Waste and Recycling Earnings: Fourth Quarter 2022 and 2023 Outlook Themes

The publicly-traded solid waste companies reported their fourth quarter 2022 results and presented their 2023 outlooks over the past several weeks. In this edition of the Business Report, we highlight the common themes, as well as note the differences, in both the reports and outlooks.

Pricing Ends 2022 on a High Note, But Volumes Are Lighter

Across the board, pricing in the fourth quarter was higher than expected and generally up sequentially. GFL Environmental (GFL) and Waste Connections (WCN) led the pack, with solid waste core pricing of 9.9% and 9%, respectively, while Republic Services (RSG) and WM (WM) reported yield of 5.9% and 7.7%, respectively, all up sequentially and significantly. The only exception was Casella Waste (CWST), which saw a deceleration in pricing to 6.2%. Guidance was somewhat more nuanced, reflecting, at least to some extent, various management stances on inflation. Both WCN and CWST intend to set price assuming inflation remains higher and stickier, with WCN forecasting full year 2023 core pricing of 9.5% and CWST projecting 6%-7%. Both WM and RSG forecast yield of roughly 5.5%, and GFL core solid waste price of 8%, down from fourth quarter levels, assuming open market pricing may trend down during the course of the year with falling inflation and on tougher comparisons. On the other hand, CPI-linked pricing is expected to provide a sizable boost in 2023, with WCN seeing a gain from 5% to 7% in its exclusive (or franchise) business, and RSG expecting a bump of 50 to 100 basis points on its restricted pricing. Despite these historically record levels of pricing, price retention also remains very high, as capacity, both in labor and trucks, remains constrained.

Volumes were generally weaker in the fourth quarter, mostly surprising to the downside. WM, CWST and WCN all reported modestly negative volume results of -0.3%, -1% and -2.5%, respectively, but, by and large, did not call out a weakening economy as the primary culprit. Although the slowing housing market was mentioned, there was more focus on the intentional shedding of “non-regrettable” business. RSG and GFL were the exceptions here, reporting volume growth of 1.5% and 1.2%, respectively, both noting continued broad-based strength. A majority of the companies cited a pickup in January volumes, likely mirroring the strengthening in the overall economy that seems to be indicated from recent economic data points. This in turn likely influenced the volume guidance outlooks, which though generally muted, were largely better than the actual fourth quarter volume figures. WM and GFL forecast roughly flat volume projections, while WCN projected volume flat to down 1%. RSG and CWST were again the outliers here, forecasting 0.5-1% positive volumes. It should be noted here that most of the companies do not forecast a material change in the economy as they set their projections, in keeping with typical practice in the industry.

Recycling Bites in the Fourth Quarter and Outlooks Diverge

As expected, recycling was a headwind to results and margins in the fourth quarter given the precipitous fall in recycled commodity prices. That said, fourth quarter EBITDA results were generally about as expected, with RSG and WCN surprising modestly to the upside, CWST and WM reporting a slight miss, and GFL in line. For 2023, the recycling outlook embedded in the overall guidance varied, with CWST, WM, and RSG forecasting higher average recycled commodity pricing in 2023 than current levels, up anywhere between roughly 20% to 30%. WCN and GFL assumed consistent recycled commodity prices in 2023 with current levels. Although recent data do indicate an uptick in recycled commodity prices, particularly for PET plastic and to a lesser extent old corrugated cardboard (OCC), analysts noted that the differing underpinning assumptions denoted a variation in the perceived conservatism of the 2023 outlooks.

2023 Margin Outlooks—A Tale of Two Halves

Across the board, the companies forecast higher overall EBITDA margin expectations in 2023 than in 2022, ranging from RSG looking to be up 10 basis points to GFL expecting a 100+ basis point pickup, despite the anticipated recycling headwind. It should be noted that several of the companies also have mix and/or acquisition issues that influence overall margin expectations. Bottom line, most of the 2023 EBITDA projections were considered “in line”, with RSG a bit above consensus. Underlying solid waste margin expectations within the overall margin projection were outsized, in the range of 80 to 200 basis points, versus 30 to 50 basis points expected in a “typical” year. Most of the companies cautioned that the first quarter margin in particular, and likely the first half, would be depressed by the recycling (and for WM and WCN lower renewable energy credit (RIN) pricing) headwinds but that the second half would show more notable increases, as those particular comparisons eased and inflationary pressure (hopefully) continues to moderate. Even the companies expecting stickier inflation noted that cost pressures, particularly for labor and labor availability, had eased. As a result, second half implied margins look to be up significantly, potentially setting all the companies up for another outsized margin expansion year in 2024, particularly given the widespread confidence in the pricing outlook.

2023 Free Cash Flow Outlooks Messier

Free cash flow (FCF) forecasts for 2023 generally fell a bit shy of analyst estimates, with the exception of RSG, due to a number of fairly consistent factors. Higher cash interest and cash taxes, unsurprisingly, were forecast as headwinds for all the companies, while lingering supply chain issues were noted by several companies (GFL and WCN) as having pushed expected capital expenditures (capex) in 2022 into 2023. Additionally, as discussed further below, increased sustainability investments by a number of the players were also cited as a factor in lower projected FCF generation than expected in 2023.

2023 Setting Up to Be Another Outsized M&A Year

2022 was a very robust year for mergers and acquisitions (M&A), with all the companies completing acquisitions within or above the ranges they had set, which were all far larger than a “typical” year. All the companies noted still robust pipelines, and WCN and CWST noted sizable transactions already completed or under letter of intent in the first quarter, setting the companies up for another outsized year of M&A. Interestingly, GFL is calling for a potentially more muted year of $300-$500 million in acquisition spending in 2023 versus $1.27 billion in 2022, not for lack of opportunity, but rather due to greater focus on internal operating and growth initiatives and digesting what has been a very aggressive M&A program over the past several years. In conjunction, GFL also noted that it expected to divest non-core solid waste assets that it had acquired as part of larger transactions, with total proceeds of at least $1.5 billion, which it plans to use to deleverage to the “high 3xs”. GFL management intimated that the purchase multiples will average a very healthy ~14x EBITDA!

Sustainability Investments Remain a Key Focus

WM led the pack in terms of sustainability investments, detailing in a separate presentation not only expanded capex for its renewable natural gas (RNG) and recycling businesses but also detailing the incremental EBITDA and FCF outlooks for the businesses out to 2026, with a virtual information session on their sustainability businesses scheduled for April 5. WCN has budgeted $75-$85 million for sustainability related projects in 2023, and both WCN and GFL provided more color on the EBITDA expected to be derived from the RNG business by the end of 2025, with WCN noting incremental EBITDA of roughly $200 million expected by 2026, and GFL projecting a cumulative run-rate EBITDA contribution of roughly $175 million by the end of 2025. So, although the sustainability businesses are expected to dent the FCF outlooks in 2023 in several cases due to the higher capex investments, given the high potential profitability and flowthrough to FCF of the RNG projects, the investments are expected to take the conversion of EBITDA to FCF to new highs by 2025-2026. Interestingly, the underlying assumptions--$2 RIN prices and $2.50 per MMBtu natural gas—are remarkably consistent among all the players. The EPA’s recent unveiling of an anticipated e-RINs program (though many details remain to be ironed out) is generating considerable buzz in the analyst community. The companies are not yet willing to speculate on the potential size of the opportunity as yet, but all noted future upside as a result of the new program, as well as greater optionality to monetize landfill gas in general, and current operating landfill gas-to-electricity projects in particular.