In February, all the publicly-traded solid waste companies will report fourth quarter 2014 earnings and present 2015 outlooks. In this month’s issue of Waste360 Business Insights, we continue our tradition of sharing our thoughts on the outlook for the key industry drivers of the solid waste industry.
In particular, we are struck by how the plunge in oil prices is likely to influence so many industry drivers, in ways both positive and negative, with primary, secondary and even tertiary impacts, and no doubt in other ways as yet unforeseen!
Oil’s Impact on Price and Volume Very Divergent
Lower oil prices are likely to prove a headwind to price increases in several ways. First, lower gas prices were reflected in the decline in the consumer price index (CPI) in the last two months of the year, and that decline is expected to accelerate into 2015. CPI growth had already been languishing around 1.5 percent for much of 2014, versus estimated industry cost inflation of about 2 percent.
As a result, CPI-linked contracts will not get any price relief in 2015. This is likely to hasten the industry’s nascent efforts to switch to alternative pricing indices, such as the more representative “water, sewer and trash” component within the CPI. But that process will occur gradually over time as contracts come up for renewal. It’s likely to meet with some municipal resistance.
Second, to a greater or lesser extent, the industry also employs fuel surcharges. As these surcharges decline in concert with lower diesel prices, it will negatively impact revenues. Harder to gauge at this time is the behavior of the local independent haulers, who are less likely to employ surcharges—do they keep the extra profit from lower fuel costs, or are they encouraged by a lower cost structure to go for greater volume and market share via a lower service price? Related to this is greater ability to compare and “shop” landfill tip fee differences, as the transportation cost (an important consideration in landfill choice) has gone down.
Bottom line, the solid waste companies are likely to hold the line on recent price increase levels, but are less likely to raise the bar—indicating likely price (yield) targets of 2 percent for Waste Management (WM), 1 percent to 1.5 percent for Republic Services (RSG), 2 percent for Progressive Waste Solutions (BIN) and 2.5 percent to 3 percent for Waste Connections (WCN), all similar to 2014 levels.
On the other hand, lower gas prices should, ultimately, be a net positive for volumes, and particularly for the key commercial volumes, which have been so stubbornly lagging. The much vaunted “tax cut” for consumers in the form of lower gas prices is expected to spur consumer spending, particularly in several commercial collection verticals, like retail outlets and restaurants. Although overall consumer spending reports have thus far been largely inconclusive, anecdotal evidence, particularly with regard to restaurants, has been encouraging.
That said, the companies are likely to be upbeat about volumes, citing continued construction and demolition (C&D) and special waste strength, but more circumspect in calling a material commercial waste upturn, which could prove to be upside. A commercial upturn, in turn, could help pricing, as it is well known that better volumes go a long way to alleviating pricing pressures!
All told, RSG, WCN and BIN are likely to forecast volume increases in the range of 1 percent to 2 percent, with the likelihood of being on the high end. WM, with its more aggressive price strategy, is likely to still post negative volumes in 2015, though approaching breakeven in the second half.
E&P Waste Forecasts Will Be the Biggest Wild Card
Impacting volumes on the negative side will be oil exploration and production (E&P) waste. Although WCN has the most exposure at just under 15 percent of revenues, energy waste has been a growth area for WM (2 percent of revenues) and represents a new foray for RSG (now also 2 percent of sales with the Tervita acquisition).
Although BIN has no direct exposure, it could be argued that much of Canada, where BIN has a major presence, is an E&P play. Based on E&P capex (capital spending) budgets, estimated to be down 30-40 percent in 2015, WCN’s E&P waste revenues could fall 10-15 percent in 2015, according to a number of industry analysts.
Oil’s Impact on Recycled Commodity Prices and Fuel Has a Number of Variables In Play
Simplistically, at current old corrugated cardboard (OCC) prices, recycled commodity pricing looks to be a headwind in 2015. After peaking in March, OCC pricing has gradually declined all year. December 2014/January 2015 average OCC levels of $86/$83 per ton are below the full-year average for 2014 of $97 per ton. However, other paper high grades have held up much better (largely flat), which should have some mitigating impact.
The West Coast port congestion has certainly had a negative impact, and some OCC price relief is expected if and when that is resolved, but of even greater importance is the export market, particularly to China. Does China’s economy (a net importer of oil) get a shot in the arm from lower crude, thus spurring commodity prices overall, including waste paper? And recycled plastics are now increasingly under price pressure given lower crude.
Lower fuel (diesel) prices should be an unmitigated positive, but perhaps not as large a windfall as commonly perceived. Current diesel prices of around $2.85 per gallon are 25 percent below the 2014 average of $3.82 per gallon. However, the waste companies have generally adopted fuel surcharges to protect them when diesel was on the way up, and thus now benefit less on the way down.
But, all in, lower fuel prices will be an offsetting tailwind to lower recycled commodity prices. Generally, the fuel surcharges operate on a one-month lag, and do not cover all contracts, so there will be dollar benefit and help to margins.
Margins Look Flat to Up; Earnings Gains Still Anticipated
Given the puts and takes discussed above, there are overall margin pressures on the industry, with RSG hardest hit by the low CPI and WCN by E&P waste, such that margins are likely to be flattish. Individual company actions, such as WM’s head count reduction and BIN’s efficiency programs, should result in margin expansion.
But if lower gas prices do lead to a material improvement in commercial volumes, which results in long awaited service upgrades, the whole industry could enjoy much more robust margin improvement. Bottom line, at least initially, RSG is likely to reaffirm its preliminary earnings guidance of mid-single digit earnings per share (EPS) growth, and WM, adjusted for the Wheelabrator (WTI) divestiture, is likely to forecast mid-to-high single digit EPS growth.
Restrained Capex Likely to Result in Higher Cash Flow; CNG Trucks NOT a Casualty of Lower Oil
RSG and BIN have active programs to reduce capex spending, but overall capital expenditures are expected to remain restrained across the industry. As a result, free cash flow is expected to be up across the board in 2015, from high-single digit to low-double digit, aided by the retroactive extension of bonus depreciation.
Despite a smaller cost advantage, companies are not changing their intent to increase the percentage of the fleet toward CNG-powered trucks, which will remain a capex growth area. There are a number of other political and environmental positives to CNG trucks, and some cost advantage still remains, even with lower diesel costs.
M&A Forecast to Have Another Robust Year
As expected, merger and acquisition (M&A) activity heated up in the second half of 2014, and should remain robust in 2015. WM is looking to replace the EBITDA it divested with the sale of WTI. RSG has shown a much greater acquisition appetite, with two of the largest transactions (Rainbow Disposal and Tervita) announced in the second half of 2014 since its merger with Allied Waste in 2008. Advanced Disposal is also likely to continue a program of tuck-ins to fill out and enhance its footprint as it prepares for a possible IPO (initial public offering).