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

Hi, everyone. I'm Michael Feniger. I cover environmental services here at Bank of America. It's my pleasure to be hosting WM at our conference today. I'm going to let Devina and Tara introduce themselves and how long they've been at the company and their roles, just to help facilitate the conversation.

Great. Thank you, Michael. Devina Rankin, CFO. I've been with the company -- it will be 20 years in September.

Hi, everybody. Tara Hemmer. I've been with WM for 23 years, and I am the company's first Chief Sustainability Officer. Happy to be here.

Perfect. So I think we finished -- we first were at this conference 2 years ago, and there was clearly, with COVID, a geopolitical risk playing out. And I think I'd like to just start the conversation off with -- there's other geopolitical risk that's playing out. So maybe, Devina, you could help us understand just, obviously, you don't have operations in Ukraine or in Russia. But just how should investors think about WM right now with this macro volatility? And maybe what some of the indirect implications could be when we're looking at today's world?

I think the way from the question is particularly interesting because if we learned nothing from COVID about our business, it is really the tremendous resilience of our business model, our essential service nature shows that through just about any curveball that can be thrown at our organization, we're going to perform, and perform very, very well. When we look at the current risk and certainly one that none of us want to see playing out and hopeful that it comes to a resolution as quickly as possible. What we see is really a twofold risk. One is in our operating costs associated with diesel fuel, in particular, to some extent, natural gas as well because we drive the largest natural gas fleet in North America. And so those 2 factors will keep our eye on that there are ways for us to recapture any cost increases through fuel surcharges. So from a profitability perspective, we are really well isolated. The other place is any continued supply chain disruption that can affect delivery of assets that we need for our business. We've certainly managed through what we've seen thus far and know that we will manage through anything else that's yet to come, but we really are excited about the growth that we're seeing in the U.S. economy and would like to participate in every element of that to the best of our ability. And supply chain can slow that effort. So those are really the 2 places, but both, I think, are fairly effectively managed and mitigated through the essential nature of our business and isolated because of our North American presence.

Makes sense. And maybe just top down, I think, at the 2019 Investor Day, you guys laid out revenue growth around 4% to 6%, EBITDA growth, 5% to 7%, just in terms of ranges. Maybe you can kind of talk about those ranges, how you're thinking about 2022 and some of those inputs to think about in terms of risks or possible upside?

Yes. Really happy to see that in 2022, our guidance really is at the top of both of those ranges. So the expectations for our business are continued growth and seeing -- when you look at our 2022 guide, on the revenue line, we expect revenue to increase 5.8% to 6.2% organically, which is a tremendous growth, particularly from price and price being the biggest lever. And then on the EBITDA side, in spite of cost inflation, we expect to be at the midpoint of our guide at about 7% EBITDA growth on a year-on-year basis. So in spite of inflationary cost pressures, being able to accomplish that shows the power of pricing in our business to cover cost inflation. But then our efforts to offset the impacts of cost inflation through efficiency, productivity gains that we've demonstrated over the last decade or so, and we'll continue to focus on in the 10 years ahead.

And you mentioned inflation, I think Jim Fish, the CEO mentioned, I think it was the third quarter where you guys observed acute inflation. So maybe you kind of help us, where is the inflation in terms of the business lines? How did that kind of trend to the end of the year? And how do we kind of think about this in 2022?

The most significant elements of inflation for us are on the labor front. And it's either direct labor or indirect labor. WM is a people-first organization. So we were already making investments in our people -- but with the significant demand in transportation, specifically, we've all heard about those through the pandemic, right? We're all getting more Amazon boxes than we even were 2 years ago. So truck drivers are in high demand across North America. We've all seen what played out in Canada, as an example. So the labor cost pressure was, far and away, the most significant driver of our inflationary costs, and we estimate it was in the ballpark of 6% to 7% in the back half of the year.

And do you see -- are there any signs so far, of that easing? Or is it still kind of too early for us to tell right now?

