Fitch Affirms Ratings, Outlook on Waste Management (WM); Says Leading Market Position Bolsters Confidence
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Fitch Ratings has affirmed Waste Management, Inc.'s (NYSE: WM) Issuer Default Rating (IDR), senior credit facility and senior unsecured notes at 'BBB'. The Rating Outlook is Stable. The ratings cover approximately $9.5 billion of debt as of June 30, 2016. A full rating list is included at the end of this release.
KEY RATING DRIVERS
WM's ratings are supported by its leading market position within the environmental services industry, stable credit metrics and consistent capital deployment strategies. In addition to generating higher free cash flow (FCF) levels, WM's credit profile has benefited from its continuous process improvement initiative and industry-leading position in de-risking its recycling business. Further supporting WM's ratings are its defensive position in an ever-consolidating industry. Fitch estimates that WM currently controls a substantial proportion of U.S. solid waste landfill airspace.
In second quarter 2016 (2Q16) the company posted its highest operating EBITDA margin in seven years and generated a 27.9% margin through June 30, 2016, on an LTM basis. WM's EBITDA margin has consistently trended upwards in recent years and Fitch expects a FY2016 EBITDA margin well north of 27%. Fitch further expects the company's total debt/EBITDA ratio to remain in the 2.6x range as it has been for the last couple of years. Through 2Q16, WM's total adjusted debt/EBITDAR was 2.8x, which is unchanged from December 2015. WM proactively issued $500 million of seven-year 2.4% coupon senior notes in May of 2016 to refinance maturing senior notes and Fitch expects near-term debt financing to be minimal, as we anticipates FCF generation to be high in 2016 with a FCF margin of approximately 4.5% (after dividends and excluding any proceeds from divestitures).
Ratings concerns include a potential shift in operational or financial strategy or a potential new-found appetite for debt-funded share buybacks. WM currently deploys a higher proportion of FCF to share buybacks than any of its peers and Fitch remains concerned that the level of buybacks may become inflexible in the event that FCF declines in the future. Additional concerns include the relatively high exposure (7.6% of revenue in 2015) to the sale of recyclable commodities when compared to its peers and the potential for significant cash costs related to environmental clean-up at landfills. An additional concern is frequent acquisition activity.
WM has remained focused on shedding low-margin volume, operational improvements, disciplined volume addition in rapidly growing geographies, and restructuring recycling contracts to limit commodity risk. The company has benefited from a constructive pricing improvements and a robust commercial and industrial volume environment. WM has automated 58% of the firm's residential fleet, and also converted 39% of the overall fleet to compressed natural gas. The company has successfully renegotiated roughly 75% of its recycling business to contracts in which WM eliminates downside commodity risk while retaining exposure to a recovery in commodity prices, which significantly mitigates the risk that commodity prices bring to its business profile.
Recent pricing trends have been positive as well with the more profitable commercial and industrial business segments posting, respectively, 470bp and 290bp of yield improvement through 2Q16 over the prior year. WM has also recently been successful in winning new business in the industrial and commercial segments with new awards outpacing lost business. As the company has increased focus on shifting toward more profitable volumes in recent years, overall volumes fell in three consecutive years. Through 2Q16 this trend had reversed, largely driven by robust commercial volumes, as the firm experienced 1.1% of total volume growth through the 2Q year to date.
--Low single-digit revenue growth through the intermediate term;
--Annual capital expenditures between 9% and 10.5% of revenue;
--The company continues to invest moderately in acquisitions each year;
--The company engages in at least $800 million of share buybacks in 2016 and continues this annual pace through the intermediate term;
--Dividends grow modestly on an annual basis.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
--Maintaining leverage (total adjusted debt/EBITDAR) below 2.5x for a prolonged period;
--FCF margin consistently greater than 4%;
--A change to a more conservative financial strategy.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--Total adjusted debt/EBITDAR above 3.25x for a prolonged period;
--FCF lower than 1.5% (or 2% excluding cash outflow from minority distributions) for a prolonged period;
--Debt-funded share repurchases, dividends or a large debt funded acquisition;
--A change to a less conservative financial strategy.
WM's liquidity should remain healthy, as it maintains a $2.25 billion revolving credit facility (RCF), maturing in July 2020 which had $1.44 billion of unused capacity after $814 million of outstanding letters of credit as of June 30, 2016. In addition WM had $39 million of cash on hand as of June 2016 as well. The company also has CAD50 million of availability under its Canadian RCF which matures in March of 2019. Following the repayment of the maturing 2.6% notes due this coming September, the company has no significant maturities until 2018.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings with a Stable Outlook:
Waste Management, Inc.
--IDR at 'BBB';
--Senior unsecured revolving credit facility rating at 'BBB';
--Senior unsecured notes rating at 'BBB'.
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