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February 2, 2021
[00:00:00] Liz Bothwell: Hi everyone, welcome to Waste360's NothingWasted! Podcast. On every episode, we invite the most interesting people in waste recycling and organics to sit down with us and chat candidly about their thoughts, their work, this unique industry and so much more. Thanks for listening and enjoy this episode.
[00:00:25] Liz: Hi everyone. This is Liz Bothwell from Waste360 with Michael Hoffman from Stifel. Welcome, Michael, and thanks for being on the show again.
[00:00:33] Michael Hoffman: Yes, hi, Liz. Thanks for having me.
[00:00:39] Liz: I know you and I have spoken before, but could you please remind the audience about your background in waste and recycling?
[00:00:47] Michael: Sure. I work in Wall Street. I'm known as a subject matter expert in environmental services. I also cover pest control and especially distribution, but I'm a sell-side analyst is the phrase. If you're listening to the business news, they talk about it. The analysts are saying, "I'm one of those voices related to environmental services", which includes solid waste, industrial waste, medical waste within our coverage.
I've been doing it since 1987 and have always covered this space, used to be called pollution control, now it's called environmental services, and then have added broadly lots of things around industrials. I also am the group head of the Diversified Industrial Coverage at Stifel with a team of five other analysts, while covering other spaces.
[00:01:40] Liz: Great. Thank you for that. I'm going to dive right in. I'd love to hear your thoughts on the recent administration change and how you think it might affect the industry.
[00:01:50] Michael: Coming into the election, what we were watching for is, would there be a blue wave or not? The thought of a blue wave was there going to be enough control of Congress that the administration could affect its legislative policy initiatives pretty much unencumbered. It didn't really matter what the opposition was going to say or do, and that didn't actually play itself out in the end.
I would define it more as a blue ripple. This is my view. Why? Because the Senate split 50/50. The House actually narrowed the majority. It's one of the narrowest points of the majority in decades. Between both sides of Congress, there are enough moderate fiscal, moderate Democrats who I don't believe will support radical tax initiatives or super radical climate initiatives. The Green New Deal, I don't think happens or capital gains taxes don't go from the low 20s into the low 40s, which is what the campaign ran on.
If that doesn't happen, then you don't get real upheavals in the broad-based business model of the US economy. If you did take capital gains from the low 20s into the 40s, I would suggest you could see one of the greatest transfers of family wealth in the history of this country, because all of these family-owned businesses are taxed personal basis for the most part and capital gain's a big deal.
If you could radically change it that much, the value which they sell their business has to go up proportionally to be able to have the same after-tax process. The likelihood you'd get that kind of value appreciation is low, so you'd see this race to get your company sold before the tax change came into effect. We don't see that happening at this point. I think, from a standpoint of principles that are going to underline action, climate right at the top of the list, that's clear.
Environmental justice. How does that impact our industry? Candidly, I think the climate changes that are coming in direction, so going back into Paris or slowing down development of upstream energy exploration on federal lands. Or stopping the Keystone Pipeline. None of those are going to have particularly meaningful influences to the solid waste industry. Even actions around focusing on specific components of greenhouse gases.
Solid waste was an early and meaningful adopter of alternative fuel vehicles. Over almost 30% of the whole fleet, not just the public and trades, but the whole fleet is CNG, that's a much cleaner emission than diesel, so they're well down a path of embracing, reducing greenhouse gases. I think incremental changes around things like PFAS.
Would we get a federal MCL? Sure. We were going to get one, whether it was Trump or Biden. It's just a win and I don't think it's going to happen particularly faster. Likely in '21, by the time all of the mechanics of this have to happen, but we'll get one. How low will it be is what matters. It's likely to be less than the 70 parts per trillion that was proposed by the Trump EPA back in 2019 and 2020. But I don't think it goes below 50 in my opinion, so it sets a bar. I think the bigger issue on PFAS will be at the state level, which has less to do with the Biden administration and the definition of who is a generator.
There's some movement in some states about that and its early days. Garbage is early in this process and what they have to avoid is being defined as a generator because they're not, but they allow the definition to be so loose that they get swept up in it. Because leachate concentrates PFAS even if it's at low levels compared to what's in public own treatment to which sleds wastewater treatment system.
