Episode 69: Crystal Ball Insights on the Economics of Waste & Recycling (Transcript)

[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.

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[00:00:25] Liz: Hi everyone. Before you dive into this great episode with Michael Hoffman, I just wanted to let you know that the Waste360/Stifel Investor Summit registration is open. This event is amazing; you get insights from all of the top executives. This year, there's four topical panels about rail hauling, waste, and energy lessons from the UK and Europe, safety, private equity, plus Ron Mittelstaedt from Waste Connections will be back to make his first public appearance in almost 18 months. This is going to be insights that you won't want to miss and it's all online, August 10th. You can register at WasteExpo.com and go to the Investor Summit. Thanks and enjoy this episode.

Hi everyone. This is Liz Bothwell from Waste360 and I'm with Michael Hoffman from Stifel. Welcome, Michael, and thanks for being on the show today.

[00:01:20] Michael Hoffman: Hi, Liz. Thanks for having me.

[00:01:21] Liz: Michael, we usually start in the beginning, so could you please tell us a little bit about your background and how you ended up in waste and recycling?

[00:01:29] Michael: I have been working as a self-site analyst for a little over 30 years, came out of graduate school, landed in Wall Street and, back in the late '80s, it was called pollution control. Now it's called environmental services, but it was a hot industry going through lots of consolidation. One time there was almost 20 public solid waste companies, and I was hired to cover this space at a firm that actually doesn't exist anymore called Solomon Brothers, and I've been covering environmental services my whole career. All the way through, I've done other things, broadly, in industrials, covered multi-industry, especially chemicals.

Right after 9/11, invented a space that I called Homeland Security Soldier Force Protection and covered a whole bunch of stocks related to that issue, as well.

[00:02:28] Liz: Good for you. You've seen a lot over the past few decades and I would love your take on the impact of COVID on waste and recycling, what you thought was happening in March compared to where we are now.

[00:02:42] Michael: I would describe these last few months, called the last six-seven months, into three buckets. There's a before, during, and an after. The before, if you were talking to companies even at the end of March, or all through April, but didn't know there was a pandemic and you just said, "How was the first three months of the year?" They said, "We're off to a great start. Better than last year. Going to be up five to seven percent between organic growth and rollover acquisitions, plus M&A we're doing".

Then, clearly, the pandemic hit at the end of March, the worst of it was seen in April, that's the during. What we've learned now is that it pretty much found its bottom in April and began to show gradual recovery within the context of the business fundamentals, beginning early in May. Pretty much every week it was incrementally better, so the during was short-lived four to six weeks. The after is now, a stage of improving trends, but -and that's the most important statement, the but- it really depends on a company's geographic mix and what was the condition of and current state of an economic restart.

Pretty much the great shutdown, as it's discussed on a national basis, is really state and local driven, when did a state and local economy allow a reopening, and therefore, where is an individual company's business relative to that. What you're hearing broadly is the bottom was not as deep as feared. The sustain on depth of that bottom wasn't as prolonged as feared and most of the companies, not all, but most of the companies speak to trends that are going to be better than overall.

From a stock market standpoint, the overall stock market's perception of how that may play out, and where there's an exception, it has to do with geographic mix. It's not that a company is running their business poorly, it's a function of the geographic mix and what are you exposed to as far as where are we in an economic restart.

[00:05:03] Liz: Tell me a little bit about that regional play. Are you saying that because the parts of the northeast are faring better, in terms of lower cases, being able to open, and stay open relative to what's happening in the south, is that what you're saying, Michael? That correlation?

[00:05:20] Michael: Actually, I would reverse that for a moment. Today, there's this improving trend, but early on, they keep a line. Pretty much mid-Atlantic, call it Virginia, Maryland, Pennsylvania, and everything up was much later restarting. All of Canada, because Canada put a national shutdown on. Illinois, the West Coast were really slow in restarting, so as it relates to the second quarter and the messaging coming out of the second quarter to the degree that there have been resurgences occurring in states that opened earlier.

