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

This is Michael Hoffman. Good afternoon. I'm from Stifel. I'm a Group Head of Diversified Industrial Research. I cover solid waste, industrial waste, medical waste, pest control and specialty distribution. Welcome to day 2 of CSI. It's my pleasure to welcome Waste Management's Chief Financial Officer, Devina Rankin; and the Vice President of Finance and Investor Relations, Ed Egl. Welcome both of you, and thanks for being here.

Thanks, Michael.

Thank you.

So why don't we jump right into advanced disposal and bring us up to speed on how your integration is going. You felt at the time you closed it last fall that you have a lot of the heavy lifting done by the time we got to about this time of the year. You were slightly ahead of plan in 1Q. So give us an update on that integration and how that's progressing.

Well, I agree that a lot of heavy lifting is done, there's more heavy lifting yet to go in terms of customer migration, as an example, as one of the things that will be really imperative to the long-term success of our integration. But I would say the integration is certainly ahead of plan in just about every respect. I think what's been most important is highlighting really the strength of WM from a culture perspective, from a people-first environment. We've seen really strong reception from legacy ADS team members who see our safety culture, our commitment to the customer, the focus on the environment and recycling as a line of business that really matters within WM, all of those things being really important. And so I -- whether it's on the synergy side, which is certainly important from a financial return perspective on the investment we've made or on integrating the new team members into the WM family, all of those things are going better than expected, and we had high bars or a high bar for ourselves going in. So we're really pleased with where we are, but a lot of hard work yet to do.

So one of the -- if I were to do a comparison, and this is the biggest transaction Waste Management has done in a long, long time. But prior to that, you've done 3 pretty chunky ones. There was Deffenbaugh in Kansas. There was Southeast...

SWS.

Yes, SWS in Miami. And then...

RCI in Canada.

In Canada. And RCI, actually, I think, on a comparative basis, probably went a little bit smoother about this. You had employee turnover issues because of, could they meet drivers and technicians meet your standards. And those are private companies. So this is a public company. I'm assuming that's part of this is you've got a pretty well-run business as far as the threshold of things like driver qualifications, mechanic qualifications. And that's helping some of this?

Oh, absolutely. I think that's a great point. The challenges that we encountered, particularly with Deffenbaugh and SWS. With RCI, it was a broker model on the driver side. And so that wasn't necessarily the same challenge. But on those other 2 acquisitions, we did see a lot of driver retention challenges just because WM standards are very high with regard to what we expect from a safety performance and a cultural perspective. The ADS team members have been fantastic. And we -- examples that we talk about internally that I think have been most impressive, we've talked about processes like our service delivery optimization model, whether it be on collection efficiency or the maintenance side of the business. And when we implement those standards and practices at WM, we do have some resistance from our driver base, right? They're accustomed to doing things a certain way or the technicians on the maintenance side. And these new processes changed -- we're creatures of habit, and we like to do things the way that we've always done things. The ADS team members have been so receptive to these standard practices because they see the value and the benefit. But you're absolutely right. The ADS management team has a lot to be proud of. They ran a great company, and we've been beneficiaries of that.

So one of the things that you have -- and I want to sort of touch on this about the underlying free cash flow, and I'm jumping around a little bit. A couple of years ago, it was about 2 years ago, you reset the baseline of the free cash flow to about $2 billion. I think if ADS is adding $150 million plus to that baseline. Is that the right way to think? And I think that's captured in your guidance in that $2.3 billion plus, you've got organic growth plus the baseline left off of ADS?

Yes. That's right. The one thing I would clarify there is we're not fully leveraging ADS from a cash flow perspective just yet because we're actually making incremental capital investments in that business to integrate. So deciding that neither the collection facilities are really exactly what we need in order to bring those together. So the capital expenditure side of ADS is a little higher than we expect normal run rate to be. So we're not fully maximized in terms of that piece of the equation yet.

Okay. So that speaks to maybe the baseline is a little better than the $2 billion, and then I add in organic growth, plus what you're going to get from ADS. But then I think there's more self-help opportunity. And you all have been very visible and vocal about the need to fix recycling, need to fix residential collection. And am I estimating correctly about what's left that there's $75 million to $100 million of lift on the recycling side, maybe $75 million to $100 million left on your efforts around the residential pricing initiatives? So again, a range of sort of $150 million to $200 million that's self-help that will impact EBITDA but also cash because you don't have to put capital to work here for that. Is that a good number to think about there? Is moving the baseline again?