Environmental justice will be interesting, mostly because it's about the definition. Solid waste is perfectly happy to address environmental justice in a permitting process. Whether they're expanding capacity or siting new, there's no resistance by the industry about that. What they need is a clearer understanding of what the definition is, so that they can then come at it with good data, analysis, and have effective dialogue. That doesn't exist at the moment neither at the federal level, or individually at the States.
The risk in our view is you get too general of a definition, this isn't really been about environmental justice anymore. It's a tool in which can be used for growth, unfortunately, and we have to avoid that in the process. Those are, I think, the patterns that are playing themselves out in say 2021 very little influence on the industry directly. As a term works its way out. By the middle of the term, you'll start to see these knocking on the consequences into an economy, growth rates, and the like, but so far, it's too early to tell what that's going to look like.
[00:07:58] Liz: That's great insight right there. Thank you. What about the outlook for M&A?
[00:08:06] Michael: We believe M&A reverts back to, I'm going to use the term, normal course. What's that mean? From 2000 to 2016, so pre-tax reform that was done in the prior administration. Other than some obvious examples, the pace of M&A, or the industry consolidation, if you will, kept pace with the underlying organic growth of the industry, 1% to 3%. What do I mean by that? The rate of change of the buyers' growth of sales.
They had a hundred million of revenues. They're buying it 1% to 3%, you're buying one to three million dollars. That was the underlying pace of the organic growth of the industry. Over that 15-ish year period, pretty much what you saw was that consolidation absorbed the organic growth with some obvious exceptions of the public buying Allied and Connections buying Progressive. Extra form comes and it comes at a time when we're eight, nine years into a business cycle. You've clearly lowered personal tax rates or you've lowered capital gains, and you saw this acceleration.
Our view is that, known sellers who principally have what I call the five Ds and it leads with descendants, then behind it, it accelerates the pace of this is death, divorce, disability, or disease. You don't have a succession issue or succession opportunity. You're going to sell the business and you pulled it forward. It goes tax reform, lower capital gains, and you're sitting at nine years into a business cycle.
Statistically, business cycles last seven years. You're long in the tooth and the business cycle going. When the next cycle happens, likely, you're going to get multiple compression and going to have a reduced level of profitability. What do I get to sell the business for? I know I'm going to sell it, so you do it early. You saw [unintelligible 00:10:10] average M&A, '17, '18, '19. Theoretically, we're going to in '20 and then the pandemic gets in the way.
I think now we've had our business cycle and we've not recovered pre-pandemic levels of profitability yet. We're close, but not there yet. I think we settle into a more normal course, and then there's some obvious reasons. Waste management is probably out of the big M&A game. Anything meaningful beyond tuck-ins because they've got to absorb advanced disposal.
Even GFL, I don't think is doing big chunks. Because they've got to absorb Advance and WCA, they'll do tuck-ins. It's lots of tuck-ins. That's what I think happens. Exception might be Republic because they've got Santec still waiting to be closed and their pipeline was pretty full coming into '20 and not a lot of it got closed, so they may end up with a chunkier year. But I think all in all the years, the industry is going to see a more normal course back to the underlying organic growth will be the consolidation pace.
[00:11:18] Liz: That makes sense. That's a great way to look at it, too. I know another round of earning calls are coming up and I read your reports. Garbage is good and the industry has been resilient as we get through the COVID-19 pandemic. What are you expecting this time with these calls?
[00:11:36] Michael: The fourth-quarter results are going to be good. What's interesting is the stock market. If I take it from a stock market perspective, they're treating the industry as if it's about to enter into a slowing of-- or even some compression of sales and profits. The garbage has been viewed, and is -I'm not disputing this or debating it- dean defensive. What is the definition of that in this case?
Is highly recurring, repeatable revenues and profitability that aren't sensitive to the cycle as it's unfolding until way late in the business cycle. For garbage, typically it's the commercial and industrial C&I collection piece way, way late into an economic downturn. Eventually, that customer base may raise his hand and say, "Hey, the five day, eight-yard service. You're going to do a service interval downgrade." Your five day, eight-yard service turns into a five day, six-yard service, and when that happens, you reduce revenues and it reduced profits. That's the defensive aspect of garbage.
