Waste Connections, Inc. (WCN) Earnings Call Transcript & Summary

Good afternoon, everybody. We are back with the last presentation of the day. We're going to close out day 2 strong here with the continuation of the waste theme. We're happy to welcome Mary Anne Whitney, CFO of Waste Connections to the conference. Of course, Waste Connections, one of the largest solid waste providers in North America. Mary Anne, thanks so much for joining us today.

Well, thanks, Brian. We're glad to be here, and we appreciate Goldman Sachs including us in this virtual conference. And welcome, everyone.

Thanks. Before I get into my own question, I just wanted to remind the audience, everyone on the webcast, that you do have the option to submit your own questions. Unfortunately, we are not in-person this year, so no ability to do it audibly, but you are able to submit them electronically through the webcast. There should be a dialogue box on there. And those questions will come in to me. I'll be reading them aloud towards the end of the presentation. But first, I do have a couple of my own to kind of run through. The most important ones will be around recent volume trends and sort of what you are seeing that seems to be what people are most focused on and most interested in these days. And the earnings call was pretty recent. But interested to hear if some of the early signs of a recovery have continued since then. And it's probably too early to call the slope and the shape of the recovery. But just interested to hear if we have seen some of that momentum continue and if there's any metrics you can provide on volume trends in the last couple of days.

Sure. Glad to. As you mentioned, Brian, on our call last week, we talked about some of the trends that we were seeing in the business really for the month of April and our trackers that we've been using on a daily and weekly basis for the last several weeks and how we were seeing the improvement in the business, which was encouraging. So specifically, some things that we look at and the trends we've seen, we'd start with landfill volumes. What we said last week that landfill volumes were down about 13% at the trough. And as of last week, it recovered about 5% of that. And at this point, that number has increased to 9%. So we had about a 3% sequential increase week-over-week to add to our landfill volumes. Similarly on roll off pulls, another good real-time indicator of activity, of course, construction-driven, we had pulls down about 17% at the trough. As of last week, we talked about getting back about 9%. That number is now 12%. So again, similar sequential improvement on the roll-off pulls as well. And then the third indicator we had talked about last week in terms of activity levels would be with respect to our commercial account activity. And what we said there last week is that we track our competitive commercial account, and we have seen, as of last week, resumptions or increases at 12% of accounts which accounted for an increase of about 9% of the revenue that we had lost or had gone away through suspensions or reductions in service. And those same metrics as of this week would be about 17% of our accounts, representing about 12% of revenue. So coming off the bottom, and we've seen this week-in, week-out now where we've seen improvement, it became less negative for several weeks, and then we saw it turn positive. And now as I mentioned, we continue to see the sequential improvement, and that's in those accounts where you saw reductions or suspensions of service. And generally, that was due to the shutdowns required in various municipalities, where we've seen the business drop off most dramatically.

And so am I thinking about it right, that it sounds like in April, in general, you saw somewhere around low double-digit decline in volumes overall and then now it sounds like you've gotten back maybe at 15%, 20%, maybe a little bit more than that, and that's kind of how you're tracking of the decline?

Well, I'd say, the absolute numbers, if you think about the fact that we got back 12% off the bottom, you've got a mixture of what was going on in April. It was declining or stabilizing and then starting to come back. So I think more in terms of the sequential improvement in May, if we had negative 12% volume in April, could it be a little better in May based on these numbers we're seeing? Yes, that's a reasonable way to think about it. I mean arguably, what this math says is we've gotten back about an 8% of what we lost, right? So we're still way off the prior peak. But we're beginning to climb out.

Got it. That helps clarify. That makes sense. And is there a chance that these -- if the volume drop is really just temporary in nature? Obviously, the lockdowns are driving a lot of it. Yes. So we could get a sharp snapback as businesses reopen? And have you seen that in those cities that have started to reopen? Houston is -- we both live in Houston, it's kind of sort of trying to reopen a little bit by bit. But are those the markets where you've seen that snapback in volumes so that we can kind of extrapolate it and say, hey, this is really just going to play out regionally based on when lockdowns end?

