Waste Management, Inc. (WM) Earnings Call Transcript & Summary

Well, good morning, everyone. I'm Noah Kaye. I'm Managing Director and Senior Research Analyst in Oppenheimer's Sustainable Growth and Resource Optimization Practice. We're very pleased to welcome to our conference Waste Management's CFO, Devina Rankin; and SVP of Field Operations and soon-to-be Chief Sustainability Officer, Tara Hemmer. Good morning, and welcome to you both.

Good morning.

Morning.

So Devina, maybe we can start with cycle, and it's a topic that we've been talking about at the conference so far that the leading indicators we typically track, housing industrial activity, CPI, they're all telling us we're in for a multiyear growth cycle in waste. We had a very protracted growth cycle during the last decade before COVID, and it does include the scope of this recovery is going to be different. So how are you thinking about and planning for potential multiyear industry growth?

Yes. I think what's exciting about the outlook for the period ahead is how well positioned we are for this growth cycle. As we think about those indicators that you speak to, there are certainly ones that we've looked at as strong indicators of growth in our most profitable segments of the business, think about commercial and industrial collection as well as MSW, C&D and special waste projects at the landfill. So all of those things give us tremendous optimism about the path ahead. Certainly, when you look at 2021, specifically, there will be some noise with regard to how the volume unfolds. The second quarter comparisons are going to be quite unique, certainly, off of dramatic declines that we saw in 2020. But that being said, we expect that by the end of the year, we're already seeing landfill above 2019 levels, which is a strong indication of the path forward, given that that's our highest margin line of business. But commercial and industrial still have room to grow from where they are to get back to where we were pre-pandemic. I think in terms of the scalability of this organization, given that we have an unrivaled asset network, we're certainly well positioned to respond to that growth. And then centering ourselves around a people-first culture and really driving the organization to be an employer of choice, I think, will be equally important as we participate in growth because people are what makes our business run and make service to our community possible. So all of those things together should position us well as the volume recovers.

And a follow-up question here. As we are playing through this reopening, one question we get a lot is how to think about the mix of business evolving over the coming years. After the Great Recession, we saw changes in mix away from construction, heavier on commercial business. It wasn't dramatic, but a couple of points here and there. And presumably, that mix is going to change, evolve again over the next several years. And you already commented to your earnings call and some of the strength that you had in resi pricing coming from the belief that there may just be structurally higher volumes in resi for a period of time. So I guess where are the opportunities for your business in that evolution? And what are the challenges that you're working to overcome?

Residential pricing is certainly an interesting one. But I think I'm more optimistic as you think about the landfill pricing outlook, thinking about ensuring that we are pricing disposal volumes in the right way to capture not just our cost structure, but the optimal position of our landfills, particularly in those markets that we expect to rebound nicely. In addition to that, I think industrial collection is an interesting piece of the equation as you think about with the last recovery versus this recovery. One of the things we did with the last recovery is really prioritized more permanent halls rather than the temporary type business. And moving ourselves even further down that path with this recovery, I think, is going to be something that we focus on, given constraints that we see coming in the marketplace. I think commercial recovery is still one of those that we see tremendous upside to because at this point, while we've seen strong recovery in certain segments, there are a number of segments that still have yet to recover with only about 72% of COVID loss volume on a yard basis recovered at this point. So there's clearly upside from where we are today.

Yes. I think we've heard some of our companies during earnings talk about high conviction that we're really at the start of a broader North American manufacturing cycle. And so your ability to position and capture some of that growth, I think, will be a good factor -- a good vector to track. I guess a bit more near term, one of the headlines from waste earning so far is the pretty strong price stickiness we've seen in the open market, being held by declining churn, markets reopening. Just want in your view is supporting the better pricing? Is it underlying inflation, other factors? How do you attribute it?

I wouldn't say that it's underlying inflation at this point because we haven't seen inflation take hold in terms of pricing. We talk about 35% of our collection revenue and then 40% of the overall book is indexed to some sort of inflation metric of some sort. And if you think about it, we haven't seen the inflationary cost in those indexes such that we're seeing that in price. So this really is an open market conversation rather than those longer-term contracted revenue dollars. I think the momentum on pricing really just speaks to the discipline in our practices that we've had in time. And then to some extent, in 2021, for Waste Management specifically, this will be a year-over-year comparison story as well. We took proactive steps that were customer-centric during the pandemic, particularly with small and medium businesses. to ensure that they didn't see price increases as they were working to take care of their own employees and really sustain their business models through a tough environment. So we see strength and resilience in the North American economy that positions us to move forward with pricing activities in the current year. And so I do think that, that's one of the things that will show itself as continued strength for our business and then broader -- more broadly for the industry. I think you guys are the ones that are the experts on that. But I will tell you, I do think that Waste Management is showing tremendous discipline, particularly in residential, which you spoke of earlier, and then in the landfill part of our business. But we're going to continue to push on that commercial and industrial side as well as we see constraints in the system as this volume recovery really takes hold.