What's been happening in the stock market since about September, is the strategist in the market have been saying, "You should be rotating out of defensive stocks into cyclical because you're going to see this price and volume recovery in cyclical, and defenses haven't yet", or just starting this pattern I just described. We’re not just changing our view, the garbage is defensive, it is. It's just the pattern described happen in May, June, July, it already happened.
What garbage is actually variances right now, I would categorize as what looks like new business formation, even if it's an existing customer that was on a service on hold is being turned back on from an accounting standpoint, when you turned it off, that looked like a cancel. When they call up and say, "Okay, I'm willing to be open" and you turn it back on, that looks like new business formation, and you're doing it on a leaner cost structure because garbage proved to be very nimble. Lowering costs as a result of the pandemic impacts, the incremental is better.
I think the fourth-quarter will surprise the market, and the driver here will be commercial industrial volume will be less negative than it perceived, and as a result, they'll be more profitable, generate more free cash. Wouldn't be surprised that several of the companies prepaid the CARES Act because the cash was that good or pre-spent capital spending, so they pulled forward capital spending into 2020 to continue to drive productivity, better asset utilization, and support some of the growth that was occurring.
Then, you have really robust housing cycle. Remember, there's this long-term relationship between household formation and new business formation. You build enough housing, we need a dry cleaner, or a quick [unintelligible 00:14:53] or a coffee shop, and no, maybe we're not going to be building schools and office buildings yet, because the pandemic is still disrupting all that, but what about the empty storefront? And the entrepreneur sees that empty storefront, and he has had this vision to open a business.
You open the business, you put a two, four, six, eight-yard container behind it. That's new business growth, and it comes on really good incremental. I think the pattern in '21 will be good, healthy pricing, 2% to 4% and positive volumes of 1% to 2%, and M&A will be the upside surprise. The stock market will sit up and go, "Well, I didn't expect that", and watch the group start to rally again, as it has often done on fourth-quarter results going into the coming year.
[00:15:48] Liz: That's great to hear. Fingers crossed. We'll be watching [laughs]. You've been doing a top 10 industry trends list for years now, could you please talk about that? And what made this year's list a little bit different? Because I know it was.
[00:16:05] Michael: About six years ago-- I think it was six, seven years ago-- This was not a unique idea on my part, I forget what I was reading, but there was some interesting top 10 call out, and I thought, "Oh, I should think about that all the ways", and started putting down on a list what I thought would be influencers, and have time being wide enough that the influences could be practically seen as possible, and have every year published an update to it.
The list garbage is evolutionary, it's not revolutionary. The list has been pretty consistent with subtle changes in it. This year saw the biggest turnover in the list, half the items we're pretty much the same over and over again, [unintelligible 00:17:00] absolutely, and then, the recycling one has been in and off the list often enough to be repeatable, but not quite been there every time as has some conversation around technology, but we had four new outright additions.
The influence of work from home, is there another round of consolidation? There's a peer of mine, thinks there's going to be some big massive round of consolidation in '21, and I don't see that one. I don't think the big four are going to be allowed to consolidate into each other, but you do have [unintelligible 00:17:42] with a publicly announced strategic review going on. At some point it does because I have to, or should it contemplate a sale for no other reason than a billion dollars of revenues doesn't come about very often, so will that be a way to maximize shareholder value on a sustained basis as a stale. That's the consolidation I think that could happen over the next 10 years.
My phrase was, "And then, there were four", meaning it's you're left with just waste management, Waste Connections, Republican, GFL. PFAS is an issue that's not going away, but we think solid waste will be part of the solution, and then ESG and sustainability is here to stay, and the industry has actually been very good about issues around the S and the G for years, and has realized it needs to be much better at disclosing what it's done in the E, and is starting to do so.
With that, you're seeing in their corporate sustainability reports often referred to CSRs that each year they're starting to add more quantifiable data and put goals and timelines in all three categories of the EBS and the G, but in particular, for them, they need to draw out things that they're doing part of their corporate strategy and day-to-day operations and [unintelligible 00:19:09] better. Then established baselines at which they can show improvement.
