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November 3, 2014
In this month’s edition of the Circular File, we review third quarter 2014 highlights from the publicly-traded solid waste companies’ reports and conference calls, and preview some 2015 glimpses as well as more explicit guidance from Republic Services (RSG).
Although gradual, continued volume improvements characterized the third quarter. Despite warning about tougher comparisons in the second half, both Waste Connections (WCN) and RSG reported volume gains slightly in excess of 2 percent, above expectations of 1 percent to 1.5 percent, while Progressive Waste Solutions’ (BIN) volumes turned slightly positive, at 0.5 percent, for the first time since the third quarter of 2013. Even Waste Management (WM), which has pushed price over volume, had a 10 basis point sequential improvement in volume to a negative 1.3 percent, while noting that the loss of several national accounts accounted for about 100 basis points of that decline.
Of key interest, commercial volumes were generally described as improving, to various degrees, with WCN the most optimistic. Special waste volumes were a source of strength across the board.
Investors and analysts became concerned that industry pricing conditions may have deteriorated after Waste Management said on its conference call that it planned to reinstall a “pricing gate” (whereby a portion of field and corporate managers’ bonuses are tied to a specific level of pricing) in 2015. However, WM’s management noted that its pricing program is a key part of the company’s overall strategy, and the pricing gate is one of management’s “guardrails” to ensure that local and corporate leaders remain focused on pricing goals; the reinstallation of the pricing gate does not represent a change in strategy or a response to current industry conditions.
Underlining that were the actual results—WCN and BIN both reported sequential core pricing upticks in the third quarter, while WM and RSG yield results were consistent with the second quarter results. In conference calls, all of the company managements characterized the industry pricing environment as generally supportive, in concert with gradually improving industry volumes.
Both WM and BIN experienced margin gains sequentially and year over year, as WM’s pricing push and BIN’s focus on improving its Northeast operations continued to bear fruit. WCN’s margin was nearly flat, year over year, because of the strength in its R360 (energy waste) division, and its solid waste margin decline of 25 basis points narrowed from last quarter’s 75 basis point decline, as it successfully implemented a small incremental price increase to offset cost increases in its collection division.
Notably, RSG’s margin was disappointing, falling below its targeted 28.5 percent to 29 percent EBITDA (earnings before interest, taxes, depreciation and amortization) margin target for 2014, as weather, recycled commodities pricing and insurance increases depressed its margins. RSG’s refined guidance for the full year also indicated margin pressure in the fourth quarter, and it noted that in addition to the aforementioned items, last year’s fourth quarter margins benefitted from some favorable environmental adjustments not expected to recur.
WCN reported an upside earnings per share (EPS) surprise, due to both solid waste and energy waste results above expectations, while the BIN and WM EPS results (which were both well above expectations) benefitted primarily from lower tax rates. In both cases, underlying EBITDA and operating results were generally in line with expectations.
As a result, full year EPS expectations for WCN, BIN and WM now exceed the original guidance given out in February. RSG’s third quarter EPS was slightly shy for the reasons touched on above, despite a lower than expected tax rate as well. Fourth quarter expectations were largely unchanged in the wake of third quarter reports and commentary, though RSG’s fourth quarter expectations came down on muted full year EPS guidance (which was taken to the lower end of the original range provided in February).
Free cash flow targets were generally reaffirmed or indicated to be higher, largely due to continued capex spending (capital spending) restraints, coupled with operating improvements. WCN continues to pull 2015 capex forward into 2014, to keep free cash flow more in line with earlier guidance, and WM indicated a similar intent with excess free cash flow in 2014. BIN noted that replacement capex had fallen to 8.0 percent of revenue, as its incentive compensation programs aided better capital management.
Headline merger and acquisition (M&A) activity was dominated by WM’s agreement to purchase Deffenbaugh Disposal (though little detail is yet available), but RSG also picked up Rainbow Disposal in Southern California, which is larger than its usual tuck-in acquisition size at an estimated $50 million in annual revenue.
After a first half lull, WCN acquired assets in both solid waste and energy services with $30 million in annual revenues, hitting one half its typical annual target, and indicated that it expects to close more transactions before year end.
WM indicated it is looking at more potential targets to replace its soon to be divested Wheelabrator EBITDA, but emphasized again it would not pay in excess of its own multiple. Seller expectations were characterized as still high, or only coming down modestly.
Other major announcements were details on WM’s realignment, which has resulted in an approximate 650 employee headcount reduction (in corporate) and more than $100 million in cost savings expected by the start of 2016, with roughly $80 million labor savings benefiting 2015.
BIN was not able to reach an agreement with Jersey City’s port facility, which resulted in the New York City (NYC) contract going out for rebid, although BIN is still favored. BIN’s NYC setback has probably jumpstarted a re-evaluation of its Northeast assets, which may result in an asset impairment and hasten Northeast divestitures, such as Long Island, which was broached during the third quarter conference call.
Although official guidance for 2015, as always, is given in February, some hints were thrown out, and in the case of RSG, more explicit guidance given. The general watch word is more of the same, at least with regard to solid waste. Pricing expectations were generally considered as consistent with 2014 (certainly no degradation); volumes were characterized similarly (probably up 1 percent-2 percent with WM trending to flat), while in specific cases, such as WM’s reorganization or BIN’s focus on capex controls, some extra help to margin or free cash flow is likely in their cases.
RSG gave more explicit EPS guidance, which was below consensus given the lower 2014 base, but it did not signal any fundamental changes either.
Principal, LTY ERC, LLC
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. From 1990 through 2008, Young was with Citigroup in New York as Managing Director, Senior Environmental Services Analyst and was responsible for industry coverage and stock recommendations for companies in the environmental services sector for Citigroup's equity research department. She was ranked #1 in the Institutional Investor poll for eight consecutive years.
Young is noted for her historical perspective, depth of industry knowledge and collaborative approach with clients and companies.
Young has a BA in Economics and an MBA in Finance from Cornell University.
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