Business report

November 2022 Activity Report — Third Quarter Themes and Highlights

Over the past two weeks, publicly traded solid waste companies have released their third quarter 2022 results and held follow-up conference calls. In this edition of Activity Reportwe highlight common themes and address differences in reporting and management commentary.

Strong prices generally up and to the right

Overall, prices have been very strong, beating expectations and rising sequentially in almost all cases. WM (WM) and Republic Services (RSG) announced yields that increased sequentially by 90 basis points and 60 basis points, respectively, and reached record highs. Similarly, core prices at Waste Connections (WCN) and GFL Environmental (GFL) were 8.3% and 8.6%, up sequentially by 110 and 130 basis points, respectively. Casella Waste (CWST) reported a sequential decline in prices, likely due to less help from consumer price index (CPI) resets on CPI-linked contracts than its bigger brothers. Notably, customer receptivity has also been positive, with retention and churn rates remaining stable.

CPI resets on the indexed contract portion of the business have been pegged by multiple management teams at a price rollover of around 450-550 basis points through 2023, leading to forecasts of high prices in 2023 – with prices ‘locked in’ from this alone, coupled with current open market prices frequently and consistently set between 5% and 6%, with more open market action likely to drive higher still 2023 prices. WCN said it expects its exclusive market (franchise) prices to increase from 5.5% to 7% in 2023, with overall prices between 8% and 9% . GFL echoed saying it had seen 2023 prices in a similar range.

Solid volumes, despite expected recession fears

Volumes were also generally quite strong and above expectations. CWST and RSG reported volumes of 2% and 2.2%, respectively, while WM’s collection and disposal volume growth was 1.7%, even after noting the loss of three unprofitable contracts more important. Volume strength was characterized by a broad base, both geographically and across all lines of business. Management teams have not noted any signs of economic weakness (yet) in their companies, although this is not particularly surprising as solid waste is seen as a concurrent, if not lagging, indicator at best. It should also be noted that special waste, often considered an economic or economically sensitive indicator, is up 15% for WM and 13% for RSG. WCN was the exception here with volume (1.5%), but this was attributed to company-specific factors, not macro factors, and management noted positive C&D volumes. Importantly, key volume metrics (net service intervals and net new business) remained positive. While management teams were certainly aware of the economic risk to volumes, they were quite optimistic about the outlook.

Prices for recycled raw materials fall precipitously, becoming a larger headwind in the fourth quarter

The main negative development in the third quarter, unsurprisingly, was the fall in recycled raw material prices (largely on the recycled raw material “basket”), which became a headwind in the third quarter after having been a contributor positive in the first half. But the precipitous drop in old corrugated cardboard (OCC) in October, as reported by RISI, forced companies to cut recycled raw material price assumptions much more dramatically in the fourth quarter than previously reported, generally at levels about 45% below the third quarter average. The resulting fourth-quarter expected recycling headwind was also generally a bit larger than analysts expected. Although OCC has been the main recent driver and many industry experts fear that a bottom has yet to be reached, plastics have also been a significant drag year-over-year, although prices for recycled plastics appeared to stabilize in the October report.

Prices outpace inflation, squeezing margins

Although they were also helped by operational efficiency, management teams generally characterized pricing as being above inflation. RSG’s return of 5.6% was higher than its internal cost of inflation, which was estimated to be around 5%. CWST’s solid waste price of 6.6% exceeds its cost of inflation, which it estimated at around 5.9%. As a result, underlying solid waste margins increased between 40 bps and 120 bps, and overall business EBITDA margins also increased, despite recycling headwinds. The exception to an overall increase in the company’s margin was RSG, where the company’s overall margins were impacted by the low-margin acquisition of US Ecology.

Although labor availability issues, staff turnover and wage inflation appear to have at least peaked in a number of companies, overall levels of internal cost inflation remain consistently high. high, albeit more stable, according to frequent comments from management. And, although most have expressed the expectation (or hope) of lower inflation at the dawn of next year, apparently no one has seen it yet!

Orientation reaffirmed or increased

All companies raised their forecasts in the second quarter. In the third quarter, WM and RSG generally reaffirmed their guidance for full year 2022. The sudden and sharp decline in recycling was characterized as being offset by higher organic growth in the solid waste core business, mainly focused on price. The three smaller players generally raised items on their boards. CWST and WCN raised their 2022 revenue and EBITDA guidance, and both companies reaffirmed their free cash flow (FCF) guidance. GFL raised its revenue forecasts and reaffirmed its EBITDA and FCF forecasts.

Outlook for 2023 Margin “Bump” Cloudier

During the second quarter conference calls, there was much discussion about the potential for an outsized margin “bump” in 2023, given the outlook for much higher CPI resets on the indexed business, combined to lower inflation costs, in particular labor costs. Given stubbornly high internal inflation costs, coupled with what are now seen as material recycling headwinds, there was now more hedging on this potential margin boost, unsurprisingly, as companies (and analysts) tend to “base” their recycling assumptions for 2023 on the fourth quarter. levels, which as noted earlier have dropped dramatically. That said, most management teams continue to target 30-50 basis point margin improvement in 2023. GFL stood out here, still seeing the potential for 100 basis point margin improvement in 2023, including the headwind of recycling!

Other headwinds are developing on the free cash flow front

Given rising interest rates, interest expense is expected to increase significantly in 2023, while cash taxes are also expected to be generally higher, in part due to lower premium amortization. In addition, and again at odds with the prospect of a gloomier economic situation, expected higher capital expenditures have been announced by a number of companies for growth and sustainability investments. CWST raised expectations for investments related to higher inflation and disposal infrastructure, while RSG plans to spend more on polymer centers. WM stood out here, as management indicated that 2023 would mark the largest investment year for recycling and renewable natural gas (RNG) – the company is targeting $1 billion in sustainable investments in 2023 vs. $550 million expected to be spent in 2022.

Mergers and acquisitions continue at a high pace

After all the companies pointed to outsized acquisition opportunities at the start of the year, the third quarter results essentially allowed all the companies to hit those lofty targets. WM made over $200 million in acquisitions in the third quarter, helping it hit its target of $300-400 million. Excluding US Ecology, RSG spent $400 million. Year-to-date, CWST has already completed 13 acquisitions with $48 million in acquired revenue, with an additional $30 million under Letters of Intent (LOI), while WCN has signed or completed acquisitions with approximately 570 million dollars in total annualized revenue. M&A pipelines were characterized as still robust, with many high-quality private players eager to sell.

Signposts for 2023

All the companies give more specific and formal guidance in their Q4 reports in February, but typically some 2023 metrics are released in Q3, and typically RSG typically provides high-level EPS and FCF ranges. Management teams were more circumspect in this regard in the third quarter, likely due to economic uncertainty and recycling. RSG noted that it expects high single-digit growth in revenue, EBITDA and FCF, compared to the low double-digit growth that management thought possible in the second quarter. CWST announced prospects of high single-digit revenue growth, low double-digit EBITDA growth and FCF growth of 10% to 15%. WCN essentially reaffirmed that it still sees double-digit revenue and FCF growth in 2023, while it still expects above-average underlying solid waste margin improvement, which which will offset the headwind of recycling. Finally, GFL expects high single-digit organic growth, high EBITDA growth and double-digit FCF growth, given higher interest expense.