Those were the four big changes in the model. Things that have been there for a while, alternative fuel vehicles or the rate of solid waste generation, or our belief that organics diversion is not happening until somebody effectively defines and develops technology that not only works, but you can scale it and doesn't require a subsidy to work. Which so far, nobody has figured that out yet.
[00:19:40] Liz: I love this list and watching it each year. Like you said, this year was the biggest difference, so very interesting to see. I also loved the Investor Summit, how you really did ask all of the companies about their ESG and sustainability goals. You talked a little bit about how they're all focusing. I think a common theme in that was, like you said, they have to focus more on the E part and actually communicating that. It wasn't that they weren't actually doing it, they just needed to either communicate it better, or to your point, maybe get better data and communicate that data better to show what it is they're doing. Do you see any other challenges or opportunities around this for the industry since it is so unique?
[00:20:28] Michael: First I think this is not a fad, I think this is here to stay within the investment world, for sure, but I think it becomes part of a walking, talking dialogue as citizens. That's not to say we're all going to wake up and somehow become free hugging mindset, I don't want you to get flooded with emails from the tree hugging world, I just mean, don't think there's some radical shift more than it is. We all are going to talk about this more often, and that's the important part of it, is the garbage industry has been doing things that are very beneficial to human health and the environment for decades and never talk about it. They have to learn how to talk about it.
There's no particular reason they haven't, it's never really occurred to them they should, public or private, because every garbage company has a permitting issue at some point. If you have a transfer station, you have a depot, you have a permitting issue. Whether you're public or private, you should figure out how to talk about this. That's what the intent was last summer when we brought this up at the Investor Summit you appreciate was the audience is diverse. It's my community of investors and private equity, but it's also Waste360's point base as well.
There's this [unintelligible 00:21:59] audience of service providers, and equipment vendors, and suppliers, and finance. Everybody needed to hear in our view that this needed to be part of your day daily dialogue. By the way, we think you're already doing all of these things strategically anyway, you just have to figure out how to measure it so that you can have a data set that you can disclose that's defensible. It can't be questioned and challenged, so it's got to be good quality data just like your financials and then share it. That was what we were trying to draw out, is how much was already being done. You've heard me talk about this before.
The solid waste industry has been selling baseload power into the grid for nearly 25 years. But isn't this landfill gas, it's renewable energy. Outside of hydroelectric, there are two forms of renewable energy coming in out of the garbage. Is the waste energy side, which is burning trash and making electricity, and then landfill gas, solar and wind are sold as peaking power. They're not sold as baseload. Even to this day you can't rely on it, the wind will blow and you want it, the sun will shine, and until we figure out bulk energy storage, it can't be relied on his baseload power, and their definition here is baseload means, you're part of a guarantee of the baseline that it will always be there. That's your commitment.
We've been that in the solid industry waste industry, as I said, for 25 years. The technology has only gotten better as they've been able to gas off and improve it. That's what I think the industry had to talk about. I mentioned earlier, alternative fuel vehicles, 30% of the fleet is ENG. It's the largest vocational fleet converted, the only other group that's bigger as municipal buses. When battery electric vehicle, or battery electric vehicle in combination of fuel cell becomes commercially viable -not there yet, but we're getting there- our average we'll openly embrace it.
One of our top 10 [unintelligible 00:24:10] is that we think some combination of those ENG, BEV fuel cell will mean that 50% of the fleet operating, which is about 115,000 vehicles today, will be an alternative fuel, not diesel. [unintelligible 00:24:27] should talk about this. That's what we were trying to draw out. I think it's part of our day-to-day dialogue anymore. I know lots of people who are coming from all walks of life, from social economic, political, who look at labels now and try and really understand, or really are beginning to appreciate what's diversion versus really recycling, the recycling being to reuse, or diversion being done, go to something first, which is how recycling is usually defined in most cases.