I think that's a fair way to think about it. What I can say is the following: we've seen sequential improvement in all of our regions, which is encouraging. But to your point, how impacted each area was really has varied by the nature of the pace, the degree of the lockdowns. And what we said on last week's call was, by way of example, there's a big contrast between our most impacted region. And in our model, that's our Eastern region, which includes the Northeast end markets like New York and Upstate New York and Rhode Island, for instance, in our model. And then Canada, where you had province-wide lockdowns or shutdowns of both construction activity and a real cessation of commercial activity. So those were harder hit. And for instance, we said in April that the volumes there were down about 20%. And that's a market contrast to other parts of the country, like the Midwest for us, our Central region, and also our Southern region and Western, where the decreases were 6% to 8%. And I mentioned that contrast because, as I said, in all of those regions, we're seeing improvement. And as we said on the call last week, by way of example, at our landfills and hauling locations, roll-off pulls and landfill tons, more than 70% of them are showing that improvement off the bottom. So that's very encouraging. And I'd say it's broad-based. I'd say the degree to which there's coming back varies. And as you might expect, it's more pronounced. The snapback is more pronounced in the regions, the areas that were harder hit that have now reopened. Not to suggest that this is a V-shaped recovery or that they have come all the way back. But by way of example, in a market like Montreal, where they shut down construction and the commercial activity, when construction was turned back on, we saw the pulls, which were down 50%, come back halfway. So it's still down 25%, but obviously, a market improvement from the prior period when they were down 50%. So we're encouraged by that. And yes, I would agree with your characterization that the pace of reopening should dictate what that snapback looks like.

And I know on the earnings call, Worthing said, he doesn't expect that it's going to be a V-shape recovery. And nobody really can say definitively. But I think it's better to be conservative about these things. And so you talked about it kind of taking -- being a little bit of a longer recovery. So how does that change the way that you plan the business the way that you think about allocating capital spending, the way that you think about acquisitions, the way you think about how much cash you need on the balance sheet if we are sort of planning for a longer recovery from here?

Sure. Well, in my mind, I sort of put it in 2 phases, 1 being this initial shock, if you will, to the system, where everything has been shut down. And therefore, of course, that we really arguably hadn't been through a period like this, I guess, no one has. And therefore, the response was a little different and that the shape of what went on was different from what we experienced in the Great Recession. As you may recall, in the Great Recession, our commercial business was only modestly impacted. The real impact was to the most cyclical portion of the business, the roll-off business. So we certainly know that when you're in a decline and you have a better sense of what the steady state, the new run rate is, you can make more wholesale changes in an individual market like taking, certainly, rerouting and rightsizing your operations to the extent it is a lower run rate. But I would say that you can take those same steps even in this environment if a market has been hit hard enough. Certainly, when you lose 50% of your volumes, you take a look and you reroute and you rethink the need for the number of trucks on any given day, and therefore, the need for manpower. So I would say you're making those steps more dynamically in this environment, but you have a greater opportunity across all of your markets to do that when you have a better sense of what the new run rate is. And I would say with respect to capital allocation and how we think about that in an environment like this, CapEx, for instance, we've already talked about the fact, as we described last week, that we've cut CapEx by about 20%. As you can appreciate, the 2 largest buckets of CapEx are where we had the greatest opportunity to do that, and that would be your landfill build-out and trucks, your fleet and equipment. And of course, if we -- as we see the year playing out and we provided some sense of how that could play out in our remarks last week, under that scenario, we have high single-digit negative volumes. And therefore, in our model, you wouldn't need as many trucks this year, and you certainly don't need to build out your airspace as quickly if tonnage declines are a part of that year-over-year decline. So I think what -- as we think about it, you can certainly adjust that to the extent the business comes back more quickly. And so we have the flexibility to do that. In terms of other aspects of capital allocation and M&A, the way we approach that is, certainly, we like to come into any year with the flexibility to conduct M&A. And certainly, this year was no different in that respect. And I'd take it 1 step further and say, we'd like to be prepositioned, particularly in a downturn to take advantage of that opportunity because there could be opportunity that maybe someone else isn't prepositioned for. So I would highlight the fact that, as we said on our call last week, our net debt-to-EBITDA is about 2.3x, and our -- we have tremendous room on any covenants or in terms of leverage because we can take our leverage over 3.5x, we can pick it up to 3.75 to do deals. And so tremendous flexibility there. And in terms of liquidity, we've got about $2 billion in liquidity with no near-term maturities. So again, very well positioned in terms of our balance sheet strength and the kind of flexibility we have coming into this year, and particularly, in this environment.

