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November 9, 2016
Over the past two weeks, all the publicly-traded solid waste companies reported their third quarter earnings and held follow-up conference calls.
All the companies reported consistent, stable pricing. Both Waste Management (WM) and Republic Services (RSG) reported yield of 2.1 percent, a modest sequential deceleration for WM and a slight acceleration for RSG, but above both companies’ target of 2 percent. Waste Connections (WCN) reported price of 2.6 percent on its legacy business, a sequential deceleration, but also within its targeted range. Importantly, WCN noted progress already in raising pricing on the recently acquired Progressive Waste (BIN) assets—heading from around 1 percent prior to the acquisition to over 2 percent. Advanced Disposal Services (ADSW) reported a sequential improvement to 2.3 percent, aided by its environmental fee.
Casella Waste (CWST) recorded strong solid waste pricing of 3 percent, driven by collection pricing of 3.7 percent. Volume performance was more divergent. WM posted a positive surprise, with total volume growth rising 120 basis points sequentially to 1.6 percent. At both RSG and WCN, volume growth, though still positive, decelerated from earlier in the year, with RSG reporting 0.6 percent and WCN 1.1 percent, while ADSW’s volume fell 3.2 percent. CWST’s volume also fell 1.5 percent. In all cases, however, company specific rather than macro reasons were cited. In RSG’s case, the company noted that it deliberately shed broker business, and both RSG and ADSW cited lost, but unprofitable, residential work. RSG, WCN and ADSW did report negative special waste growth, however. CWST’s volume loss was attributed to its Southbridge landfill and lower shale business.
But, what was completely consistent was follow-up commentary from all the management teams that they did not believe that underlying fundamentals were deteriorating or that solid waste volumes had peaked. The continued housing recovery was most frequently cited as a driver behind this. WM noted the strong trends in the commercial collection business, with volume growth of 1.2 percent, as did RSG, when adjusting for lost broker business. WCN noted the strength in roll-off pulls, up 4 percent, and C&D volumes for WM, CWST and RSG were up double digit. Importantly, landfill tonnage, particularly municipal solid waste (MSW), remained strong. WM’s MSW volume grew 6.1 percent, while WCN’s MSW volume was up 11 percent. Even with regard to special waste, which was consistently more negative, project timing or election jitters were blamed, rather than economic weakness. Underlying solid waste volume growth was characterized several times as likely being in the range of 1 percent-2 percent.
The lack of margin growth that had plagued RSG in the first half reversed in the third quarter as its EBITDA margin rose 80 points, in part helped by a legal settlement, but progress nevertheless. WM’s margins also benefitted from leveraging its flat S.G.&A. ADSW ‘s EBITDA margin rose 110 basis points to 30.3 percent, due to both operating and SG&A leverage, while CWST’s solid waste EBITDA margin reached a similar 30.1 percent, up 265 basis points. WCN’s overall EBITDA margin was down due to the acquisition of lower margin BIN, but it benefitted from the improvement at BIN, as the underlying margin on those assets improved to 30 percent, which was ahead of plan. WCN also noted, unsurprisingly, that its $85 million synergy target was running north of $100 million. Interestingly, the incremental margin that would be expected from higher volumes does not appear to be materializing to any great extent in the operating line, but as a result of S.G.&A. cost control. Revenue enhancing and pricing tools or operating and customer initiatives were cited by all the companies as drivers for both current and future improvement in the margins.
On a combination of flat to up volumes and an improvement in recycled commodity pricing, recycling turned into a tailwind for all the companies. For WM, the three cent recycling benefit offset the rising leachate costs it has been experiencing. For RSG, it accounted for 10 basis points of the margin increase.
That said, all the companies, but particularly WM, stressed their commitment to changing recycling contracts to fee-based, processing cost recovery contracts, regardless of the improvement in recycled commodity prices, which were generally up double digit year over year. If pricing remains at current levels, it will benefit the fourth quarter as well, just as the benefit from lower fuel costs starts to wane.
Given more positive surprises than negative, third quarter earnings were better than expectations across the board, and guidance was raised for full year EPS or free cash flow (FCF), often both. WM bumped its EPS guidance up and held firm on FCF after increasing it last quarter, while also RSG nudged up its EPS and FCF guidance. WCN’s third quarter FCF was an upside surprise, resulting in higher expectations for the second half. CWST nudged up its EBITDA guidance for the third time this year and increased its FCF guidance.
By far, WCN was most bullish on the merger and acquisition (M&A) outlook. Management noted that discussions had really heated up and attributed it to election concerns. WCN reaffirmed that it had one or two bidders for all the BIN properties that it intends to divest. And, management believes the company will now exceed the $120 million in acquired tuck-in revenues that it had previously targeted. In contrast, WM and RSG were more measured in their commentary—expressing their belief that they would achieve their tuck-in goals but indicating nothing major on the current horizon.
Although all the companies reiterated the disclaimer that formal guidance will be given in February, sneak peaks and outright projections abounded. RSG laid out 2017 EPS guidance of $2.31-$2.36 vs. $2.19-$2.20 in 2016 and free cash flow goals of $875-$900 million in 2017 versus $840-$850 million in 2016, both a little shy of analyst consensus, but generally characterized as conservative. RSG’s estimates were based on the continuation of the same favorable trends it is currently seeing, including margin expansion. WM noted that it sees holding price at or above 2016 guidance expectations. Management also sees potential margin expansion of 50+ basis points. WCN noted that its margin expectations are running about a year ahead of previous expectations, and it can see an EBITDA margin of 32 percent next year, stemming from an additional 150 basis points from operational improvement and divestitures and swaps at BIN. Additionally, it also indicated that free cash flow in 2017 is now likely to be $700+ million, versus previous expectations for $650 million. Free cash flow is directionally up across the board, and the common undercurrent or assumption is the belief that the underlying solid waste fundamentals look to remain strong, at least through next year.
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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