Casella Waste Systems, Inc. (CWST) Earnings Call Transcript & Summary

All right. So I guess we can go ahead and get started. Welcome, everybody. Thanks for joining us here. My name is Will Grippin. I'm an associate analyst on the alternative energy and environmental services equity research team at UBS. And today, very pleased to have with us Ned Coletta, who is the CFO; and Charlie Wohlhuter.

Wohlhuter.

Thank you very much, who heads up IR at Casella. So first, I guess I'll note, if anyone has any questions, feel free to raise your hand and ask or you can turn them into the tablet I have up here by scanning the QR code. So with that, maybe I'll just hand it over to Ned, just for a quick kind of lay of the land here coming out of the pandemic. I mean it feels like the business has been pretty strong. But just curious how you're feeling about business performance, underlying trends kind of heading out of the pandemic here and into 2023.

Thanks, Will. Thanks, everyone, for attending. You're right. The trends have been very positive. We never shut down during the pandemic as an essential service provider, but parts of our business were negatively impacted, whether it be on the construction side, some of the commercial small business side or even into landfill volumes. And over the last 2 years, we really have seen most of these areas return to pre-COVID or better levels. On the construction side, we've seen trends in our company centered in the Northeastern United States. We've seen trends that are the best we've seen in 10 years. Now not back to levels that you had in '07 through '09, but still very positive trends. The consumer has been strong. Small businesses have been strong. Probably our one continued weak point is New York City, still hasn't returned fully to pre-COVID levels and a lot of waste from New York City makes its way to our landfills. So we still have a little bit of a negative headwind there, but it's been far more offset by other growth we've had both from an acquisition standpoint and organic growth.

Got it. Thank you. Yes. And I think we'll get into a lot of those pieces here as we go through the Q&A. But just wanted to start with kind of a top line topic of inflation. Could you kind of speak to the extent that you -- that you can pass along cost inflation to your customers, the pricing cycle, sort of how that works through and what kind of attention has been?

Sure. I'll start on this, and then you can hop into you, Charlie. We've got a pretty unique book of business as a company where about 70% of our collection customers, we can price it well and about the same at our landfills. We don't have a large degree of municipal contracts or other types of contracts that have CPI resets. So adjusting fees, pricing, we have tons of flexibility. So we typically price once a year as a company. And in this cycle, we're looking at more flexibility, whether we need to price certain customers twice a year as we've seen inflation in areas like labor and parts and tires. On the fuel side, we've got a great flexible fee. We put in place about 17 or 18 years ago, we call it our energy and environmental fee and it floats monthly. Although it looks back to the previous month, and it really does cover all of the cost increases with fuel in the business. In our first quarter, we were hurt a little bit with that fee in 2 ways. One, in a very fast rising market, you get some margin compression because you're looking backwards and you might get some under recovery. And we also had some headwinds from that because we've done a lot of acquisitions in the last 3 years. And not all of our newly acquired customers had this floating fee on their bill. And that caused almost close to $1.8 million of cost headwinds that weren't recovered in the first quarter. We've worked really hard in the last 3 months to get that floating fee onto all of our customers' bills and get the compliance levels up to where they should be. So that will be solved coming into the future. And we're big believers in floating fees and making sure risk is passed back to our customer base.

In terms of the cycle, it's about 70% of our customers are priced in January. So very early on, beginning of the year and kind of to Ned's point, evaluating whether we want to do a second round or not historically speaking, we just do one pricing increase per year, but it kind of gives us a nice ability to kind of look at to see what the inflationary environment is. And so perhaps the beginning of the third quarter. So we can kind of go back, reevaluate to see what's going on and if need be, a second PI to our customers. So as we sit here today, just with one pricing increase as we've done again before, we have great visibility on what our pricing increase environment is going to look like for the entire year.

And you mentioned being a big fan of floating fees. I know you've had the recycling SRA adjustments for quite some time now. As you do more acquisitions, I mean, how quickly have you been able to kind of advance getting those pricing mechanics push through to your customers? What sort of a time line is that on?

