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The Margin is the Story — A Lower Cost Structure Emerges


Over the past two weeks, the publicly-traded solid waste companies reported third quarter earnings and held follow-up conference calls. In this edition of Waste360 Business Report, we present the highlights, as well as explore the similarities and differences, of what were again simply stellar results across the board.

Pricing Remained Healthy and the Volume Recovery Was Better than Expected

Pricing remained relatively stable, if not generally expanded, from second quarter levels, and pricing results were largely in line with expectations. The exception was Waste Management (WM), where yield bounced back to a healthy, pre-pandemic level of 2.6% from second quarter levels of 1.6% when the company took intentional steps to support small business customers.

Driven in part by higher container weights within the residential line post-COVID, residential pricing was a bright spot with Republic Services (RSG) and WM reporting yield increases of 3.1% and 3.5%, respectively, as the companies strive to improve profitability in that line. Despite the COVID-related hit that landfill volumes have taken, post-collection pricing also remained solid, with WM posting core pricing north of 3%, while Casella Waste (CWST) again reported very strong landfill pricing of nearly 7%.

Across the board, volumes were better than expected, and the sequential recovery from second quarter declines was notable. Waste Connections (WCN) and WM recorded solid waste declines of more than 5%, versus general expectations of around a negative 7%. RSG and GFL Environmental (GFL) were even less impacted in the third quarter, posting volume declines of 3.4% and 1.7%, respectively. This contrasted to the second quarter where volume declines ranged from high-single digits to low-double digits. Needless to say, a key focus was the commercial line of business, which was particularly impacted by the COVID shutdowns. Commercial customers resuming service that had suspended service due to the pandemic ranged from 65% of commercial and industrial revenue at CWST, 68% of customers at WCN, 70% of volumes at WM, to around 80% of commercial customers at RSG. It was generally noted that the easy gains had likely been made — in the second quarter, the markets with lighter lockdown restrictions recovered first, whereas much of the gain in the third quarter stemmed from markets which had experienced generally longer lockdowns, such as the Northeast U.S. and Canada — though there is still room for more modest gains if and when reopenings continue and restrictions are eased.

Given that, the company outlooks for fourth quarter volume declines were relatively flat with the third quarter, or modestly up or down, driven largely by individual company views of, or concerns around, the recent coronavirus resurgence and the potential for tightening restrictions or reopening slowdowns. That said, despite the resurgence in the pandemic, October volumes were generally characterized as flat with September and not yet showing any material impact.

Although municipal solid waste (MSW) landfill volumes had a very dramatic sequential recovery in the third quarter at almost all the companies – closing the quarter around the flat line by a number of reports – construction and demolition (C&D) and special waste remained laggards—with volumes typically down in the high single digits to low double digits in the quarter. Generally, management teams attributed that to delays, rather than cancellations, particularly with regard to special waste, and several management teams noted that they expected a resumption of projects in 2021, given the strength of their backlogs.

Major Upside Surprise in Margins — A New, Lower Operating Cost Structure Seems to be Emerging

Absolute EBITDA results and EBITDA margins were again a positive upside surprise across the board, confirming that trend first seen in the second quarter. Despite the headwinds from COVID, total EBITDA margins rose 70 basis points, 90 basis points and 230 basis points at WM, CWST and RSG, respectively. Solid waste margins at WCN and GFL also rose almost 200 basis points and 240 basis points, respectively. There was fairly consistent commentary, particularly highlighted by WM and CWST, that this margin improvement was durable and sustainable, such that the companies have learned to operate with a lower cost structure than in the past. As a result, margins likely have even more upside as volumes recover and turn positive. That said, there was some tempering of near-term expectations, as certain costs, such as healthcare and fuel, are more likely to turn into headwinds versus tailwinds as we enter 2021.

Free Cash Flow Was Very Strong and Cash Conversion Levels Were Very High

The combination of robust EBITDA performance, coupled with consistent working capital improvement, resulted in free cash flow performance that also exceeded expectations at all the companies. Certainly, the CARES Act provided some help, as the companies were able to defer payroll tax payments, but additionally, cash collection efforts were noted as strong, despite small business suspensions and closures. Thus, cash conversion levels—particularly from EBITDA to free cash flow — are running in the mid-to-high 40% level for WM and RSG.

M&A Activity Varies, but Company Acquisition Pipelines and Outlooks Strong

Obviously, WM and GFL merger and acquisition (M&A) commentary primarily revolved around their recent large and transformational deals. CWST and WCN announced incremental tuck-in acquisition activity that put them firmly on track to meet or exceed their respective goals of $20-$40 million and $125-$150 million in acquired revenue, while RSG management raised their estimate of expected acquisition investment to $850-$900 million, up from $600-$650 million just last quarter. The results of the election – if divided government ends up the result as it now looks – may relieve the more acute fears of potential tax increases that had been often cited as a driver of M&A activity. That said, M&A activity was still considered to be robust going into 2021, given current pipelines and perhaps some “pandemic fatigue” setting in among potential sellers.  

2020 Guidance Increased and Higher Earnings Estimates Follow

WM, CWST, WCN and RSG raised all or parts of their revenue, EBITDA or free cash flow guidance for 2020, despite taking relatively conservative stances on expected margins and/or increasing capital expenditure budgets. As a result, analysts also raised 2020 estimates across the board.

Sneak Peaks into 2021—The Current Positive Momentum Expected to Continue

Another common theme among company management teams in reviewing the events of 2020 was the belief that their companies were coming out of the pandemic stronger than they went in — in part reflecting a lower cost structure, but also the more rapid adoption of various technologies, also in response to the pandemic. As a result, the positive momentum that characterized the third quarter was expected to carry into 2021.

In general, management teams were fairly confident, particularly RSG, GFL and WM, in continued upside to pricing potential in 2021, particularly in the residential and post-collection lines, while GFL management noted that it was still early days for its pricing focus.

Expectations for margin gains (for those who gave them), ranged from 30-50+ basis points, despite the expected return of some costs, as previously discussed. And again, despite the headwind of the expected repayment of the CARES Act payroll tax deferral, all the companies saw a clear path to greater free cash flow in 2021. WCN and RSG generally give more signposts for the outyear in the third quarter and that was again the case. WCN is looking for price growth in the range of 3.5%-4%, margin expansion and double-digit free cash flow growth. RSG declined to give the usual preliminary EPS outlook it normally provides but noted its expectation for high single-digit growth in free cash flow and yield in the mid-2% range.

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