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

All right. Let's go ahead and get started with the next presentation. So first off, thank you for all of you that have made it out here. It's a beautiful Orlando. It's nice to see everybody in person again. But this morning, I'm really excited to have Republic Services joining us. Presenting today is the company's CEO, Jon Vander Ark; company's CFO; Brian DelGhiaccio. I think most of us like we know Republic, but Republic is the second-largest solid waste company in North America. They have a great disposal footprint. There's been some interesting developments here of late that I'm sure we will get into around some corporate development on the M&A side. We don't have any slides, but for everybody's -- so we -- this is going to be a little bit of an interactive fireside chat. But for everybody's kind of just base knowledge, maybe we could just start off, kick it off and just talk a little bit about, Jon, just a little bit about Republic, the story, who you are, what you do. And then from there, we'll kind of kick it into, again, that interactive fireside Q&A.

Sure. Yes. So we are the great, great, great grandchild of 1,000 acquisitions, like a lot of people in this space. The most formative of which was Republic Services and Allied Waste merged in 2008. And it was a company with a really good balance sheet, Republic Services, and pretty good processes in Allied that those companies came together and formed what is now the 8th largest locational fleet in the United States. We operate in 47 states, 35,000 employees, and we are an environmental services leader. So we operate in recycling and solid waste and environmental solutions more broadly.

Short and sweet. I love it. So the first question I got to ask is I've been getting this question from investors around fuel. So obviously, fuel is likely an inflationary pressure. So maybe this is better for Brian, but can you talk about fuel as your overall cost stack?

Sure.

Do you hedge fuel? Do you have fuel surcharge mechanisms? Is there protection on that side? Just maybe if you could talk a little bit about that.

Yes. If you look at fuel cost, it's about 3.5% of revenue. When you take a look at how we protect ourselves against rising fuel prices, it's through our fuel recovery fee. So absent a little bit of timing, a little bit of a lag, we recover essentially all of the change in fuel. So it lags about 2 months, but we would expect this increase in fuel cost not to have a significant impact on either EPS or free cash flow. We'll have a little bit of an impact on margin just because you're raising cost and revenue by the same amount, but we're able to essentially pass all that through.

Okay.

And I would say more broadly, I think we'll see a little bit of headwind with that increase in the second quarter. We'll see where it goes. But for the year, I'm optimistic it will be a push or maybe even an advantage because we also operate in our Environmental Solutions business in upstream oil and gas. And I think we are seeing more elevated drilling activity, which is going to drive outsized revenue opportunities for us.

One thing I was going to add too to that, though, as well is that most of our fuel recovery fee happens in the open market. When you think about the contract base where we have those contractual-based pricing restrictions, that tends to be more of an index-type pricing mechanism, that will lag. So you'll ultimately get it, it just may come 12 to 18 months later.

Right. We're going to get into a little bit about that. But first, let's just kind of set the stage and let's talk -- I mean, I know you reported your quarter a couple of weeks ago, so it's all pretty fresh. But obviously, inflation is a big issue. The nimbleness around pricing is something that I want to talk about. And I just want to talk about your ability to really offset the unit cost inflation you're seeing. Are you seeing any peaking in unit cost inflation? And just can you start maybe on the cost side and then we'll kind of move into the pricing side.

Yes. Our biggest cost category is labor. And we've always given our people a fair wage increase. It's kind of deeply who we are, what we believe. So even in an environment where CPI was 50 bps or 1%, we were giving our people 2%, 2.5% wage increase. Now that was north of that last year. This year, it will be probably between 3% and 3.5% increase for our people. So substantial, but we are going to price ahead of our cost increases and expand margin, and that's outside of productivity. That will be further enhancing the margin expansion. So wage is the biggest category. Then think about the other goods that we buy. A lot of that shows up on the balance sheet in terms of CapEx, so trucks, equipment, et cetera. Seeing some increases there, but not the outside -- increases are not what you're seeing on headline CPI of 6%, 7% kind of bumping up on 8%. For a couple of reasons, one, we're under long-term contracts with our suppliers. We have long-term strategic suppliers. We're a great customer because we buy every year. We're such a predictable business that every year, we're going to buy 1,000-plus trucks. And so we tend to be treated very well by our suppliers in terms of getting the first production slots they have and sticking to their contracts over time. And again, as we see a little bit of elevation, which again we're seeing in container steel, for example, in other places, we're going to pass that through on price to our customers.