We typically do it very slowly and probably too slowly, where we'll -- you buy a business and a lot of what you're buying are the customer relationships. So you don't want to say, "Hey, welcome to Casella here are our new pricing mechanism." So we'll want to deliver very good service, have customers become comfortable with who we are. And it might take us 2 years typically before we get on to our floating fee structures, whether it be energy, environmental or the recycling floating fee. And with the inflationary environment fuel, it caused us to throw that whole playbook out the window. And we decided in the course of 2 months to just roll that fee out to 90,000 acquired customers. And we've had very little pushback. It's well regarded by customers. They understand we run a very fair program where if fuel prices come down, the fee will come back down. Our sales force has done a nice job explaining it, and it should give us great risk mitigation and actually a little bit of a tailwind as well because we are under recovering in the first quarter. We've also identified some other parts of the business that were a bit of a black hole where our transfer stations. We hire a lot of third-party haulers to move waste from transfer stations to landfills or from transfer stations to recycling facilities. And those third-party haulers had step function fuel surcharges. So there would be like a threshold, no fee below that -- above that a fee. And we stepped into those fees in the first quarter. So we've now introduced a new floating energy and environmental fee at our transfer stations as well to pass that risk back to the marketplace, and that's going very well for us.

And you mentioned limited pushback on some of those changes. I mean to me, that sort of speaks to why these businesses tend to be good in sort of recessionary environments, right? I mean it's an essential service. It's relatively small bill in terms of the overall customer spending. Just curious sort of how you would kind of characterize your position here? Should the economy slow down and how you're thinking about the business and ability to kind of maintain or expand margins?

Yes. I'll start about this and Charlie, you want to hop in. One of the things that's a little different about us versus 2008 through '10 is our mix of our business is different. So if you flash back to 2009-ish time frame, as much as 17% or 18% of our revenues were derived from construction and demo, whether it be hauling, transfer, landfill, and we very consciously over the last 15 years, have reblended our business. And today, only about 10% is associated with construction and demo. And furthermore, in the Northeastern United States where we operate you don't have as many boom bust cycles. So where we sit today, we're feeling much more confident about that part of our business and some cyclicality. We really have been able to show during COVID, how our use of technology has allowed us to flex cost very, very well and quickly. We use dynamic route optimization software, onboard computing and our trucks. We use Power BI to understand on the daily basis, changes in customer needs, expectations and we're able to really reset our business daily, weekly versus 15 years ago, you'd close a month, start to put plans together. You might be 6 weeks, 8 weeks in the trailing rearview mirror before you're making fundamental changes. And then I think on the margin side, Charlie, if you want to talk about that?

Yes. I think, again, to Ned's point, COVID just taught us a lot about the business to be nimble, flexing variable costs, and we're you able to make changes essentially in real time in terms of routing efficiencies, we can -- if we're moving customer from service intervals of, say, 4 times a week, down to 3, we can very real time and dynamically change the route for that truck where it doesn't need to make that incremental or additional stop and kind of pull it back and make other various changes.

Yes, we were able to do that without laying people off either. So we are able to first take overtime out of the business. And our industry typically runs too much overtime. We always have shortages of drivers, mechanics, helpers. So being able to pull that over time out, reduce our cost even a faster rate as we're rerouting tracks. And then we always have needs for hires. So it's actually a pretty amazing environment in how we reacted, and we feel like many of those same lessons and tools could come into play. But we haven't seen any slowness yet. I mean, we've got such a great read on the economy, whether it's a resident or business or the construction site or industrial activity, and we still are seeing the same levels of waste generation. We're in our seasonal increase period and the seasonal increase looks relatively strong.

So one of the unique things about Casella relative to some of the other publicly listed peers is what you noted in your concentration within the Northeast market. Curious if you could speak to what maybe unique opportunities that creates for Casella? And also, do you think that it, in a way, maybe limits some competition just given that your dominance in ownership of the landfills that are remaining?

Yes. I don't know if I'd characterize it quite as dominance, but there's a good balance in the marketplace. We have about 20% of the disposal capacity in the Northeastern United States. And between about 5 players publicly traded, 1 private company it's about 90% of the capacity. So you really have a group of companies and organizations who understand the true long-term value of these assets. How hard they are to replicate? How expensive they are to run and build? And you have an environment where laser focused on returns. And I would hazard to guess many of our peers are as well in this environment. And this has been a long time coming. I mean this really flashes back to the mid-1990s from a public policy standpoint and a political standpoint where regulators, politicians decided the fastest way to have more sustainability and society was to make it really hard to have more landfills and to expand to permit new sites. And there's only been one new greenfield site in 35 years. So you flash forward to today, we don't quite have a crisis, but we're not far from it, where there's not enough places to put all the garbage produced by society each year in the Northeast. So today, about 30% of the garbage produced in New England, New York is exported to Ohio, Virginia, South Carolina, Alabama, it's put on rail cars, trucks and moved very far distances. So having the network of transfer stations, landfills, recycling facilities in the Northeast, puts us very close to population centers and gives us a very good strategic platform to build on, and this is only going to get worse over the next couple of years. As you know, Will, we project another 2 million to 4 million tons a year or between 10% to 20% more capacity will come out of the marketplace. And it's one of the reasons why we are now bringing online our McKean landfill in Pennsylvania. It's going to be the closest rail-served landfill to major population centers in the Northeast. We've got the sites permitted to mainly develop. We're putting in rail infrastructure now.

