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GFL Environmental (GFL) Stock | NYSE: GFL | TSX: GFL.TO

Covered by Stratosphere

Death, Taxes and Garbage

Patrick Dovigi, founder and CEO of GFL Environmental Inc. ("GFL"), has coined his company the "Big Green Machine".

There are three things we do know for certain:

1. GFL has grown aggressively since its humble beginnings - it owned only a single solid waste transfer station in 2007.

2. You certainly cannot miss the bright lime Green Machines near warehouses, industrial lots, and alleyways.

3. Death, taxes, and garbage are the only true guarantees in life.

GFL is an environmental services company. It primarily engages in non-hazardous solid waste management, infrastructure, soil remediation, and liquid waste management services.

Stratosphere Score

8

Growth

9

Valuation

10

Quality

6

Margins

3

Dividend

5

Balance Sheet

2
Braden Dennis

Author

Braden Dennis

Founder

Investment Thesis

  1. The founder-led business run by Patrick Dovigi has won impressive long-term contracts penetrating a mature market with high barriers to entry.

  2. Waste collection, infrastructure, and environmental services provide reliable and growing cash flows.

  3. GFL's verticals are highly fragmented and ripe for continued meaningful consolidation opportunities. The business has demonstrated a strong ability to acquire and integrate.

  4. GFL has excellent optionality in the growing environmental services sector both organically and through acquisitions.

Key Company Metrics

A set of metrics we constantly keep updated to monitor the investment thesis.

Competitive Advantages

Capital Intensity

GFL's widespread reach across North America and its fleet of 10,000 trucks is the result of over 140 acquisitions since 2007. Between the 2016 - 2020 fiscal years, GFL deployed nearly $15 billion on business acquisitions and capital expenditures combined. This is no easy feat for any regional operator to compete against.

The waste industry is still highly fragmented in North America with thousands of small regional players and few large incumbents. GFL, as a large waste company, can use its access to public investor capital to swallow up hundreds of these smaller companies. Its diversified business lines across many regions are also a major advantage - GFL can source acquisitions from a wide pool of targets and increase the odds of integrating smaller businesses in an accretive manner.

Decentralization

Although the overarching operations, administration, and execution and integration of acquisitions are managed by a centralized senior management team, GFL's decentralized management teams take care of operations at the regional level. Additionally, these teams "own" their regional portfolios in that they maintain relationships with local vendors and seek out acquisition targets within their region.

A decentralized operating structure is imperative in a fragmented industry. Applying a "blanket approach" to all regions when each region has unique needs and desires when it comes to waste collection and other services is a poor strategic move. GFL recognizes this - it understands that local leaders know their region best and can manage their trusted multi-decade relationships better than corporate can.

In turn, customers can rest assured they have GFL representatives working for them that understand them better than anyone else can, and corporate will not take that privilege away.

Contracting a Moat

GFL typically undercuts other bidders for its collection services contracts. As part of its "land-and-expand" strategy, GFL obtains exclusive rights for garbage collection in each designated region in the municipalities in which they operate. Once GFL wins a contract with exclusive rights over a certain area, barriers to entry skyrocket for any local or national player, especially considering how low many of GFL's bids for these contracts are.

By bidding low, GFL has been able to win major contracts after which it sets out to build its empire. Although counterintuitive at first, the strategy is brilliant. The market is mature and growing slowly, so GFL is using a different strategy from other incumbents - landing in solid markets to expand its local visibility and regional know-how to increase its chances of pinpointing great acquisition targets and sell other cost-efficient services to cities and businesses in surrounding areas. Over time, this may prove a winning strategy that takes share away from incumbents as cost efficiencies from route density and network infrastructure kick into full gear.

These contracts also "guarantee" stable, recurring revenues for many years. Municipal contracts are typically 3-10 years in length often with one- or two-year renewal terms. Similarly, commercial contracts are signed for long periods of time, generally between 3-5 years. That is not all - GFL also includes price escalators, demonstrating the pricing power inherent in its offerings and value proposition.

GFL OperationsSource: GFL Q4 2021 Investor Presentation

Opportunities Ahead

  • GFL is a prolific acquirer of waste management businesses. The waste business has been largely a consolidation play across the industry. GFL plays this game, but slightly differently. The company is notorious for using debt to quickly scale through acquisitions. The reason is this - the waste business is highly stable over the long run, and if GFL is not able to acquire a willing seller, Waste Connections or another major industry player will. It is crucial for GFL to acquire such targets, and the aggressive approach has worked thus far (more on the risks in the "Risks" section below).

  • GFL has started to reap the rewards of scale. The company is witnessing expanding (adjusted) EBITDA margins as a result of pricing power and operating leverage. Additionally, GFL has been benefitting from procurement, productivity, and cost control initiatives that have helped expand margins. We think as GFL continues to scale, we will see margins continue to expand and reduce the leverage risk GFL faces.

  • Organic growth will remain strong. We believe the North American waste industry will remain robust and provide GFL with solid organic growth opportunities. With the sale of its infrastructure business, GFL will now focus on growth in the solid waste business even more while still maintaining an equity stake in the infrastructure business. There is now more cash on hand and a renewed focus by management on investing in growth initiatives in solid waste.

Risks

The Elephant in The Room

When GFL went public in 2020, its heavy debt load scared most investors away while markets were crashing.

In an attempt to build out its scale as rapidly and as large as possible, GFL finances many acquisitions with (cheap) debt. The debt load to fuel acquisitions is real and GFL definitely recognizes they need to de-lever the balance sheet.

Although GFL's recent IPO was a brilliant way to perform large M&A expansion in the US and reduce the company's debt, it still has a high net leverage ratio.

GFL's high net leverage ratio by any standard and carries a few risks. If its acquisitions and expansion plans do not work out as initially planned, or competitors respond to GFL by opening their M&A floodgates, GFL may be left "holding the bag".

While we cannot discount the high leverage as an obvious risk, we think GFL is still managing its capital prudently. We have three reasons for this:

  • GFL is growing aggressively in a highly fragmented market. The only way to compete with the "big boys" is to acquire before they do.

  • We believe the denominator of the net leverage equation will grow substantially over time. The terminal risk for a waste management business is microscopically slim. This will naturally de-lever the company.

  • GFL's capitalization ratio is not far from peers and continues to trend downwards. In fact, WM has a higher total debt to total capitalization ratio.

Speed Kills (Maybe)

The waste management industry is a slow-growing one, and that means lots of GFL's growth will come through acquisitions.

In addition to its large debt load, GFL is also at risk of targeting and integrating acquisition prospects effectively.

If competitors change their strategies to compete with GFL on the acquisition front, GFL may be out-bid by larger waste management incumbents.

As every incremental business is acquired, the risks around recognizing great business with ample synergies that could be integrated well with GFL slowly diminish.

The lack of solid acquisition opportunities could eat away at GFL's financial standing over the long run, especially if coupled with high debt.

It is key that GFL maintains stringent acquisition criteria and does not grossly overpay for assets, no matter how attractive they may seem.

Revenue Cyclicality

Believe it or not, waste production can also fluctuate with the economy. As individual and business consumption and investment drops, so does waste production.

Slowing population growth and weak or unstable growth in North America or smaller regions within could hinder GFL's ability to generate strong, recurring cash flows.

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