So in terms of the lift that we can get from both residential and recycling, I think you prioritized 2 really important things of our internal initiatives to optimize our base business. There are capital investments that we can be making in each of those. On the recycling side, you can think of it in terms of the recycling plant of the future and the state-of-the-art technology and robotics that we've been putting forth and accelerating some of that investment. And then on the residential side, we continue to see automated side loaders as a huge benefit to the overall effectiveness, efficiency and safety of that business. And so we're going to continue to make investments on that front, too. But all in all, I think you've estimated it well, and I like the term self-help because in some ways, it just speaks to WM's really strong discipline. Of taking this great business model and enhancing it that much further. And I think that when we look at baseline free cash flow, you can look at 2021 and say, wow, this business is going to generate $2.3 billion or more in free cash flow. And that means -- and that's without a full optimization of the recycling line of business and the full optimization of the residential line of business that we've made tremendous progress on both fronts, but there is more to come. Specifically, defining how much is in recycling and how much is in residential. I'm more optimistic there's more upside on the residential side of the business, just because of the size and scale of that business relative to where recycling is today. And I'm thinking about recycling on a like base. But I think over time, you could see our recycling business grow. As we've really differentiated ourselves as the leader in that space. And so if we see that growth, I think that high end of the range is more likely.

Fair enough. But my point is, if I take the $2.3 billion, I get to add another $150 million to $200 million to that setting the base, and then there's a recurring growth rate to that. And then that leaves me with one of our favorite topics, yours and mine, which is working capital. And you've been very candid about the gap that exists between net receivables and your payables, and it's 5 or 6 days. And if you look at your obvious national peer, that's actually a positive 5 or 6 days. So how do you at least get those 2 numbers neutral? And by the way, that's $200 million? And how -- and when can you do it?

The when is a good question. I would say, how do we do it? We've got work to do. We've always talked about the fact that there's more that we can do on the DPO side than on the DSO side, we don't want to do this on the backs of our customers. And I think WM showed very deliberately what a good job we did of taking care of, particularly the small and medium business customer during the pandemic. While we see some value on the DSO side, a lot of times, we have to be sure that we're taking into account those places where we pre-bill and bill in advance. So that we're taking into account this the cycle, the subscription-type nature of some of our business. But overall, that $200 million number that you've put forth is one that we all look at internally. We have a working capital team that works very diligently on each and every element of this. We just implemented a new payable system that gives us better visibility. So we're taking all the right steps. We certainly didn't plan for a pandemic in the middle of executing upon some of those things. But I see good progress over the next 2 years.

Okay. And this has been on -- it's been slow. I mean I don't think you're high from that. It's been slow. Is there something structural about Waste Management's mix of contracts or vendors and the like that contributes to that? Or is this, frankly, there's a culture as you hear that you got a shift and you're working on that shift?

The one thing that I would say stands out as structural for me is the growth that we've seen in national accounts. So national accounts volume growth, which we see as a tremendous indication of WM's leadership and sustainability and our ability to differentiate ourselves with that customer base. But that customer base also expects longer pay cycles. So that's the 1 place that I see a meaningful difference. The rest of it, I would say, is just long-standing processes that take time to move across an organization our size. And aside from that, it's just good change management and diligence and working hard to collaboratively advance a process that you know that can be better than it is today.

Okay. And just to help put it in perspective, how big is national accounts out of approximately $15 billion today?

Ed, I don't know if you know the specific number, but it is, call it, I think, around 7.5% of the total business.

Yes. Sometimes it's even 8%. Yes.

Well, but that's not a trivial number. Yes. That's just -- so if they're pushing for 40 to 60 days, that's a -- now that can be a 2- or 3-day drag right there. All right. I want to go back to talking about price volume inflation. When the -- from a comparative standpoint, the marketplace always wants to go, okay, well, this one put forth at this price, and that one did that. I think there's an important comment to be made of the definitions. So would you -- if we took your peer group, and specifically, I think Republic is probably the most obvious to compare. Would you say that you define yield the same way they define it, which is sort of is that average price that they achieved net of rollbacks in churn?

I think we are more aligned with the Republic model than we are with the Waste Connections model. The Waste Connections model has a little bit of a difference where our core price comparison is more aligned with Connections' approach to measuring their prices or their price metrics. The other things that I think are important are the fact that we talk about structurally, Waste Management has more open market. Republic tends to have more that is indexed and tied to those larger contracts. And so that is a structural difference that I think is important. Churn can have an impact where some of our measures are based on customer count rather than the volume of the customer. The thing that I think is really important for us is that we look at how different our pricing outcomes can be across line of business. So the blended total can have noise in it for us that I think of in the commercial line of business, as an example, in 2020, one of the things that significantly impacted to the downside of Waste Management's pricing metrics was the absence of our snapshot revenue, which is much more volume-driven than price-driven in some respects. But because it shows up as a fee, it impacts the pricing metric. But overall, our commercial pricing strength has been pretty resilient and consistent over time. And so looking at a more line of business by line of business view of pricing, I think, is really important in order to get a fuller picture of how we compare across this space.