Got it. And do you see this sort of tightness in disposal capacity continuing to put pressure on smaller haulers to sell? And I know you've been fairly aggressive on acquisitions over the last several years. Just curious how you kind of see those dynamics evolving getting better or worse.

Yes, I don't think that's probably the main reason why we're seeing sellers. We charge ourselves the same as we charge everyone else, right? So it's not like there's some sort of competitive advantage that's coming from us having this capacity, we are giving ourselves the same price increases as third parties. But what I do see from small haulers and independents in the markets, the labor crisis has been very hard on them. And many of these small competitors are tired and many of them are wearing 10 hats in their business. They can't get the labor they need. Regulation also has been very hard on them, where you see a small business where it reaches a certain size, say, $5 million or $10 million in compliance with law becomes a lot more complicated in our industry. And there are -- the normal reasons people are retiring or there's a depth. But that labor shortage and that compliance with law are probably 2 of our biggest pipeline feeders today. The disposal capacity is definitely in the backdrop and being vertically integrated knowing we have certainty where we can bring our waste, I think, allows us to be more effective from a growth standpoint and bidding, but it definitely doesn't create a competitive disadvantage for those smaller haulers.

You touched on labor. That's one thing I wanted to ask about. I mean you had put in place several years ago some training initiatives to help sort of give folks coming in at the entry level, a career path to progress. Maybe just give us an update on sort of how those initiatives are going? What else have you been doing just given the tight labor market to try to increase your ability to attract talent?

Yes. It's a single biggest effort we have as a management team. So if you flash back as much as 4 or 5 years ago, in our enterprise risk management program, our #1 risk was labor availability. You flash forward to today, it's still our #1 risk. So a lot of what we spend our time on as a management team where we're focusing development efforts are on creating pathways looking at how we're recruiting, selecting onboarding, training, incentivizing growing key roles in the organization. And probably a couple of our most exciting areas are driver apprentice roles. We've created a new set of roles where we only hired drivers previously or 21 years old. And what's interesting, if you have a commercial driver's license, you have to be 21 years old across a state line, but you can be 18 to stay within a state. So we have many routes where we can have 18-year-olds driving trucks. And what we found was we were missing this whole category of potential new employees coming out of high school to be drivers because we had a 21-year old horizon. So we've created this new apprentice role. We've created our own CDL driving school, and we've graduated the last year, 80 drivers. Our retention is amazing. 77 of them are still with us, which is spectacular. We've doubled the amount of training for a young driver, and we've also created kind of a trainer situation where they have a more tenured driver they're partner with for over a year period and they step into more and more complicated equipment. We've also opened up, I believe, a lot of new pathways for women to drive, and it's one of our fastest-growing areas in our workforce, whereas we move more and more of our trucks to automated robotic side loans, especially on residential routes. It takes a lot of the labor intensity out of the work. It's still a very challenging job. And our drivers are very well compensated but you're not lifting 1,000 in [indiscernible] or bags, you're using a robotic arm to do it, and we've really started to see a lot more accessibility into those jobs, which is creating really more stability as well.

About 10% of those graduates are women. And to Ned's point, automatic side loaders automation. We'd expect that number to increase in time.

Yes, that actually gets into the next topic, which is investment in technology, and you touched on the side loaders, but curious maybe where else you're seeing opportunities to invest maybe to even take out some of the harder to fill labor rules and whether that be recycling or elsewhere in the company.

Yes. Well, I think probably among the most difficult and challenging at times is recycling. There's definitely a temporary labor component to our MRF. We are in the process of investing about $20 million in our Boston MRF facility retrofitting it with newer technology, optical sorters, various other technology to increase throughput, robots as well, yes, which will increase throughput upwards of 50% and just making it a lot safer and cleaner streams.