And on your earnings call, you guys did give, I guess, I wouldn't call it guidance for the year, but you did sort of talk about what kind of revenues and margins could potentially look like. A lot of other companies aren't even providing any guidepost because it's really so hard to predict. But just curious, the decision, the thought process that went into providing those numbers. And what do we need to see happen to hit those? I know we sort of talk about not hitting a V-shape recovery, but certainly, you probably need a little bit of continued sequential improvement from here. But do you guys feel like those are estimates that are your best effort to get a hold of things? Or there's a little bit of conservatism in there? Or I guess, just a thought process around providing any kind of an outlook.

Sure. So to your point, we did provide a sense of how the year could play out. And the thought process for providing that, Brian, was that we thought it was -- it's great when people provide statistics and some data around activity levels, and we can certainly, as we did, talk about landfill activity and roll-off pulls. But at the end of the day, it's hard for people to then take that information and translate it into the dollars behind it. So we thought that given the fact that we were reporting when we were closing our books, it gave us the opportunity to share with folks how those statistics translate into what revenue we'd be reporting or using will be included in Q2. And so our April numbers, as we said, that with revenue down 6%, and really what that implies is that our solid waste volumes are down around 12%. And in terms of our ability to deliver those numbers and the thought process behind how you communicate full year a possible scenario, I'd say a few things. First of all, it is a possible scenario to give people a road map to one way that 2020 could play out and to help people understand that, that was based on data we have been tracking for the past several weeks, where we've seen improvement, which gives us confidence that April may be as bad as it gets. But we also acknowledge the limitations of only having several weeks' worth of data. And the uncertainty around -- as you know, we're both sitting in Texas, and we know it's reopening, and we know there are concerns of sliding backwards when as economies reopen. So we tried to be mindful of the risks still around having 1 months’ worth of data. So a way to -- that I have encouraged people to think about it is that even though we continue to see data, which suggest sequential improvement, which would suggest that May would be better than April, I would encourage people to think about that negative 12% type of volume we saw in April might be a good indicator for how Q2 plays out, and then maybe there's a step-up sequentially in Q3 and another step-up in Q4. And the round numbers I put around it was that negative 12% to step to negative 10%, and negative 10% goes to negative 8% as economies open up. And again, it's making allowance for some puts and takes in any individual market, but that the overall trends continue to be -- to follow the same trajectory over time. And so what that all implies is that we don't recover all the way, and if that's because economies aren't fully open, if it's because there has been some slippage, if it's because there's a certain percent of our commercial customers who don't make it through and that there are others who maybe come back at some percentage of the prior business that we were getting from them. That's the way to think about the allowance for why you would still be showing negative volumes in Q4. And by the way, it doesn't limit the ability to show another step-up next year in Q1, as we continue to come back and really anniversary the impact we started seeing last March or this past March.

No, that makes sense. But it helps to just at least kind of understand what kind of assumptions are in the numbers. And it seems to make sense to me. And based on what you're saying for April and May improvement, it sounds like things may be even trending slightly ahead of that plan, which is great to hear. So I just wanted to pivot a little bit towards pricing. And I think you did talk about on the call also that you're going into the year, I think, targeting, I think, I remember, right, 5% type pricing. And now it looks like it probably trend more towards 4.5%. There's a mix probably component in there, too, because we have seen maybe some of the volume declines are in some of the higher-priced portions of the business. But as we look out to the back half of the year and next year, what kind of guidance would you give folks on pricing? Do we think -- we've been in this elevated environment for the last year or two. We've been kind of coming off of this 5% kind of numbers. Do you think we can see pricing get back to -- I think the industry has talked about more about a 2% to 3% kind of a range? Do you think we head back into that sort of a range next year? Or is it going to depend more on CPI? Is it going to depend more on the shape and scope of the recovery? But based on what you are seeing today, do you think getting back to that 2% to 3% range is more reasonable?

