GFL Environmental: Business Doing Well With Deleveraging In Progress (NYSE:GFL)

Description

I am changing my view from hold to buy as I see better performance ahead for GFL Environmental (NYSE:GFL). I acknowledge that I missed the good buying opportunity back in Jan when the share price was at low 30s. I failed to recognize that GFL presents a good opportunity for investors to allocate their funds in a strong and defensive name, particular in the current climate. From a business perspective, GFL continues to perform well. The company’s solid waste and Environmental Services segments both contributed to a 1Q23 revenue increase. In particular, the core price of solid waste with surcharges increased to 13.1% in 1Q23 from 11.5% in 4Q22. In addition, synergies with Terrapure, pent-up demand from COVID, and a mild winter in Canada all contributed to the continued growth of the Environmental Services segment as well. Going forward, I anticipate GFL to begin reaping the benefits of the headwinds it endured (e.g. fuel), as reflected in the 2Q23 guide that indicates and increase of 70 to 90bps of adj. EBITDA margin. Even better news is that management believes the company can outperform the high range of its FY23 guidance, with pricing that is higher than the 8% guide.

Growth outlook

Although Q1 results were strong, management decided to maintain guidance and leave room for an outperformance, which I believe the consensus is already pricing in. Consensus are expecting $7.7 billion in revenue which is ~$100 million higher than the high end of the range. I believe there are still some investors left in the market that are still leaning towards the conservative side, which is likely to jump onboard the bandwagon when management confirms the guide in 2Q23 (might cause share price to go up further). Also, cost inflation moderating through the year and pricing resets (7% to 9% increase) in the restricted book have me convinced that GFL can easily surpass the high end of its guidance. Since most price hikes occur in January, I see little chance of prices falling short of projections (85% to 90% are already locked in). An important upside opportunity is that management is not expecting recyclable commodity prices to rise in 2023. In conclusion, I am still convinced that GFL will experience significant price and margin growth in 2023.

Pricing/Margin

The fact that GFL’s core solid waste pricing in 1Q23 was 12.6% (higher than that of competitors RSG, WM, and CWST) is, in my opinion, evidence of the benefits of GFL’s disproportionate exposure to favorable rural markets relative to competitors. As I see it, pricing will remain a positive factor in the coming quarters as peers are being rationale. In addition, FY24 may be the turning point for GFL’s margins, as I expect prices to stay high due to the CPI-linked book resetting at similarly high rates. This, along with moderate increases in unit costs, might make 2024 a year of even more pronounced margin expansion.

Balance sheet

The focus on GFL balance sheet has always been the deleveraging story, which I think is progressing well as GFL has intention to sell some non-core assets, and anticipates the gross proceeds from the sales to be around CAD1.6 billion. A good portion of that amount is earmarked for variable debt pay down. Assuming 70% of it is used for debt paydown, GFL will reduce its leverage ratio to around 4.3x net debt to EBITDA in FY23 and 3.89x in FY24. Once GFL shows the market that it is on its way to peers’ level of leverage, we might see further improvement in valuation multiple.

Summary

From a business perspective, GFL continues to perform well, with both its solid waste and Environmental Services segments contributing to revenue growth in 1Q23. Looking ahead, I anticipate GFL to benefit from the headwinds it faced, with a projected increase in adjusted EBITDA margin in 2Q23. The growth outlook appears positive, with the potential for an outperformance of guidance and pricing resets expected to drive revenue growth. Additionally, GFL’s pricing and margins are expected to remain favorable, particularly in rural markets. The focus on deleveraging the balance sheet through asset sales further supports GFL’s progress. Overall, I remain convinced that GFL will experience significant price and margin growth in 2023, and further improvements in valuation could be seen as the company reduces its leverage ratio.