It's too early for us to tell, but a lot of the steps that we took were in terms of long-term changes to the compensation for our team members. And so those are really more sticky or step change cost increases. We expect the level of year-on-year cost increases to moderate in '22. And we're pretty optimistic that with the proactive steps we've taken, that moderation should occur in beginning -- in about July.

Perfect.

I think -- if I can just add. I think one of the things that was also key, if you look at what happened over the last, really, 12 months is we had significant impacts of absenteeism related to COVID that drove overtime costs up, and we had training, our costs, and we're seeing a lot of that moderate. We have nowhere near the COVID absenteeism that we had before, which is fantastic to see. So we're looking at that, and it's certainly moderated and optimistic about where it's headed in 2022.

A great point.

And Tara, just in terms of COVID and all the Amazon boxes, I'd like actually to shift the conversation to recycling. So maybe you can kind of just help us understand how big is recycling in terms of Waste Management's revenue today? And just help everyone understand, it kind of feels like recycling has gone through certain cycles. So some people remember when it was good, good industry. A couple of years ago, it went through a downturn. Kind of where are we right now in terms of the state of recycling and the impact of waste management?

Well, we really do view recycling as one of our core businesses, and it's going to increasingly become more important and more critical to our core as we look at where customer expectations are heading and where governments are heading and all of the stars are aligning around that. If you look at our business today, depending upon the year, our revenues from our recycling businesses represent roughly 8% to 9.5% of revenue. I think what we're really proud of as a company is the steps that we've taken. If you go back to 4 years ago when recycling was in crisis, and there were some things happening, again, geopolitically related to how materials was moved, we took very prescriptive steps to ensure that we made the business more resilient and much stronger. And the way we did that is we built it as a fee-for-service model, where we restructured our contracts. And we're about 90% there on our contracts, where our recycling business now, we will get paid first for our processing and then share in the revenue on the upside as commodity prices increase and then we've mitigated the downside risk. And at the same time, we've been able to grow in certain markets. When you think about our national accounts presence and how we're able to help serve those customers on their broader recycling needs, that's something that's going to continue to grow and expand.

And maybe this could dovetail into your big announcement. You guys are laying out a 5-year plan. You talk about the renewable natural gas. But just on the recycling, maybe lay out what the 5-year plan is? Are these investments -- maybe you kind of dig a little deeper, how does it lower your cost? How does it help improve the earnings profile of your recycling business model?

Sure, Michael. In our Q4 earnings release, we made a really unparalleled announcement in the recycling and renewable natural gas base. And on the recycling side, we committed to approximately $800 million investment over a 5-year time horizon, $275 million of which will occur in 2022. And this is really to do 3 key things in the recycling space. It's to strengthen our position in existing markets and further automate those facilities. And by automating the facilities, we'll be able to lower our cost-to-serve. Our biggest expense in those plants is labor today, and it's typically lower skilled labor. And if we're able to use automation to think optical sorters, think robotics, we're able to do that, and we've proven that we can, through our Chicago installation that occurred 3 years ago and a couple of others that we've done, we can dramatically reduce labor expense and at the same time improve the quality of material that we're generating and also drive more capacity in the marketplace. And the second key thing is there are new geographies that we think we can enter based on demand signals that we're getting. And we clearly think that recycling is going to be a much broader business. It's something that our customers really are consistently asking for and the complexity of solutions that they're seeking is really key.

That's interesting. And most investors, I think, big picture, look at your landfills as the moat, as you can't go out and build a new landfill. So I guess maybe to shift it to Devina, how do you look at this, as maybe more of the stream, 5, 10 years starts to go more towards your recycling centers? And how should we kind of think about that in terms of returns on these businesses and the margins? Because I think most people feel like landfills are high margin, your barriers to entry when you think of this industry.