The major difference of this cycle of this is that they're not shutting down whole economies, that they're- maybe an analogy would be they're pulling their foot off the accelerator a little bit, but as opposed to just pulling up to a hard stop, throwing the parking brake on, turning the engine off, and walking away, that's not happening. Companies that had, and have, Northeast, midland Northeast Canada, and West Coast, Illinois, exposure are just further behind, relative to the one areas around the country that restarted their economies beginning in May.

Most of those didn't restart until the middle of June. As it relates to the second quarter, that geographic mix is about when did you start phase one, and where are you relative to phase one versus three. Even the hot states, Florida, Texas, and places like that, are still in a phase two, or some version of a phase three. They're just tempered pieces, as opposed to going all the way back to zero.

[00:07:04] Liz: That makes sense. What do you think needs to happen for you to really feel like we're out of the woods?

[00:07:11] Michael: I have written consistently that I felt we were in a swoosh. First I called it the Great Shutdown, then I said, "I think this is going to be more swish-like." Back in end of April, as the early trend started to show. What I think it is a series of swishes, so if we stood way back and it was like looking at a piece of art, you can see that it was something different. You get really close too and it looks very different, so if you get really close to it, you'll see a lot of little switches. Is that we'll have these pockets of short dips, then a long, shallower improvement, then a dip again, but the overall trend, when you step away from it, is gradually improving.

What I am concerned about, and I think the companies are acknowledging they have to be prepared for. If we think about what's happened here, you basically took an economic cycle that might normally trend into a downturn over a nine, 12, 15-month period before you declare the bottom, then there was a beginning of a restart and you compressed it into four to six weeks. If you look at an economic cycle, when you do it normally, there is a certain level of business value.

Early on, the message from the public garbage companies, and even the bigger privates, very few cancels. This is really about commercial collection, very few cancels, less than one percent. Most of the commercial business wherein economy was reopened, trying to get back on their feet, whether the PPP money helped, whatever the circumstances where they're trying to restart. What I fear, and I think this is sad but true, there will be some businesses that won't make it.

If you look at the Great Recession as an example, the US census tracked the data all way through, and garbage industry talked about it going out 12-13. They lost five percent of their customers. Now, the census data is two point five percent in the three years they measured, but the garbage industry will talk about a loss of five percent of their commercial customer base. Are we going to have a five percent loss of customers? I don't know.

What I do believe, though, is they're going to have losses that are greater than the one percent, that they talked about in early May when they were doing first-quarter reporting and in another two weeks, we'll hear more about that.

From an industry standpoint, through the during, they ran at full employment, didn't furlough anybody. The public companies, smaller companies, had to. They didn't have a choice, but the bigger public companies, the bigger operators, didn't furlough anybody, maintain the integrity of services, did all the things you're supposed to do from an employment standpoint, from a safety and security with all the right personal protection equipment.

The employee base rose to a level that doesn't surprise me covering this for 32 years and going to the NWRA Awards breakfast every year, listening to the driver awards, but I think lots of people were surprised.

They showed up every day, did the work brilliantly, absenteeism was low. What I believe we'll see going through the next six months is there will be some right-sizing of the economy and with it, the industry will have to adjust. I think most of that will be done through attrition, there's always certain turnover. I'm not looking for big furloughs, just there'll be some attrition and that's the important message.

I think the garbage industry learned a lot about how to adjust its business model quickly because the Great Recession, and will be able to repeat that as needed. They're planning for the best, operating as if it's a V planning for it to be worse, and in a position to be able to respond when, and if it happens. If it doesn't, great, and if it does, they'll adjust. I think that should be made clear, there's not going to be any unit pricing pressure. Great misperception.

