Over the past several weeks, the publicly-traded solid waste companies reported their second quarter earnings results and held follow-up conference calls. In this edition of Business Insights, we review the highlights, as well as compare the similarities and differences.
Organic Growth Above Expectations, Disposal a Consistent Bright Spot
All the companies reported strong organic growth, with both price and volume generally above expectations. Pricing came in at or topped guidance for the year. Waste Management (WM) and Republic Services (RSG) reported yield of 2.7 percent and 2.8 percent, up 40 and 70 basis points, respectively, from the prior year, and RSG noted that its yield is pushing toward 3 percent. Waste Connections (WCN) reported core price of 5.0 percent, topping expectations, though that figure did include roughly 50 basis points of recycling pricing or fees, which RSG and WM did not include in their yield figures. Casella Waste Systems (CWST) reported accelerated solid waste pricing of 5.1 percent, while Advanced Disposal Services’ (ADSW) yield of 3.2 percent was a sequential deceleration, but still healthy.
Although all lines of business generally enjoyed strong pricing, a particular bright spot this quarter was post-collection, or disposal, pricing. CWST noted that landfill pricing was up 6 percent, in part driven by shrinking airspace dynamics in the Northeast. WM’s municipal solid waste (MSW) yield was 3.6 percent, and during the conference call, management noted that yield above 3 percent through the first two quarters of 2019 represents a step-change improvement from the last several years. All the companies cited landfill cost pressures as a driver, particularly leachate, but also noted the need to get adequate returns on this capital-intensive line of business.
Absolute volume levels remained more muted, but again, were generally better than expectations. WCN and ADSW volumes inflected to the positive, with both at 0.8 percent, which was better than expected, though their overall volume results remained dampened by deliberate shedding of certain accounts. WCN put underlying volume growth at 1.5 percent. Adjusting for the shedding of non-regrettable brokerage business, RSG put its underlying volume growth at about 1 percent. Once again, the volume standout was WM, with 4.4 percent volume growth in its collection and disposal business. Here too, a consistent bright spot was disposal volumes—WCN’s and CWST’s landfill tonnage were both up more than 6 percent (excluding the Southbridge closure in CWST’s case), and WM’s MSW volumes rose 6.1 percent. The across-the-board strength was notable, particularly considering the strong disposal pricing, and helped to allay investor fears of an economic slowdown, which was a frequently cited area of concern and analyst questions on the conference calls. Several management teams pointed to the strength, not only in MSW but also in special waste volumes, as a sign that the underlying economic environment remains healthy, supporting underlying volume growth trends of 1 to 2 percent.
Recycling Results Diverge as Recycled Commodity Prices Continued to Sink
Despite the fact that prices for recycled commodities (particularly old corrugated cardboard, or OCC) continued to trend lower in the second quarter, several companies began to buck the trend and report better revenues or profits, or both. Although WM’s recycling revenues continued to fall from last year, it reported a year-over-year increase in EBITDA as a result of its efforts to charge contamination and processing fees and change the business model. Management believes they are 35 to 40 percent of the “way through” their customer base, though the renegotiation and restructuring of certain municipal contracts will take longer. RSG and CWST both reported revenue increases in their recycling lines due to the same type of actions WM is taking, as well as higher volumes. Nevertheless, WM and RSG both signaled that the recycling business would be a greater headwind than previously forecast, based on the current, historical lows for OCC pricing. Given the early implementation and success of its SRA fee, CWST was able to maintain its recycling guidance. The outlier was WCN, as it detailed not only a higher revenue impact but also noted that recycling would have a decremental impact on margins of greater than 100 percent. Given the proportionately higher piece of its business that is franchised, WCN noted that its available remedies are longer term in nature and lower recycling prices must be recouped by higher core pricing over time. Additionally, it noted that, relative to its peers, it has a smaller percentage of its volumes coming into its material recovery facilities (MRFs) from third parties (limiting its ability to charge processing fees), while in turn, it is paying higher processing fees at other MRFs, hence the EBITDA hit in excess of the revenue impact. Management indicated that they were probably in year two of a four- to five-year process to recoup the recycled commodity price losses through price. None of the management teams were optimistic about a recycled commodity price upturn anytime soon and assumed current pricing to reset expectations for the recycling line of business.
Incremental Margins Become More Visible
After much of last year, when strong top line and solid waste results were not as visibly or readily translating into margin upside or operating leverage, margin expansion was more apparent this past quarter. Almost all the companies had a margin improvement of at least 60 to 70 basis points in the underlying solid waste business after excluding the recycling impact, or in the case of CWST, the short-term impact from its Ontario landfill issues and Southbridge landfill closure. RSG and WM had total company margin improvement of 50 and 30 basis points, respectively. The greater strength in margins is certainly in part due to the companies’ own actions to combat the recycling downturn but also likely due to slightly less overall cost pressures than they experienced in the second half of last year.
Guidance Generally Better Than Feared, with Solid Waste Results Overcoming Recycling Headwinds
Going into the quarterly reports, there was a fair amount of angst that guidance would have to be revised downward, given further recycled commodity price pressure. However, as in previous quarters, and given the underlying strength in the solid waste business, WM and RSG were able to reaffirm guidance, though RSG got a bit of help from a lower tax rate. CWST was actually able to raise its revenue and EBITDA guidance. The exception was WCN—although the company raised revenue guidance, it modestly lowered EBITDA and free cash flow (FCF) guidance. Apparently, aside from the relatively greater recycling hit, WCN was also (surprisingly) impacted by the decline in renewable energy credits pricing. A common theme remains higher capex—though that is largely in response to better-than-expected growth. Although WM reaffirmed its FCF guidance, it increased its capex expectations to the top of the guidance range on fleet and landfill expansion spending, while WCN’s modest reduction in FCF guidance was entirely due to increased capex expectations stemming from new contract wins. CWST also maintained FCF guidance as capex is rising, given current opportunities.
M&A Activity Remains Elevated
Through the first half of the year, merger and acquisition (M&A) activity remains elevated for all the companies. CWST has acquired or signed agreements on more than $48 million of acquired revenue, versus its original target of $20 million to $40 million. RSG now sees acquired revenue of $550 million, up from original guidance of $200 million, while WCN has already completed “an outsize year” of acquisitions with $160 million of acquired revenue. Even without considering the pending ADSW acquisition, WM has already spent $440 million on acquisitions, versus original guidance of $200 million to $400 million. None of the management teams expect a slowdown in M&A activity in the foreseeable future, with all describing a strong pipeline of opportunities.
Leone Young is the principal of LTY ERC, LLC, providing consulting and research services to, and conducting special projects for, the environmental services industry, primarily the solid waste sector.