Right. And so let's talk a little bit about pricing. So maybe, Brian, if you can set the stage as we think about your revenue base. So some of it, you can touch pretty easily. Some of it, you can't. And maybe you can talk a little bit about the mix of your revenue and kind of how that's comprised. And then on the pieces that you can't necessarily touch today, maybe talk about how CPI and some of those inflationary pressures ultimately iterate through price down the road.

Sure. So of our revenue base, 50% is in the open market where we have more flexibility, and we can be in the market more on a real-time basis to deal with inflationary pressures, and 50-odd percent has some sort of contractual pricing restriction. So of that 50% that's contract-based, about half of those have an index that are associated with them, so it could be CPI, it could be water sewer trash, it could be garbage trash. The other half tend to either be a fixed price increase, so let's say, 3% or 4% per year, or in certain markets where we have a rate review, where you're guaranteed some level of return or a certain level of profitability and it tends to lag. But to my point on that 50% in the open market, we saw some of the inflationary pressures in the market beginning as early as April of last year. We saw it with some of the increased cost in steel. We started to embed, right, some of those increased costs into our capture pricing tool. So we started pricing on the new work side as well as pricing in the open market to recover some of that cost inflation, which is why when you take a look at our cadence from a pricing perspective, we disclosed average yield. We were increasing that yield every single quarter sequentially, and we expect that to continue to increase as we look forward.

So I don't necessarily want to go down a rabbit hole here because it can be a little bit. But if you think about some of your peers, maybe some of their headline pricing looks a little bit higher than, call it, that 3.5% that you're -- to 4% that you're talking about. Can you maybe just explain that? Because I think it's important for everybody to really understand that calculation, how it may be similar, how it may be different?

Sure. So we disclose 2 different pricing metrics. We disclose core price, and we disclose average yield. So core price is that on a same-store customer base what was that average price increase that you saw year-over-year. What average yield further takes into consideration is the impact that, that bringing on new work has on our average price per unit as well as losing work, what sort of impact that has on your average price per unit. It's more of a classic price volume. The reason we disclose both is that core price tends to measure the effectiveness of your pricing program, right? And again, that's on your same-store customer base, whereas average yield tends to be a better predictor of overall profitability. So we give the reader and the investor both data sets. Again, I think what you hear in the industry is sometimes people are only disclosing core price. One of our competitors doesn't disclose average yields. The other does. So again, when you're looking and you're trying to compare across the industry and understand that sometimes you're comparing or could be comparing an apple with an orange.

So yes, let me dimension it in kind of practical terms. This is a subscription-based business. And if you're used to selling units in product, it's kind of hard to get your arms around it, but think about a 4-yard container. So something behind a dry cleaner, right? We might pick that up 1 time a week. Our average selling price for that 4 yards is probably in the high $3 per yard. That's what we sell in. We keep that customer, right, on average, for about a decade. When we lose that customer on average, we lose them in the high 5s. So this churn that Brian talked about is that difference between, hey, if I lose a unit at $5.50 right, and I take a new 1 on, right, at $3.50, right, that $2 compression in that yield. So that's the difference between that core price on the same-store basis and then our overall net price, which is yield.

Right. So I guess at the end of the day, the physical manifestation regardless of how you -- what you're looking at will ultimately be margins, right?

Correct.

So can you talk a little bit about -- I think you gave some guidance. Just talk about kind of the outlook for margins broadly speaking for this year. And then any help on some of the cadence around that.