Thanks, Devina. That was great color. And actually, it is worth remembering, as you pointed out, the company did some very deliberate strategic actions around supporting small business customers last year. And I think there's always a positive impact to pricing just with customers -- taking us customer retention, that service continuity. And so presumably we're going to see that flow through in the quarters ahead given what those comps were for the past year.

Yes, absolutely. I think customer churn is one of those things that gets overlooked often in terms of the power of pricing. And we saw a really good move, a positive change in churn in the first quarter, and we're hopeful that, that continues over the rest of the year.

So CPI isn't really helping yet. But we are seeing some inflation, obviously, across the industrial space. As demand comes back, how are you managing labor cost inflation, fuel price increase? Any driver shortage impacts to call out? You made a point of kind of consistently investing in human capital, and that's so important in this industry. But can you just give us some color on your expectations for inflationary trends on the cost side.

I'll start and then ask Tara to jump in, particularly with regard to our steps on the labor front because it's so important. When you think about fuel, those impacts really for us become pass-through oriented. And so you do have impacts on your margin of the business, but it's not really an indication of a change in overall profitability for us. So we do look more to those things that can be long-term indicators of where the cost structure of the organization is going and how we need to be responsive to that. Labor is certainly front and center there. We are a human capital-intensive business as well as an asset-intensive business. So that really is the the long pole in the tent, so to speak. I would say, again that the focus there is being an employer of choice and driving down driver turnover being key for us, and I think we're making good strides in that regard.

And just to add to what Devina said on the labor side, you talked a little bit, Noah, about some of the intentional steps that we took. One of our commitments and values is to be a people-first organization, and we've led with that throughout COVID, and we had a 40-hour guarantee. We didn't lay off any of our drivers. And so we have this capacity of people who can continue to do the work on behalf of our customers as we grow as a company. And the other thing that we did was really look at how can we run the business a little bit different and take the key learnings from the COVID experience and make sure that we optimize our work week. So we've moved towards 4-day work weeks, which give us some capacity in the system when we do have driver shortages. The other thing I will say is we've been very intentional about how we grow our own talent, looking at the longer-term trends on drivers and technicians. And we highlighted some innovative employment pathways and finding ways to put people to work, to put them on a pathway to get a CDL. And if we do this, we can win on the talent side and at the same time, be in a position to capture the volume and capture the volume at the right price.

Thanks, Tara. That's great color. Before I continue, I just want to make 2 quick comments. It is possible, if you're interested to submit a question via the chat, so you can do that. We will try to address it. I just want to acknowledge a [indiscernible] VP of Finance IR, who is hiding out here and can tell me when I get out of line. So let's continue here. I guess on the M&A front, 3 questions. One, just for Waste Management, how do you size your TAM and M&A at this point? Two, we've seen certainly some regulatory challenges for the entire industry and doing large deals and seeing those time lines have expanded. Just curious how if at all your focus areas for M&A are evolving? And third, your view of how tax reform could impact the M&A?

Yes. Great questions, Noah. I would say in terms of TAM, sizing that is an interesting exercise in our business, particularly because of the second question. While you can do all the math with regard to the size of the largest players in this space, and arguably, the 4 public companies in traditional solid waste are the place to start. You still have about 50% of the share of traditional solid waste that's in the hands of other parties. Now there's a large municipal presence there. But then on top of that, there still are some sizable, we'd call them, more medium-sized businesses across the landscape. That really, I think, is the sweet spot of the addressable market, and there still are a number in that space. We certainly have learned a lot going through the ADS acquisition. That tells us that our runway with regard to something of size and scale in this space is limited. You've probably seen the largest transaction in traditional solid waste from WM that we could possibly make given what we've learned from this experience. And that's telling not just for us, but for the rest of the players in the market. With regard to tax reform, it's interesting. I know that people always talk about death, divorce, disease as being the lead indicators of when the smaller players consider exiting or selling their business. But I think what's more important is recognizing that the owners of these businesses are proud men and women who have built these businesses for many years and decades, and they often look for decisions that are very personal. And sometimes those personal decisions include tax decisions, financial position decisions. And we certainly are hearing more in the way of interest from potential sellers. And that's not surprising given the backdrop that we all see with regard to the potential for tax reform. That being said, we are a disciplined allocator of capital. And I think that while sellers are motivated, we also have to be conscientious about putting a dollar towards something that gives us the right returns. So we're actively engaged and involved. We are monitoring the market, and I would say it's more active than it had been. But we're going to be disciplined in terms of how we allocate capital.

