January 30, 2014
As yet another year begins, we continue our tradition for the first Circular File issue of the year to share our thoughts on the outlook for key industry drivers of the solid waste industry. In February, the largest publicly-traded solid waste companies will report their fourth quarter earnings and provide their outlooks for 2014.
Steady As She Goes
Led by Waste Management (WM), the industry reasserted price discipline in 2013, and the majors don’t intend to lose ground in 2014, despite a lower consumer price index (CPI) environment. CPI in 2013 averaged 1.5 percent versus slightly more than 2 percent in 2012, which will be a drag on pricing in the index-based part of the business.
That said, all the major companies intend to push pricing in the competitive markets, such that we believe Republic Services (RSG) will forecast consistent pricing of 1 percent to 1.5 percent and Waste Connections (WCN) 2.5 percent to 3 percent, versus roughly 1.3 percent and 2.6 percent in the first nine months of 2013, respectively. Waste Management, which exceeded its initial 2013 pricing expectations of 1 percent to 1.5 percent, is likely to forecast pricing expectations of around 2 percent, roughly the same levels where it exited last year. Though impacted by mix, Progressive Waste (BIN) is likely to target improved pricing in 2014 as well.
The long-awaited volume upturn finally occurred in 2013, and WCN, RSG and BIN all posted U.S. volume growth in excess of 2 percent by the second half of 2013 (BIN was more than 4 percent in the U.S.), versus original expectations of flat to modestly positive volume. Nevertheless, all three are likely to provide more conservative guidance of volume growth around 1 percent for 2014, with RSG possibly a bit higher.
Volume gains have been largely driven by the industrial and construction and demolition (C&D) sectors, not the commercial segment. By all reports, the commercial volume recovery remains slow and elusive, though signs emerged in 2013 that it had at least stabilized and began to turn up modestly. If a stronger recovery does not emerge in commercial volumes until later in the year, or perhaps 2015, 2014 volumes will then be impacted by the tougher C&D comps in 2014, as the 2013 strength came off an extremely low base in 2012.
As WM focused heavily on price, it did not enjoy positive volumes in 2013, and given that continued price focus, the company is unlikely to forecast positive volumes in 2014, particularly in light of the general outlook for a modest commercial volume recovery.
Fuel and Recycled Commodity Pricing Look Stuck In Neutral for Now
Diesel fuel remained in a very tight range throughout 2013 — there was less than 5 percent variation all year. The companies tend to forecast fuel based on the year-end level, which was an immaterial 1 percent decrease from the full-year 2013 average, thus implying a neutral fuel impact on projected 2014 earnings compared with 2013. Thus, far, January levels have remained equally stable, largely unchanged from year-end.
Old corrugated cardboard (OCC) pricing is not as good a proxy for recycling results as it once was, given the China Green Fence’s impact on costs, and the increase in plastic volumes. That said, it remains one of the more measurable barometers. Again, most of the companies forecast recycling results by projecting prior year-end price levels into 2014. Unfortunately, December OCC pricing dropped roughly $10 from November to an average $103 per ton (and remained there in January), and assuming that level holds in 2014 (a very artificial construct to be sure), the 2014 average would be $5 to $10 below the 2013 average of $110 per ton. Although modestly negative, most of the companies are likely to call for recycling results to be largely neutral when comparing 2014 to 2013.
However, one thing certain about recycled commodity prices is their variability. Somewhat surprisingly, several industry experts believe the bias on OCC pricing is to the upside in 2014, despite the recent drop, based on a tightening supply situation that is just starting to materialize. Whether it will be sustained, however, is the question.
Margin Gains Will Take Work
Although fuel and recycling will probably be forecast as neutral, other margin pressures remain in 2014, despite the upturn in organic growth. Although pricing was positive in 2013, for both RSG and BIN, it remained below the cost inflation in the business, while as previously noted, volume forecasts are likely to remain conservative. The Affordable Care Act is also expected to add to inflation in healthcare costs for the companies. Additionally, BIN has some company-specific issues and a weaker Canadian dollar to contend with.
As a result, RSG and BIN are most likely to project flattish margins in 2014 versus 2013. Although WM does not explicitly forecast margins, implied margins in their forecast are likely to be up modestly, given the emphasis on, and higher, price level and the pledge to hold SG&A dollars constant.
Additionally, WM was hit relatively hard by its recycling business in 2013, such that if it does approximate a more neutral impact in 2014, it will be incremental. WCN has already forecast a 50 basis point increase in margins, in part due to improvement in the higher-margin R360 acquisition, but the company also assumes an underlying pickup in solid waste margins of 20 to 30 basis points.
Both Capex and Free Cash Flow Look Relatively Flat
As volume forecasts are generally likely to be positive but modest, overall capital expenditure (capex) budgets are likely to be flattish, albeit with a bias to increasing the number of compressed natural gas (CNG)-powered vehicles within fleets. WCN’s budget is likely to be down, as it pulled capex into 2013 from 2014. Correspondingly, WCN is likely to project free cash flow gains — from around $300 million in 2013 to more than $325 million in 2014.
BIN has had two elevated years of capex spending in 2012 and 2013. Thus, its capex may come down somewhat as a percentage of revenues, but probably not back down to “normalized” industry levels of 10 percent. RSG and WM, are likely to forecast free cash flow as flat. That implies underlying strength or improvement, as both companies are facing an increase in cash taxes due to the expiration of bonus depreciation, while WM will face an additional headwind of incentive compensation payout.
Major Regulatory or Legislative Action Looks Unlikely, But Look for More Local Organics Programs
Anything significant on the regulatory or legislative front on a nationwide basis looks highly unlikely. However, there is likely to be a further proliferation of local organics (food waste) diversion pilots and initiatives, building on 2013’s trend, most recently capped off by expanding programs in New York City and Denver, as well as a host of smaller towns.
Cost and siting issues will continue to hamper these programs, however. Assorted extended producer responsibility efforts are also likely to be proposed, again primarily on a state or local basis.
M&A Likely to Pick Up
After a very quiet year in 2013, merger and acquisition activity is likely to pick up, at least in comparison. Despite the increase in 2013, interest rates (the cost of debt) remain at very low levels by historical standards, and private equity has apparently shown renewed interest in the space, often backing returning industry veterans.
At least one of the large, privately-held regional companies is likely to be sold this year. Seller price expectations may be up, but their underlying businesses have improved too.