Yes. So overall, we've guided to 30 to 40 basis points of margin expansion next year, right? So that's on top of 130 basis points of margin expansion 2020 over 2019, another 60 2021 over 2020 and now another 30 to 40, okay? So now when you unpack that 30 to 40, there are some headwinds that we have to overcome. Fuel is a headwind. As I mentioned, even though we're going to recover most of the increase in fuel cost, it has an impact on margin, and we're projecting that to be a little over 40 basis-point headwind. We got a little bit of a dilutive impact from acquisitions. The combination of fuel and the acquisitions is about an 80 basis-point headwind that we have to overcome. Now we get about a 50 basis-point tailwind from projecting incentive comp at target levels. We outperformed in '21, so we had higher levels of expense above target. But even all that said, when you take a look at the net of those things I mentioned, that means the underlying business has to expand 60 to 70 basis points in order to drive the 30 to 40 basis points overall. That is a direct outcome to your point, right, and margin doesn't lie, of pricing in excess of your cost inflation, and that's about half of that margin expansion that we're expecting and then the other half being productivity improvements. Key point there is that we are pricing in excess of our cost inflation before we take into consideration the impact of productivity.

So talk a little bit about that before we get off the subject to some bigger subjects. But just when you talk about productivity, and I know there's a lot about the story and about what you're trying to do with multiple aspects of your story. But from a productivity perspective, what are some of those things that are ultimately helping drive some of that unit cost inflation, hopefully down just a little bit?

Yes. We have 3 big priorities or capabilities we're going to get world-class on, customers yield, digital and sustainability. So digital is really what's driving that productivity benefit, right? We put in a platform called RISE, which is basically putting in digital into our dispatch function. So that's the function that really builds routes and manages routes throughout the day to make sure that we get the recycling and the waste off the ground and then put tablets into our trucks. And we're about 60%, 65% of the way through doing that, right? We think over time, that's a $100 million-plus cost takeout of the business, right? We've already seen at least $30 million to $40 million of that, right? We'll get another chunk this year, and then we'll get another chunk again in 2023. And that's just the first wave. Once we get the direct impact, thinking about things like advanced analytics and getting really more scientific around how we build and structure those routes, we think there's more upside yet beyond that.

Perfect. So let's talk about those 3 key pillars a little bit more. So we talked about digitization. Customers yield. What exactly does that mean?

Yes.

It's a great question. And then ultimately, what is the physical manifestation of that as well? And how does that ultimately translate back for folks like us?

Yes. I started out with the company about a decade ago as a Chief Marketing Officer, which was a big title, but I was the first marketing employee in the history of the company. So back to our legacy or heritage, right, we're a perpetual roll-up. While my previous leader had the foresight to say, listen, there wasn't another huge structural deal to do, and we're going to do more tuck-in acquisitions, we've got to get better at organic growth. And that starts with the customer. So I'm the one who really kind of led the path of the organization to get passion around customers. And the idea of customers yield is we want to be maniacal about customer service, and want to measure ourselves not just against the other industry players, but against anybody else. Against a Southwest Airlines or Nordstrom or Apple or everyone else. So we're an NPS culture company. So Net Promoter Score, that's the ultimate loyalty metric of our customers. We pay our frontline team, our general managers, our operating leaders, based on that NPS. And then back towards so what does that mean? Well, think about our retention rate, right? We now have a loyalty rate of 95%, right? So 95% of our revenue is with us the next year. So it's an incredible sticky business and then to get back to that example I talked about with that 4-yard container, right? The economics of loyalty in this business are really, really strong. So when you can get a customer to stay 1 more month, 2 more months, 1 more year, at the back end when they're already paying a very attractive price, that's hugely accretive to the business. So we do customers yield, not just because we love customers, we do, but we do it because it really manifests itself into the financial performance arena for us.

Right that overall lifetime value of the customer that lasts 6 months is disproportionate. I think that's key.

Hugely valuable.

And that's -- and to your point, where do you see it, right, you see it in the retention rate, but you also see it in that spread between core price and average yield. So as you're retaining more of those units, right, as you're keeping some more of those higher-priced customers in the portfolio, there's less of a dilutive impact between those 2 pricing metrics.

Right. Since we're on the 3 pillars, we might as well kind of skip ahead and just talk about sustainability. So what does that mean for Republic? We'll talk bigger picture with some other things that you're doing on the sustainability side. But just talk about that third pillar and what that ultimately means for you.

