Republic Services, Inc. (RSG) Earnings Call Transcript & Summary

[Operator Instructions] After the presentation, an archive will be available here.

[Audio Gap] put off, though, when I kissed him on either side of his cheek. But that's just what Italians do. We'll start off by reminding you that our presentation contains forward-looking statements. You should review our SEC filings, which outline the risks and uncertainties that may cause our financial results to vary. Republic's management team routinely participates in investor conferences. When presentations are scheduled, the dates and times are posted on our website at republicservices.com. So we'll start with a brief overview of the industry. So a basic and essential service, a service that everyone needs. We have good visibility into our revenue and into our free cash flow, into our earnings, because most of our revenue is secured under multiyear contracts. I talked about this very strong, very predictable free cash flow, and we have good operating leverage because of the fixed cost nature of our business and a little bit of inflation is good for us. Because that's how we price increase our customers. The other benefit that the industry has is 35% of the revenue is in the hands of the private entrepreneurs. This creates consolidation opportunities for us. In terms of Republic's specific strengths, we are a vertically integrated North American solid waste and recycling provider. We're in 41 states and in Puerto Rico. We have a high-quality asset base. A very modern fleet, so the average age of the fleet is about 8 years. Very reliable fleet, also because of our maintenance programs. We also have a network of long-life landfills, 198 active landfills and always looking for opportunities to continue to expand those landfills. We have a very efficient cash utilization strategy, which includes returning cash to our shareholders, while maintaining our investment credit ratings. How do we create value by profitably growing the business, gaining pricing power through differentiation, reducing our costs, achieving operational excellence, generating consistent earnings, free cash flow, improving ROIC and increasing our returns to our shareholders, as I had mentioned. So how we performed? Well, in 2019, we increased our EPS high single digits. We generated over $1.2 billion of free cash flow. We returned almost $900 million to our shareholders in the form of dividends and share repurchase. So that includes repurchasing 500 million of our shares for approximately $400 million, and we currently have $705 million remaining under our share repurchase authorization. And TSR in 2019 was almost 27%, and you can see our 3-year run rate versus the S&P 500. Now what distinguishes us a little bit from some of the other companies in the industry is our matrix organization structure. So what we do is establish our strategy and have functional leadership and support at our corporate office. And when I say functional leadership, so think of HR, sales, maintenance, those types of functions. We have some of those functions that reside at our -- 1 of our 10 areas also. And what that allows the divisions to do, our 165 divisions, is really to focus in on the P&L, which they control and also, and very importantly, they own the customer experience. That's not something that we can handle up at corporate. Very important, this -- the structure has been very successful for us. When we think about our strategy, it's really profitable growth through differentiation, and what, we believe, this will allow us to do is to consistently increase our earnings and our free cash flow, while improving our ROIC. There are 5 pillars to our strategy that you can see here, and I'm going to go through each one of these quickly. The first one being our market position. So when we think about market position, when you think about accumulating assets and infrastructure, which are going to give us a leading position in all of our 235 markets. So in those 235 markets, we're either #1 or #2 in 94% of them, right? Now we do this, we obtained this leadership position through internal growth opportunities, through infrastructure and through acquisitions. When we think about acquisitions, we think about tuck-in or bolt-on acquisitions. We like these acquisitions because this allows us to maximize our productivity and further densify our routes, and we get the synergy off of these acquisitions very, very quickly. As we move forward, we're looking to continue to acquire companies that are in adjacent geographic locations. We're also looking to continue to acquire companies that are in the downstream environmental services business. Now we talk a lot about recycling, and as you can see on the chart on the right-hand side, we believe that the desire to recycle is going to continue over time. And so we're well positioned to provide these services to our customers. But there's a couple of things that are required. One, there's got to be obviously a demand. But also, there's got to be a willingness to pay for the service, and we have to get an appropriate return. So we're focused in on traditional recycling in select markets. And we're also in the process of converting how we charge for the service, making it more fee-based as opposed to relying on the commodity pricing on the back end of the process in order to maintain a return on our collection and processing facilities. Our operating model is all about standardized best practices to deliver a consistent, high-quality service to our customer and also to reduce our costs. So there are a number of different components that go into this, and let me hit on a few of those. First is alternative fuel. So about 20% of our residential fleet right now, 20% of our fleet operates on compressed natural gas. And we like this because it's a lower cost fuel for us. And it also creates a competitive advantage for us to the extent that customers are looking to be serviced by alternative energy fleet. We have electric drive dozers at a number of our landfills. And this is great for us because they consume about 30% less diesel than a regular dozer. And we're also partnering with Mack Trucks and working on EV technology. So an EV garbage truck. And that's something that we believe that we're going to be able to start testing sometime in the first half of this year. We are focused on automation. 