Well, with respect to capital management, I have to bring out the recent debt deal that the company successfully completed. I guess, again, can you just give us some parameters around that, not just sort of impacts on the P&L, but why this was the right time to be doing that deal? And what do you think the outcome says about the market's view on the business?

I'll start with that last part because I just think it was a tremendous execution and a really strong indication of investors' sentiment about the strength of solid waste generally and the strength of Waste Management specifically. The transaction was targeted at allowing WM to take out some of its higher coupon debt and exchange that for very attractive rates. And while we don't yet know the results of the tender exercise, we'll have those results in the coming days, we're optimistic and certainly are very happy about the new issuance and the rates that we secured there. In terms of the value to the P&L, I would tell you, we're looking at annual interest savings in the ballpark of $10 million to $15 million. The tender execution is what gives us that result specifically. So too early for me to specifically say, but that is the range, and I think it gives you an indication of the relevance to the overall cost of capital.

That's perfect. So one of the notable announcements during earnings last week was, as I mentioned earlier, of course, the Tara's appointment as SVP, Chief Sustainability Officer effective in July. So Tara, maybe can you outline for us the priorities you will have in that role? And why this roles being created at this juncture in the company's sustainability churn?

Absolutely, very exciting time for Waste Management as a company. And one thing that I always like to come back to is the very -- the work that we do each and every day, I'd like to say. We make living in cities and communities possible. And so we are at the epicenter of providing sustainability services to our customers and our stakeholders. One key element of my role, and the language was pretty intentional that Jim used, is to leverage sustainability for growth. And based on where we are in the world today and based on some of the announcements from the Biden administration, you can see that there's an opportunity for Waste Management as the largest residential recycler and some of the capabilities that we have to help our customers with the circular economy. On decarbonization, we are the largest renewable energy producer in the waste space. And we have an opportunity to leverage those platforms through renewable natural gas and closing that loop with our fleet. We run the largest heavy-duty natural gas fleet in North America, and we have an opportunity to make these connections. At the same time, we're seeing other trends emerge. Organic continues to take off, and municipalities and entities are focused on Zero Waste and Zero landfill. We have an opportunity to help our customers with their efforts to be more sustainable. So what really is about connecting what's happening in the here and now and then also looking for what are those opportunities in the future where Waste Management can continue to grow our broader sustainability platform and really help grow our customer base, the top line and the bottom line.

Let me pick up on one of the points you touched on, and then I'll probably pick up on some of the others. So there's a lot to dig into here, but we are increasingly seeing corporate zero waste to landfill commitments. So maybe you can talk to us about the opportunities and the challenges that presents and how the company is positioning to what extent this can be a wallet share gain opportunity.

Sure. Well, obviously, in the short term, you've seen us make significant investments in our recycling infrastructure, and we're seeing those investments pay off. But when we think about customers and communities coming up with zero waste goals, today, the most productive way to handle our waste from an economic perspective and environmental perspective is for it to be landfilled and to do that in an environmentally responsible way. But there's a recognition that there are trends to move away from landfilling, and we have solutions that we can offer to our customers. If you look at our organic platform, as an example, we are one of the largest recyclers of organics, and we can help our customers with those solutions. Presently, many of them are not as cost-effective as landfilling. But we're going to work on that transition. And you have heard Jim say that if there is a technology that exists that will replace landfilling and can do it in an economically sustainable way, and at the same time, move the mass quantities of material that needs to be moved and handled each and every day, we are all for it. It's one of the reasons why we're really keeping our foot in the water and understanding what those broader trends are so we can step in and serve. On the recycling side, which is something that's really emerging when we think about the circular economy and some of the trends really moving from commercial to residential, if you think about where hardboard used to be and where it is today, we have an opportunity to partner with a larger consumer products organizations, and that's something that we're doing to make sure that what gets put in the bin can ultimately be recycled. And we're investing in our recycling infrastructure so that we can be very nimble when there are markets for material, we can pull that out. A great example is what's happening today. If you look at plastics pricing, plastics pricing has exceeded aluminum pricing, which is unheard of. And we have optical sorters in our plants where we can set them to look for that material that has the highest value that has market. Those are examples of things that we're going to be doing and pressing forward as we go on the search.

