The publicly-traded solid waste companies reported third quarter earnings and held their conference calls in the latter part of October. Firms reported improvements in fundamentals in a quarter that was also marked by solid margins and continued mergers and acquisitions activity.
WM’s core price and yield were consistent at 4 percent and 1.8 percent, respectively, as traditional solid waste volumes almost reached the flat line (-0.1 percent), up from a -0.6 percent decline last quarter. On the other hand, RSG’s yield ticked up to 2.5 percent in the quarter, versus second quarter’s 2.4 percent. RSG’s volume rolled back a bit–to 0.6 percent from 1.1 percent, which was attributed primarily to tough special waste comparisons, as collection, municipal solid waste landfill and construction and demolition volumes all had solid gains.
Waste Connections (WCN) and Casella Waste (CWST) both had strong price and volume gains–WCN had a 2.7 percent core price increase and a 2.6 percent rise in volume, while CWST had price and volume gains of 2.9 percent and 3 percent, respectively. WCN again benefitted from particular strength in the West, stemming in part from the area’s housing recovery, and to a lesser extent some Central region cleanup activity as well. CWST’s continued focus on both sourcing landfill volumes and now on better pricing on those new tons, remain a major driver, though collection trends also improved.
Progressive Waste Solutions (BIN) recorded solid volume gains of 2.1 percent and pricing of 1.7 percent, largely as anticipated, with the volume strength largely driven by its U.S. operations, while pricing was stronger in Canada. Notably, all the companies noted strength in the key commercial collection line, indicating that the long anticipated cycle of service upgrades was finally occurring.
Flies in the Ointment
EBITDA (earnings before interest, taxes, depreciation and amortization) margins in the companies’ core solid waste segments improved largely across the board, and generally improved beyond just the benefit from lower fuel costs. WM’s overall EBITDA margin improved by 140 basis points, with a number of factors besides lower fuel expense contributing. Despite lower recycled commodity pricing and volumes, WM’s recycling operation was flat year over year.
RSG noted a 50 basis point improvement in its underlying solid waste margin that was offset by a 20 basis drag from recycling and 30 basis points from recent acquisitions, most notably its energy waste purchase Tervita. WCN had a 200 basis point improvement in solid waste (150 basis points from lower fuel), but that was entirely offset by the margin decline in R360, its exploration and production (E&P) segment. CWST’s EBITDA margin improved 100 basis points on its internal growth metrics.
The biggest fly in the ointment, however, was BIN’s West region, where margins unexpectedly fell to 23.3 percent from 25.9 percent last year. Although its North and East regions had solid margin progress, the West region experienced large, unanticipated cost overruns stemming primarily from poor fleet maintenance (and local management) issues, which caused the company to pre-announce a $10 million quarterly EBITDA shortfall and change its full year guidance as a result.
The aftermath of Texas flooding in the second quarter brought to light management and operating procedure issues that (reading between the lines) may have been the result of the “roll up” nature of the West region, and exacerbated by unintended consequences from BIN’s change in incentive compensation, which was rolled out earlier last year. BIN has made a number of management changes and instituted preventative maintenance and repair programs, but estimates it will take six to nine months to return the segment to higher operating margins.
With the exception of BIN, which due to the above-mentioned reasons lowered its full year EBITDA target to $480 million to $485 million from $500 million to $515 million, all the other players either reaffirmed comfort with their full year 2015 operating guidance, or in the case of WM, indicated that results could be above the high end. Thus, fourth quarter earnings are now expected to be roughly in line with expectations for all the companies after reporting largely on target, or slightly above expectation, third quarter results.
Unfortunately for WCN given the strength in its solid waste operations, its fly in the ointment, the R360 E&P segment, will cause WCN to take an impairment charge due to the prolonged and extended slump in oil prices. The charge amount will likely be for a significant amount of the associated goodwill and intangible assets, but it will be noncash, however.
Free Cash Flow Shines Despite Higher Capex
Similar to earnings, companies generally reaffirmed or indicated probable upside to their free cash flow projections. RSG reaffirmed its free cash flow target (after raising it in the second quarter), despite higher capex (capital spending) this year. WM indicated that it expected to exceed the high end of its guidance range, also on higher capex. WM also noted that it may look to prepay some potential cash flow headwinds in 2016, most likely some of its cash taxes, which it pegged as increasing $300 million to $400 million in 2016.
WCN reaffirmed its goal of around $350 million, despite having pulled in more capex spending into 2015 from 2016. CWST also reaffirmed. For the same West region reasons, BIN had to lower its free cash flow guidance from $165 million to $180 million to $144 million to $149 million. The bulk of the capex appears to be concentrated on fleet spend for almost all the companies, and CNG-powered vehicles are still a focus, though perhaps a more tempered one, given lower diesel costs.
As Expected, M&A Picks Up
Announced and prospective M&A activity picked up across the board. The most notable was WCN, which was able to announce $90 million in acquired revenues in the third quarter, including one large company with annual revenues of $75 million that is under contract. However, BIN also announced that it had completed acquisitions for total consideration of $100 million. WM noted that it had $18 million in acquired EBITDA closed and expressed comfort with meeting its $50 million to $75 million goal of acquired EBITDA for 2016.
Preliminary Peeks into 2016
Although formal guidance will be given in February when the companies report fourth quarter earnings, as usual, there were some early indications. RSG was the most explicit, projecting earnings per share of $2.13-$2.17. RSG noted that the guidance contained a 3-cent and 4-cent headwind from a higher tax rate and a lower Consumer Price Index-related price impact, respectively, such that the range did not prove to be a negative surprise to the analysts’ consensus of $2.19.
WCN also put out preliminary revenue and EBITDA guidance of $2.22 billion to $2.25 billion and $750 million to $760 million, respectively, with the recently acquired revenue offsetting lower E&P expectations. It put solid waste organic growth at 4 percent to5 percent, split fairly evenly between price and volume. BIN estimated 2016 price at 1.5 percent to2 percent and volume at plus or minus 1 percent. It believes total capex as a percent of revenues will be around 10 percent.
In general, the companies signaled their comfort with continued positive price and volume trends, though perhaps at a slightly lower rate of increase than 2015 levels. Importantly, for the first time since 2011, recycling was generally characterized as likely to be neutral in impact rather than negative!
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.
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