Parsing First Quarter Results from the Big Three Solid Waste Companies

Last week the three largest publicly traded solid waste firms Waste Management, Republic Services and Waste Connections all reported first quarter numbers. Advanced Disposal and Casella Waste Systems numbers are still to come, but key trends were evident looking at the big three players.

Pricing was largely as expected across the board, and consistent with both recent results and the companies’ full year targets. Waste Management (WM) reported core price of 5.1 percent, consistent with the fourth quarter, and yield of 2 percent, which was in line with its full year goal. Republic Services (RSG) reported yield of 2.3 percent, slightly above its full year target of 2 percent. Waste Connections (WCN) reported price of 2.6 percent on its legacy business, in line with its typical 2.5 percent-3 percent range, though it noted that on the Progressive Waste (BIN) legacy business pricing was 4 percent, as the company continued its push to improve underlying pricing on the BIN assets.

Volumes surprised to the upside, again across the board. This was particularly notable as the first quarter was expected to be a tough comparison given the very mild weather that characterized last year’s first quarter, in which some volumes were pulled forward from the second quarter of 2016. WM reported volume of 1.9 percent, and even adjusting for an extra workday, volumes of 1.4 percent were generally better than expected.

RSG reported volume growth of 1 percent, also topping expectations of sub-1 percent. WCN had very strong volume growth of 2.1 percent, beating both recent results and expectations. WCN attributed its volume strength to same-store landfill tonnage, which rose 15 percent. Volumes within the legacy BIN business were down 2.5 percent, as unprofitable contracts were shed.

The strength in volumes was characterized as very broad based. Construction and demolition (C&D) continued to be remarkably strong, with both RSG and WM experiencing growth in the high teens, while municipal solid waste (MSW) volumes rebounded from fourth quarter levels of 1 percent to 6.8 percent for WM, while WCN enjoyed 15 percent MSW growth. Service intervals improved and container weights were up, boding well for continued strength in the commercial collection business, where the recovery had lagged.

Only special waste was inconsistent across the three companies, which likely reflected lumpiness and individual company project timing. Although volume comparisons continue to get tougher, none of the company management teams thought that overall volumes (or this cycle) had peaked. Adding icing on the cake, the energy waste business began to rebound, most directly benefitting WCN, but also RSG as well. WM expects this business to begin to grow next quarter. 

Recycled Commodity Prices Boom as Rising Fuel Costs are a Partial Offset

Depending on the company’s recycled commodity “basket”, recycled commodity pricing rose anywhere between 61 percent to 70 percent year-over-year, boosting all the companies’ revenue growth more than anticipated. WM estimated that recycling pricing added $0.055 to earnings, and RSG $0.01.

However, fuel costs were cited as a partial offset, by $0.02 and $0.01 for WM and RSG, respectively. This was due to a combination of the fuel surcharge lagging the fuel cost increase in the first quarter, as well as the expiration of the compressed natural gas (CNG) tax credit.

Average commodity prices in the first quarter were higher than all the companies’ full year assumptions laid out in February. Nevertheless, all the management teams declined to change their various recycling business assumptions, citing the recent volatility and pullback in fiber in the beginning of the second quarter, although all noted that the bias is to the upside.

Where’s the Margin?

Although absolute EBITDA levels were either roughly in line to above, for RSG and WM, respectively, EBITDA margins were down 40 basis points year over year for RSG and roughly flat for WM. This caused some consternation in the investor and analyst community, which questioned both why there was no “flow-through” from the upside surprises on the revenue line from recycled commodity prices and why the “incremental margin” from better-than-expected volumes wasn’t higher.

RSG noted several unusual factors—severe rains on the West Coast and temporarily higher landfill operating costs that hampered margins by 50 basis points in the first quarter. In a similar vein, WM noted $0.02, or a 30 basis point impact from higher executive severance costs, as well as the fuel impact, a portion of which the company views as transitory. Both companies expect that margins would improve in the remainder of the year, and both reaffirmed their full year EBITDA margin targets—20 to 40 basis points for RSG and 50+ basis points for WM.

Unquestionably, there was unusual “noise” in the first quarter costs for both companies, but it is worth noting that both companies, but particularly WM, have been actively renegotiating recycling contracts in order to “de-risk” them, and as RSG management noted, that can involve some loss of the upside potential. In describing the various cost trends, both companies had large increases in COGS (or recycled commodity rebates to customers) within their operating expense lines.

WCN, on the other hand, had a more substantial upside surprise in its EBITDA number and a 50 basis point improvement in the margin versus its outlook. The company noted the strong landfill tonnage, higher recycled commodity prices, better-than-expected execution on the BIN transaction and the rebound in E&P waste activity as margin drivers, the latter two either unique or more meaningful to WCN.

Free Cash Flow and EPS Guidance Reaffirmed

The big three all reported strong free cash flow in the first quarter, which if annualized, would put them at or above their free cash flow targets for the year. However, citing items like cash taxes or anticipated increases in capital expenditures, all three maintained guidance, though the bias looks to be toward the high end or up.

Similarly, despite higher recycled commodity prices (and recycling results), RSG and WM maintained their EPS forecasts, though again with greater confidence. WCN also did not alter its full year forecast, but its second quarter projections were modestly above consensus. It is typical for the industry to reevaluate guidance after the second quarter and the seasonal upturn.

M&A Prospects Continue to Be Bright, But Timing is a Question

All three companies continue to target acquisitions as a preferred use of free cash flow, but actual deal activity varied in the first quarter. After a big bang start to the year with the acquisition of Groot (with $200 million of revenues), WCN had four more, small tuck-in acquisitions and the pending acquisition announced in February. WM’s first quarter acquisition activity was modest, while RSG had a surprisingly strong start to the year, acquiring $55 million in tuck-in revenues, versus a full year target of $100 million.

WCN has been the most bullish on the M&A environment, and still remains so, but management did note that while sellers may be actively pricing and shopping their businesses, there may be a bit of a timing pause as people wait to see what actually transpires in terms of tax reform.

Leone Young is the Principal of LTY ERC, LLC, providing consulting and research services to, and conducting special projects for, the environmental services industry, primarily the solid waste sector.