You're seeing behavior changes and it will be the consumer ultimately leads to, "Are we going to fix this packaging issue?" The consumer is going to drive that, and packaging companies will respond because you'll stop buying things, it'll because it's a multilayered packaging material, or it's not a recyclable material. That's it, the garbage industry talks about it and then it seems as part of the solution, that's the only good for them, and they are part of the solution.
[00:25:30] Liz: Absolutely. I love how you're helping them realize that, and that they need to talk about it. That's amazing that 50% alternative fuel vehicles, that if we can hit that, that's remarkable.
[00:25:45] Michael: We're at 30, and we did the 30 in probably the best 10 years. Maybe it's been over 15, but certainly the last 10 years. I had another 20 points in another 10 years. Now, we do need battery electric vehicles, you got to get the costs down, we have to be assured that the hours of service really can be 12 hours. There's an infrastructure play here around whether it's recharging for electric or hydrogen recharging.
We recently did a fireside chat where we had the three main players in this, three up several, but three. We had Autocar, Lion Electric, and Vaughn out of Germany, and all of them are producing something. Autocar, the CNG. Lion's the battery electric vehicle, and then Vaughn is doing [unintelligible 00:26:40] and fuel cell. They're all big believers, this is inevitable. It's happening, garbage will be there, and the bigger issue is just cost and hours of service.
[00:26:51] Liz: It's happening, that's awesome. Michael, I know you've been asked if coal ash will be at PCB or in asbestos play. Can you talk about that?
[00:27:01] Michael: What does that mean when I say PCB or asbestos? 30 years ago, both of those topics were on the forefront of everybody's mind because the amount of discovery and the negative consequences of its existence. What occurred is a realization that there was more harm being done trying to remediate for asbestos, so that when it became fryable and you were pointing it out. You created such small particulate, it gave out airborne, and there was no way reliably sure you can capture it.
It wasn't a dollar issue. It was the physical limits of being able to successfully remediate a building, pull it out, and then replace it. It didn't play out the way it was expected to when all the rules were passed. With PCBs, it was a gift that kept them giving for almost 30 years with billions of dollars spent in everything from taking old electric transformers and managing the PCB liquids that were in them, to cleaning up around industrial sites, lakes, and rivers, and streams that had PCBs in the sediment with the biggest being the GE cleanup of the Hudson River. They spent or recollect correctly several billion dollars alone.
That's what we think coal ash will prove to be, and underlying that assumption that really carries this is that the states-- and there's like 11 states where most of the coal ash is generated and where these ponds and lagoons exist, where the coal-fired utilities are, and we generate about 110 million tons a day. I don't think that number changes meaningfully over the next 15, 20 years. Might come down a little bit, but not meaningfully, even with [unintelligible 00:29:01] I don't think you're going to see that massive amount of retirements because we don't have a plan for what you're going to replace it with in the play, and you can't replace it that fast.
Where I was going with this, the states and the utilities have all agreed on a plan. Most importantly, the states or the Public Utility Commissions have agreed rate relief will be approved, and while the current consumer may be crowing, "Why am I paying for this?" The reality is if 70 years ago, if we had figured out that we didn't want to do on some lagoons, you'd have been putting in rate relief for line landfills and what we're doing today then, this was going to get rate release, and that's why everybody's going to figure it out we got a lot rate release.
Once you got that virtually, "Sure, this is going to happen", because now the utilities will go do what they do, very pragmatically and programmatically. They'll walk a plan out over a 20 plus year period of this all happening. You're starting to see awards being made, and on bigger scales with longer timelines or not, "Aren't these one, two, and three year contracts being released for eight, 10, 12-year contracts?" A real commitment to a cleanup process.
Most of this is going to be clean and close, not tap in place, which just makes it a bigger business opportunity because it's more expensive to do clean clothes. But in the process, you're going to beneficially reuse some of that ash. Where does it get used? It's in the cement industry, it's a raw material replacement and meaningful cost reduction. That has positive long-term environmental consequences too.
[00:30:53] Liz: Definitely.
[00:30:54] Michael: The play there is a small little company called Charah Solutions, which is little, it's a couple hundred-million-dollar market cap, but it's a pure-play in coal ash. Waste Management has a nice business. We estimated 50, 60 million in revenues. They talk about it a lot, is an area of incremental growth is pretty good, but you could see other more of, probably, the industrial waste side as the remediation sites starts to play itself out. They're good at that type of work. Could they have a role in some of the remediation work?