Yes. So our landfills are a very significant moat. The network we have cannot be replicated. And those are finite assets. And so when you think about the recycling line of business, in so many ways, it preserves our moat because the landfill is not being displaced, instead it's being preserved for a longer period of time to serve the communities that we serve, which is really fantastic. If I just think about pure economics, though, it's important to ensure that we don't just look at margin and overemphasize margin in this business. the landfill line of business certainly has our highest margins, but the recycling line of business is our second highest return on invested capital business in our portfolio. And so as we think about the best use of $1, we certainly see any displacement of tons out of the landfill toward recycling as a win, economically and environmentally.

That makes sense. And I think most people generally would think landfill is bad for the environment. Yet clearly, you guys have done a lot of the landfills in terms of engineering-wise and environmentally. And I think this comes to the second big investment you're making in terms of renewable natural gas. So before we dig deeper into the RNG market, maybe, Tara, you can kind of help us understand, how much is landfill gas as a percent of sales for waste management? And what are you doing there exactly to convert landfills into more of a renewable source?

Well, I think it's important to note that WM has been at the renewable energy business for quite some time. We have a rich history in it, for over 20 years now. And our landfills generate gas. We collect that gas in a very environmentally responsible way. And for years, we have been converting that gas to electricity. Now we're pivoting to renewable natural gas, which I'll get to in a moment. But our portfolio of renewable electricity and renewable natural gas today represents, roughly, 1.5% our revenue, and we're looking at how we can significantly scale this business. The demand for renewable energy is only going to continue to grow. And we've demonstrated through the 4 renewable natural gas plants that we built ourselves that we can do it in a way that drives very strong returns. And the market is continuing to evolve in a way that -- we think that there's going to be direct demand for renewable natural gas from industrial users, but we'll also be able to monetize the broader RIN market long term. So the investments that we're committing to make, again, another $800 million investment over 5 years, Devina mentioned that the recycling business is our second highest ROIC business. But if you look at our renewable natural gas business that we're building today, it would rank above that with payback periods less than 3 years at very conservative rates per MMBtu. So very, very excited about the prospect, and it really does help us reimagine what a landfill is. If you think about the materials that we all discard, and WM is not generating, the waste that goes into our landfills, the broader a community is, but we have the ability to take that landfill gas as the waste decomposes and offset fossil fuels. And that's really, really important to the transition that North America is on to a more renewable fuel economy.

And with what we're seeing with the conflict that's played out, obviously, we're seeing what's happened to natural gas prices. You're seeing a lot of renewable plays have really re-rated in the backdrop. Can you kind of lay out the $800 million investment over 5 years? What are kind of your baseline assumptions around there? And by -- I think it's by 2025, 2026, what type of returns or what kind of incremental earnings could we be expecting, just from these type of projects?

So based on our announcement and like I said, we've used pretty conservative assumptions in there, given that we're aware of the volatility that exists and so it is a commodity-based business, but we're moving from, again, 4 facilities, adding 17 to the mix to get to a 21 total, and we would be increasing our renewable natural gas production 6x over that time period. And we expect to generate over $400 million in incremental EBITDA from these investments. If we go back to our assumptions and certainly with the backdrop of what's happening in the Ukraine and also natural gas prices, we use very conservative assumptions, $2.50 per MMBtu on natural gas and $2 per RIN, which is what we sell to obligated parties like BPs or Chevrons of the world who are required to purchase those because we're able to close the loop from a transportation pathway. And today, RINs are selling in the $3.50 range. So if you rack and stack that up, our assumptions were $26 per MMBtu, but today, we're well north of $40. And at north of $40, the payback periods go to less than 2 years.

Wow. And so when we think of the business lines under you, we're talking about recycling, talking about landfill gas. Add that up, it's probably, what, like 10%, 11% of overall revenue today of Waste Management. Where do you see that looking like the sustainability business line? Where do you see that looking like by 2026?

