In the month of February and into early March, the publicly-traded solid waste companies reported their fourth quarter earnings results and unveiled their 2018 outlooks. In this edition of Business Insights, we review the highlights and discuss the similarities, differences and surprises.
Organic Growth Outlook Strong, with a Few Surprises
Waste Management (WM) and Republic Services (RSG) provided yield (pricing) guidance of 2 percent or greater and 2.25 percent, respectively, both in line with expectations and roughly in line with 2017 results. Casella Waste Systems (CWST) provided strong solid waste pricing guidance of 2.5 percent to 3.5 percent, also tracking recent results. Waste Connections (WCN) topped price expectations of around 3 percent, with guidance of 3.5 percent, citing both help from a strengthening consumer price index (CPI), and secondarily, continuing repricing of the underlying legacy Progressive Waste (BIN) business. After a disappointing third quarter price figure, Advanced Disposal’s (ADSW) fourth quarter pricing improved, but more importantly, the company predicted a rebound to 2.1 percent to 2.8 percent in 2018, allaying any fears that it was pursuing a market share strategy. All the companies noted a strong underlying economic backdrop and a strengthening CPI as factors bolstering their price expectations.
On the other hand, volume guidance generally came in a little more muted than was generally expected. RSG, CWST, ADSW and WCN all forecast volume growth in a range of flat to up 1 percent. More specifically, RSG gave volume guidance of 0.0 percent to 0.25 percent, CWST of 0.5 percent to 1 percent, ADSW of 0.4 percent to 1 percent and WCN of 0.0 percent to 0.5 percent, versus the widely-held assumption that underlying industry volumes are growing between 1 percent and 2 percent. In fact, all the companies basically acknowledged that they were forecasting volume growth below the underlying industry volume growth, as the strong industry fundamentals enable them to concentrate on a price-focused strategy. Additionally, the common theme of culling unprofitable business and tough special waste comparisons were also noted, and in CWST’s case, the impact from closing its Southbridge landfill. The exception was WM, which forecast volume growth of 2.0 percent to 2.2 percent, citing a strengthening economy in many of its markets and business lines, as well as two significant contract wins in New York City and Los Angeles. WCN’s management also noted that they believe underlying municipal solid waste (MSW) volumes are growing at 2 percent to 2.5 percent. Bottom line, volume guidance looks likely to prove conservative.
Recycling Outlook Worse than Originally Expected, E&P Waste May Provide Some Offset
Many of the companies had provided some preliminary estimates of the recycling business’ impact on overall results at the time of the third quarter reports, and unsurprisingly and across the board, the outlook for recycling was significantly worse. WM now estimates that its recycling line will negatively impact the company by $0.08 to $0.10 per share versus $0.04 at the time of the third quarter report, while RSG also noted that the impact was now expected to be around $0.07 per share versus $0.04 to $0.05 previously. WCN noted that recycling was expected to shave 50 basis points from its margin in 2018, while CWST put the recycling drag on EBITDA at $2 million to $3 million. All the companies cited the lower February pricing for fiber, and China’s mixed paper and plastics bans and import license restrictions, while generally noting a belief that the newest Chinese action—the 0.5 percent contamination standard—may well be strictly enforced. ADSW’s CEO went so far as to say that he didn’t see any reason for prices to rebound this year, and that we may well not have hit bottom yet. On the other hand, given the second half 2017 rebound in oil prices, E&P waste is expected to be an incremental tailwind for a number of the companies, with WCN having the greatest exposure to energy waste, RSG the second largest exposure and WM also expected to be a beneficiary.
Margin Outlook Generally Positive, Inflation More Friend than Foe
Despite the drag from recycling, WCN forecasts an EBITDA margin improvement of 60 basis points, up slightly from 50 basis points in its preliminary guidance. WM’s guidance also implies margin improvement, despite the bigger recycling hit, while CWST’s forecast indicates margin expansion of more than 50 basis points in its solid waste line. RSG guided to an underlying 10 to 30 basis point margin improvement, further aided by a 100 basis point revenue recognition accounting change. ADSW forecast flat margins at the midpoint of its guidance, including a negative 40 basis point impact from recycled commodity pricing. In answer to a number of analyst questions on the impact of inflation, the companies all acknowledged rising costs, particularly in the labor line. Given the preponderance of CPI-linked contracts in the business, however, all felt that the increased pricing power stemming from inflation would outweigh the negative cost or interest rate impacts.
Earnings and Free Cash Flow Aided by Tax Reform, EBITDA Forecasts Largely as Expected
RSG and WM are major beneficiaries of the new tax law, and the impacts were more clearly delineated on the conference calls. As a result, earnings and free cash flow estimates rose materially from 2017 results for both companies, while CWST and ADSW also forecast higher free cash flow in 2018, although they do not benefit from tax reform on a cash basis. Perhaps more importantly, underlying operating forecasts (EBITDA) generally came in around or slightly higher than consensus analyst estimates, with the exception of ADSW, which came in slightly below.
Incremental Cash Most Likely to be Deployed on M&A, Capex and People, Not Share Repurchase
A frequent question within the industry was how the new tax law cash windfall would be spent and what other ramifications its provisions would have on the industry. As expected, WCN was the most bullish on acquisition prospects, noting it has closed (or has under agreement) $110 million in acquired revenue in the first six weeks. CWST has already hit the bottom of its targeted acquisition range, while RSG and ADSW both noted very strong pipelines and reiterated a bullish outlook, though ADSW expects 2018 acquired revenues to be back in its normal range. Importantly, the tax reform enables more potential deals to hit required return parameters, which should help to offset the fact that acquisition purchase multiples are rising by almost all reports by anywhere from one half to two turns. The exception to this trend may be in the Northeast, as noted by CWST, where smaller haulers may actually be worth less given the double whammy of increased recycling costs and declining landfill capacity.
A portion of the cash tax savings is generally being plowed into higher capex, to a greater or lesser extent, depending on the company. WM is spending $100 million to $200 million over 2017 levels, primarily on its fleet, but also on technology initiatives, and higher fleet spending was also referenced by RSG and CWST. Landfill buildout is also increasing capex for CWST and ADSW. And, although WM was the only company to announce worker bonuses, RSG talked about increased spending on worker facilities, such as locker rooms, while WCN is raising the minimum wage it pays to $12 per hour, which captures about 3 percent to 4 percent of its employees, and adding to its 401(k) contributions. Everyone is focused on employee retention. Thus, although share repurchase was and is a part of WM’s, RSG’s and WCN’s future capital allocation strategy, it does not seem to be where the incremental dollars are going.
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.