[00:31:29] Liz: Thank you for that overview. I'm going to shift gears a little bit. I know you're a humble guy, but the NWRA has said that your decades of consistent and helpful guidance has led you to be inducted into their hall of fame. It's amazing, but yet not unexpected. Has it sunk in that you're up there with some of the most legendary waste icons we've seen?
[00:31:54] Michael: I pinch myself every time somebody asks me about it. I humbled. You could go to the NWRA website, there's a hall of fame place. They have every year, you can click on a year, it opens up and it shows you who was inducted that year. Then, you get to the bottom of the list, and there's a consolidation year, but you start looking at who's in the hall of fame and your words are the right words. They were legends, because their people had great influence on the direction that this industry has taken over the last 50 years, and the opportunity to be part of that club, I cannot express enough how humbled I am.
For Don Slager, Brian [unintelligible 00:32:48] and the team there for sponsor me through this process. I cannot appreciate it, or say enough thanks for that. I was flabbergasted when I got the phone call. It's a neat feeling, and a cool club to be part of.
[00:33:08] Liz: It definitely is, and so well-deserved. Thank you for the work you're doing. I'm glad that you're being recognized for it.
[00:33:16] Michael: Thank you, that's so kind of you. Truly is an honor because there are people in this industry that if I landed in some part of the world and I was in trouble, no matter what it was, they wouldn't ask anything. They would just ask where am I, and they'd come get me. That's what this industry is.
Look what happened, it's 5%, 6% increase in the total trash generated at the home. We had an industry that radically change contract terms to help small business survive [unintelligible 00:33:59] of political decisions to shut our economies down. We clearly have learned we shouldn't have shut the economies down, we should have figured out movement restrictions and all that, but make an economy grow so people can thrive and feed their families.
Look what the carpentry industry did all way through that. It showed up every day with no interruption. The private marketplace showed up every day and did its job. With the uncertainty of risk and everything they did their job, and the companies did right by their employees on multiple levels, public and private again, between the PPE and either waving pay time off issues or granting families, the lead to deal with their own family issues related to exposure. All of those, they just responded in a way that makes you proud to be part of.
[00:34:54] Liz: It really does. Like you said, this past year between these companies putting safety first for their own employees, and then looking out for these small businesses where they weren't writing them off, they weren't following up with bills or anything else. They changed it to suit them, and they all hope that they would all come back and they supported that. That's salt of the earth, and you're right, that's what this industry is.
[00:35:20] Michael: You opened with how was the year-end. The year ended really well because garbage's role in providing a lifeline to small business, and not be trivialized. While this is 1 to 3% of the small business costs, on the margin, having that extra dollar to be able to stay alive long enough to be out of reopen, and you're seeing it in fourth-quarter numbers. Garbage deserves an applause for their part of why this economy is still on its feet, without question.
[00:35:57] Liz: I agree. A positive of the pandemic is really highlighting these frontline workers as well. I just love that it elevated this whole industry to the masses in a way that it hadn't before. That's fantastic too.
[00:36:13] Michael: Yes. It starts with the humor of all of the things that got thrown away in the end of March and April, because you're all at home. Again, the garbage industry is okay. You ended up with this relationship with your local garbage man as they pulled up and you'd managed to put things on the curb. They're like, "Really? You want me to take that?" But they took it.
[00:36:35] Liz: [laughs] Yes, and continue to. It's amazing. Michael, it's always so good to talk with you, thank you so much for all of these insights. We unpacked so much that I think I'm going to have to listen to this again to get the full effect. Thank you for taking time out of your busy schedule. Again, for the work that you're doing, and congrats on your award.
[00:36:56] Michael: Thank you, Liz. Like I said, it's an honor, and this is a great industry. The people in it are truly friends, they're just not business colleagues. Thank you very much, and thank you for asking me.
[00:37:07] Liz: Awesome. Keep in touch, can't wait to hear how '21 and beyond goes.
[00:37:12] Michael: We'll do. Thank you.
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