And on the technology side, we've talked about trucks, dynamic route optimization, onboard computing in the back office from programs like our Power BI, which is integrating a number of disparate data streams and getting data to our operators, but also to our customers. It's been really powerful. And then we are 4 years into refreshing all of our fundamental systems as a company. We adopted NetSuite as our financial ERP in 2018 and 2019. We've put Coupa in from a procurement standpoint and that was launched last year were redeveloping our entire procurement systems and processes, and we are launching in pilot in conjunction with Hitachi and Microsoft, a new service management order cash system, which will fully digitize the entire stream and interaction with customers. And that one is probably the most exciting because this is a pretty old industry, where there's a lot of paper, a lot of manual process and not -- I would say, it's probably 10 to 15 years behind other route-based industries. So there's just a lot of room to go there to really automate and use AI and a lot of technology improve what we're offering and how we're interacting with customers.

Yes. always surprises me the sort of lag in adopting even very simple technologies. I mean I deal with a trash company at a building. I have that you can't even pay them automatically. It's got to be over the phone or mail it's crazy.

And I'll tell you kind of the basis of that. It's really interesting. This industry grew up around IBM AS for 100 databases. And every major waste company still runs their entire business on green screen technology. And why that's important is every one of these waste companies also create an environment where they'll give every customer, whatever service they want and negotiate a price. So you've got tens and tens of thousands of SKUs and you've got completely open architecture in these old databases. So allowing customers to interact with that data or creating simple modern-day interfaces. It's pretty complicated. And you can't just change how you're offering services or pricing customers, you need to be able to move that along. So it's kind of the birth and growth of this industry has created some technology challenges. And I'm actually pretty excited because I think we'll have the ability to leapfrog ahead over the next couple of years, especially with the customer interaction because people want to hop on their app. They want things done for them. They want simplicity. They don't want to call somewhere.

Yes. Maybe in that regard being a bit smaller is going to be more helpful in making that transition. I mean if you're a national company, that's a result of many, many mergers over many, many years, I mean, you've got a lot of disparate technologies in the Iron systems. I can appreciate how difficult that is. But within the recycling business, you touched on some of those investments. I mean to the extent that you're able to extract a higher dollar value for the bailed materials. I mean, could you help us understand to what degree that may be shared with the customers, just given the fee structures you have in place?

Yes. It's a great question because we want to make investments that generate positive returns for ourselves and we want to share some with our customers. So if I make an investment we really have to contemplate through our revenue-sharing programs, are floating fees, how that works because you can't float all of that back to customers, but we are cognizant that we can create additional revenues, rebates, whatnot for our customers. And we'll see that really -- it's important to really live in the space of how do you fundamentally improve process technology and equipment to get costs out, while at the same time focusing on positive pricing programs. And you see the same thing in our fleet. In this inflationary environment, our investments in the fleet automation are holding our inflation down to a pretty reasonable level. We were at 4.3% inflation in the first quarter, and you really see those investments helping to get cost out of the system.

Yes. Also wanted to touch on the sort of investments in sustainability and the sustainable solutions, customer solutions segment that you have, which I think doesn't really get talked about a whole lot, but it's kind of unique to your business. Could you just kind of give us an update on what sort of investments you have planned there and opportunities kind of within that segment?

Yes. Our Resource Solutions group encompasses are recycling, our organics our professional services businesses, consulting. And Charlie touched on one of them, our Boston recycling facility upgrade. We have additional robotics and opticals going in across the franchise. We have some work we're doing with the digital organics. We have a new depackaging facility that we opened up, working closely with Ben & Jerry's, Cabot Cheese, Great Mountain Coffee, others to take production like spoils and create beneficial use streams, whether it be on the organic side or the packaging side. We are currently working on a new organics facility in Southern New Hampshire, New organics facility outside the city in New York. So infrastructure continues to come online in those businesses. But a lot of it's capital-light and it's working with key customers like Becton Dickinson. We're working with one of our larger customers on how do you create a complete circular economy for their products. And that's a complicated one because they're selling medical products into hospitals. And we've got a great trial going now with Gareth Hitchcock and Becton Dickinson to see what type of circularity can you develop with their products and get more post use or not exposed to medical, but post kind of waste back into their production cycle. And there's a lot of examples of that where key customers are demanding better and better solutions of how can they get higher recycled content into their products, and they get really excited if they can get their own products back in. And that's a huge area of growth for us.

Would you say that, that service kind of also helps you win new customers with -- in the collection and hauling piece of the business. I'm sure that some of your smaller competitors in the area just don't offer sort of the full suite of services.