Again, part of the evolution of the company, and this is what we're ready for now, right, at one point, we were a garbage company, right? And then we got into recycling, right, because we kind of got dragged into it, if I'm honest. And then we start to understand, hey, listen, the world is resource constrained and population is increasing. So we need to drive recovery of these resources, and we started to get recognized for our sustainability performance. And now we've really gone to a sustainability and environmental services company and part of sustainability is being a good operator, right. Treating our people well, driving diversity and inclusion, thinking about climate, what we do with carbon neutrality, being engaged with our community, safety, all those things are kind of the intel inside how we operate. But increasingly, it's a platform for growth. So you think about landfill gas to energy. On one hand, we're driving recovery. Some things are going to end up in the landfill. Well, how do we take that and we drive electricity and now increasingly renewable natural gas out of the back end of those facilities. We just announced last week a new polymer center. So we're forward integrating one step into recycling, which we think is going to drive a higher level of recovery and drive a higher price point while helping us manage volatility in that space, right? And that's a growth driver for us, a new opportunity. So again -- in our own mind, environmental sustainability and economic sustainability are intimately linked. And when they become decoupled, right, the world doesn't become cleaner or safer. It's the opposite. And so we're passionate about doing things that are, again, good for our next generations in a way that we also make money today.

Yes. I mean this industry is interesting in the fact that the E part of ESG actually can provide growth. It's not necessarily a cost like you want to shift over, say -- yes.

I think that's a great point. Most people when they look at ESG, it's a constraint and a headwind, and a negative drift and you think about we have a strategy and then an ESG strategy, I think, well, that's just a science project, if it's different from your core strategy, right? ESG is totally the center of what we're going to get done.

Right. And so obviously, you briefly touched on it. A lot of people talk about the E, but then there's the S and the G. And maybe you can talk about that S part and about culture and about Republic way, if you will, or maybe talk a little bit about the investments that you're making there as well.

Yes. Listen, part of it, again, it connects right back to economics, right? Part of the reason that I think we've done a good job of managing cost inflation and probably have a labor number that's going to be different than others you hear is -- people care about what they get paid, we're not naive to that and we're very mindful. They also want to work in a great place. And so we always talk about we want to be the place where the best people come to work. And so our frontline leaders, right, get paid on 3 things. They get paid on the P&L, 70% of the bonus, 15% is on NPS for the customer and the other 15% is on employee engagement. So our employee engagement score is in the mid-80s, which for any metric or any industrial comparison is really good. The one difference is, let's talk about participation, most people will get in the low 80s. We have 100% participation. Every voice matters. And so all the boo birds, all the naysayers, right, we collect all that feedback, and we still have a score of 84, which just tells you how much we value culture. Diversity and inclusion. When I was in a process to take on my current assignment, the Board asked me to come up with 5 metrics to measure myself over the period of a few years. And 1 of my 5 metrics I put on there was leadership diversity. And we've doubled the number of diverse leaders we have in the last 3 years, and I think we're going to double it again. So we serve everybody, we've 12 million customers, and we want to have a team that looks like our customer base. And we're well on the way to that journey.

Yes. So I want to switch over and talk a little bit about US Ecology. So US Ecology for those that may not know them, they're one of the largest hazardous waste disposal companies out there, have a field and industrial service arm to them as well. But can you talk a little bit -- because this is actually -- some people may say it's a pivot. I don't know it necessarily is. I mean this is something that you guys have been working on for years. Obviously, you made some comments on the Q3 call, if I recall, about wanting to be much bigger. But maybe can you talk about where it started with maybe Tervita back in '15, if I'm -- I can keep it all straight, but '15, I think. And kind of where this is kind of an evolution in that process? And maybe talk a little bit about that.

