We originally initiated an “Own a Garbage Stock” thesis in July 2014. Since then, we have downgraded the group twice—once in October 2016 and again in April 2019. In both cases, we were drawing attention to the impact of much lower recycled commodity prices versus the market’s current understanding and expectation primarily for recovered fiber prices.
However, in both situations, we noted the macro factors influencing solid waste markets remained stable—gross domestic product (GDP) is holding a pattern of 2 to 3 percent with consumer price index (CPI) in a range of 1.5 to 2.5 percent, up from a sustained period of 1 percent or less.
Consumer engagement, as measured by the Michigan Survey, remains positive, and in the past three years stable in a range of 90 to 100 percent. Housing starts have been holding in a range of 1.2 million to 1.3 million but—for a shortage of labor—could trend higher.
Since July 2014, solid waste prices as an index and mostly as individual equities have outperformed the market annually and cumulatively compared to the S&P 500 and Russell 2000 over the same time period.
We believe solid waste should be a core holding and investors should trade around the position: overweighting when going defensive, underweighting when deep cyclicals and financials are in favor and market weighting otherwise. Solid waste is attractive at 4 to 5 percent free cash flow (FCF) yield, demands new money be put to work over 5 percent FCF yield and becomes a source of funds below 4 percent FCF yield, in our view.
We have completed four surveys of market participants in solid waste: survey #1 (May 2016), survey #2 (May 2017), survey #3 (December 2017) and now survey #4 (May 2019). The first survey established a baseline of data to provide insight on the trends underlying the solid waste industry. Like the prior three surveys, this one was conducted in conjunction with Waste360 and distributed electronically to both its digital database and attendees at WasteExpo. Waste360 is a division of Informa, the international business intelligence, academic publishing, knowledge and events group.
The first survey had 413 respondents, of which 256 were highly correlated to the public company peer group. The second survey had 510 respondents, of which slightly more than half were highly correlated to the public company peer group. The third survey had 706 respondents, with about half correlated to our public company coverage peer group. The fourth survey had 266 respondents, but unlike the prior three surveys, nearly 90 percent are involved in waste and recycling/collection/hauling. All four surveys more than exceeded the response levels needed to have statistically determinant results.
The pool of respondents was similar in all four surveys, with the mix of collection and disposal, or fleet composition, nearly identical. Over the course of the four surveys, the collection mix has split: about 35 to 45 percent commercial; 35 to 45 percent residential; and low 20 percent roll-off. However, in survey #4, there was a meaningful shift in mix to more commercial (43 percent), up from 35 to 40 percent, and less residential (37 percent), down from 40 to 45 percent.
Overall, in survey #4, solid waste operations were split: 87 percent collection, 38 percent landfill, 31 percent recycling and 21 percent other. The fleet mix was similar over the four surveys as well. The mix in survey #4 was 57 percent front-end loader, 35 percent automated side loader and 51 percent rear loader in the most recent results.
Residential pricing trends per household have improved for 51 percent of respondents, compared to 34 percent in survey #3. The average monthly rate per household posted a material increase in the number of respondents now charging more than $20 per month for residential collection, with a similar decline in respondents charging less than $10 per month. Over the last six months, almost 40 percent of the respondents reported raising residential collection prices by more than 3 percent, with 17 percent with an increase of 5 percent or higher.
Pricing in commercial collection is clearly rising, and the pace of that change has not matured yet, with 63 percent of respondents increasing price in survey #4 versus 47 percent in survey #3. Even more important is new business pricing, with 31 percent of respondents adding new customers at $5 per yard or more. Average weight per yard was still growing but at a pace similar to survey #3, with 34 percent of respondents reporting higher small container volumes.
Roll-off—Temporary and Permanent
Both permanent and temporary roll-off activity supported better price trends in survey #4. This was consistent with the favorable price data in surveys #2 and #3 for permanent roll-off and better for temporary roll-off. The temporary roll-off volume data suggests the construction cycle remains positive, but the pace has slowed from survey #3 and is consistent with a stable to slow growth in housing starts and non-residential construction.
Recycling/Materials Recovery Facility (MRF)
In survey #4, 93 percent of respondents stated they offer some type of recycling services versus only 85 percent in survey #1 (May 2016). Whether a solid waste operator, resident or politician, all want or are willing to support recycling, and there appears to be a willingness to pay.
The data also suggests the fundamentals remain poor and have even deteriorated. Processing cost per ton has gone up since the latest survey, with 30 percent of respondents at more than $80 per ton, compared to 26 percent in survey #3, 15 percent in survey #2 and 12 percent in survey #1.
Capacity utilization has improved, with more than 60 percent of the respondents seeing utilization levels above 80 percent versus only 34 percent of respondents hitting these levels in survey #3 (December 2017).
Contamination remains an issue, but at the high end has improved, down from 22 to 17 percent of respondents at 20 percent or more residuals; however, 50 percent still have contamination greater than 10 percent. The solid waste market consistently discusses that contamination needs to be less than 10 percent to lower the cost of processing.
Even more of respondents are not covering the cost of recycling, at 64 percent compared to 48 percent in survey #3. Nearly 50 percent of respondents need $8 per household per month or more to cover the incremental cost of adding recycling collection, with 70 percent of these at $10 per household per month.
Expenses and Capital Spending Trends
There has been a clear and evident shift by the solid waste industry to a focus on cash-on-cash returns, and it is driving behavior at both public and private solid waste operators. That draws attention to capital spending: how much is spent and on what.
The mix of spending in survey #4 reaffirms the growth spending trend that appeared in survey #3. The incremental dollar of spending is mostly for rolling stock—vehicles and containers—with technology for vehicles the next biggest focus at 23 percent of a new incremental dollar of spending.
In addition, landfill cell development cost is on the rise, with 46 percent of respondents spending $300,000 or more per acre compared to 40 percent in survey #3. Of note, there was a spike in respondents’ spending between $150,000 and $200,000 (30 percent) per acre.
There appears to be a shift to more landfill operators willing to raise price with only 52 percent at the same price in the past six months compared to 65 percent in surveys #2 and #3. Of the 48 percent of respondents that increased price, 20 percent were at 2 to 2.9 percent and 20 percent were more than 4 percent—both are material increases compared to all three prior surveys.
Driver Trends and Safety
As the fifth most dangerous occupation, there is increasing focus on training and the installation of cameras, diagnostics and GPS. The data shows over the past two years, the industry has invested in more equipment and technology on the trucks.
However, we are surprised the total number of cameras has not really shifted. Given the low cost and clear advantage to the employees to have more, not fewer cameras, we would have expected to see a more pronounced shift to more than three cameras. In addition, from a safety perspective, we would have expected the residential fleet to have more cameras. While the presence on the commercial (front-end loader) helps validate the need for service changes, the use of more cameras in residential should help reduce some reportable incidents.
This report is prepared by Stifel and distributed with permission.