DBRS Assigns Ratings to GFL Environmental Corporation

DBRS has today assigned an Issuer Rating of B (high) with a Stable trend to GFL Environmental Corporation (GFL or the Company). The rating reflects GFL’s reasonable business profile, with a growing presence in the solid and liquid waste handling and soil treatment businesses. The waste handling business has a moderate long-term growth trend, is fairly resilient to recessions and has relatively high barriers to entry. The waste handling business also features predictable cash flow generation. However, the Company is disadvantaged by its modest scale and lower profit margin compared with the much-larger industry leaders in a highly fragmented market. Its acquisitive strategy also contributes to an overall weak business risk rating. Furthermore, GFL has a leveraged balance sheet and low debt coverage ratios as a result of funding growth initiatives (acquisitions and capital investments) mostly with debt. In the near term, DBRS expects GFL to maintain steady growth and to see a gradual increase in profitability, benefiting from recent acquisitions and cost reduction initiatives. However, the Company remains acquisitive, which may limit its capacity to deleverage; therefore, GFL’s financial profile is likely to remain near current levels. DBRS has also assigned a recovery rating of RR4 and an associated instrument rating of B (high) to GFL’s Senior Unsecured Notes, also with a Stable trend.

GFL’s rating is supported by the following: (1) The Company is well positioned in the growing and relatively stable waste handling industry. The industry is expected to maintain a moderate long-term growth trend supported by a growing population base and the normal expansion of industrial activities. GFL has demonstrated its ability to generate solid growth, albeit mainly through acquisitions and good cash flow generation. (2) The Company’s solid waste collection business is well positioned in the most populated areas of Ontario, supported by a network of strategically located hauling yards and transfer stations. (3) The Company’s good customer service and strong track record in winning and renewing municipal contracts in solid waste collection is a competitive advantage. Municipal contracts tend to be longer term, enhancing earnings stability. (4) The Company is well positioned in the solid waste collection segment (about 50% of 2012 revenue), which has lower environmental risk exposure. The Company also has a growing, higher-margin liquid waste collection and processing business and a soil treatment business, which adds business diversity. The Company focuses on industrial liquid waste and used motor oil (market share leader in Western Canada), which are less volatile than liquid waste from the oil patch. (5) Increasing regulatory hurdles and environmental concerns have created high barriers to entry in the industry, from which incumbents like GFL have stood to benefit.

However, the Company’s rating is also constrained by the following challenges: (1) Despite recent rapid growth, GFL still lacks scale and resources compared with the industry leaders, which is a disadvantage in a consolidating industry. (2) The waste handling industry is fragmented, with many small participants, and only a few top companies have meaningful scale. Competitive pressure is intense. (3) The Company has consummated a large number of acquisitions over the last few years. Even though GFL has a good track record in integrating the acquired businesses, integrating new operations always poses risks. The Company’s ongoing strategy to sustain growth through acquisition and the resultant growing portfolio of acquired businesses to be assimilated in the existing business has increased the potential of a mishap and hence, the overall operating risk. (4) Evolving environmental standards and stricter regulatory oversight have increased operational complexities and potential liabilities, an ongoing challenge for the waste handling industry. The Company is continually exposed to the risk of non-compliance with tightening regulations (particularly in the liquid waste business, which faces higher risks). In addition, changing environmental regulations could require GFL to take action to meet new operating standards imposed by governments, which could adversely affect its operations and financial performance.

The Company’s financial profile is weak, characterized by a leveraged balance sheet and low profitability (return on equity). Funding acquisitions mostly with debt has led to a leveraged balance sheet. The high interest expenses associated with the acquisition debt also weigh on all the debt coverage ratios. Furthermore, the risk of a write-off of the large amount of goodwill and intangibles has lowered the quality of the equity base. In the near term, DBRS expects GFL’s revenue to continue to grow, supported by contract wins and contributions from acquisitions. Benefits from cost savings and productivity initiatives would also boost profitability. However, the Company remains acquisitive, which will limit its ability to deleverage. Hence, DBRS expects the Company’s financial profile to remain steady.

Pursuant to the rating methodology for recovery ratings for non-investment grade corporate issuers, DBRS has created a default scenario for GFL in order to analyze when and under what circumstances a default could hypothetically occur and the potential recovery of the Company’s debt in the event of such default. The scenario assumes that the Company has failed to renew a few key contracts in 2014 and 2015 and would exhaust its liquidity, trip the financial covenants and default in late 2015. DBRS has determined GFL’s estimated value at default using an EBITDA multiple valuation approach, consistent with a view that default would likely result in the restructuring and/or recapitalization of the assets with value as a going concern versus the sale of its individual assets. EBITDA multiples utilized are applied to cyclically normalized EBITDA at default as opposed to the actual low EBITDA values expected at the time of default, reflecting the forward-looking nature of the valuation. The valuation considers the issuer and the specific debt instruments, allocating value proceeds accordingly. Based on the default scenario above, the Senior Unsecured Notes would have recovery estimated between 30% and 60%, which aligns with a recovery rating of RR4. Therefore, the instrument rating on the Senior Unsecured Notes is B (high), identical to the Issuer Rating.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Companies in the Services Industry, which can be found on our website under Methodologies.