76% of our residential fleet is currently automated. And that's a service that's provided by one person driving the truck and working a joystick that picks the container up and puts it back down again. We like this line of business because it's more efficient, and it's safer for our employees. We're working with our OEMs right now to assess continued automation in autonomous technology in our vehicles. And we're also working on and have up and running our next-generation positive-sort recycling facility in Plano, Texas. What this does is instead of pulling the bad materials off of the line as it goes across, it's actually pulling the good materials off, and this creates a much better product for us to be able to sell to end users. I had mentioned before, our standardized maintenance program, currently 100% of our fleet is certified under our maintenance program. This gives us greater fleet reliability and availability. It allows us to service our customers better, gives us better asset utilization. It also lowered our CapEx. So because of this program, we were able to get an additional year of useful life out of our fleet and save onetime $200 million of CapEx. We also are working on and have started to roll out what we call our RISE platform. And so this is real-time routing information and data visualization tools that help us better route our trucks. So this includes in-cab technology that is available to the drivers. Ultimately, what this will allow us to do is not just to be able to -- not just be more efficient routing the trucks, but to develop that connectivity between our customers and the trucks, which is something that our customers have told us that they wanted. Now our focus on our operating model has paid benefits to us. During 2019, we had 30 basis points of EBITDA margin expansion, much of that being driven by the items that I mentioned here. One of our pillars is people and talent. We believe that the team with the best talent wins. And so we're always looking for opportunities to attract and retain the best talent. Now because of our industry, safety is number one, right? And so we're -- we prioritize safety above everything else, and we have industry-leading safety programs. And as you can see by the chart, our safety performance over the course of the last 11 years is almost 40% better than the solid waste industry as a whole. Our employees have told us that they want robust learning and development programs. And we provide those. So that includes experiential training as they enter the organization. Think about a driver actually getting behind the wheel and operating that vehicle in a contained environment for a number of weeks prior to us releasing them out into the streets to service customers. But also think about being able to develop our employees throughout their careers. And inclusion and diversity is a focus of ours also. Annually, we survey all of our employees. We ask them how they feel about their jobs, how they feel about their managers, how they feel about their company. And we incent our general managers based upon their engagement scores. We had very good results during 2019 with engagement that went up by 100 basis points to 86%. So we're very happy, very pleased with the progress that we've made there. We're also looking to pull from a diverse pool of employees, right? So pulling more women, more veterans and more minorities into our business. And you can see the benefits that this has provided to us being recognized as an employer of choice by a number of different organizations. We talk a lot at Republic about customer zeal, and that's driving customer loyalty and, ultimately, a willingness to pay, and we do that by differentiating our service offering. Now that starts with customer segmentation, really understanding what customers want, what they need and then being able to sell into a differentiated service offering. Then we've expanded the products and services that we've offered to our customers. And that includes a suite of services that maybe we don't provide ourselves, but maybe we provide through an alliance partner. So maybe that's some kind of medical waste services or electronics waste services. And then ultimately, the goal of all of this is to maintain that loyalty -- that customer loyalty, maintain that stickiness with the customers, which obviously helps us in terms of our pricing. We talk a lot about technology and our investments in technology really started with our digital platform. How we interact with the customer, making sure that we're easy to do business with. So we have a portal, and we have an app. And what that allows customers to do is to interact with us on their own time, pay their bills, maybe through the portal, order services maybe through the app and self-serve in a lot of cases. We have e-commerce capabilities, which allows customers to procure our services in real-time and offers us a lower cost sales channel. And then we have a capture pricing tool, which we've been talking about for a number of years. So this is a digital configure price and quote tool. It professionalizes the sales process and the entire experience. It also enhances the quality of our revenue. Now we're seeing benefits associated with this digital platform also. We had the highest pricing in over a decade during 2019. And we continue to have very low defection of 7%. In addition, we continue to see an increase in online sales of our services. Moving on to sustainability. We're committed to sustainability. We believe that really drives long-term profitability. And if you think about ESG, that's kind of our space. That's where we live. That's where we've always lived, right? We're an environmental company. Now we have a Board Committee that oversees our sustainability and corporate responsibility initiatives. We recently achieved all of our time-bound goals that were established back in 2014. And last year, in 2019, we unveiled all of our new goals. We believe that these goals are -- address critical macro trends in our industry -- in industry in a broader sense. And the goals also align with the United Nations sustainability and development goals. The other thing that's important to note about these goals is that they're part of our annual budget and they're part of our 3-year long-term plan that we're incented based on. So this isn't just something lofty that we put up on a slide deck to present to potential shareholders. We are committed to these, and our bonuses are based on them. And then finally, our cash flow utilization priorities. First thing is invest back into the business in terms of internal growth and tuck-in acquisitions. Second thing is to pay a dividend. And although we don't have a dividend policy, the dividend has increased by about 8% over the course of the last 8 years or so. We repurchase our shares opportunistically. And we do all of that while maintaining a very strong capital structure and those investment credit ratings that I had talked about. And in 2020, we expect to give over $900 million back to our shareholders in the form of dividends and share repurchases. Okay? Now Tyler is going to ask some really difficult probing questions. Let me stand over here.