I appreciate you bringing up the technology because we've always taken the view that Applied Technology is a critical enabler of sustainability. So I want to ask some broader question about technology. And then if I actually take some of that commentary in recycling and CNC. I guess as you think about your technology capabilities as a company, what do the pandemic teach Waste Management about effective deployment of digital platforms, all fuels and some of the other technology buckets, where is it pointed to lead for accelerated adoption or development priorities?

I can start with this, and then Devina, I'm sure you can add on. I think the first thing I would say is it's technology and innovation and making sure that we have those both variants together. And it really is the speed at which we've had to adapt. And some of the investments that we made pre-pandemic have really helped us. A great example is in our national accounts space, where we have reporting platforms that have helped our customers really give them greater insights into their waste processing and recycling and benchmarking, so that we can help them manage their business better, but also provide them with insights in how they can be more sustainable. And if you look at that, those are some great examples of how we've been able to win in the national accounts space. Another example is on the technologies that I mentioned that we have in our recycling facilities. There's so much innovation that's happened in the optical sorter space, really looking at robotics and how we put those puzzle pieces together, we've been able to test how we can adapt more from the standpoint of how different materials have value, but also this is an example of how we can lower our cost to serve. Because having these technologies in place in a space that historically had been very labor-intensive, it helps us create cleaner material. And also when we're in a tight labor market, it's helping us there as well.

Yes. I think Tara covered it well, but the one thing I would add in terms of what we learned over the course of the pandemic that really helped us as an organization is the value of focus and scale. I think when you look at large multifaceted organizations, often you have a lot of people working on multiple things at one time. And the senior team really intentionally stepped back from all of our priorities in April of 2020 and said, you know what, we need to focus on fewer things and move those forward with more intent and deliberate focus from the entire organization. And so in the customer service digitalization side, that's something that we've talked a great deal about in terms of the investment strategy that we had really adopted several years ago. But accelerating our focus there, thinking about how the customer wants to engage with waste management, ensuring that our digital platform is established so that they have those channels of choice available to them. And we've all, in our own lives, figured out that we can do much more and we prefer to do business with companies that have given us tools that make doing business with them easier. And so all of those things have been priorities, but we've not lost focus on our sustainability efforts at the same time. So we know that one of those focus areas has to be on advancing recycling, CNG, some of the pilot considerations that are ongoing with regard to electrification and seeing what's going on in that avenue. Just being extremely deliberate about focusing on those things that we think will fundamentally shape the future of the business, both from a customer and the environmental perspective over the long term.

Yes. That's great color. And I know Jim has talked in the past about Waste Management really aspiring to be a world-class company and some of the learning lessons from some of the best logistics companies in the world. I actually think you do some things better than some of those logistics companies, and that was evident during the pandemic. But watching these technology platforms get put to the test has been really illuminating. Just a couple of specific additional questions on technology deployment. Tara, we're really talking about the improved quality of optical sorters and standards and robotics. And so it seems like a business case for MRF automation is really improving. So I guess, prior review how you look at that business case. What do you think is the potential profitability margin uplift from increasing automation in the recycling line? And do you anticipate elevated CapEx and recycling over the coming years?

Well, as Devina likes to remind everyone, our MRF line of business has the second highest ROI fee of all of our lines of business. And so when you look at what we did in the quarter and how we improved the recycling line of business, despite the fact that pricing, we had seen some price lift, but it wasn't at record levels. We really have fixed the underlying business model to be a business model that's sustainable. And it's also a business model that we want to continue to reinvest in. And so even during the downturn, we were continuing to reinvest in the business over $200 million over the last 2 years. And we're expecting that we're going to continue to do that. We'll reinvest in maintenance capital as our facilities are aging and things like failures or upgraded optical sorting. But we're also going to invest in MRF of the Future or state-of-the-art MRF we built in Chicago. We opened the Salt Lake City facility. We just opened one in Raleigh. We have one that's underway in the Houston Metro area, and we have a pipeline of projects that we're looking at today. Make sure that we have recycling assets in those markets that we see as growth markets where we're in a position where we can marry that recycling infrastructure up with the rest of our business. So we do expect to continue to reinvest in the recycling line of business, and we see that as a big piece of future differentiator for Waste Management.

