August 2021 Business Report: 2Q Themes and Another Beat and Raise

Over the past two weeks, the publicly-traded solid waste companies reported their second quarter 2021 results and held follow-up conference calls. In this month’s edition of Business Report, we distill the common themes, and note the differences, that emerged.

Second Quarter Strength Driven Primarily by Solid Waste Organic Growth

The solid waste companies beat expectations across the board. Pricing came in as expected, or more typically slightly better than estimated, and up sequentially. Pricing was around 4% for Casella Waste (CWST) and GFL Environmental (GFL) and 4.7% for Waste Connections (WCN). Republic Services’ (RSG) yield was as expected at 2.6%, while Waste Management’s (WM) yield popped to 3.7%, though due in part to an easier comparison. The bigger surprise was the strength in volume growth. Almost all the companies reported volume growth at least a percentage point or two above expectations, which generally were in the mid-single digit range, while WM was the standout at 9.6% with RSG not far behind at around 8%. Both RSG and WCN noted that growth could have been even better if not for driver shortages!

Continued second half strength was forecast, as all the companies noted strong special waste pipelines and pockets of commercial (i.e. education and certain geographies like Canada) that had yet to fully recover. Although various lines of business for each company had returned to pre-pandemic revenues or tonnages, it was noted that they really had not yet experienced economic growth.

Recycled Commodities, RINs and Sustainability—Tailwinds and Growth Drivers

As expected, recycled commodity and renewable energy (RIN) pricing were described as substantial tailwinds, and again, further strength was forecast for the second half. Generally, underlying assumptions for recycling in the second half assume consistent pricing with the second quarter, which would imply a second half year over year gain in and of itself, and recent old corrugated cardboard (OCC) price strength (just reported by RISI) indicates the second half forecasts could prove conservative. August OCC pricing now averages just under $160 per ton, or an average monthly increase of $30! Domestic mill demand for recycled paper and brand commitments to using recycled content (primarily plastic) were cited as more durable demand drivers than in past commodity cycles, and as a result, there was greater confidence in a longer-term bullish trend/outlook for recycled commodity prices, and therefore, much more focus on materials recovery facility (MRF) investments. As we have noted previously, corporate sustainability efforts and goals are viewed as growth drivers for WM, CWST and more recently RSG, given service lines geared to helping companies reach their targets.

Margin Strength Proves Resilient as Volumes Return

All the companies reported EBITDA margins that beat expectations, with RSG and WCN the standouts with 110 and 140 basis point increases, respectively. Importantly, recycled commodity and RINs pricing were not the main driver, as underlying solid waste margins were also up materially, especially when considering higher incentive compensation, which was a headwind of anywhere between 50-100 basis points for all the companies. Thus, the solid waste companies are hanging on to the lower cost structure that they achieved during the pandemic, despite the upward creep of container weights and healthcare costs as things normalize. Bottom line, all the management teams are focused on pricing to not only cover cost inflation, particularly labor inflation, but expand margins, and all are comfortable that they have the ability to do so, given the favorable industry and economic backdrop. There were numerous mentions of dynamic pricing, often aided by technology investments enabling it, to cover cost increases as they occur.

Intense Focus on LFGTE Opportunities

Although a small part of the industry’s overall business, there was intense focus on landfill gas-to-energy (LFGTE) operations and opportunities on all of the follow-up conference calls, likely driven by the very high valuations currently accorded to standalone renewable energy companies. All the players are currently working on anywhere between 5 and 15 projects, in a hybrid mix of internal development or in partnership, as there appears to be no lack of companies outside of the industry interested in investment in the area. Several solid waste companies noted that it made sense to tap other sources for energy expertise and capital. GFL made perhaps the biggest splash, as management talked about forming a renewable energy platform with 18 landfills targeted as potential project opportunities. GFL estimated the potential opportunity at $175 million in total (with very high levels of profitability) and likely closer to $75 million-$100 million net to the company if it partners.

Guidance Raised Across the Board

Although WM, RSG and CWST had already raised guidance after the first quarter, it was widely expected that the companies would raise guidance again, and they did not disappoint. Importantly, although higher recycled commodity and RINs pricing were certainly a material factor in pushing EBITDA and free cash flow (FCF) guidance up, the key driver was higher than expected organic growth in the solid waste business, with most of the companies raising their price goals for the year, but virtually all increasing their assumptions for volume growth. Volume gains were obviously outsize in the second quarter given the easiest comparisons, but volume growth is now typically assumed to be 50-100 basis points better than original expectations--now generally ranging between 2%-2.5%+ versus 1.5%-2%. FCF estimates for all the companies were raised, even with higher capital expenditure assumptions at RSG and WCN.  Bottom line, however, all the new forecasts were still considered conservative by the analysts, with more runway in both recycled commodity prices and volume noted as potential sources of further upside, though there was some caution with regard to the resurgence of Covid-19 in the form of the Delta variant.

M&A a Hotbed of Activity with More to Come in the Second Half

Another frequently cited factor for potential upside to guidance was merger and acquisition (M&A) activity. Year to date, WCN has already almost acquired what would be a “normal” year of activity. With the acquisition of Willimantic, with over $60 million in annual revenues, CWST is already through its more typical $20 million-$40 million in acquired revenue goal, and both companies noted that they expect an even busier second half. RSG has invested $567 million in acquisitions this year (primarily Santek), and the company continues to target over $600 million and sees “no pause” in activity, in both traditional solid waste and adjacencies. GFL deployed $135 million for nine tuck-ins, but noted that it sees the potential to acquire $500 million to $1 billion in private company revenues over the next 12-16 months! Labor issues and potential changes to the capital gains tax rate were the most frequently named drivers for the record seller interest. As we noted coming out of WasteExpo, it appears that independent haulers increasingly believe NOW is the time to sell.

Glimpses into 2022

Looking out a little further (though of course there will be no formal guidance until the fourth quarter), continued optimism was the consensus. As anywhere between 40%-50% of the solid waste companies’ businesses are priced based on some form of index, the recent strength in the CPI is the most obvious 2022 tailwind, along with the hope that some of the recent cost inflation, particularly in labor, will moderate. Housing, special waste and E&P waste were also generally viewed as likely tailwinds. The biggest question mark is recycled commodity and RINs pricing—though again, there was a general perception that “higher lows” than in the past are likely, and that the recycling business is now economically sustainable with good returns given the changes in contract structures that all the companies have put in place.