Yes, sure. Yes. We're -- to your broader point, we're deliberate, right? We don't do things impulsively or certainly not reactively. So in 2015, we bought Tervita, it was the North American assets of a Canadian company called Tervita. They primarily did oil and gas drilling recovery. So when you drill a vertical horizontal well, you produce 4 things. You produce drilling fluids, water, oil, residual oil and dirt. So that company came in and cleaned up those waste streams, separated them out, returned the fluids and the oil back to the driller and appropriately handled the water and the solid waste on that front. And so we got into that business and we discovered, hey, they're -- what we do, frontline labor management, safety, material handling, permitting, regulation, all those things, right, we can apply in that space and create a lot of value. Now oil has got some cyclicality to it. We saw the low points of it, and now we're starting to certainly see the upsides of that. In parallel to that, they had a downstream business, so more in the petrochemical plants, so helping people in the waste streams coming out of the plants. And things like container rental and plant turnarounds, and tank clean-outs. And we realized there, boy, the customers are asking us to do it, and we're good at managing that business. So we kind of slowly and quietly expanded that business in the Gulf Coast, primarily bought a company called Sprint that does container rentals. And what we saw is a lot of cross-sell opportunity, a lot of connectivity between those customer bases, which led us to look for other opportunities. We purchased a company last year called ACV, which is primarily in the Northeast. More, again, on the field services side of that business. And same thing, we saw when we know how to manage that business and we're seeing a lot of cross-sell opportunities both ways. Like in the case of ACV, customers who they couldn't get to independently or we couldn't get in the door independently for national deals or contracts that jointly customers want to talk to us, because we had a really broad set of services. And in parallel all that, our business development team is looking at everybody in the space. And we've always admired US Ecology in part because of a world-class capability around handling some very complicated waste streams and having the largest position in hazardous waste landfills, 36%, with a set of assets that cannot be replicated. And so, started some dialogue with them and also believed that this vertical integration thesis, which we've seen create so much value in the solid waste and recycling space over time, applied in this space, in a couple of ways. One, it allows you to reduce volatility in the business, more steady consistent recurring revenue, which is very important to us and our investor base and also ultimately drive higher returns in that space. A place where the margin is kind of in the low 20s, right, over where solid waste used to be 20 years ago, we see an opportunity over time, there's no reason that shouldn't take another 10 points of margin expansion over time, not basis points, but 10 points. So something that should, over time, migrate into the high 30s. So -- or into the high 20s or 30s. So purchased it. We priced the deal based on intrinsic and cost synergies, which was at about $40 million. We haven't priced any of the deal on revenue synergies, but ultimately, that will be where most of the value is created over time. We think there's $75 million to $100 million of cross-sell. They're about $1 billion in revenue. We got $1 billion plus in that industrial manufacturing space with customers looking for a one-stop-shop solutions provider. And then on the pricing side, right, we've got a really deep capability in pricing and revenue management, which again has shown up in the last decade or more into our P&L, and we're going to apply those skills into that space upon closure of the deal.

And so pro forma, roughly how big will that environmental services piece be?

It's about $1.4 billion of revenue between what we have today, exit speed as well as layering in US Ecology.

Right. And Jon, you had mentioned being to $1 billion. So we're kind of -- so -- and this is -- I don't want to necessarily put you in a box, but I am curious about the longer-term vision here. So is the idea that you want this to -- because you made some comments that you wanted it to be a platform for growth. So is this something that you could see now is maybe a $2 billion business longer term? Or how should we think about that in the broad -- or is it that you want it to be a certain percentage of the revenue? Or how do you think about that?

Yes. We don't think necessarily in those terms, right? We think about a customer's and intrinsic value. We don't run the business for the quarter, right, for long term. So we think about intrinsic value and returns. Now that being said, in this space, this is really a platform-type acquisition for us in this space. And so it gives us a great national footprint, and we'll take our Northeast business and our Gulf Coast business and really integrate it into US Ecology's platform in many ways. There'll be follow-on acquisitions in that space. But I think what's underlying some of the questions is then, hey, are you out of outs or out of opportunities in the solid waste recycling standpoint. And we couldn't be more excited about our opportunities there. We're not growth constrained. We're not opportunity constrained in that space, right? We couldn't have done this deal 5 years ago because we were still building out our functional excellence. And now with a business, again, that's expanded margins, 250 basis points. So that's solid. This is both and not either or. So I think if you think about capital or M&A going forward, the balance of that will certainly be in the recycling solid waste space. And we'll look for opportunities to do some of the roll-up on the field services side, but that ends up being smaller, more regional or product line tuck-ins that should be hugely accretive just like they are in the solid waste space. So where that matriculates over time, if that ends up being 15% or mid-teens percent, that's probably where it goes because we're going to grow both sides of it.