You can't have this volume compression and not have price compression unit. Price in this context, price per ton, price per yard, price per pole, we see no pressure on that. The breadth of this is pretty equitable across all pump companies servicing this industry, in the sense of everybody seeing very similar circumstances, so that small little company that sits here in their truck's 80% full saying, "I'm going to steal somebody's customer to fill the truck." Everybody's had 80% full, conceptually.

We're not seeing pricing pressure to move business around, but I think that's another lesson that was learned out of the Great Recession. I'm not saying nobody's going to do this, but in my career, in prior cycles, where the little company always thought that they should be full, I think lots of business, garbage companies, service companies, collection sites learn that they're better off 80% full at 100% price than 100% full at a discount, and that will be a major difference as we come through this cycle.

[00:12:41] Liz: I like that. It'll be interesting to watch. You mentioned earnings calls are coming up, but is there anything that you're expecting?

[00:12:51] Michael: We've had a couple of pre-announcements or, for instance, two in a pre-announcement. Waste Connections came right out and just told the market, "Hey, numbers aren't going to be as bad as we thought", and reset them. We've been in front of a hundred percent of our coverage in the last three to four weeks, and the general message was business was going to end up being better than we thought it was going to be.

The one, tempered voice, and I want to be careful here, I'm not trying to say, "Waste Management's out there going; oh, it's horrible", because they're not, but they're a little more tempered. I think that has everything to do with mix, that's the comment I made at the beginning of our podcast. Over 60% of their revenues are in the geography, as we talked about, that were slower in the economic restart. They're further behind and they're 55% urban, so we're just seeing a slower recovery in their commercial collection business.

On the other hand, I think their landfill volume's probably has popped back nicely. The combination of the two might temper their numbers on a relative basis to waste connections, GFL, Republic. Republic issued and [unintelligible 00:14:02] last week, end of the week, talking about a credit agreement adjustment for their covenants that was opportunistic, there was no need to do it other than, "Let's shift them because we can", didn't cost them anything. But they made a reference to where their leverage ratio would be at the end of 2q being similar to 1q.

If you work the math on that, the expectations of the stock market are way low about where Republic's numbers are going to come out. The point of the statement is we could end up with some upside surprises. Connections took that out of the market because they told you it was going to be better. I think GFL, Republic, could end up pleasantly surprising the market. I suspect that Casella is right in line with expectations, is slightly better because this is their seasonal period. Might be a little bit tempered by we're not moving around and traveling as much in New England, a tourist destination. I think Waste Management, probably, has numbers that aren't quite as attractive comparatively. not that they're bad numbers, just comparatively.

I think the other interesting issue will be there's clearly a big merger in the marketplace with Waste Management trying to buy advanced disposal, they recut the terms. We're waiting for the justice department to announce that they have a consent order meaning they're allowed to proceed with the closing. We don't have it yet, and by the time they report we'll be four weeks into the reset terms. You would have thought, if you were resetting your terms, that you at least had a sense of a commitment by justice to get to a finish line.

That'll be a fascinating set of conversations on the Waste Management call if they don't have an announcement that they have a consent order. Then, when are we getting it? Because it seems that should be happening by now. Why isn't? What's holding it up at this point?

[00:16:07] Liz: Right. Definitely, I can't wait to hear more about that. Speaking of M&A, I know that you have written about and you're thinking that, possibly, M&A activity will heat up again. Do you still stand by that?

[00:16:23] Michael: We do. Remember the industry consolidation, if you look at the 21st century, all of the 2000s, and you think about the public companies, except for Republic buys Allied, and then Waste Connections buys Progressive, that's in '16. Then, in '18, GFL buys Waste Industries, such a big transaction. Those three big deals. Other than those funky bits, pretty much the consolidation kept pace with the underlying organic growth of the industry, which is about 3%.

We then got tax reform in 2017. With it, corporate rates were changed permanently, personal tax rates were changed with a sunset at the end of '22. Meaning in 2023, unless they were extended, the rates will all going to go back up to where they were pre-tax reform. The vast majority of the 12,000 plus private companies that are out there that make up 25 billion dollars of a 75-billion-dollar industry are taxed on a personal basis, they're not C corps.