Sure. So just to take a step back to remind folks how we think about pricing and how we think about what drives pricing. And the fact that in our mix of business, about 40% is CPI linked. It's typically a local CPI, and most of those are on the West Coast. And you've seen over the past several quarters, we've gotten 3%-plus in those markets. And then we typically target CPI plus 100 to 200 basis points in our competitive markets. And what you then -- the end result is a blend of those 2. And over the past dozen years or so, that's average CPI plus 150 basis points. And so I really think in terms of the spread to CPI, because as long as I'm getting a spread and that CPI is representative of what my costs are doing, then I should be showing margin expansion if I'm getting that sort of pricing. And I would say that we have demonstrated that we have done that historically and arguably in contractions and expansions. I think we've also demonstrated that if there are situations where we see cost pressures which are outsized, like we have over the past 2 years, arguably, labor, which we felt wasn't being captured by CPI, and we did incremental price increases because of those pressures. And also arguably, we put in incremental price increases when recycling was a headwind. And it was a way to help recover some of the impacts there. We noted that that's what afforded us the opportunity to do greater pricing because there was a need for greater pricing. So if we fast forward to next year and CPI is down, and we're in a recessionary environment, the growth has slowed dramatically, you are not seeing inflation in the business, I could absolutely envision a 3% type of price. And again, if in that scenario my costs are more closer to that 1.5%, I'm getting that spread to the extent that cost pressures, whether it's wages or some other pressure is outsized and it was a little higher than that, I would be targeting, maybe it's 3.5%. But even pre-COVID, we came into this year, just by way of reminder, even our 5% price that we guided to for 2020, initially, that was -- what we communicated was that it would start higher at 5.5%, and then the year lower because our expectation was that those cost pressures had abated. They were starting to abate as we came into the year. And therefore, we wouldn't need as much price. And so just philosophically, that's how we think about the way we price in markets, and it's less about the absolute value. It's more about the spread to our cost.

Great. That makes sense. And that's consistent with how you've talked about it. And I think it makes sense. I think -- It seems like we probably are heading into a little bit more of a deflationary environment. So would seem to make sense that it ticks down some. But I think to your point, you can still get margin expansion even in an environment with decelerating pricing as long as that spread is maintained there. Yes. And then on the topic of cost this year, you mentioned there may be some opportunities there. Obviously, over time, has come down some as the volumes have come down, even if you flexed the -- some of the variable costs. The decremental margin question has come up quite a bit, and we've gotten that from some investors. I think you talked about around a 40% margin, decremental margin. Is that the right number to be thinking about? Are there opportunities to kind of improve that later in the year as you have more time to take corrective actions? Or should we really think about kind of that 40% number throughout the balance of 2020?

Sure. Well, I think to your point, to the extent that, first of all, the volumes improve a little, so there's not as much of a headwind, and also to your point, that as things stabilize perhaps that we can take a more holistic look at our cost structure, I think that does argue for some improvement off of that. My feeling is at this point in the process, however, it's the right way to think about it. And arguably, it tells you we have done a pretty good job already or the realities of the limitations on all of us to incur other costs have given us the opportunity to do a good job in the short term because with a 40% decremental, what we talked about in Q1, we also talked about the fact in April that really most of the margin drag was COVID-related costs. So it tells you that, yes, there are decrementals there, but we're managing to pull other costs out of the business. And I mentioned that because, in my mind, there are a few different buckets of the cost, and there certainly are the straight variable costs that we'd all think of. If there are fewer tons being picked up, that means there's lower third-party disposal and brokerage costs and franchise fees and fuel and other consumables, and your maintenance goes down, all of the things that you would expect to go down. I would say there's also the other buckets, which are really put upon us because of a shutdown. And that's certainly travel and meetings and entertainment. And even as you think about the fact that people aren't going to the doctor, you think about the fact that fewer trucks are being driven on the road, and therefore, it's great that we all in the industry have seen an improvement in our safety records, you would expect us to, given the fact that there's less traffic on the road. So there are a number of factors, I think, which have actually helped us in this environment. And we need to be mindful of the fact that as things open up, some of those benefits go away. And so I would encourage people just for now to think about 40% as the right kind of decremental in spite of the fact that maybe, as we both described, there's an opportunity down the road to do a little better.

