August 5, 2015
During the past several weeks, the largest publicly-traded solid waste companies reported their second quarter earnings and updated their full year outlooks. Across the board, company executives spoke to an improving economic environment that was driving generally higher volumes. The outlook for special waste and construction and demolition remains favorable, as in prior quarters, and the long-awaited upturn in commercial volumes now appears to be occurring as well, with companies experiencing service increases and upgrades, and with increasing frequency, citing net new business formation. Unsurprisingly, this has resulted in an improved pricing environment, with all the companies pointing to lower churn, less rollbacks and just plain greater retention of the price put out on the street.
Interestingly, Waste Management (WM) and Republic Services (RSG) flip-flopped their usual price/volume pattern. WM’s yield came in slightly below its targeted 2 percent, which management attributed to mix issues, as core price was consistent and above 4 percent. RSG reported higher than expected yield at 2.4 percent, which the company attributed in part to the success of its pricing tools. RSG now believes its full-year yield will be closer to 2 percent than its original target of 1.5 percent. On the other hand, WM’s overall volumes improved to a negative 1.3 percent, versus a negative 3 percent in the first quarter, which was generally better than anticipated, while RSG’s volumes were 1.1 percent, below its 1Q levels of 1.9 percent and below its target of 1.5-2 percent. This was partially due to a tougher comparable, but volume growth may have been slower due to its pricing strength as well.
Waste Connections (WCN), Progressive Waste Solutions (BIN), and Casella Waste (CWST) reported solid strength in both price and volume, and those metrics generally came in above expectations for all three. In particular, WCN noted its West Coast operations, BIN its Canadian operations and CWST its landfill operations as key sources of strength.
Margin Performance More Mixed Given the Two Faces of Energy
The strength in organic growth often did not result in the incremental margin that would have been expected, given the industry’s large fixed-cost base, for a variety of seemingly company-specific reasons. RSG ended up with a flat EBITDA (earnings before interest, taxes, depreciation and amortization) margin, as the underlying 60 basis point improvement in the solid waste business was eroded by the recycling operations and its new energy waste business, Tervita.
BIN’s overall EBITDA margin was down 130 basis points from last year, in large part due to the flooding in Texas, which it noted cost roughly $10 million, as well as a number of other unusual items. Management expects a sharp, second half snapback in margins, however. WCN had an improvement of 180 basis points in its solid waste margin (with 120 basis points of that attributed to lower fuel costs), which was completely masked by decremental margins in its energy waste business, such that the overall EBITDA margin contracted by 140 basis points year to year. Only WM and CWST posted overall margin increases, despite recycled commodity price pressure–in both cases due to internal initiatives.
The decline in oil prices is proving to be a two-edged sword for the industry. Obviously, lower diesel costs are a big boon, but for WM and RSG lower fuel surcharges are catching up and the benefit has lessened. For WCN and CWST, which are less reliant on fuel surcharges, the fuel benefit has been negated for WCN by the impact on its energy waste business, as noted above, while CWST’s landfill gas-to-energy business has been hurt. And BIN, which has been negatively impacted by a weaker loonie (Canadian dollar) all year, doesn’t get the benefit it should from lower diesel, as it is priced in dollars!
Full Year Guidance Generally Raised
With one exception, full-year earnings guidance was generally raised or reaffirmed at the high end. WM and RSG exceeded their quarterly EPS (earnings per share) expectations, with part or all of the upside, respectively, driven by a lower tax rate. As a result, WM reaffirmed its full-year earnings guidance range and indicated that it expected to reach the higher end, despite a bigger recycling headwind than anticipated in the beginning of the year.
RSG raised its full-year earnings guidance modestly. WCN and CWST do not provide EPS guidance, but CWST raised revenue and reaffirmed EBITDA guidance, while WCN increased EBITDA guidance. Given the unforeseen first-half costs, BIN trimmed its full-year EBITDA and earnings guidance, but again, anticipates a strong recovery in the second half.
Free Cash Flow Strong, Despite Higher Anticipated Capex
WM also reaffirmed its free cash flow at the high end of its range, while WCN also expressed strong confidence in its free cash flow target of $350 million. RSG and CWST raised free cash flow guidance modestly, though BIN lowered its free cash flow guidance because of the aforementioned costs.
In a change from previous quarters (and in several cases previous years), the positive free cash flow changes are occurring despite the expectation of higher than anticipated capital expenditures (capex)—either capex is expected to be at the high end of the original range, or in the case of WCN, raised by $10 million. In WCN’s case, the added capex is project oriented, but in general, the higher spending is fleet related.
United Front on Recycling
Given the persistently low level of recycled commodity pricing, and across so many commodities, recycling was not only an earnings headwind this past quarter and thus far this year, but it also remains a drag on overall returns on capital for the industry. Recycling has been the topic du jour since WasteExpo, and its problems have been widely reported in the national media. (See our last column.) In unprecedented unity, however, all the publicly-traded solid waste companies are determined to change and improve their recycling business models, and all have taken various steps to change contracts, increase tip fees, push back on rebates and decrease contamination levels.
Although old corrugated cardboard (OCC) pricing has come off the bottom, many other recycled commodities remain very depressed, and in any event, it does not appear that higher commodity pricing will cause any of the companies to veer off the chosen path of changing the recycling model from commodity based to fee-for-service based.
More Share Repurchase Now, More Mergers and Acquisitions Later?
Despite a flurry of recent merger and acquisition (M&A) activity among the smaller, privately-held players in the industry, there was little M&A activity to report among the publicly-held companies. WM noted that it believes it will have $50 million-$75 million of acquired EBITDA under agreement in the second half of 2015, and WCN noted that it expects to close its typical $75 million in acquired revenues this year.
All that said, it appears that there is a lot of deal discussion and activity ongoing, and apparently plenty of opportunities, such that announced M&A activity may well pick up in the second half of the year. In the meantime, share repurchase programs and activities have increased.
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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