If you knew you were an eventual seller of your business, and tax reforms happened in '17, and we're nine years [unintelligible 00:17:41] economic cycle -the great recession it's the bottom in '08- and we haven't had an economic cycle yet, we're nine years into-- This has been flat for '05 until '14. Then in '14 on, we started seeing this gradual improvement. You're looking at lower taxes, and you knew you're a seller, and we're way late. At this point, they pulled forward your deal. We had this above average pay in '17, '18, '19. That's where this is going.

We come into '20, again, pre-COVID, and the guidance is, "We're going to have a really good deal here like '17, '18, '19." Pandemic happens, clearly for lots of reasons things get pause. At the minimum, can you do due diligence? I think it's going to restart. I think the pipelines were chockablock full. Then, you have two interesting questions. Are there sellers out there that go, "I'm not going to fight this fight and try to rebuild this. Let's just get it done." That's the COVID effect. It pulls a certainty on, "I'd like to get to the finish line, let's get it done".

The second one, and I normally never talk about presidential actions, and people say to me all the time, "Well, but this it's environmental stuff, so it must be something they'd run on." I go, "Actually, on my old career, it's irrelevant." The rules are pretty mature. We've known that republican administrations tend to do more cleanups and democratic administrations tend to do more enforcement actions. Outside of that, it's pretty mature environment. But no, actually presidential elections never really matter. This one does less about the individual people, more about the platforms, and the platforms couldn't be further apart about tax. There's a clear message, the democrats have made it very clear, they're raising corporate tax rates and they're letting all of the personal rate sunset.

You want tax certainty on your sale, you got to get it done in 2020 because, at the moment, if the polling data is right, you're going to have higher taxes. Therefore, you'd like to pull forward your deal, make sure it gets done. If that's the case, you really pretty much have to be in the market negotiating pretty much no later the end of September. It's hard to get it done, just the mechanics of it. If it's anything, 10 million or bigger. We're advocating, we could exit the year where 2021 guidance will have 3, 4, 5%, 6% rollover, depending on the size of the company, deal activity out of 19/20 into '21 because you got a whole bunch of things closed at the end of 2020.

[00:20:24] Liz: I like what you said about the COVID effect, it's definitely accelerating some stuff for sure.

[00:20:31] Michael: Some people go, "Do I really want to fight the fight of trying to rebuild it?" If you listen to the talking heads, we're like, "This is going to be years before we find our way back to the pre-COVID economy." I'm not sure I'm in that quite bearish of the view, but if you think that's the case, would you want to fight the fight? You knew you're a seller, you get your business old. Sorry, you were going to say something, Liz.

[00:20:54] Liz: No, absolutely. Especially if the leader or leaders of that company are getting a little bit older, they might not feel like fighting the fight, like you're saying.

[00:21:06] Michael: Remember something, in March, first half of March, January, February, first half of March, we were looking at an industry that was running at 5% open positions when you're normally at two and a half. Your driver turnover was high, you're having a hard time finding labor. You had owners driving garbage trucks again because the labor environment was so tight. This is six months ago.

[00:21:28] Liz: It feels like forever ago, doesn't it? So much has happened and changed.

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[00:21:37] Liz: Another thing that has changed, and I would love your perspective on this, the Waste360/Stifel Investor Summit is coming up, it's on August 10th. Could you please give our listeners an overview of this awesome event and what takeaways will get by attending?

[00:21:54] Michael: This is the eighth year now that we've done this in partnership. Myself, and you have actually been in a couple different firms, but this is our eighth year. For the participants, those who've come to it in the past, it will feel a lot like a normal investor summit in the sense of it's a full day of getting caught up on solid waste, industrial waste, medical waste.

