March 27, 2014
The dust had barely settled on fourth quarter results and 2014 guidance when the major solid waste companies made presentations at a number of investor conferences during the past month. In this month’s edition of the Circular File, we feature some key highlights.
Similarities and Differences
One consistent theme was the focus on return on invested capital (ROIC) as a key metric and decision driver, and the emphasis on increased generation of free cash flow. All the companies now base incentive compensation on one, if not both, of these metrics. The importance of ROIC and free cash flow has come to the fore during the past several years, gradually replacing what had been a traditionally EBITDA (earnings before interest, taxes, depreciation and amortization)-driven industry.
Another similarity, which is somewhat ironic in light of the nascent industry volume upturn, is a common drive to hold capital expenditure (capex) budgets flat, or even decrease them, and instead work on increasing the asset utilization.
The companies have long had their differences over which type of markets they prefer, but a new differentiating factor is the increasingly divergent company views of the recycling business—is it to be avoided when not regulated or required, or embraced as a growth area, albeit selectively?
Progressive Waste Solutions (BIN)
In concert with its new management structure (discussed in December’s Circular File), BIN is transitioning from a largely acquisition-driven company to one focused more on operational execution and internal improvements. Top management is now concentrating on improving asset utilization, streamlining maintenance practices and capitalizing on its purchasing power.
In essence, BIN is now more fully integrating all its acquisitions with an eye to enhancing its overall operating efficiency. BIN has not turned away from acquisitions, however, and expects to be a major player in what it foresees as the next round of consolidation in the industry. But management also intends to be price disciplined (in concert with its ROIC focus) and believes current seller expectations are too high.
BIN sees improving industry volumes supporting a more constructive pricing environment, and as such, it prefers the more dense urban marketplaces, where the company believes there is greater upside leverage for margins and returns.
That said, in the process of improving the Northeast operations, the company has jettisoned unprofitable accounts and divested certain assets and markets. The pending New York City contract should also be a boon for the Northeast operations, particularly for improving pricing at its Seneca Meadows landfill in upstate N.Y.
With regard to recycling, given both customer demand and increased waste diversion, BIN continues to view the business as a growth area, albeit market specific, and again noted the importance of density to recycling economics.
Republic Services (RSG)
RSG noted four drivers of the solid waste business that are largely out of its control – housing starts, the consumer price index (CPI), fuel and recycled commodity pricing. While improved housing starts are, at least in part, driving an improvement in volume (RSG has the highest volume guidance of the top four players), the stubbornly low CPI, which directly or indirectly affects 50 percent of their business, continues to hamper RSG’s pricing, which remains below cost inflation.
In fact, management noted that in a more robust CPI environment, RSG has traditionally priced above CPI, while in the low CPI environment of the past four years, its pricing has been below CPI. At the same time, recycled commodity prices are at a five-year low, while fuel is running around a five-year high.
Despite these headwinds, the company noted that it has been able to hold margins relatively flat by focusing on the things it can control—operating efficiency and standardized maintenance programs, and augmenting growth with tuck-in acquisitions and privatizations.
Ultimately, however, it believes that operating leverage and materially higher margins are dependent on a better CPI/pricing environment, driven by a more broad-based volume recovery. RSG also recognizes that recycling is growing as a percentage of the waste stream, and looks to take advantage of that in carefully selected markets over time.
Waste Connections (WCN)
On the solid waste side, WCN is sticking to its knitting—preferring to remain in either franchise or secondary markets, which the company continues to believe offer better pricing and margins, which translates into better free cash flow conversion.
WCN is also the most negative on the recycling segment, believing that the business only makes sense in regulated markets, as it is generally not cost effective outside of those. Management also sees excess recycling capacity, particularly in urban areas, which was built when old corrugated cardboard (OCC) pricing was much higher.
Though recognizing its inherently greater volatility, WCN views E&P (exploration and production) waste as its primary growth driver, particularly if regulations tighten. Besides its R360 footprint, WCN sees the potential for leveraging its municipal solid waste (MSW) landfills with E&P waste. In its facility map, WCN noted 15 landfills with E&P waste potential, with a few even outside the current shale basins.
Waste Management (WM)
Although WM has refocused on its traditional solid waste business during the past year, it noted that its sheer size, diverse asset base and range of services remain a competitive advantage as its customers are increasingly demanding more sustainability services and programs. However, the company is now more focused on waste conversion technologies that it believes have more near-term upside, such as its pelletization capability, currently coming on line in Philadelphia.
WM sees the recycling segment as one that must be fixed, with better pricing and contract protections, particularly as lower results in that business have masked the improvement in the traditional collection and disposal business. WM also noted that its recycling infrastructure is fully in place, not an area of expansion or growth, and in fact, less recycling spending is expected to help WM keep the overall capex budget flat.
WM sees some signs of an improved volume environment, particularly in certain business lines and certain geographies (management noted Florida and Arizona). Regardless, it will continue to focus on its pricing push, even at the expense of volume, as it still sees the price/volume trade-off as positive for both margins and absolute income dollars.