Stifel’s Hoffman Discusses State of Waste, Recycling Amid COVID-19

The novel coronavirus, or COVID-19, continues to bring challenges to virtually every industry across the globe. And although the waste industry has been deemed “essential,” it’s dealing with its own set of challenges as it works to keep living and working environments sanitary.

One of the industry experts tracking the state of the waste and recycling industry during this pandemic is Michael E. Hoffman, managing director and group head of diversified industrials at Stifel, which just released a report, “Solid Waste: Revising Models for C-19, Volume Down, Price Durable, Deal Flow Slows, FCF Stands Out,” that explains how the impact of COVID-19 on solid waste will “look like both 9/11 and the Great Recession.”  

To provide further insight on the state of the industry, Waste360 sat down with Hoffman to discuss stock markets, mergers and acquisitions activity, labor, commercial and residential recycling, safety and more.

Waste360: How are industry stocks trading relative to the overall stock market?

Michael Hoffman: I would have said that the stocks have done what you would have expected and outperformed the stock market in a time of crisis like this because they should be seen as very stable, repeatable business models.

In the mean, that has happened, but they have been a little less defensive in the last week or two. We highlight this in our recent report to remind the marketplace that the lessons learned from the Great Recession and the changes in the operating models have provided more ability to flex the cost structure in response to any negative changes in the business environment.

The industry has the ability to park equipment, adjust labor hours, walk back overtime, adjust capital spending, etc., and I think the main thing everyone focuses on in garbage is structural cash flow, which will prove to be quite durable.

Right now, there’s a slow information flow from companies, but I expect we will hear more from companies in the coming weeks.

Waste360: Waste Management is now expecting to close its acquisition of Advanced Disposal in Q2 opposed to Q1. Can you shed some light on how COVID-19 is impacting M&A activity within the industry?

Michael Hoffman: Waste Management might have to ask themselves the same question, but, in reality, the size [of the acquisition] doesn’t really matter. There will be negative consequences to this economy, and companies need to understand what they are buying because some commercial customers may not survive this.

In some cases, owners of businesses will say they were near the end and are not going to restart, and there are some that possibly wouldn’t have survived anyway. This situation has just accelerated that decision. So, if you’re a buyer looking at someone’s book of business pre-COVID-19, that book of business could very well look different post-COVID-19. You just have to look at the whole picture and decide what you’re willing to pay for.

Overall, I think M&A activity is on pause until companies understand what they’re actually buying, but the good news is the multiples of enterprise value has improved over the last 10 years, and the free cash flow conversion of the industry has dramatically improved as well. The tax reform in 2017 certainly helped, but the free cash flow conversion was improving without it and kept improving after it, which resulted in an increase in the value of what the market was willing to pay for a garbage business.

You have to take all of that and more into consideration when you think about the M&A environment right now. You also have to think about the sellers as well and how they may have to reevaluate based on EBITDA, multiples of enterprise value, etc.

It’s also a presidential election year, and while we saw a heightened level of M&A post-tax reform and before COVID-19 when everyone’s business was operating really well, businesses are now playing against the expiration of personal taxes and tax cuts that sunset in 2022, and the democrats have a clear message that they will be raising taxes and rapidly.

So, if you’re selling your business and have slightly less EBITDA post-COVID-19, you will likely worry about who is going to win in November, as the change in taxes could be 2021 opposed to 2022. Before COVID-19, this wasn’t really a concern, but now it raises the question: do I want to try and push for a done deal even if my company is slightly smaller due to the effects of COVID-19 because I want certainty about taxes? That’s a big unknown.

Waste360: What are you focusing on short and long term for modeling guidance?

Michael Hoffman: The short term is what we just built into the model, and we had to make assumptions for that based on if we contain the virus and see some relief by June. I sent [the model] to our client base and spoke to a lot of public and private companies about this, and my assumption is that we can go back into our offices and gradually return to normalcy in June. Therefore, this is short lived, and the pressure around Q2 will be dramatically negative, with improving trends following.

There are a few things to keep in mind. Right up until the first full week of March, we were looking at a very healthy economy with a very engaged consumer. And now, because the American consumer by nature likes to consume, I think we can expect to see some hits followed by gradual improvement post-COVID-19.

The lever is really on if we can contain the virus and get back to resuming normalcy in June. If we have to lengthen [the time period], the amount of businesses that don’t make it could rise, potentially causing some further impacts.

Waste360: Companies are starting to see a decrease in commercial waste and recycling volume as nonessential businesses are ordered to temporarily close in many areas to slow the spread of COVID-19. How is the industry responding to this?

