Hauler Confidential, Q2 2013

Michael E. Hoffman, Wunderlich Securities

Summary

There is clear evidence that solid waste industry fundamentals have been improving. Volumes are nearly flat if not already positive and real price leverage is back with a positive spread to inflation likely being realized in many markets during 2013. In the first Waste360/Wunderlich solid waste survey there was clear evidence of price stability with an upward bias.

In the first survey nearly 35 percent of commercial market respondents added customers from newly opened business and 63 percent did so at market rates while 23 percent offered below market rates to win.

In the residential markets the first survey showed nearly 80 percent of respondents reported service renewal prices were flat or up with only 12 percent down and 22 percent reporting increased rates.

In the second survey contract renewals split almost evenly between rebids and negotiate-and-extend and only 7 percent resulted in a lower rate per household — a clear improvement from the first quarter survey.

While industry fundamentals are clearly improving, it is happening on very low economic growth and little or no new household formation. The recovery in housing is only about 12 months old. While the data continues to improve, housing starts remain stubbornly below the long-term post war average of 1.5 million starts per year. Arguably, demographic shifts mean that housing may never recover to the historic average. The consequences of these trends impact how the waste industry should seek to maximize profitability and free cash flow, bringing attention to capital spending and how new capital may be deployed to improve productivity.

Survey Method and Approach

The second survey narrowed the discussion to further analyze if automation is an untapped opportunity and what impact that may have on capital spending. Automation relates almost entirely to the residential market, including both regular waste collection and recycling collection. The second survey drilled deeper into the residential market to gain better insight into the characteristics that define this segment of the solid waste collection market.

The objective of the first survey was to establish a baseline of data about the current state of the solid waste industry. While there were several observations, the overriding conclusion was that price leverage was back and it was still the early days of a gradual but improving trend in price discipline.

Like the first survey, the second survey was conducted by sending an email invitation to participate on April 11, 2013 and was left open through April 24, 2013. The invitation was sent to Waste Age subscribers and WasteExpo attendees and exhibitors. There were 177 respondents, representing a mixture of private companies (95), government agencies (65) or public companies (17).

Second Survey Highlights

The private company respondents in the Q2 survey are similar to those in Q1. The public agency and public company respondents are new. About 45 percent have 10 or more employees and the business mix across the private and public operators splits almost in equal thirds between residential, commercial and industrial customers. Nearly 40 percent of the respondents have either operating budgets or sales of $5 million or larger.

Of residential collection service controlled by municipalities, only 32 percent is outsourced and the average contract length is 5-6 years. That ratio is big enough to restart the discussion about privatization of municipal services.

We do not see a wave of privatization to come. More likely there may be a few conversions per year. Contract renewals split almost evenly between rebids and negotiate-and-extend and only 7 percent resulted in a lower rate per household with 56 percent charging $15 per month per household or more.

As price pressure subsides the need to extract more value out of the residential revenue stream brings increasing attention to adding or increasing recycling participation to increase volumes and the possible addition of automation to reduce cost in regular waste and recycling collection routes.

Residential collection is not highly automated with over 50 percent of routes still serviced with helpers. Even more surprising was that nearly 60 percent of respondents that were not automated had no intention of doing so. For 60 percent of the routes that are automated, the container of choice is 90 gallons.

If long-term economic growth is 2-3 percent with 1.5-2 percent inflation and housing starts are at 1 million plus, then solid waste volume growth is probably 1-2 percent and price growth is 2-4 percent. This combination of macro factors should drive margin expansion, but not without capturing productivity gains and cost cutting too. Choosing not to automate puts an operator at a competitive disadvantage and at a minimum means the business is less profitable than a company that has automated.

Improving recycling participation is gaining more attention. The household is a new source of fiber, particularly cardboard (think about all the boxes that come with online purchases). Household participation in recycling tends to be low if small containers and finite source separation are required.

However, if a single large container is provided the participation rate can double. Typically the household is instructed to mix all paper, plastics, cans and maybe glass in one container. Residents find it is easy to comply and rarely fill the large container. Small containers almost always fill to quickly and they are hard to store once loaded, which impacts participation.

Nearly 65 percent of respondents are required to offer recycling and about 45 percent provide that service on a separate route from the regular collection service. Automation of recycling routes is up less than the automation of traditional collection service. That is not surprising as single-stream recycling penetration is relatively limited.

The container of choice splits almost evenly between 65 and 90 gallons. That said, 30 percent of respondents still deploy 18-gallon (multi-container service) containers.

In the Q1 survey one-third of respondents planned to spend more capital in 2013 and 40 percent said they would be flat year-over-year. Only 16 percent said they will lower capital spending in 2013. Nearly 50 percent of respondents’ capital spending will be on trucks and containers. The purchase of CNG trucks accounted for 11 percent of capital spending. The public companies are spending 40-50 percent of their truck buy on CNG.

In the second survey capital spending trends shifted slightly to flat spending year over year versus less. The most marked difference was that 35 percent of respondents said they would spend on both diesel and CNG trucks, which was down from 50 percent in the first survey. The slow growth economy and improving but muted housing recovery could account for this trend shift.

Conclusion

Whether providing waste services as an owner/operator or a public company, there is increased pressure to improve operating performance. Municipal operators are being pressured to generate more revenues for the general fund and, if run as an enterprise fund, have cost pressures not unlike those facing public or private company operators.

If an operator has any interest in selling its business, then the better its EBITDA, the better the valuation the owner can command. For the public company, there is constant pressure to improve margins and thus free cash flow generation. To that end they have to improve productivity and manage costs. Automation is a sure ticket to satisfy both of these goals by reducing headcount and being able to service more households per route.

Michael E. Hoffman is the managing director for Wunderlich Securities, Inc.