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

Okay. We'll move right along, and we're honored to have with us this morning, Republic Services. And from Republic Services, we have Brian DelGhiaccio, CFO; and Aaron Evans, Investor Relations. Hi, Brian, how are you -- good to see you. Republic Services is the second largest waste provider in the United States, serving 41 states. Brian joined Republic in 1998 and has held roles of increased responsibility across the business. Aaron joined in 2007 and took over Investor Relations in 2022. Republic has 312 million shares, trades around $245 for a $76 billion market cap and about $12 billion of net debt. Gentlemen, welcome. I'll sit down, and we'll have a nice chat.

Well, it's great to see you guys. Thanks for being here and making the trip out. Sorry about the weather. It's not Phoenix. Well, maybe we can do -- to start off, Brian, for those maybe a little less familiar, you could just give a quick brief overview of what you guys do and how things are going?

Yes. Republic Services, so we're a leading provider of environmental services, predominantly in the U.S., but also in Canada. We operate primarily in 3 domains. So our traditional recycling and waste business, which is a vast majority of our business. A little over 12% of our revenue is in Environmental Solutions. So think industrial hazardous waste. And then increasingly more, we're building out sustainability and innovation. So these are putting businesses around both decarbonization as well as circularity.

Okay. Let's maybe let's talk about -- again, we'll hold -- maybe hold the tariff discussion, which is beneficial to you guys until the end. You guys have done a lot of acquisitions recently. Have grown in Environmental Solutions. Maybe you could sort of talk about your traditional business and then why you look to pivot more into Environmental Solutions industry?

Yes. If you think about why we expanded more broadly into environmental solutions, customers actually brought us into that business. So we have a $1.5 billion market vertical that's focused on manufacturing end markets. And these customers were saying, you pick up the nonhazardous waste material, the traditional recycling and the solid waste, why can't you pick up this material as well, right? So again, these customers, they value safety, right? They value convenience, right, and they value performance. And so we got into the business in a smaller way, we bought a company, the U.S. assets of Tervita, which was primarily in the upstream oil and gas business, I think the drilling muds, but they had a downstream business as well. And we started to build out that downstream business, primarily in the Gulf in a slightly -- it was a silent way, but we were building it out piece by piece, and we realized that these customers really did value the services that we were providing. So then we expanded into the Northeast. And we then looked and said, this is a -- there's natural synergies. There's cross-sell opportunities between the nonhazardous waste business and then this industrial waste business. So when U.S. Ecology, and again, this was a business that had irreplaceable assets. When you think about the post collection infrastructure, which tends to be the moat in both the traditional business as well as in the Environmental Solutions, they had 5 of the 18 landfills in the U.S. and Canada. So 40% of every hazardous waste ton that goes to a landfill, went to one of these 5. So irreplaceable assets, really strong culture around serving the customer. They just got into a little bit of a debt trap. The leverage was around 5x, and they couldn't get out of the way of the leverage itself. So it became a unique opportunity for us to expand into this business, but do it in a prudent way from an investment perspective. So -- we acquired that in May of '22, right? We predicated the deal on $40 million worth of cost synergies, but we knew that there were revenue synergies above and beyond that. Again, just in any deal, we don't pay for revenue synergies, the ability to cross-sell between that $1.5 billion market vertical I mentioned as well as the ability to price. And what you've seen is that when we bought that business, it was kind of a mid-teen EBITDA margin company. As you saw that the Environmental Solutions segment is now in the mid-20s. So we've moved that business nicely. There's still room to run, right? We're going to settle into a more normal cadence right now as far as how we're going to move that business. But we still think the EBITDA margin expansion opportunity in that business moves a little bit faster than what we see in the traditional recycling and waste business.

Well, you've done a great job and looking back, it all makes sense, but I'm -- you guys nailed it with that. Well done. Current -- maybe if we talk about the current outlook on volumes, obviously, going into this year, we're seeing some trepidation with the U.S. consumer. Maybe you could just talk about what you're seeing right now with volumes and the outlook.