Okay. That makes sense totally. I guess to shift a little bit to M&A. We talked about it a little bit at the beginning around ways you react lower -- for longer scenario. But you came into the year, M&A was certainly a tailwind. We had a pretty full pipeline. I'm sure there were some deals in 1Q that would have been closed if not for the virus and are maybe being pushed out a little bit. But as you think about M&A for the year, in general, maybe you won't hit the numbers you came into thinking because of the virus, but do you think it will still be an elevated year, still a little bit higher than what you would do in a normal year? And then just thinking about the rebuilding the pipeline, do you think you will be more cautious about the next wave of deals you look at and maybe want to wait and see how the virus plays out, see what the new level of EBITDA is in some of these markets?

Sure. So for starters, just thinking about M&A at a high level, just to remind folks that, for us, a "normal year" is about $125 million to $150 million in acquired revenue, and we've been coming through the past few years where we did about twice that amount. And so I would say that I think that to get to a "normal year" is achievable this year. As you point out, there were things that we already had pretty far along and that should have, frankly, closed in Q1. That slipped because of COVID, so you should expect to see some deals get done, I would think, in Q2 or in July by the time we report because we can get -- we would expect that we will be able to get diligence finished and get those to the finish line. We also have some other deals, which totally unrelated to COVID are in various stages of dialogue. And the question mark is how long do they take to come to fruition. And of course, there's uncertainty associated with whether or not they all get done. But so we do have -- certainly have things in the pipeline. I think the question is then anything that's COVID-driven, if you will, as people say, do things sort of shake loose because in this environment, someone decides they want to get out or depending on the state of their business. And our attitude is that good businesses in the right markets are always of interest to us. As I said, we like to come in prepositioned to take advantage of that. So it's not as though we're not going to be actively pursuing things. I think the reality is, and certainly, the history coming through the Great Recession, is it takes a little while for people to come to terms with the decision to sell perhaps when they realize a lower run rate implies a lower value. And I look back to the recession, and there were things that definitely, the conversation was happening in 2010, for instance. But the real -- the bigger year of actually closing deals was '11. So that took a little time. So if that's any indication, maybe you could see us start at the end of this year, but maybe it takes into the middle or end of next year for those things to come to fruition.

I know you never put incremental M&A in your forward outlooks. But for those of us keeping score at home, it sounds like maybe we would dial back expectations for what it could look like next year, given kind of what your comments around how it trended coming out of the Great Recession.

Yes. Again, every situation is different. But you're right, we would encourage -- we never put M&A in until it's done. But that's probably a fair way to think about based on right now Brian, based on what we're seeing.

I'm going to switch over to the audience Q&A. We just kind of had 1 or 2 come in. But one, on E&P waste, which we didn't touch on yet. And what you're seeing in that market, obviously, it's tied to the rig count. It held up extremely well last year. And then I think we saw 1Q started off well. But towards the end of the quarter, it started to finally drop off there with oil prices hitting a new leg lower. So maybe you can just kind of talk about what you are seeing in the E&P business and where you think that's headed.

Sure. So just to remind folks, for us, the E&P waste business is a landfill niche business. So it's the disposal side of E&P waste. And there, last year, we had done about $255 million in revenue and had expected it, as you note, Brian, we were surprised, frankly, for the last 2 or 3 quarters that the business held up as well as it did, given the rig count decline since it's highly levered to rig count or linear feet drilled. And so you've seen those numbers continue to decline. And what we have said is that the run rate we saw in Q1, which was $19 million to $20 million of revenue per month, that has stepped down already about 35% because we were doing about $14 million in April, and we said it was going to step down again. So down about 45% from there, which implies around $10 million or $11 million in May. Given the fact that rig count continues to decline and what you hear from drillers is the dramatic reductions, we could see that continue to step down. And the way I would think about sort of modeling it out for the rest of the year would be that maybe it finds a steady state in the high single digits. So maybe something like $8 million per month in revenue. And that would be based on some amount of drilling continues and there's production that would drive some of it as well and then some remediation work. So there's some modest level of activity that goes on. And just remind folks that the decrementals are very high. They typically are running 70%. And that given the cost structure, would be even greater on those final reductions. And that down at that $8 million run rate, I would think of it as about a breakeven EBITDA.