So first off, per usual, this is interactive, so if you have any questions out there. So maybe I'll start. So I do want to talk a little bit about pricing. If you go back and you look at pricing, just for you or really the industry, and if you really go back 5 to 7 years, we've kind of seen this upward drift in price, particularly yield. I think you guys talked about 3% yield into 2020. Can you talk about maybe some of the reasons why you believe that, that started to accelerate, just broadly speaking?

Yes. I think that there's a number of reasons that have provided us with pricing power in the industry or pricing power recently. One of the things is the economic backdrop. So if you think about what we're tied to, it's really the consumer. It's really not that much in terms of industry. Less than 10% of the revenues that we generate are from industry, it's really from consumers. So think about people eating out, think about them going to Disney World or Universal, eating at -- and staying at a hotel, eating at their really expensive restaurants that they have here, all of that generates trash, all of that's good for us. So I think that the economic backdrop is certainly part of it. Think about our focus on service, right, and the price points, to which people are paying. So when we talk about residential service, typically, people are paying maybe $25 a month for the residential service. For small container type of business, like restaurant, they might be paying anywhere from $250 to $300. So that restaurant, we're at the bottom of their P&L. So provided that we give them good service, don't give them a reason to pick up the phone and call to get a price from somebody else, we think that we can maintain that stickiness with the customers, right? They just don't want to have to worry about the trash. So providing really good service. And then we've got a piece of the business that has been tied to CPI. And that's been a headwind for us for a long period of time. We started a number of years ago converting that book of business to an index that's a subcomponent of CPI called water sewer trash or a fixed rate of 3% or greater. And we're comfortable with the 3% because, as you know, we've been able to keep our cost inflation, kind of, circa 2.25%, 2.5%. So that's worked out really well for us. So we currently have about $780 million of that portfolio converted to some of those indices. And the other thing is that the CPI is just coming back a little bit. So we're getting that on the rest of the book. The other thing that we're really encouraged about is landfill pricing. And so we've heard a number of others in the industry talk about landfill price and talk about the cost of maintaining these landfills, which is going up. And the landfills really aren't the mode. That's really where the pricing should emanate. And we're starting to see some of that pricing power. So that's very encouraging for us also. So I think it's a combination, Tyler, of all those things.

Yes. I mean that last point was actually my next point. I think we've seen now 3 -- or if I say, 4 straight quarters of over 3%, if we look at MSW yield, which is -- maybe help people understand, but that's particularly notable considering there's a lot of your landfill business that is actually contractually maybe CPI type linked.