Yes. I think this is one of the benefits of having a high floor, right? A vast majority of our business is scheduled service, right, which isn't necessarily impacted by changes in demand, at least in the short term, right? Because again, when you think about a majority of our business, you are charging for the frequency of service and the size of the container. We're not charging based on weight for the most part. So in periods like this, again, that part of it, it continues to sit that we continue to provide a good quality service to our customer, and we continue to see the same number of units. The cyclical portions of our business certainly can be impacted, right? So that includes construction activity, which really if you take a look at construction activity in the U.S., it's been in a negative demand environment for at least last couple of years. And we've seen that in our volume performance as well as on the manufacturing sector, even though kind of the progress I just mentioned of what we did with that US Ecology business, that was in the backdrop of, I would say, a relatively weak manufacturing sector. I mean, I think we just saw ISM pop above 50 for 2 months, but it just fell back below, right? It was kind of a little bit of a head fake, right? And for 30 months, it was south of 50, and we still were able to produce those results. When that returns, we will get that volume because most of what we've seen is we've kept a majority of our customers, what we've seen is our existing customer decreasing the frequency of service. All the while, we've been expanding share and actually gaining new business. So we have more clients today than we did 3 years ago. It's just the units are down because the same-store customers had instead of coming 3 days a week, I only need you to come 2. So as manufacturing resumes, we will get those units. Right now, look, I think with the announcements last night and even the back and forth that was happening for the last 30 days or so, it's kind of paralyzed, right? Some of these customers. The good news for us, though, is that, again, we've demonstrated this before, is that when there is a decline in units, we can aggressively take the cost out of the business. And so while the cyclical units, while there may be a little bit of softness there, we feel really good about our ability to do so and again, meet the commitments that we made on the bottom line results.

Definitely proven in the past, you can do that. Maybe on the pricing side, inflation. Obviously, is not -- it's still sort of rearing its head. Your operating expenses, your spread, how are you able to -- how has it been going able to offset that cost inflation?

Yes, starting with the spreads. So we look to price about 100 basis points ahead of our cost inflation, okay? So in an environment that entering into 2025, we're thinking our cost inflation is going to be circa 4%. So we're looking to get 5% price or yield average -- the change in average price per unit on our related revenue streams. And with that, we feel confident that we can generate 30 to 50 basis points of EBITDA margin expansion. So we still believe that's the case. Now the backdrop of inflation is actually a positive to our business. I mean, I don't think any business loves hyperinflation, right? But 3%, 4% inflation is the sweet spot for us to operate. What we don't like is when we're in a very low inflationary environment for a long period of time. If we're 0% to 1%, that's not great for us because we've got about 40% of our business that has a pricing restriction. Those pricing restrictions are generally with municipalities who subcontract work to us. And included in that contract, there's a pricing mechanism, many of which have some sort of indices that back that pricing mechanism. So it could be headline CPI, it could be sub indices, water sewer trash, garbage trash. So if you're getting a 0%, 1% price increase, but you think about our largest cost is the cost of people and we're paying our people a fair wage increase every single year, 2.5% to 3%. So again, a 1% price increase with 3% cost, not a great environment. So we welcome inflation. And right now, we would sit there and say this kind of 3% to 4% is a fine place for us to be.

And Tony, when you think about how we've evolved that pricing model over time, you go back a decade ago, the vast majority of those restricted contracts were tied to headline CPI because that is just the traditional way the municipalities would contract, they would issue the RFP and contract with their service providers about a decade ago, as Brian mentioned, coming out of the Great Recession. The CPI environment was running in the kind of -- had a one handle on it for a number of years. So we were -- that compounding effect of year in and year out, low inflationary indices driving our pricing mechanism was just putting pressure on margins in that portion of the business. So we made a concerted effort to move to these alternative indices or fixed rate increases of 4% or greater. And you have seen great progress there, which is giving us confidence in a better pricing backdrop as we move forward in that 40% of the revenue portfolio that is restricted.

Yes. And I mean, just to put a little finer point on that. If you just -- you've seen headline CPI, you've seen that modulate, right? It was as high as 9% a couple of years ago and now with 2% -- with 2.7%, I think, over the last 6 months. By moving to these alternative indices, one, we think they're just -- again, it's a more fair way to price based on our business because the cost structure is more aligned with what we do, but they also tend to run a little bit higher than headline through the cycle. So garbage trash, which is one of those sub indices, that's been running about 4% over the last 6 months, and water sewer trash closer to 5%. So as we look at our ability to produce that 5% yield on related revenue, supported by the fact that now a majority of our pricing mechanisms are tied to those sub indices, water sewer trash and garbage trash over headline CPI, which gives us confidence that we can continue to maintain that price in excess of cost inflation.

Yes. I guess that would be the definition of pricing power. You touched on it -- you touched on a little bit on the margin expansion algorithm in Recycling and Environmental Solutions side, particularly. Could you maybe walk through in a little more detail how you -- I guess, on both sides on how you do it, but maybe particularly the Environmental Solutions, how you got it from teens to 20s.