So if you look at all the different elements of the business that are under me, it's around $3 billion in revenue of our $18 billion, so roughly 1/6. I think if you go back to the numbers that Devina referenced on Investor Day and the 5% to 7% EBITDA growth, I think we're expecting that these businesses would grow at a higher clip than those others. And that's because a lot of these are where the world is headed. It's where our customers are looking for broader solutions and so you would expect that. But I want to be clear, in particular, within the recycling business, that is part of our core business today. We view that as part of our core, and that really is about just building upon some of the capabilities that we already have in existence today. But we also know that there are going to be other things that are opened up as part of this journey. If you think about what's happening with recycling and the potential for extended producer responsibility or customers meeting their own sustainability goals, they're seeking solutions for materials that may not have a home today and won't be able to find markets for those, longer term. So it's an exciting time.

Yes. And obviously, sustainability has been a big theme at this conference, but also in the market right now, is margins with price/cost. So I'd just like to turn it over to Devina. I mean WM did an amazing job from basically 2013 to 2018, the time when you became CFO, of driving EBITDA margins really like 400 basis points. I mean you guys were -- it felt like every year was up 50 to 100 basis points, like clockwork. What's interesting is, in the last few years, it's kind of leveled out, the headline, at this 28%, 28.5%. Now one could say that's impressive because one of those years was a pandemic. But I guess just going forward, why has the margins you feel like leveled out? And what should we think about that margin level maybe stepping up in the next few years? How are you kind of thinking about that?

So I think when we look at it internally, it's that we disaggregate the 28.5%, and we look at it in terms of the significant drivers, and we're continuing to see the 50 basis points of annual benefit from the efficiency of the collection and disposal business. Some of that has historically been price leveraged, certainly harder to come by in the current environment with cost inflation. But it's been really about efficiency and productivity, and those efforts continue. What I think has impacted that headline number that's really important for us to look at, really comes down to 3 things. The growth in the recycling business, while recycling is a great return on invested capital business, it has a lower margin than the rest of our business on a blended basis. So as that business has grown, you've seen a little bit of a compression, particularly on the recycling brokerage side. Second is our SG&A cost line. We've not seen the same leverage that we had seen in that period that you referenced. But that's been intentional because we've seen opportunities to make investments in technology that we believe will pay dividends over the next decade-plus. The investments in technology that we've talked about have been associated with customer service and ensuring that we communicate with our customers in their channel of choice. Other things have included, some of the back office functionality where we know that we can be more effective with regard to technology automation to remove some of our manual processes. The third is ADS. And the ADS business was 400 basis points lower margin than WM, and we knew that we would be on a path to improve their margins. And really happy with the synergy realization, synergy capture that we created in '21, but it's a journey, and we expected the exit rate for ADS at the end of '21 to be more reflective of and representative of WM's long-term margin, and we accomplished that. So stepping back from it, we still see the momentum with regard to long-term growth in margin. And we want to be sure that we're investing not just for a quarter result or a year result, but investing for the long term. And I think when you look at number -- all 3 of those factors, it's because we're doing just that.

That makes sense. And to your point about investments you're making for the future, I think we were talking about your investments, basically $1.6 billion, right, in recycling and RINs. So optically, the free cash flow does look more subdued. So maybe, Devina, you can help us understand the free cash flow conversion? And when we -- after we get through this big period of investments, does the free cash flow conversion maybe have an opportunity to step up higher? How should we kind of think about your priorities there with the free cash flow?

Free cash flow conversion is a fantastic story for WM for the industry. When you look at a business that takes about 50% of every dollar of EBITDA and produces it in free cash flow, it really is just a fantastic result. And there may be -- free cash flow is difficult. We talk about not measuring it a month at a time, it's really hard to even measure sometimes a year at a time. But when you look at our long-term growth, it's hard to look at 2021 specifically, but we had approaching 20% growth in free cash flow, which is just fantastic, and it shows the leverage of the ADS business. It shows the leverage of some of the technology investments that we're making. We think that looking at the $1.6 billion of investments that we're talking about, more like an acquisition dollar than a capital dollar is the right way to think about it because the return on invested capital of these investments far outpaces the return on invested capital of even really accretive tuck-in acquisition spend. And so for us, it's looking at how we run and hold ourselves accountable to capital discipline for running the business and ensuring that we have the right framework to continue to do that. And we know that in '22, we expect that 50% free cash flow conversion to hold. And then after the investment period that we've talked about, if we assume that there's not something else fantastic to invest in, we do think that free cash flow conversion for the overall enterprise can have some step change, particularly on the renewable energy side because the conversion of every EBITDA dollar to free cash flow will essentially be approaching the 100% level.

