, with the more aggressive analysts forecasting “2 and 2” (2 percent price and 2 percent volume), particularly given ADSW’s favorable demographics. This translates into expected adjusted EBITDA growth, with most analysts forecasting that EBITDA will rise to around $430 million in 2017 versus expectations of $411 million-$413 million in 2016, though there are always outliers.
This also implies margin growth, with most analysts looking for an adjusted EBITDA margin just under 30 percent in 2017 versus 28.6 percent in 2015. Most analyst models do not include acquisitions, which are anticipated to add 1 percent-2 percent of upside to revenues. All of the above should continue to drive the leverage down, with all the analysts forecasting the leverage ratio to be “below 4x” by the end of 2018, usually around the level of 3.7x. ADSW intends to be in the 10 percent-12 percent of revenue range for capex.
Whither the Stock Price?
Surprisingly, given the fairly narrow range in EBITDA estimates (there is less than a 5 percent differential between the high and low end of 2017 EBITDA estimates), price targets for the stock are in a much wider range—spanning $21-$26. In general, this is primarily due to the choice of valuing the company on 2017 or 2018 estimates, as the target multiples—the EBITDA multiple assumption used to generate the stock price target--are remarkably consistent at around 8.5x-9x!
Leone Young is the Principal of LTY ERC, LLC, providing consulting and research services to, and conducting special projects for, the environmental services industry, primarily the solid waste sector.