It's 10 public companies, we have four topical panels that we're going to tackle this year, rail hall, and the role of rail hall in the marketplace. We're looking at waste energy, which is seen as a key component of a long-term solid waste management plan in the UK and Europe, and it's not in the US. There lessons to be learned from that with the two biggest players in US, but also they're part of the development cycle that's going on in the UK.

I'm a big believer that we need to take safety out of the closet to speak of, pull it out and make it a top three. It's got to be talked about all the time. I'm not saying the companies aren't, but I'm doing a safety panel, I've got this thesis, I call it out of 10 and 10, meaning, "Let's get us out of the top 10 worst industries, most dangerous industries measured in the United States in the next 10 years".

We're going to do a private equity panel, we do that pretty much every two, or three years. We add private equity, just talk about where they are in the investing and the industry. Then, the last one, which I'm really excited about, is that we have Ron Mittelstaedt, who's the founder and executive chairman of Waste Connections. This will be his first big public stepping back in from a visibility standpoint with the marketplace since taking his leave a year and a half ago. We're really looking forward to catching up with him on the state of the industry and his perspective on what's going on. He always has great insights to share with the marketplace.

That's the agenda this year, it's going to look a lot like it normally would, but obviously we're doing it virtually, would be webcast. I think we're working out together, we're going to try and do it virtually, so you'll get to see us all somewhat live. As somebody email me, "Are you going to sit at your desk and wear a bow tie?" Because I always wear a bow tie when we do this thing, and I said, "Yes. Of course, I'll have my bow tie on".

[00:24:23] Liz: [laughs] Yes, you need the signature bow tie. That's great, I'm really looking forward to that. Like you said, having him come and share his insights that have always been amazing, Ron, that's going to be a big plus for the audience. I know you have to go, you have a hard stop, but I can't have this interview without asking how you felt about being named one of MWRA Hall of Fame winners? Congrats, it's well deserved. How do you feel about this honor?

[00:24:55] Michael: Thank you very much, Liz. Humble, I'm truly humbled. If you have an opportunity sometime, go on to MWRA site, go to their hall of fame section, click on and start looking at who's in the hall of fame. To be accepted and acknowledged as worthy of that group, it's a fascinating group of people, a lot of them I know and knew through my career. Humbled to be part of that organization. I love this business, and these are people who are the salt of the earth. It's very family-oriented industry, they love this country. It's a critical essential necessary service that's done [unintelligible 00:25:50] every single day, and it's just amazing to be part of it. Humbled is the best I could say.

[00:25:58] Liz: Congrats again, you really are joining legends. We're very happy to partner with you, you've added a lot to this industry and continue to.

[00:26:08] Michael: Thank you very much, I appreciate that. Those are kind words.

[00:26:11] Liz: I know you have to go, but anything else we should be paying attention to in the world of waste and recycling? You've always have an eye towards the future.

[00:26:20] Michael: There's lots of talk about the pandemic leads to long-term permanent changes and how and where we'll conduct our lives. Yes, there will be change. The garbage industry tends to adjust to those changes in a timely and orderly manner. Very rarely are those changes revolutionary, most of the time they're evolutionary. What you'll watch is the industry make the adjustments as they can in a very disciplined manner.

Whether it's more volume and coming out of the homes and less coming out of offices, or it's moving from a commodity-based models to process fees, or moving away from index-based contracts to fixed fees or different index that better reflects the industry. They just put their head down, their shoulder on the wheel, they push forward, and they gradually grind it out and the model adjusts accordingly. Underlying it, are these great businesses with high degree and integrity.

[00:27:27] Liz: Great. Thank you so much, Michael. I appreciate all of your insights, I'm so glad we finally got to do this.

[00:27:34] Michael: Me too, thank you very much, Liz. Enjoy the rest of your summer. I look forward to August 10th.

[00:27:40] Liz: Me too. Okay, chat soon. Take care, Michael.

[00:27:43] Michael: Take care, bye-bye.

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