Right. Yes. So over 60% of our business is contracted or might even be a little bit higher than that. And so that's really based upon CPI. So to be able to see the yield that you're talking about, that means that the rest of the book of business is moving up quite significantly. And it makes sense, right? When we take your waste from your curb, we have a commitment that we're going to maintain that waste, take care of that waste in perpetuity, right? And as you know, the cost of maintaining these landfills has increased over time. So when people think about a landfill, they think that we dig a hole someplace in the back forty, and we just put trash in it. These are highly engineered -- I know that you know better than that, Tyler, but these are highly engineered facilities. We have almost 100 engineers currently on our payroll and that all they do is take care of these facilities. So as inflation hits, they become more and more costly to maintain. And we need to make sure that we're getting an appropriate return on our investment and so do the other players in the industry.

So I want to kind of expand on this. And I want -- you guys are vertically integrated. So you have a collection operation that ultimately feeds into the landfill. But if I was, Tyler Brown hauling, and I'm not vertically integrated, this is a major cost, I would assume to them. So I guess the point is, as the landfill prices come up, that puts post-collection cost increases on my P&L, as a small mom-and-pop, and that should push collection pricing at the curb really across the entire market. Is that the right way to think about it?

That's the right way to think about it. And I think that that's probably one of the number of hurdles that Tyler Brown hauling has to face. So the landfill pricing, right, disposal being about 1/3 of their cost structure, another 1/3 is probably going to be their employees, right? It's more and more expensive to get drivers. It's more and more expensive to get technicians now to work on the trucks because the trucks are very sophisticated. And then I heard a very intelligent analyst lately, just recently say that insurance is also really expensive, especially in the trucking industry.

Yes.

I don't know if you're familiar with that analyst.

No. Yes, I've heard of him. Great guy.

It just might be him. Yes. He asked us that question on the earnings call, which is true. So the whole thing is that it's going to become more difficult, more capital-intensive, more complex for these smaller haulers to compete in this industry, and we believe that, that's going to drive consolidation over time.

How regulated and how easy [indiscernible].

Yes. The landfill space is difficult, right? Because nobody wants it in their backyard. And permitting is -- historically has been a problem. And there are just certain locations where you just know it's not going to happen. So if you want to landfill someplace near San Francisco, forget about it. It's not going to happen, right? There are certain locations in Texas, where it might be a little easier, but it's still a multi multiyear process, right? And we're pretty good at it, and even we struggle with it sometimes. So we think what we're going to see here are fewer landfills. Let me give you a little bit of context around this. Back before the regulations came out, Subtitle D, there were probably 7,000 landfills. Right now, there's probably 1,300. And we think that over the course of the next 10 years, it might go down under 1,000. The number of landfills has contracted significantly, but the size has grown. And so in a number of these rural communities where we have these mega landfills, we're one of the largest sources of revenue for those municipalities. So if you look at our 10-K filings, we'll do a roll-forward of our aerospace every year. And you'll see that we've been very successful at permitting additional aerospace at our existing landfills. And part of the reason why we've been able to do that is because we are a significant piece of the revenue base for that community. So when we say, if we don't get an expansion, we're going to have to close the landfill. They say, just tell us what you need us to do because we can't afford to lose you as a part of our revenue base. But you're right, it's very difficult to permit a new landfill right now.

[indiscernible]

Well, I talked about the -- us being able to expand our existing landfills. And right now, on average, we have 60 years of life in our portfolio of landfills. And that really hasn't changed over the course of the last decade.

And so we have talked a little bit about price. Can we talk a little bit about unit cost inflation? So what does it kind of take for you guys to achieve operating leverage and margin expansion? How much underlying unit cost inflation, have you actually seen some reprieve on that side? Maybe can you talk about labor tightness, turnover and those types, obviously, that's a huge cost and component?