Yes. As I mentioned, we didn't pay for it, but we knew there was some pent-up pricing opportunity in that business. I mean, these are critical assets that can't be replicated. And they just weren't priced based on the value of the service that was being provided. So coming out of the gate, we were trying to do a little bit of price discovery, and we did several double-digit price increases. We did 4 of them over a 24-month period, really just to find where the ceiling was. And we really didn't lose that many units. And I contrast that, and I mentioned with US Ecology prior to our acquisition, when they were a little bit constrained because of the leverage and one of the things you have to realize is that, that post collection infrastructure has a very high incremental margin. So their ability to price was limited because they were concerned if they priced that those units could exit the system. They could go to some sort of competitor and now all of a sudden, the leverage issue becomes more pronounced. Whereas, again, when we look at just maintaining the long-term health of the business, we know the price emanates from that post collection infrastructure and you have to lead price with those assets. And so we were okay with some units exiting the system, but we really didn't see that, right? We maintained most of those units, which is one of the reasons why you saw the margin expansion that you did. Obviously, we realized the cost synergies, we said we'd realized $40 million, it was closer to $50 million as well as there's just opportunities to just bring our operational excellence that we had in recycling and waste and drive productivity improvements and increase asset utilization. So we've done a lot, but we still have quite a bit of opportunity remaining. I mean, we're just at the point this year where we're going to be on a common platform on that system. I mean the IT integration for all the great things that we've been able to do with that business, the lack of integration, in particular on the system side was a little bit of a -- a little bit of a negative surprise, if you will, once we got into that business. We are now close to having that on a common platform. That will provide the foundation from which we can sit there and drive more value into that business.

The -- maybe separate from the announcement last night, but just impact on Republic from the new administration in D.C. Maybe you could sort of talk -- have you seen any changes, anything that happened after -- after January?

Yes. And I think the one thing to appreciate is that most of the regulation that governs what we do is at the state and local level, right? So at the federal level, it sets the minimum standard underneath which states have to adopt at least that standard, but many of which are more stringent. And so state to state, the regulations can vary, okay? And so that's why when we took a look at what happened with the new administration really for a majority of our business, nothing changed. Now -- there are elements of that, right, when you start talking about some of the things around some tax credits that were part of the Inflation Reduction Act, could those be at risk? Possibly. But when we made the decision to invest in, for example, the RNG portfolio as well as some of the credits that exist for electrifying the fleet. We made the decision to do so before the Inflation Reduction Act existed. So that didn't change our decision. It was just going to be additive. I want to keep those credits. I like those tax credits. But if they go away, again, all it does, it brings a north of 20% type IRR into the high teens. Okay. So though it was a little bit more on the margin, I would say, direct impact to us. Now again, I think there's some -- again, like anything, there's puts and takes. The idea of, I would say, more fair regulation, one of the things that was proposed under the prior administration with PFAS, for example, was that landfills, which are passive receivers, meaning we don't generate PFAS, we manage it, right? You want us in that food chain. And there was a proposal to have the landfill operators those that are privately owned like ours, to be responsible for treating that PFAS material, but the municipally-owned landfills would have been exempt, which makes no sense, right? So I think with, again, the current administration, I think there will be more fair regulation as it relates and put everyone on an equal playing field. So again, puts and takes, but by and large, I would sit there and say it's not changing what we do. We've operated under multiple administrations, and we're going to continue to do what we do.

Fair enough. Aaron, Brian talked a little bit about tariffs. And as like our last presenter said, it's very early on. I think the waste industry in general, as you said, it's a local industry. But obviously, there are probably some impacts, not purely insulated from tariffs. Could you maybe talk through opportunities? I mean, obviously, a lot of benefits and challenges to your industry of these potential tariffs?

Yes. As I mentioned, when we opened up here, we're predominantly domestic on a services-based company. So the direct impact of tariffs is relatively limited. I mean, some of the manufacturers that we -- they produce the trucks that we buy have components that are actually manufactured and assembled in Mexico. So that could increase the cost of some, not all of the trucks that we buy. So more, I would say, the impact for us from tariffs is more indirect, right? So what that does to the health of the consumer, which, as I mentioned, that takes a while to play out. There aren't -- there isn't this direct impact that says, okay, well, now there's less foot traffic, for example, in a restaurant that decreased my level of service next week. That could take quarters, even years to move its way through the system. And the reason we know that is coming out of the Great Recession, we saw the business hold up very well. It wasn't until 2011, 2012. So years after the beginning of the recession and it started to impact businesses like ours. And quite honestly, it's just because for most of our customers, we represent a tiny percentage of their spend. So it takes a long time for them to dig through a P&L to get to a company like us. Now on the positive, if you think about tariffs, if it puts any level of inflation, right, into the marketplace. I mentioned that 40% of our business that has those pricing restrictions, many of which are tied to an indices that could actually give us better pricing while not directly impacting our cost structure. So like anything, there are pros and cons. We'll wait to see how this all plays out. But as far as direct impact in the immediate term for us, we think it's somewhat limited.