What's interesting about your choices with your capital over the last few years is not just what you guys have done, which is buying ADSW, which at the time was the fourth largest solid waste provider, and now this $1.6 billion in recycled energy, it's also what you haven't done. So there's always been speculation about other verticals to Waste Management. Medical waste was rumored in the press. You've seen a peer of yours actually go into hazardous in a bigger way. You guys do have, I think, a little bit of some hazardous landfill. So can you maybe talk about that where you see, is recycling and renewables, is that really the next vertical or kind of part of the portfolio? Do you see, Devina, that you need to go do other M&A to find other verticals for the business? How do you guys kind of view that in the landscape right now?

Our priority is long-term growth and return on invested capital. And so when you look at how we have prioritized our capital allocation, it has been ensuring that we are investing in businesses that we know that with full integration, they will provide far more value over the long term than something that would be a bolt-on, right? And so when we talk about other verticals, a lot of times, the synergy value, synergy creation from those is harder to capture and realize and therefore, the returns can be softer. With regard to the verticals that are out there, we always have talked about ensuring that anything that WM does is extending its core competencies. And we're a transportation company but we're an environmental company. And looking at those 2 things at our core, coupled with knowing that we're very people-oriented in terms of how we deliver our service to our communities, we've got to consider whether or not those additional verticals are representative of leveraging our core competencies to the best of our ability and beyond what we can do organically. We've done tremendous amounts organically. And you did mention that we have a hazardous place business today. We've got a great team, and Tara can probably speak to this as well, that really hones in on the manufacturing and industrial space in order to leverage those assets, coupled with the other disposal and collection services that we provide to the best of our ability. And when you extend that to thinking about our presence with national accounts, we've really done a tremendous amount to differentiate WM with the customer base already. And so we're not going to do things that are necessarily asset-intensive or leading where we don't see extending across our customer base more effectively with the service offerings that we already provide.

Yes. I think that's well said, Devina. I would just add a little bit more color, where we have a WM sustainability services team and what they do is they partner with large manufacturing plants. So think automotive, think petrochemical, and they go into those facilities and help them look at all of the waste streams that they're generating and how can they generate less waste. That might be a little bit counterintuitive. But if you look at our brand refresh, where we're WM Now, we're not waste management, always working for sustainable tomorrow. We know that our customers want a partner, and they want a partner in sustainability. And a piece of that is looking at the materials they manage and plugging in where we can build those businesses longer term, expanding our haz waste core. We have that as part of our business suite today and some of our customers need that as a service, but how can we do that in a way that's thinking about where they're going to evolve and had, in longer term?

Perfect. And I do want to see if there's any questions out there. We still have 2 minutes left it. Anyone for the Q&A.

You said that right now, about 9% of your business is in recycling. How much of that is plastic right now? And how do you -- how much do you see that growing to, by 2026?

So the way I would frame it is, plastic is not 100% of our recycling stream, but is 100% of our conversation. So plastics represents roughly 5% of what we're moving. But certainly, when you think about the quantity of inbound calls and conversations that we're having with CPG companies, petrochemicals, municipalities, plastic is really overtaking the conversation. The interesting thing is it only represents roughly 5% to 6% of the stream. But in some cases, it represents 30% of the revenue value of the commodity types. So we're actively looking at where we can help pull more plastics out of the waste stream, get them into the recycling stream and get them back into the circular economy.

All right. Well, that was a great way for us to wrap this up. I want to thank Devina and Tara for coming all the way and doing this in person. So thanks, everyone.

Thank you, Michael.

Thanks so much.

Thank you.