And so both of you give enough pieces of core pricing that I come away, gone, there's not that big of a difference when you talk about core. So clearly, then it's the algebra formula of the restricted versus the open and the churns. And so both of you talk about your churn openly. I think you're probably calculating it close enough that, that's -- then the difference being their 6% and your 9% and change, the question comes what can you do to take that 9% down? And is it really as simple of stop losing the long-term higher unit price customer and keep them longer and all that, and that's churn based? And that's really the answer to you're forecasting at $2.5 billion they're for forecasting at $3 billion, that 0.5 point is about the churn?

I think churn has a lot to do with the difference. What I would tell you is that the open market versus franchise nature of the businesses is one of the lead drivers to why we think that there's so much of a gap between the 2. What can Waste Management do? I think we can be sure that we continue to serve our customers to the best of our ability and to advance our reputation from a sustainability leadership perspective. So I think when you take care of the customer, we've talked about for a long time that the reason that pricing execution in this business is what it is, is because it's a relatively small piece of any customer's overall cost structure. And when you take care of a customer and you do so well, and it's effectively a set it and forget it type service. They are cared for because they don't have to think about our service. Because it's provided consistently and regularly. That gives you more leverage on the pricing front, and that has great customer lifetime value propositions. We're doing more on the technology side, which we've talked a lot about in terms of making Waste Management easier to do business with. I think all of those things go together.

So what's the prospect of then ratably walking down? And it doesn't have to be -- you're supposed to take 9% and turn it into 6% in a year, it's -- but what's the process of ratably walking down that churn so that you retain more of your business at higher unit prices than having to replace it at lower unit prices?

I wish it were that easy to say that we'll just knock 0.25 point off of it on a semiannual basis. I think for us, it's about listening to the various data-driven metrics that we have about our customer satisfaction. The Net Promoter Score is an example. Our assessments of both the quantitative and qualitative assessments of WM service that we are getting better and better equipped to use intentionally. I think it's recognizing that there are going to be structural differences. And so our goal is continuous improvement. It's not someone else's metric. All of those things, I can tell you are coming together so that we're increasingly customer-centric. It's hard for me to say that we'll be more customer-centric than we ever have been because I think Waste Management, I've almost been here for 19 years now, and I can tell you for at least the last 15, I think there's been a customer zeal that we're really proud of within WM. And we have the anecdotes, I'm sure everyone does about customers who make a decision based on price, as an example, to go to someone else and then they come back quickly thereafter because the level of service truly is differentiated. We're going to continue down our path, doing what we can to serve the customer to differentiate based on technology, based on ease of doing business with. And we think that those things are going to create value for us and get that churn down. But what the end goal is, I can't tell you that it's the 6% of Republic because I think there are just enough structural differences that, that may be an unrealistic expectation.

And Michael...

I am more interested in the direction than I am, the absolute.

Yes. So Michael, if you look at about 7 years ago, we were close to 13% churn. And now we're -- actually, we're in the 8s now, not 9%. But -- so we've demonstrated over time that we can get that number down. And to Devina's point, I think we're going to continue to work on continuous improvement mindset to get that number improving.

Okay. And I don't think I'm wrong in is if you took another point out of it, and all else being equal, the reported price is going to be better?

Exactly.

Yes.

I mean, we've definitely seen that. It's the conversion of core price to yield, and we've seen -- I mean, first quarter was one of the best that we've ever had. So I...

Okay. All right. So the last part of that question would be, there is inflation in the economy. I think everybody is now acknowledging there's inflation in the economy. For you, as a business, I think of that as predominantly a labor-related issue. And so can you talk a little bit about where you are versus what your original expectations were around wage inflation? And then is that being addressed like it was in 2018 on a real-time basis, you're sort of walking back into the market and tweaking open market PIs to sort of account for some of that inflation?