Michael Hoffman: If someone says we’re in a recession, restaurants and commercial businesses six to nine months later make the decision that they don’t need as large of a container, so you have a service change. In this scenario, you’re basically pressing all of that into weeks.

The biggest challenge here is that so many businesses aren’t open right now, so they want to go into a cancel mindset. However, the industry doesn’t want them to cancel if they are going to open down the line, so they offer a service on hold option instead. They schedule the last pickup and resume service once the business starts up again.

The service on hold option can help maintain the customer relationship. If a customer cancels and then needs garbage service a few months later, they effectively put the service up for bid instead of immediately coming back to their old provider.

This situation looks very different depending on where you are in the country. If you’re in the New York metro area, on the West Coast or in the Greater Chicagoland area, there will be a much bigger revenue reduction. The rest of the country is more mild right now, and while we took an aggressive view of this from a modeling standpoint, I think the revenue compressions are going to be short lived, and, sadly, there will be some customers who never come back.

Waste360: With more people at home, residential waste and recycling volumes are on the rise, especially as people declutter their residences. How are companies best managing this uptick in volumes?

Michael Hoffman: You have to divide all this volume into buckets. For example, if you’re a company that does residential contracts, you have to see if your contracts have provisions stating residents can only put out one 96-gallon container twice a week, and if additional materials are put out, there will be an additional cost. 

If you’re a company that does take-all contracts, you likely built that model based on how many bags the typical household in the area puts out. In this case, you will find yourself in individual contract conversations to account for any increase in materials.

If you’re a landfill or transfer station, you have to think about how much residential waste comes to you from third-party haulers and residents who are dropping off more and more material because you’ll see an increase there as well.

There’s really no winning or losing here—just the possibility of the residential model math holding up nicely.

Waste360: Companies also are handling more medical waste generated by COVID-19. Can you discuss the precautions being taken to ensure this waste is safely and properly managed?

Michael Hoffman: The CDC [Centers for Disease Control and Prevention] has deemed that this waste is no different than normal medical waste, and interestingly enough, the amount of waste generated by a COVID-19 patient is no more than a non-infected hospital patient.

With Ebola, for instance, the generation of waste per Ebola patient was much more than a non-infected hospital patient. While that’s not the case with COVID-19, there’s still more medical waste being generated in volume because hospitals are running at high capacity in highly impacted areas.

Very little of this waste is physically touched from a collection standpoint because it’s placed in bags and picked up by workers wearing PPE [personal protection equipment], and companies can further avoid risk by not picking up loose trash or items like furniture that may be placed at the curb.

Waste360: On the fleet side of the business, do you think companies will see a decrease in emissions as well as costs for maintenance and fuel as there’s less traffic on the roads?

Michael Hoffman: Labor is about 20 to 25 percent of the cost of sales, and about 20 to 25 percent of the dollars of labor are overtime, so you will see an hours of service reduction in regard to the number of hours employees are physically working.

Slower activity levels mean you have less engine hours, less fuel usage and less vehicle miles driven, which is already 30 percent lower cost wise. As more people stay home and social distance, vehicle miles could be down 10 to 20 percent in this 10-week window of March through May, according to estimates.

In addition, we could see a huge reduction in air pollution due to decreased vehicle traffic and faster routes from point A to point B.

All of these things together could result in cost decreases.

Waste360: In the era of COVID-19, how do you think social distancing is affecting the industry’s workers who are on the frontlines each day?

Michael Hoffman: If you think about the actual function of collecting and transporting trash, sanitation workers are naturally separated from others. However, when they get to a transfer station, for example, they will be around others in the breakroom or restroom.

Right now, companies can avoid that contact by not having meetings in a tight space and placing everyone on a work order where they report to work and receive information via an electronic device or a piece of paper. CDC guidance should also be given to employees, and cabs should be cleaned every night.

It’s important to note that about 75 percent of residential collection is now done with automated side loaders where there’s one person in the cab, and PPE is given to every worker to use.

I think the greatest point of risk is the recycling processing side of the business because you’re moving a lot of volume through conveyor lines that are constantly shaking and stimulating the material, releasing things like dust into the air.

You also have picking lines, which you would have to slow down dramatically to maintain physical separation. On the picking lines, workers are touching a lot of volume, and we’re hearing from mainstream media that the virus can stay on cardboard for up to 24 hours, on plastic up to three days and so on.

Materials are going through MRFs [materials recovery facilities] in real time, and if facilities don’t have highly automated systems to handle the material, municipalities may make the decision to temporarily stop operating recycling processing centers. They could tell their garbage service company to go directly to the landfill for the time being to avoid putting the workforce at risk or possibly spreading the virus.

This is certainly not an objective, but we could see a pickup in closures in April as more actions are taken to do the right thing for all parties involved.