Noah, on the return perspective and thinking about what can happen to margins as we continue down this path. I think what's been so important in the recycling conversation is that the change in how we have the customer think about recycling as a service has been key. Because, as Tara mentioned, the profitability that was achieved in the first quarter was achieved in spite of commodity prices still being kind of mildly below long-term averages. We're not looking at commodity prices that exceed in a meaningful way our cost of processing the recycling. And so anything that we can do to proactively reduce the cost associated with recycling, a ton, is really important. And we have seen our operating expense per ton growing by double digits on a percentage basis for the last several years. And what was driving that was contamination increases, labor cost increases. And so anything that we can do to ensure that contamination is an easier part of the management of the process, and we've done that on the fee side. Now we need to do it on the technology side. And I think we're seeing great results on the investments that have been made thus far. And so GOE, while it's still increasing at a higher kind of percentage than we would like to see for our overall cost structure, we are seeing it come down from those peaks where we were seeing a 10-plus percentage increase on a year-over-year basis in that cost. And so anything we can do to expand the use of that technology across our network will be valuable. And as Tara said, we've invested significantly over the last couple of years, and we have plans to continue those investments in the next several years.

Really great color. Tara, I think you mentioned the renewable natural gas and closing the loop. Just how do you view some of the landfill gas to RNG participation opportunity set here in light of the RFS policy support in your own natural gas fleet, what kind of pipeline you have for new high BTU RNG projects over the coming years?

Yes. So first, on the Biden administration point, we really do believe that the Biden administration perspective on RFS and RINs is going to provide some stability to the program. And so that's really helpful to us as we think about building new plants. Just to level that we have 4 plants that we've built ourselves. We have another one that's under construction today. And those plants provide rate returns of 2- to 3-year payback. And there -- an opportunity for us to take the landfill gas that we generate, turn it into pipeline quality and close the loop with our fleet of CNG collection trucks. And right now, we run about 65% of our fleet or routed fleet on CNG, and over 55% of that is connected to renewable natural gas, and it's a great closing story. There's no other company in our space that can say that. We have another 13 projects that third parties have built on our landfills. And we also have a pipeline of 10 to 20 projects that we're looking at today where we could build these plants on our landfills and close the loop. And it's a great example of fantastic economic returns for Waste Management and an environmental sustainability story. It really helps also with our landfill platform as well.

I have one last question that I think is really a good question for you as a leader in the waste industry. I'm not sure you can answer it all in the 2 minutes. In fact, I'm sure that it's tough. But the climate pledge taken by the Biden administration. It's kind of heavy focused on environmental justice and so does several other executive actions that have been taken by earlier administration. So as a leader in the waste industry, how do you engage with issues of environmental justice and what are some of the initiatives you would point investors to?

So what's interesting, and we've been tracking and tackling this issue if you go back to 2010. And we've been looking at all of our facilities and mapping our facilities to see where they stand. Are they in higher income, higher minority, lower income, high minority quadrants. And if you look at where our facilities are, believe it or not, the majority are in the top right quadrant, which would be higher income, lower minority. Now that being said, we have facilities that are not in those quadrants. And we are very focused on being strong community partners in those areas and engaging with regulators, with community members, with community activist in some cases to understand -- and we have facilities there. In some cases, those facilities have been there for 20 years. And we want to continue to be really good operators and also to really be good community partners. So understanding what some of those needs are. And we have some great examples. We have some facilities in New York City, as an example, that are in urban markets, minority -- high minority concentrations. And we've done some things where we're building community gardens that benefit the community. We've done STEM education. And these are based on things that the communities are coming to us and are saying, we need your health and support here. That's something that's obviously going to continue to evolve, and we're going to continue to track going forward.

Well, I think your efforts here and really kind of the ability to use your platform to highlight those efforts is a very good example for the industry, and I look forward to hearing more. With that, I think we've reached the end of our allotted time. So I just want to again thank you both, Devina and Tara, and then, of course, for participating today. I hope everyone has a great conference. If you have any questions, you can reach me at [email protected]. Thanks so much, everyone.

Thanks, Noah.

Thanks, Noah.