I see. Because I do get this question about whether it's a pivot, if solid waste acquisitions are debt or not, but it doesn't feel that. And I think even in your guidance, you have something like -- correct me if I'm wrong, but it's about $0.5 billion of implied M&A in the more traditional vertical.

Yes, excluding the US Ecology.

Exactly. Exactly. Okay. So we have a couple of minutes here left. I wanted to -- there was a little nugget in the US Ecology release, if you read down in it, about by 2024, you expect to be about 47% free cash flow conversion. What that calculation would effectively be is what percentage of your EBITDA turns into free cash flow. That's not where you are, either you have been or guiding to in '22. So can you help us bridge that gap? Because even with US Ecology coming on, you still believe that by 2024, you can get to that target. So maybe talk a little bit about how we bridge that gap and how we get there.

Look, it's been an area of focus for us, free cash flow conversion. We were circa high 30%, bumbling around 40% for a couple of years. And I think you look at the progress that we've made, now being in the mid-40%, kind of 45% free cash flow conversion and expecting that to continue to improve in '22. And we've had a stated goal that we can get into that high 40% free cash flow conversion, right, in the next couple of years. So the point of that 47% was that the US Ecology deal doesn't sit there and impede our ability in order to achieve that high 40% free cash flow conversion. That's why we put that marker out there, and it's something that we think that we've got line of sight to, just with the actions that are within our own control.

And part of the US Ecology deal, that space in general, right, today has a lower margin. We're not satisfied with that. We're going to think there's upward expansion opportunities on that. It's also less capital intense, right? And so it's just different geography between the P&L and the balance sheet, and which why from a free cash flow standpoint, we think these convert over time. Broadly speaking, this side of the portfolio will look, right, maybe not identical, but very, very similar to the traditional solid waste and recycling, both in terms of the predictability of the revenue as well as the returns profile.

And that -- and the thing I want to point out about that 47% is that US Ecology has had some capital investments, in particular with their disposal infrastructure, that's created a little bit of lumpiness.

For sure.

So that 47% is -- the capital spending on the disposal infrastructure is going to sit there and taper off. That's a through-the-cycle type number. So it's not just capturing a kind of a tapering off of investments in their landfill infrastructure. That's something that we think we can achieve in 2024 and then expand from that point forward.

Interesting. Okay. That's very helpful because they do have a drop and -- but it will come back. So my last question here, if anybody has any questions, I think we're down to a minute, a little bit about margins. So I think US Ecology today is going to be something on the order of 80 basis points dilutive. You had thrown out a target of like a 32% type of margin. Again, I don't want to put you in a box, but does it feel like, is there any structural reason why even with US Ecology and your environmental services platform getting bigger, you couldn't get there longer term?

No. No, there's no constraint to that. No. Timing, right, probably is that just arithmetically, right. Yes, we are probably a little bit behind, because it will be dilutive from a margin standpoint, but not necessarily from a free cash flow conversion standpoint over time. But listen, we are going to price ahead of cost inflation in recycling and solid waste outside of productivity, right? so we are in front of pricing. And if we look at the outlook, again, we've got pretty good visibility on the restricted portion of our business over the next 18 months. We see upward trajectory on price, the CPI numbers you see today, but that really manifests itself over the next 12 to 18 months. Into the pricing side and the open market side, our tools, our science, right, has never been better. And again, back to customers yield as we get the service and the product offering that much better, customers stay. They're willing to take that price increase, and that's how all those pieces come together.

Excellent.

And Tyler, to your question on timing on that, on the EBITDA margin. So our plan is once we close the US Ecology deal is to break out the segments sort of have that Environmental Solutions in its own segment. So direct line of sight to that 32% in the recycling and solid waste space in the next couple of years. And then a little bit longer overall when you consider the impact of the Environmental Solutions business.

Perfect. That would be very helpful. Thank you so much. I think we're at time. Thank you, guys.

Thank you.

Thanks.