Over the past two weeks, the major solid waste companies reported second quarter results and held follow-up conference calls. Some common themes emerged among all the players—along with some key differences.
Price Holds As Volume Reflects Expected First Quarter Pull Forward
Across the board, pricing was generally better than expected, as it remained consistent with very strong first quarter levels. Waste Management (WM) and Republic Services (RSG) reported yield of 2.6 percent and 2 percent, respectively, consistent with the first quarter. Casella Waste (CWST) reported solid waste pricing of 2.6 percent, within which residential and commercial collection pricing rose 5.3 percent. In a number of cases, the differential between core price and yield shrank, reflecting that more of the pricing “put out on the street” was retained and now falling to the bottom line.
Although mix can always be a factor in this, several management teams called out the successful rollout of revenue and profit enhancing technology tools, to which they attributed at least some of the pricing retention success. Although various management teams noted that the lower consumer price index (CPI) could put pressure on contract price resets in the second half of the year, most looked to offset that with stronger open market pricing. Waste Connections’ (WCN) intent to refocus the legacy Progressive Waste (BIN) sales force on price rather than volume should also aid the overall pricing environment, while Advanced Disposal Services (ADS) noted that in July it increased its environmental fee to offset higher leachate costs.
Although in almost all cases volume growth remained positive in the second quarter, it did shrink from growth reported in the first quarter. That was certainly not unexpected—it was well telegraphed in first quarter conference calls that first quarter volumes benefited from unseasonably mild weather (versus a very harsh winter the year before), as well as one extra workday in the quarter. The question going into the second quarter was to what extent volumes would be “pulled forward.”
WM reported traditional solid waste volume growth of 0.8 percent in the quarter versus 2.4 percent in the first, while RSG saw 0.5 percent volume growth versus 2.5 percent in the first. The most dramatic swing came from CWST, with a decline of 4.2 percent in solid waste the second quarter versus an increase of 4.5 percent in the first quarter.
In CWST’s case, the swing attributable to the weather “pull forward” was further aggravated by actions taken at its Southbridge landfill to push out low-margin tonnage to preserve landfill capacity during the permitting process. On the other hand, WCN surprised to the upside with 2.4 percent volume growth, beating expectations.
Given current investor concerns over the possibility of a recession, as well as the pullback in volume growth rates sequentially, there were a number of questions on the conference calls regarding the strength of the underlying market, particularly within certain verticals such as manufacturing and restaurants. Without exception, commentary on the conference calls reaffirmed the strength in the underlying fundamental solid waste business, with virtually no one seeing signs of a recessionary volume decline.
This was borne out by the second quarter trends in the various lines of business—construction and demolition (C&D) disposal and roll-off, or temporary industrial, collection volumes showed the greatest growth rate drop-offs, in concert with what would be expected from a weather pull forward, while municipal solid waste (MSW) disposal volumes and commercial collection in particular, were much more consistent.
In WM’s case, commercial volumes turned positive for the first time in over a decade! In characterizing the current cycle, a number of the company executives noted their belief that the industry was still mid-cycle with room for further gains in the commercial line, while construction was still expected to be a tailwind for disposal volumes.
Margin Picture Becoming More Consistent
Despite the continued strength in price and volume, the flow through to margins remained uneven, though improved over the first quarter. RSG had flat margins year over year, though it attributed that, in part, to a legal settlement which cost it 20 basis points. But, RSG still reaffirmed its full-year margin outlook, which implies greater strength and increased margins in the second half. On the other hand, both WM and CWST enjoyed significant operating benefit from the top line strength, with EBITDA margins up 140 and 270 basis points, respectively, both handily beating expectations.
As a result, CWST increased its EBITDA guidance for the year, while WM increased its EPS guidance. Although energy waste remains a year-over-year headwind for WCN, it appears to be stabilizing, while WCN’s solid waste margins improved 110 basis points. WCN’s top line strength, combined with better than expected contribution from the BIN merger, has positioned the company to meet or exceed the upper end of its combined company year one EBITDA guidance of $1.25 billion to $1.3 billion. ADS’s second quarter EBITDA margin improved 120 basis points to 30 percent and EBITDA rose 5 percent to $107.5 million, both a record for the company.
Recycling Turns into a Tailwind
An improved recycled commodity price environment, coupled with internal cost control efforts and progress on renegotiating contracts, generally put recycling operations slightly back in the black, although recycled commodity pricing remains well below the prior peak. Although no one wanted to hang their hats on continued price improvement (or even stability), CWST and RSG noted possible upside to their forecasts from recycling, with RSG in particular noting that it could end up at the top of its EPS and free cash flow guidance if current pricing was sustained.
Another common theme was the “de-risking” of the recycling line of business, with several companies noting that internal cost and contract changes that they had been able to effect had taken much of the downside out of the business, while preserving some upside if recycled commodity pricing does make a sustained move to the upside.
Free Cash Flow Targets Confirmed or Raised Despite Higher Capex
RSG did not change its capex expectations and, as noted, confirmed its free cash flow guidance. On the other hand, both WM and CWST signaled that capex was likely to be higher than previously forecasted, though both companies noted “one-off” reasons behind this.
WM is building a leachate treatment facility to cope with its escalating leachate costs, while CWST has had step up its spending at its Ontario landfill. Despite that, WM took its free cash flow guidance up by $100 million to $1.6 billion to $1.7 billion, while CWST reaffirmed its free cash flow range. WCN sees upside to its $610 million year one free cash flow.
Quiet on the M&A Front For the Moment
Although WCN is obviously busy integrating BIN in the blockbuster deal of the year, it noted that its acquisition pipeline remains robust, and it was still targeting $100 million to $125 million in acquired revenues annually. The company believes it will swap/divest BIN assets that don’t fit its profile (estimated at $150-$200 million) by the first quarter of 2017, after reviewing the results through the third quarter of 2016.
But, merger and acquisition (M&A) activity outside that has been muted, at least thus far in the year. RSG acknowledged “a slow start” but still looks to spend $100 million in tuck-ins, while WM also noted a lack of larger acquisition targets “at the right price” at this time. As a result, both companies noted dividend growth as a preferred use of their healthy free cash flow.