Tony, from a demand standpoint, if you think of the long-term implications and I think the goals of the Trump administration to bring manufacturing -- the manufacturing base back to the United States, while that may take a little while for the supply chain to work its way out, manufacturing expansion to take place, we would be a direct beneficiary from a demand standpoint. Again, that may take a little bit of time. But between our recycling and waste business, where we've got a $1.5 billion market share there and then the Environmental Solutions portion of the business, we would be a direct beneficiary as that reshoring and manufacturing expansion occurs here domestically.

Good point. And Brian, we just talked about it, but maybe just back to regulation tax reform. What are you seeing whatever you hearing from maybe your lobbyists or the industry in D.C. of where they think the administration is going? I know you mentioned it probably less so with the PFAS for the private landfills. But are you seeing it as generally going in a positive direction for your industry? Or how would you sort of sum that?

I think we've heard a little bit of everything, right? You heard 21% going to 15%, then you heard 21% might go up, right, in order to sit there and to fund some of the other things that the administration wants to do. So I think there's not a lot of clarity right now on that front. But right now, the 21% is law, right? So this isn't something that expires like the personal tax rates, that 21% is the law of the land. So it would have to require a change in law for that to move. That said, one of the things that certainly has been on the table is the prospects of bringing back bonus depreciation. So right now, bonus depreciation is expiring. And just for '25 alone, if that were to be extended just for this year, that would be an additional $75 million worth of free cash flow vis-a-vis a reduction in cash taxes. So we would certainly welcome the bonus depreciation. There's other provisions that sometimes can be tacked on to that as well. For example, the CNG tax credit has expired almost $20 million impact to us. We did not include that in our full year guidance. So if that were to be tacked on as part of the extender package, again, that would be $20 million worth of upside. So there's a number of things that we think, at least based historically that have been passed and approved in multiple administrations, like both bonus depreciation and the CNG tax credit. While, we think that they could and would be extended or just basing our full year plans and our guidance based on what we know.

Maybe let's move to areas of differentiation. John's just and the team has done a great job of, I think, sort of your pricing models? And maybe you could sort of talk about what differentiates Republic?

Well, I would say, certainly, as we talked about going more broadly into environmental solutions so that we can provide all of the services, in particular, to our manufacturing customers. So we're the only one that can do that, right? So we can walk in, we can handle everything. And usually, what you see is that the service providers are either focused on the recycling and waste portion or they're focused on the industrial or the hazardous waste piece, but not both. And we think that gives us a competitive advantage because, again, back to my comment about what those manufacturing customers are looking for, right? They want simplicity. They want convenience. Like I said, it represents a tiny percentage of their spend, but can have a big impact on their operation if things go wrong. And so they want a provider like us with a great safety record. A lot of times we're on site, right? That is just absolute paramount for them as well as us, and they know that. Being a good environmentally conscious company, right, they want that because they never want this waste to come back to them, right? And then if you can bring them some of the capabilities that we can around digital tools, just making it easier on these plant managers in order to do their job, they value that. And with that, then they're willing to pay more and stay with you longer. So again, I would think right now, Tony, if you had asked me that question 7 or 8 years ago, it would have been a little bit tougher to differentiate amongst at least our larger peers. And now I think you're seeing some of the most differentiation that probably you ever have in the history of this industry. People are choosing different paths for growth, different structures, different ways in order to sit there and to go to market and not to sit there and say that some of the other things that people are doing aren't necessarily good, it's just different.

That's good summary and good points. Maybe we can shift to sort of update on your -- you guys have talked about your sustainability investments, plastic circularity, the polymer centers. Maybe you could just give us an update there? It seems like there's a lot going on. And we've -- I know, we talked about it, Aaron, the other day.

And you want the polymer center?