And then theoretically, that's probably a pretty good floor if nobody is making any money in the business. Typically, these cyclical types of markets sort of bottom out around there. Is that around the revenue run rate you guys were at the last time we had that oil price decline in, I think, it was 2015, 2016? Is that around where you bottomed out at?

It is. It's pretty close to it. We reported $120 million that year, but the final months were the lowest. So yes, it's close.

Got it. And then we have 1 last 1 from the audience. So I'm going to end it there and let everyone go grab their TV, dinner or whatever you're self-quarantining. But on the question on the recycling business, you know there's a lot going on in the world if recycling is the last question you get in one of the conferences. But yes, OCC is back in the news for, I guess, for the right reasons this time. For you, at least. Not so much for my paper companies, but for you guys. And the -- yes, but it doesn't sound like you guys were too optimistic about where the total basket of recycling was headed. I think you noted some offsets there on the metal and plastic side. So maybe just talk about the overall recycling basket, where it's moved and in general, the movement in the business to try and move to more of a service model or upfront collection model instead of getting paid on the back end. How is that progressing? Has anything changed there based on the move in OCC or from the virus at all?

Sure. So I'll start with that last one since that was less a move that we were working on, but more, I'd say, the industry as a whole and our peers who control most of the recycling facilities. As you may recall, the majority of the recycling we bring to our own facilities comes off of our own trucks. And so there's not a big opportunity to impose fees at the recycling facility. So that's where we took the approach of working on getting more price. And so I think we successfully did that for the past few years. And so then moving back to OCC and those pricing dynamics and the recycling basket as a whole, you're right, Brian, OCC was around $40 a ton as we exited last year. And we -- as I said on the call last week, we have seen pricing at $100 a ton. We actually -- there are some markets where you actually saw it spike to as high as $200 a ton just episodically. I'd say that's an aberration, but we are seeing $100 a ton for sure in this past month, and we've seen that step-up in May. And it could be as high as $125 a ton as we sit here today. So nice improvement in OCC. The point we had made on the call was not to take away from the nice improvement we're seeing there, which I would just mention is at least partially driven to lower supply. And what you are seeing in this environment right now with such a slowdown, there is less being generated and more of it, a disproportionate amount, is being mixed in. And it's in -- coming out of residential streams, which are higher contamination rates. And so you have more contamination in what's going to the single stream recycling facilities, and therefore, less clean OCC coming out the back end and even mixed paper is poor quality. And so that, if you've got a supply-demand imbalance, that's part of what's driving the higher pricing that you are seeing in OCC. I'd say another factor, though, is there is greater demand because as we had discussed really over the past year or so, there would be more mills relying on recycled feedstock, and you're seeing that happen, and so you are seeing the demand there, which is a good thing. Taking a step back, though, and looking at the whole basket of recyclables, what we said on our call last week was it's great that OCC is up. Unfortunately, plastics and metals, which in the aggregate, those 2 buckets are almost 60% of the value of the basket of recycled commodities, those commodities are down. And you can appreciate with crude being down, plastics are -- the reduction is about 50% year-over-year. And metals, they were also down 45%, 50% from last year. So that has impacted the overall basket. And what we said last week was, so therefore, it would still be a drag. It would still be down year-over-year. With this recent continued increase in OCC pricing, there's a chance that as we move through this quarter, but rather than being down, we could end up with the basket being flat for Q2. So that's encouraging, and certainly, we'll keep watching that. But that may be where we end up so that recycling in the aggregate, if nothing changed, then you had the headwind in Q1, which we had already talked about. Then could it end up being flattish for the rest of the year at current rates? That's a possibility.

Great. Great. Well, we'll end it there. And I want to thank everyone on the webcast who joined in, especially those who submitted some questions. And thanks, Mary Anne, so much for making some time and joining us today. I hope everyone stays safe, and enjoy the final day of the conference tomorrow.

And thanks, again, for including Waste Connections. Take care.