Yes. So when you think about cost inflation, automatically, people go directly to the labor side of the equation. And that's been a little bit of a headwind for us lately. Now when we talk about a headwind, I talked about cost inflation kind of 2.25% and because of wage inflation probably closer to 2.5%, but it really hasn't impacted our turnover at all. Our turnover from 2018 going into 2019, in terms of our drivers, actually went down by 130 basis points. So it’s still being able to get and keep our drivers. I think, in turnover, what a lot of people don't realize is that these are really good jobs. These are not minimum-wage jobs. So they don't turnover all that quickly. If you drive a truck for us, you're making anywhere from $50,000 to over $100,000 a year, which isn't a bad gig. So we're very much focused on maintaining our employees, reducing that turnover. A lot of that has to do with the engagement that I had talked about. We've seen some cost inflation in some other components of our P&L. We had seen some cost inflation in the landfills, going back into '17 into '18. We think that we've mitigated some of that. And then we continue to focus on things like productivity improvements, which lowers our cost in procurement, making sure that we're buying things from corporate in bulk so that we can pass that savings on to our divisions. So overall, we think that we'll be able to keep that cost inflation to about 2.5% that I have talked about. And if you think of the math, if we're getting 3% yield, cost inflation kind of 2.5-ish percent, when we guide them to 2020, EBITDA margin expansion of 20 to 40 basis points, the math kind of hangs. It makes sense. And we don't see this 2020 as a one-and-done. We see us being able to continue to do this over the course of the next several years. And that's why we tell our investors that we think that we'll be able to get back to 30% EBITDA margins and having exited 2019 at 28.3%.

So 2 things I want to touch on before we part, but -- so first off, obviously, it's very turbulent market out there. And I want to talk a little bit about the business, because, I think, sometimes investors don't fully appreciate just how subscription-esque this model is. So can you talk about your collection operation? You have -- you see it -- now you guys have done a good because, I think, you call it, resi small container and large container, but some call it, resi commercial and industrial, and it's a little bit misleading. So can you just talk about how much of your collection business is really subscription-based and how much of it is really dependent on, call it, economic activity or pulls or however you want to define it?

Yes. The event piece of our business is actually quite small. We've got a little bit of that coming through on the, what we'll call, the large container temporary piece of business. Most of that is construction, materials. And I think that, that's kind of circa 10% or so, 13%. And then we have another 8-ish percent that comes through on the landfill side of the equation, that's C&D related, maybe a little bit less than that. We also have some special waste volumes that are event-driven. Those can be a little cyclical. So that's a small component of what we do also. The rest of the $10-ish billion or more of the portfolio, to Tyler's point, is subscription-based. So if you're a small container customer, you run that restaurant that we had talked about, you got a 3-year contract with us. And you -- that contract is based upon us tipping that container. So whether it's all the way full, 3 quarters all the way full, halfway full, doesn't matter, it's the same price to you, right? So that's the way it works in small container. For this hotel, it's going to be based upon how often they fill up that large permanent container that they have, right? And when they have events like this, they fill it up a lot and maybe multiple pulls a day. And so more like a subscription piece of the business. And then on the residential side of the business, that really truly is subscription, right, is that you're paying one fee per month and whether or not you put your trash out, we're charging you, right? And so if you forget to put it out 1 month or 1 week, you're on vacation, you forget to put the recycling out, it's one fee. So and this economic -- we talk about volatility in the market. This tends to be a very, very stable type of business. If you think about it in terms of free cash flow, when I go to forums with other CFOs and we talk about the guidance that we give, and we talk about our guidance for free cash flow, they're always amazed that what a narrow range I can provide or we can provide to our investor base. That's because the business is very steady, very secure, vast majority of it's secured on a multiyear contract. So to your point, it's a very stable business.

Now before we go, let's talk -- and let's finish on free cash, my favorite. So this year, you're going to show free cash flow that's relatively flat.

Right.

So can you talk a little bit about the optics and just make sure that we -- if you kind of parse out a couple of things that are a little unusual that there is still that general consistent cadence?

Yes. So the biggest thing that's driving our free cash flow performance this year is CapEx. And what we had said back during tax reform is that instead of giving our employees a onetime bonus, that we would take $200 million of capital and give it back to the employees by retrofitting locker rooms, cafeterias, safety spaces, and by buying trucks. And if you think about a truck for a truck driver, that's their office, right? That's what they care about. They care about this over multiyear periods, not just a one-and-done, if I were to give them a check for $2,500 dollars, right? So we spent $25 million of that in '18, $75 million in '19, we're going to spend $100 million here in 2020. But if you think about our free cash flow kind of run rate coming out of 2020, think about $1.3 billion. And then think about the growth that we would get on top of that for your cash flow number for 2021. So still very strong, sustainable free cash flow growth.

I can't believe it. I forgot to talk about recycling.

That's too...

Out of time.

Next time.

Maybe next time.

Okay.

All right. Thank you.

Thank you.