In this edition of Business Insights, we review and summarize the major solid waste companies’ 2015 outlooks and specific guidance. Although largely as previewed in last month’s Business Insights, there are always a few new and unexpected twists.
After nearly two years of divergence between the larger players with regard to price and volume trends, 2015 guidance would indicate that the outlook for price and volume is again converging, which is unsurprising, given the fairly homogenous nature of the industry.
Waste Management (WM) stuck to a pricing (yield) outlook of 2 percent, as expected, while Republic Services (RSG) set a target of 1.5 percent, which was an upside surprise after two years of 1-1.5 percent, particularly in light of an even more difficult consumer price index (CPI) environment. Waste Connections (WCN) targeted core price of 2.6 percent, down slightly from 2.8 percent in 2014, also citing CPI pressure, but that was largely as expected.
Commentary on the competitive environment was relatively benign, or unchanged, as industry pricing behavior seems not to have changed in response to lower fuel costs. RSG and WCN clashed over the likelihood that residential contracts could be shifted away from a CPI-based cost index to a more representative trash cost index, with WCN throwing cold water on the possibility, while RSG noted they had already had some success.
With regard to volume, both RSG and WCN are looking for growth of 1.5-2 percent, and signaling greater comfort with the high end of that range. WM noted that it sees volume trending up to -0.5 percent to flat, versus -1.4 percent in 2014. Construction and demolition (C&D) and industrial lines were again cited by all the players as the major drivers, but the special waste pipeline was also characterized as solid, possibly foreshadowing a rise in non-residential construction.
There was also more optimism surrounding the prospects for the commercial collection business, with WM in particular more positive about that line of business than it has been. Despite positive indications in commercial collection, the long awaited service upgrade cycle still remains elusive, though there is greater confidence that it will emerge this year. Progressive Waste Solutions (BIN) and Casella Waste Systems (CWST) gave all-in organic growth targets of 2.7 percent (midpoint, with price of about 2 percent) and zero-2 percent (with price growth of 1-2 percent), respectively.
Recycling Remains the Problem Child, with Some Fuel Offset
After the Business Insights outlook was published last month, recycled commodity prices suffered a relatively steep drop. In the case of fiber, the West Coast port shutdown and a stronger dollar aggravated an already sluggish demand picture due to slower growth in China and well-stocked domestic mills. And, recycled plastics followed crude oil down.
According to the Official Board Markets, the average old corrugated cardboard (OCC) price fell to $73 per ton in February from an average of $87 per ton in the fourth quarter of 2014, while high-density polyethylene (HDPE) and post-consumer PET are off more than 50 percent and 20 percent, respectively, from the fall of 2014.
As a result, there was some last minute shuffling of expectations. RSG increased the estimated recycling hit by 6 cents per share, versus its expectations at the time of the third quarter report, while WM had thought it could hold recycling flat, given its offsetting operating cost improvements, but ended up altering its outlook to a negative 3-5 cents per share. WCN estimated the recycling impact as flat for now.
The only bright spot is that the price decline has given the industry real impetus to change the terms of the contracts, and just possibly restructure how this part of the industry does business. WM has led the charge on this issue for more than a year, but other large industry participants are increasingly talking about this and taking action, while the precipitous recycled commodity price decline is already causing some smaller recyclers to shut their doors or try to merge.
Across the board, the industry had a large gross margin benefit from lower fuel costs in the fourth quarter of 2014, which is expected to extend into the first quarter for WM and RSG, after which fuel surcharge reductions are expected to catch up with the lower expense. WCN noted it was 60 percent unhedged; thus, it expects a relatively greater, more long lasting benefit. CWST also noted that it is largely unhedged, and it expects lower fuel costs to offset the recycling drag.
Margin Outlook Largely as Expected Though Exploration & Production Waste Bites Harder
RSG signaled that it expects flattish to slightly up margins, despite greater recycling pressures, in part because of higher yield expectations and its internal efficiency programs. WM does not give out margin guidance, but indicated that it expects further improvement in margins in 2015, primarily from 2014’s headcount reduction, and to a lesser extent from continued operating expense improvement.
WCN’s margin guidance surprised to the downside—its energy waste business is expected to have decremental margins of 600-700 basis points, somewhat more than generally anticipated, such that the margins for the total company are expected to be down 50-100 basis points, versus consensus expectations for flat. WCN’s underlying solid waste business, however, is expected to be up 50 basis points or better, depending on fuel costs. BIN expects strong margin improvement of 100-150 basis points, stemming largely from its internal programs.
Earnings Just Nudge Up
Ironically, 2015 earnings are only expected to nudge higher across the board, but for very divergent reasons. WM forecasts 2015 adjusted earnings per share (EPS) of $2.48-$2.55 versus the $2.48 just reported for 2014, as a result of the Wheelabrator divestiture, which accounted for 18 cents of earnings.
As a result of the recycling fallout, RSG now forecasts EPS of $1.98-$2.04 versus $1.96 in 2014. WCN does not give EPS guidance, but analyst consensus came in around $2.07 for 2015 versus $2.04 for 2014, as a result of the drag from exploration and production (E&P) waste. BIN sees 2015 EPS in the range of $1.26-$1.39, versus $1.33 just reported in 2014, largely due to the weaker Canadian dollar.
Cash Flow Outlook Stronger
Despite the varied and numerous earnings drags, cash flow outlooks were stronger, demonstrating once again the hallmark of this industry. In general, the outlooks are calling for gains of mid-to-high single digit to roughly 10 percent in free cash flows. In part, this is aided by the late extension of bonus depreciation, but RSG and WCN are keeping a very tight rein on capex (capital) spending. WM actually signaled an increase in capex after several years of very tight spending, and it noted that it intends to buy more trucks this year. BIN’s projected capex and free cash flow were higher and lower, respectively, than analysts’ expectations.
Expect an Active M&A Year
WM is looking to replace the divested Wheelabrator EBITDA (earnings before interest, taxes, depreciation and amortization) and believes it can do so (or at least most of it) at acquisition multiples averaging around 7x, though its guidance only assumes the close of the previously announced Deffenbaugh Disposal acquisition.
Though RSG may take a pause as it assimilates Tervita, it indicated an appetite for more, budgeting $100 million of acquisition spend. And, although WCN noted that it believes purchase multiples remain elevated, the company is expected to be busy in this arena as well. BIN also resumed acquisition activity, acquiring two solid waste companies in Texas in the fourth quarter.