Absolutely. I mean we see that we're more focused on that large industrial, large institutional customer and what we can offer them. And many times, that contract is won on something other than price. And one of our newest customers is Boston University, and they have been really excited about the data access, and we've been able to expose real-time Power BI data feeds to them. So they can have actionable intelligence from a facility standpoint to understand waste diversion, recycling, organics, building by building, dumpster by dumpster, and really understand what they can do to change things on the ground immediately. And that's seems simple, but that's not being offered by most people in the industry of what's the data today and how do I do today.

Right. So I wanted to also get into sort of capital allocation, CapEx. Curious how you sort of envision the split of CapEx for maintenance versus growth investment trending and how you're dealing with the inflationary environment on the CapEx side and ability to source new equipment?

So replacement capital is about 10.5% of our revenue. And then growth is basis points beyond that, whether it's organic growth, new routes, new customers, projects such as our McKean landfill. And then we do have some M&A spend just with typical acquisition we do, call it, kind of lesser sophisticated or financially available customers who are running older trucks, and we're able to replace those older trucks with newer trucks and then we get great synergies from that.

Yes. So on the capital allocation side, I mean going back to like 2013, '14, I think you were trying to sort of get the business in order leverage was a bit too high, had to get rid of some of these high capital -- high CapEx businesses. But now you've got -- you look from a leverage standpoint, a lot more like your peers. So curious how you're thinking about allocating capital to M&A, driving growth that way versus potential deployment to shareholders.

Yes. So we are actually the lowest levered waste company today, 2.4x. We've got close to $300 million of availability. So as we look to the next 5-year horizon, we strongly believe that we continue to have a great set of opportunities to either put that money to work in acquisitions or in development projects and drive high returns for shareholders. We've done a really nice job over the last 10 years. As you said, repositioning the business, getting leverage out, getting core operating programs, getting our fleet, our equipment in great shape, getting lives back to where they need to be. And today, we're deploying all of our excess cash really to acquisitions and development projects. So we have a couple of great development projects on the horizon. We talked about the Boston recycling facility. We're working at our McKean landfill to bring that online from a rail standpoint. And that will take in 1.5 million tons a year, and it's fully ramped. So I'll be a very large site. We've got a great expansion in progress at our Highland landfill in New York State, which will come online just about the same time that Republic's Niagara landfill closes, which will be 0.5 million tons a year and a really nice growth opportunity there. So you'll continue to see us put money back to work in the business. we don't believe it's in the best interest of our shareholders to pay a dividend or do share buybacks at this point in time. That's not why you're buying our stock, you're buying our stock because I don't have to go do $1 billion acquisition or a $500 million acquisition. I can do $10 million acquisitions pay very fair prices and $50 million of acquisition activity has a meaningful impact for growth for our story. And it's a storyline you've seen many times in our industry in the past and most of our peers have grown so large as hard for those smaller tuck-in deals to really have a meaningful impact. And for us, we're just keeping it simple, running a good business, investing in the core and then just building with conservative acquisition strategies.

Got it. Do you -- I know timing of acquisitions, amount of acquisitions in terms of total spend can be very lumpy. But do you envision kind of holding the line on leverage, maintaining that sort of mid-2s going forward?

Yes. So we say publicly, we'd like to be below 3x. And we're probably a little bit tax underleveraged today from a weighted average cost of capital standpoint. But it doesn't mean we're going to do something outside of our game plan. We still look at every acquisition from an unlevered free cash flow standpoint. We're looking at discounted cash flows. I never say I'm going to buy this business because my multiples x and this is less than that. We're always looking at how can you generate cash from this investment? Am I paying a fair price? How can vertically integrate it and create more synergy value?

I guess I wanted to touch on to RINs a bit. I mean do you have any investment plan on the renewable natural gas side? It seems to be something that a lot of your peers have been talking about lately.

Yes, it's interesting. We currently have 5 of our landfills that produce renewable power. And they're all electric sites today. They have gensets to produce power to the grid. We've got 2 renewable gas projects that are in process and a few more right behind that, including converting some of those existing sites. And we've chosen to not invest any money. So we've negotiated with our partners where they make 100% of capital investment, but we get 40% of the economics. So it's pretty -- it's really the space you want to be in. We're not large enough to have all of the energy expertise, both from a market, from an operational standpoint to think we can do that ourselves. So we've gone out of great partners. They take on the capital investment risk, operating risk and then we get first dollar out in revenue shares, and we share an upside as well.

That would minimize a bit of the volatility or in pricing as well, [indiscernible].

Yes. So probably a good point to check, see if we have any questions in the audience. Otherwise, we can probably wrap it there. All right. Ned, Charlie, I appreciate your time today.

Thanks, Will.

Thank you very much.

Appreciate it.