Yes. From a polymer center standpoint, we now have 2 of our network of what we believe will be 4 polymer centers throughout the United States open, where we will take the plastics that we collect at the curb from residents or businesses, we process those through our traditional recycling centers. And we'll move those ultimately through polymer center for further processing. So think of the PET water bottle, those bales of PET, we will create a hot wash food-grade flake that will be returned back into the converter or manufacturing stream for a new water bottle, new beverage container. The olefins that we have traditionally captured, we will do a further color sortation to create high-value custom blends of those color sorted olefins and those materials will move on to our joint venture with Ravago, Blue Polymers. So again, we have our Las Vegas center that opened just over a year ago and continues to ramp production, great customer demand, great quality product, kind of hitting our marks there, maybe slightly behind the original plan as far as the construction and permitting time line, but that plant continues to move forward. Had our grand opening for our Indianapolis Polymer center, 2 to 3 weeks ago, kind of mid-March. So expect volumes to begin ramping there and earnings contribution to begin occurring late this year. Polymer Center 3 announcement should be coming from a location standpoint by midyear this year. But we are seeing a great demand flow through and supporting the price outlook in that regard. You've got good state-level regulation, EPR-like regulation that is occurring in states such as California, Washington, New Jersey, Oregon that is supporting the requirement for minimum post-consumer content in the single-use plastics and helping us have a great visibility to the demand pull-through and profile for these products we're producing.

Yes. So if you just think about the premium right now that you get for the upcycle product, right? So again, this RPET trades at a premium, relative to virgin material. And if you think about what we were producing out of our recycling centers, we would bail it, but we would sell that at a discount to virgin. The spread between those 2 is what justifies the investment that we're making in Polymer Center. We're in a unique position in order to make these investments because the material is on our back. So others could invest in a polymer center, but then where do you get the feedstock, right? So again, we're collecting this material. We collect something 5 million times a day, which is why it puts us in a unique position to make this investment because we've got control of the feedstock itself. So most of what we're going to do with these 4 polymer centers is material we're already collecting.

Seems like almost that would be, as you made a comment about the reason for the investment, that arguably be more -- almost as important, if not more important to be control the feedstock like we were talking about the other day, Aaron. Maybe I can open the questions up to the audience.

First one is [Technical Difficulty] leverage ratio.

2.5x to 3x, I would say is ideal. We've done the work, and that's, again, I think anything significantly less than 2.5x, you become somewhat inefficient. If you go -- look, the assets can handle more, but as soon as you go north of 3.5x from a rating agency perspective, you could put the investment-grade credit rating at risk. It's not just the cost of the debt, but we provide $4 billion worth of financial assurance as well. So there is a cost of not being investment grade in this business.

Second question, I have is [Technical Difficulty].

Well, I think you've seen the leverage, right? I mean it was, what, 2019, we were 28% margin business and now north of 31%. So I think you've certainly as we've grown, you've seen the leverage on the business while acquiring something that structurally has a lower margin. That said, when you take a look from an overall incremental perspective, I mean, the portions of our business where we've seen, right, some of the decline in volume have really been around the cyclical volumes. So the construction activity -- the construction activity itself, it's not that, that has a high incremental margin, it's what it leads to, that's more exciting to us. It's the construction event that leads to the household formation and then more importantly, the business formation that follows. That's what we want to see in that cycle because that small business formation where you've got the small container work others refer to as commercial work. That is going to be your highest margin line of business within your collection operations because that's where route density matters. That's where you can experience the most leverage.

And when you look at how the business is structured, this is a highly contracted business. So we talk about 40% of the revenue base, having a pricing restriction. We are well over 85% of the actual customers are under some form of contract. So as an essential service -- provider of an essential service in the backdrop of the economy and in a highly contracted business, share will generally trade hands relatively slow from that standpoint. So when you look at the leverage and the value creation through M&A being able to tuck services, competitors' routes that overlays directly with ours. That is where you see tremendous value creation in this space and then customer loyalty, where we're driving that customer loyalty rate 94% plus for a number of years now. That is really where the leverage and value creation in this business occurs.

And certainly, we would welcome, as we talked about earlier, the resurgence of manufacturing activity because not only would that positively impact our Environmental Solutions business, so the customer-facing service itself. But when you think about some of the byproducts, so a lot of what those manufacturing customers produce is not hazardous and it turns into landfill special waste. So you think about the leverage that you gain at your landfills. As I mentioned, there is a high incremental -- high incremental margin associated with it because it's a highly fixed cost business. So that would be an area where if we all of a sudden get back into a consistently above 50 ISM, we would certainly see the leverage on that portion of the business.

Well, gentlemen, that was a great overview. You guys have done, obviously, you've been coming for 11 years now and done extremely well throughout the time. Thank you, Brian, for your support and Aaron. Hope to see you back next year. Thank you.