In the past two weeks, the public waste companies have reported their results for the third quarter of 2022 and held follow-up conferences. In this edition of annual reportIn the reports and management comments, we highlight the common themes and address the differences.
Strong prices generally up and right
Prices have been very strong across the board, exceeding expectations and increasing sequentially in almost all cases. WM (WM) and Republic Services (RSG) reported yields that rose 90 basis points and 60 basis points sequentially, respectively, to record levels. Similarly, core prices at Waste Connections (WCN) and GFL Environmental (GFL) were 8.3% and 8.6%, respectively, up 110 and 130 basis points sequentially. Casella Waste (CWST) reported prices that fell sequentially, likely due to less support from the Consumer Price Index (CPI) reset on CPI-indexed contracts than its bigger brethren. Notably, customer receptivity was also positive, with retention and churn rates remaining stable.
CPI resets for the indexed contract portion of the business have been set by multiple management teams at a price rollover of around 450-550 basis points through 2023, leading to projections for continued strong pricing into 2023 – with “fixed” prices alone coupled to current open market prices , which are often and consistently between 5% and 6%, with more open market action potentially driving prices even higher in 2023. WCN noted that it expects its exclusive (franchise) market pricing to increase from 5.5% to 7% in 2023, with overall pricing in the 8% to 9% range. GFL reiterated that prices for 2023 would be in a similar range.
Strong volumes despite expected recession fears
Volumes were also generally quite strong and exceeded expectations. CWST and RSG reported volumes of 2% and 2.2%, respectively, while WM’s collection and disposal volume increased 1.7%, even after noticing the loss of three major unprofitable contracts. Volume strength was characterized as broad-based, both geographically and across all businesses. Management teams did not (yet) see any signs of economic weakness at their companies, although this was not particularly surprising as solid waste is viewed as a concurrent indicator at best, if not delayed. It is also worth noting that hazardous waste, which is often seen as an economic guard rail or economically sensitive, increased by 15% at WM and 13% at RSG. WCN was the exception here with volume (1.5%), but that was attributed to company-specific factors, not macroeconomic factors, and management noted positive C&D volumes. Importantly, key volume metrics — net maintenance intervals and net new business — remained positive. While management teams were certainly aware of the economic risk to volumes, they were fairly optimistic about the prospects.
Recycled raw material prices fall precipitously and become a major headwind in the fourth quarter
The biggest new negative in the third quarter was, unsurprisingly, the decline in recycled feedstock prices (largely via the recycled feedstock “basket”), which became a headwind in the third quarter after being a positive contributor in the first half . But October’s steep decline in old corrugated cardboard (OCC), as reported by RISI, forced companies to cut fourth-quarter recycled raw material price assumptions much more dramatically than previously announced, typically at levels about 45% below the average of the third quarter. The resulting expected recycling headwinds for the fourth quarter were also typically slightly larger than analysts had anticipated. Although OCC has been the key driver of late and many industry experts fear a bottom is not yet in, plastics were also a significant drag year-on-year, although recycled plastic prices appeared to be stabilizing in October reporting.
Prices exceed inflation and squeeze margins
While this was also supported by operational efficiencies, pricing was generally described by management teams as being above inflation. RSG’s 5.6% yield beat its internal cost of inflation, which was estimated at around 5%. CWST’s solid waste prices of 6.6% exceed the cost of inflation, which is estimated at approximately 5.9%. As a result, underlying solid waste margins increased between 40 basis points and 120 basis points, and in general, companies’ overall EBITDA margins also increased, despite recycling headwinds. The exception to an increase in the company’s overall margins was RSG, where the company’s overall margins were impacted by the lower-margin acquisition of US Ecology.
Although problems with labor availability, turnover and wage inflation appear to have at least peaked at a number of companies, overall internal cost inflation remains high, albeit more stable, management frequently comments. And while most have expressed the expectation (or hope) that inflation will ease by early next year, apparently no one has actually seen it!
Guidance confirmed or upgraded
All companies raised their forecasts in the second quarter. In the third quarter, WM and RSG broadly confirmed full-year 2022 guidance. The sudden and sharp decline in recycling was offset by higher organic growth in the core solid waste business, which was mainly price driven. The smaller three players generally raised elements of their leadership. CWST and WCN have raised 2022 revenue and EBITDA guidance, and both companies have reiterated their free cash flow (FCF) guidance. GFL raised its revenue guidance and reiterated its EBITDA and FCF guidance.
Outlook for 2023 Marge “Bump” Cloudy
During the second-quarter earnings call, there was significant discussion about the potential for an outsized margin “hump” in 2023 given the prospects of much higher CPI hiring for the indexed business, combined with easing inflationary costs, particularly labor costs. With stubbornly high internal inflation costs coupled with what is now seen as headwinds for materials recycling, there were now more hedges against this potential margin boost, which is not surprising as companies (and analysts) tend to push their recycling assumptions for 2023 to the to “base” fourth quarter. Levels that, as previously mentioned, have dropped dramatically. However, most management teams are still targeting 30 to 50 basis points of margin improvement in 2023. GFL was the standout here, still seeing the potential for a 100 basis point margin improvement in 2023, including the recycling headwinds!
More headwinds are developing on the free cash flow front
Given the rise in interest rates, interest expense is expected to increase significantly in 2023, while cash taxes across the board are also expected to be higher due to lower bonus amortization. Also, and again contradicting the prospect of a gloomier economic picture, higher expected capital expenditures for growth and sustainability investments have been cited by a number of companies. CWST raised investment expectations for higher inflation and disposal infrastructure, while RSG expects to spend more on polymer centers. WM excelled here, as management indicated that 2023 would be the year of its largest investments for both recycling and renewable natural gas (RNG) — the company is targeting $1 billion in sustainable investments in 2023, up from 550 Million US dollars expected to be spent in 2022.
M&A continues at an accelerated pace
After all companies hinted at outsize acquisition opportunities earlier in the year, third-quarter results essentially kept all companies on track to meet those lofty goals. WM completed more than $200 million in acquisitions in the third quarter, moving closer to its $300-$400 million target. Excluding US Ecology, RSG spent $400 million. Year-to-date, CWST has completed 13 acquisitions totaling $48 million in acquired revenue and an additional $30 million under Letters of Intent (LOI), while WCN has signed or completed acquisitions for approximately $570 million in total annualized revenue Has. The M&A pipelines were characterized as continuing to be robust, with many high quality private players willing to sell.
Signpost for 2023
All companies provide more specific and formal guidance in their Q4 reports in February, but generally some 2023 signposts are set in Q3, and generally RSG usually offers some high-level EPS and FCF areas. Management teams were more cautious on this in the third quarter, likely due to economic and recycling uncertainty. RSG noted that it expects high single-digit growth in revenue, EBITDA and FCF versus the low double-digit growth that management believed was possible in the second quarter. CWST signaled an outlook of high single-digit revenue growth, low double-digit EBITDA growth and FCF growth of 10% to 15%. WCN essentially reiterated that it still posted double-digit growth in revenue and FCF in 2023, while still expecting an above-average improvement in its underlying solid waste margin, which will offset recycling headwinds. Finally, given higher interest costs, GFL forecasts high single digit organic growth, high teens EBITDA growth and double digit FCF growth.