In February, the publicly-traded solid waste companies reported their fourth quarter results and provided 2019 outlooks. Although there were variations as usual, a number of themes emerged from the formal outlooks and accompanying commentary on the conference calls. In this month’s edition of Business Insights, we gather and highlight those themes.
Price-led Growth and Mixed, Muted Volumes
As expected, Waste Connections (WCN) led the pricing pack, forecasting 2019 price growth of 4.5 percent. Advanced Disposal Services (ADSW) and Casella Waste Systems (CWST) also set out strong, and accelerated, solid waste price expectations of 3 to 3.6 percent and 3.5 to 4.5 percent, respectively. Republic Services (RSG) set a yield target of 2.75 percent, also a solid step up from 2018 yield of 2.4 percent. Waste Management (WM) left its yield expectations largely unchanged from 2018 guidance at greater than 2 percent, but management stressed that its price-focused strategy remained unchanged.
While strong, accelerated pricing forecasts were unsurprising and largely expected, volume forecasts were more of a mixed bag and generally more muted than expectations. WCN started off with a 2019 volume forecast of negative 0.5 percent, but even adjusting for deliberate shedding, put underlying volumes at flat. This provoked some analyst angst, prompting questions as to whether WCN was sending a signal regarding the underlying economy, but management put it down to conservatism, while reassuring conference call participants that they were still seeing 1 to 2 percent underlying volume growth in the U.S. That said, RSG’s volume forecast of flat to 0.25 percent, ADSW’s of negative 0.4 percent to 0.3 percent and CWST’s of flat to 1 percent were all also lighter than expected, as volume estimates for all three companies hovered closer to 1 percent going into the reports. Here again, all three companies cited various company-specific factors, as opposed to calling out any fundamental weakening, and RSG characterized underlying industry volumes at 1 percent plus. WM was the volume standout, forecasting 2019 volumes of around 2 percent—generally ahead of expectations—which management attributed in part to the improvement in customer retention.
Recycling Still In Flux and Thus Forecasts Were Murkier
After nine months of relative stability (albeit at low levels), February’s RISI data, which came out right before the companies began to report, was a sharp, disappointing downturn. Although some softness was expected for seasonal reasons, old corrugated containers pricing dropped $13 per ton on average from $69 to $56! The economic slowdown in China and slower demand by domestic mills were variously cited.
As a result, the companies’ ability to forecast recycling in 2019 became suddenly more difficult, and, frankly, recycling guidance was generally less precise than it has been in the past. Basically, the consensus that recycling was likely to turn into a tailwind in 2019 was upended. WCN now forecasts that recycling will remain a modest headwind in 2019, mostly impacting the first quarter, while RSG began the year at a disadvantage, as its recycling forecasts are based on higher recycled commodity levels than currently prevail, adding some risk to its projection. Interestingly, some differentiation among the companies has begun to appear. Due to their own actions on implementing contamination fees, and in CWST’s case its SRA fee, WM and CWST increased income in their recycling lines in the fourth quarter and still expect that recycling will be a tailwind in 2019, even at current prices, just not to the extent that they would have forecast just a few weeks before. Our industry sources still remain hopeful of a second half/fourth quarter commodity price rebound for the reasons we detailed in last month’s Business Insights, but at this point, all the players are understandably wary and more deliberately vague in their outlooks.
Margins Held Back by a Number of Factors, Despite Strong Price Forecasts
Going into the reports, expectations were for modest margin improvement and that generally turned out to be the case in company outlooks. That said, given the strong price forecasts, the margin outlooks were mostly considered a little underwhelming. For WM and ADSW, which forecast flattish to slightly up margins and margins up 20 to 30 basis points, respectively, investments in technology and employees were cited, which is expected to result in higher SG&A. The reduced compressed natural gas (CNG) tax credit was also noted as a factor. Elevated merger and acquisition (M&A) activity (and its initial negative impact on margins) was blamed in WCN’s forecast for 30 basis points of margin improvement, versus its previously telegraphed 30 to 50 basis points. RSG forecast the strongest improvement at 30 to 50 basis points, despite the loss of the CNG credit. Excluding these “unusual” factors, the margin improvement expected in the underlying solid waste business was generally pegged around 50 basis points.
Elevated Capex to Continue
As we surmised in last month’s preview, capex budgets remained relatively elevated from historical levels (generally in the range of 11 to 12 percent of revenues, versus the traditional industry norm of around 10 percent), despite the muted volume outlooks. Continuing the theme from the third quarter, investments in fleet upgrades and automation and employee facilities were frequently noted. RSG also highlighted investment in its first next-generation materials recovery facility and signaled potentially more to come. CWST cited an extra $8.5 million in non-recurring capex to support recently acquired operations and recycling facility upgrades. ADSW noted the need for more investment in its landfills to better control rising leachate costs (which RSG noted as well), among other things; while WM talked about potential investments in renewable energy plants at its landfills to support, and close the loop with, its growing CNG-powered fleet. As a result, free cash flow expectations (FCF) for 2019 were just roughly in line with expectations, though CWST raised its 2021 plan FCF target to $65 million to $70 million from $50 million to $60 million.
Another Big Year for M&A
As widely previewed, all the companies see and forecast another big year for M&A activity. RSG and WM put 2019 acquisition spend at $200 million and $200 million to $400 million, respectively, roughly double what would be considered “normal” amounts. CWST forecast another year at the high end or more likely above its relatively new goal of $20 million to $40 million in acquired revenues and noted that it has letters of intent to support that. Perhaps most surprisingly, after struggling to reach its 2018 goal of $30 million, ADSW put acquisition spend in a range of $50 million to $75 million in 2019, but management attributed that primarily to timing reasons versus any change in strategy.
Current Predictions Leave Room for Upside, Economy Dependent
In light of, and underpinned by, strong pricing expectations, 2019 guidance indicates potential upside. The typical practice in the industry of only “baking in” completed M&A deals in guidance looks like it will be exceeded given the M&A goals. And, the more modest recycling expectations also look prudent in light of February’s RISI figures but also could be exceeded in the event of any recycling commodity price rebound.
Lastly, by and large, the volume outlooks were regarded as conservative in light of a still strong U.S. economy. That said, as almost all the companies stated in their press releases before 2019 guidance: “Our forecast assumes no material changes in the overall economy”—any upside will be contingent on no significant downturn in the underlying U.S. economy.
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.