Yes. I'll cover that in 2 pieces: one, related to the open market nature of it, and I'll probably cover that one first. The thing that we've been talking about and I think is key, is that in a more stagnant inflationary environment, we were able to set our pricing targets once a year, and ask everyone to go run after it, run hard. And what we're recognizing is that, that once a year approach is not the right approach for the cost environment that we're in. And so what we're doing is revisiting the targets that were established and raising the bar within the year. And having conversations about whether or not pricing targets need to be set more dynamically. Instead of a once a year target, should we be setting targets quarterly? Right now, we're in-flight on those assessments. But what I would tell you is that what we're doing is stepping back from it and saying that, that target that was set in the fourth quarter of 2020 is not the target for 2021. On the cost side, I would say that we've known that wage inflation is the place within our cost structure that we've got to keep our eyes on. We've been really dedicated to people-first and making sure that WM is an employer of choice. We've made tremendous investments in our people. And I think the culture of the organization has evolved in such a positive way. And our frontline teams feel that and they're grateful for it. We took a really important step on education. And it's not just education of the WM employee. It's the WM employees' family. So for dependents, we will cover some continuing education costs, whether it's college or trade type skills. So we're doing things that set WM apart in the marketplace as an employer of choice. And I think that overall focus is what helps because wage inflation is one of those things that we we've all been working around the trucking industry, has been one 1 that's been particularly competitive over the last 5 years or so. So we're about on track from where we expected to be in 2021. But when we look at our forecast for the remainder of the year and into 2022, we're projecting that the costs may tick up above the levels that we were originally projecting. But that's in our current outlook for the year, and we're still really pleased with what we're delivering, and you'll hear more about that with the Q2 earnings call.

Okay. So one of the other things that, under your remit, is you're upgrading your ERP. And this is -- just to be clear, and everybody is listening, you're on 1 standard platform. This is a modernization issue, not a -- we're on a dozen different financial systems getting into one. So it's not it's not the one that scares you to death and keeps you awake at night, ERP transitions. But talk a little bit about the importance of one doing it and what you hope to get out of it. And particularly, I think this is just more -- as almost as relevant about everybody that works for you as it is everybody who works for John Morris.

Yes, it's important for every single Waste Management employee because we're not just replacing the finance systems for replacing the human capital systems at the same time. And you're exactly right, this is not about aggregating disaggregated pieces. It's about replacing the existing toolkit with a modern toolkit. And for us, it's standardizing processes, this is a roll up. And as much as we've worked really hard to standardize processes across this business. We still have disparity in process where it's important for us to move forward with scalability. The ADS acquisitions is the largest acquisition we've done in 2 decades. And it would have been a lot easier if we had the system in place already. But suffice it to say, for us, it's about being more agile. It's about being better prepared to make good, sound business decisions at a local level. It's about taking away the work that's required to create financial reporting and give people information in a more real-time way. All of those things benefit each and every part of the organization because it's going to make us better prepared to focus on the things that matter and work less to achieve those things that should just be kind of commonplace normal practice.

All right. So this is about table stakes at the end of the day. And you've got to get to this level because it's table stakes. How long will it take to get it done?

So our current plan is that we will go live in 2022. The current outlook is first quarter of 2022. So really hopeful that most of the journey will be behind us in about 7 months. The team is working exceptionally hard, and we're proud of what they've done so far, but lots of hard work yet to do. That being said, I think one of the things that's been eye-opening for us, and I think it's probably a shared experience for other companies going through similar experiences, is there's a level of change that is involved in moving to cloud solutions versus on-premise solutions that we've all been accustomed to, it will become normal course for you. And what does that mean about how we all adapt as an organization? It means that we'll have a team that's more focused on change management and more focused on innovation within finance. And hopefully, that will be not in addition to what we already have, but a replacement to some of those more just kind of process-oriented things that we've done historically.

Okay. So I got a couple of questions left. M&A, you all were very clear that, hey, we've got a big thing we're digesting. So don't expect us to be particularly active. But it appears that the M&A pattern in the year is percolating a heck of a lot more than everybody might have thought. So are you finding yourself having to be responsive to hands are going up and you're the obvious people to talk to. And so maybe there's more M&A in the pipeline than you were thinking?

So we're definitely busier than we would have projected. That being said, we're going to be very disciplined and intentional about whether a deal is the right deal and at the right price. And so I can't really tell you that I think that the pipeline is going to be greater than what we set out for the year. We've always talked about $100 million to $200 million of tuck-in acquisitions, and we thought we'd be at the low end of that this year. I certainly, at this point, don't think that I'm going to be at the high end. Had we be moderately higher than the low end possibly, but here we are almost at the half point. And there's not anything burning such that I would tell you that while it certainly is a more active year, I don't see us rushing to get things done at the wrong price.

Okay. And then Scope 1 emissions is something that's getting talked about a lot more. That's greenhouse gas and the like, and first garbage companies that are integrated high percentage of that your landfill and then a smaller percentage is fleet. And then there's a rounding error, probably for 1% of everything else. And I think of it as sort of 80s to 90% as landfill, 10% to 15% is the fleet and the rest is the other. You all have clear-stated goals, you've got time lines. And part of that is managing landfill gas, part of it is making decisions between low BTU or high BTU. Can you talk a little bit about those capital investments? And one, do you continue to retain your -- and do it internally the high BTU systems and therefore, you take on more volatility potentially because the D3 RIN? Can you hedge that? I mean, help balance because one of -- this is a long preamble to a question. Are you trading volatilities having fixed recycling are almost done, fixing recycling only then to introduce more volatility because of the RIN side. And yet, it's the right thing to do business-wise, but there is a point of volatility there. So there's a bunch of things packed into that question.

Yes. So I'll start on the volatility point, but I think the more important one really is the significant role that we have played in managing our own emissions from our business. And one of the points that Jim often makes is that it's important to recognize that the emissions that we create are by being really important and environmentally conscious stewards of everyone else's waste. So I'll start on the volatility point because it's one that I'm actually pretty passionate about. If you step back and think about our business, there's not one that really is more resilient, right? We have to have that conversation. When I talk about whether or not I'm willing to take on more leverage because why shouldn't I take on much more debt on my balance sheet because we just proved through the global pandemic that this business can still generate strong and consistent EBITDA and free cash flow. And for that same reason, the volatility conversation is one that I hope that we don't overplay in making good business decisions. Because this is a business that can take on volatility because the structural strength of traditional solid waste gives us tremendous security in consistent and strong free cash flow and earnings. So I think it's important for us not to be afraid to recognize that if we're making really good investments that provide strong environmental and economic returns in renewable energy, there's good reason for us to do that. And the reason is not just economics. The reason is because our landfills are emitting. And we have a responsibility to our communities, to the environment holistically, to be sure that we do everything in our power to make the right investments to manage those emissions. And we're really proud of the fact that we've reduced those by 40% in the last decade. And there's more work to do in those renewable energy projects. We're going to keep investing in them in the right places. The payback on those projects is within 5 years. Could we take some steps to hedge the RIN levels? Sure, we could. But I got to tell you, I've got a lot of experience in hedging, and I tend to find that the people on the other side are the ones that went out often in that regard. And because of what I mentioned with respect to volatility, I'm not inclined to fully go down that path. It's something that we'll continue to monitor. But at this point, we're really happy with the investments that we've made, and we see really good opportunities to continue to make investments, whether or not we do that with our own cash or by looking for partners who can help to give us better flexibility with our capital allocation toward other high-value propositions, we are going through those assessments regularly. And we'll continue to really optimize our return on invested capital and free cash flow generation. But more projects should provide economic and environmental value.

Okay. Last question because I have, in fact, run over our time. Jim made an interesting move from a staffing standpoint in the last few months, he's taken Tara Hemmer out of a Senior VP of Operations and made her the Head of Sustainability. And I know, Tara, I think of her as a real shiny dime, not only just in Waste Management, within the industry. So I'm going to ask Jim this question in 2 weeks or at Expo. But you're on the senior leadership team. And so what -- why take that person of that caliber and put them in that role?

I'm glad that you think of Tara in that way because I've got to tell you, I'm one of her biggest fans. I think she's got a bright future and a lot of impact that she can have on the organization. What is great is we've got strong succession plans. So Rafa Carrasco, who is taking Tara's position is another bright star within our organization. And so we know that we're leaving her mandate, her previous mandate in really capable and strong hands. With respect to why taking someone like Tara of her caliber and putting her in the role, I think it's more about recognizing what an important role it is. And Waste Management's leadership position in sustainability, we're just at a starting point. We know that there's growth for the organization, both in terms of how we manage our own environmental responsibility, but how we differentiate ourselves so that we help our customers think about our sustainability leadership and partnership in a different way. We've shown that we can do that with the national accounts business, but we know that there are additional opportunities. And someone who knows our business so well and is deeply ingrained not just within Waste Management, but in the industry broadly is the right person to put in charge of this mandate going forward. And it's just a fantastic opportunity for growth for WM but for Tara personally. And I'm really excited to see what she can do with this.

All right. Well, as I thought I was going to run over our time. I want to thank both of you for making time for us today and the investors. I'll see you all in 2 weeks at the Investor Summit. Looking forward to -- not sure I'm looking forward to being in Las Vegas in the late part of June. But I look forward to seeing you live, and thank you for participating today.

Look forward to being there. Thanks, Michael.

Thanks. Appreciate it.