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

Okay. Thank you all for coming back into the room. I'm Michael Hoffman, Group Head of Diversified Industrial Research. Day 2 of CSI to cover environmental services. And this is our third and last solid waste company for the day. We have Waste Management with us. Sitting to my immediate right is Devina Rankin, who's the Chief Financial Officer. To her right is Brent Bell, who's the Vice President of Recycling. And to his right is Ed Egl, who's the Vice President of Finance and does Investor Relations. Welcome to Boston.

Thank you.

It's great to see everybody in 3D again. So I have to ask the question upfront because at the Phoenix Open, you used the opportunity to, from a marketing standpoint, to change the name of the company, from Waste Management to WM. Can you talk about what that is? What's behind that? Why are we doing this? What drove that?

So I think fundamentally, what this is about is ultimately WM is about more than waste, and we certainly are the leading solid waste company in North America, continue to invest in that business and will for the long term. I think what's important is that we have a leading brand in the industry already and our customers and prospective customers recognize the WM and they know who we are. What we know is that we are working on sustainability in perfect concert with our focus on solid waste management. We're also the leading recycler in North America. We plan to have the leading renewable energy footprint in North America as well. And so I think that knowing that our brand is important to our customers as they think about their sustainability commitments is also important to us. And so representing WM as the whole of what we do and what we offer to our customers and the environment is important.

Okay. But just to remind everybody, you're a garbage company who does really cool sustainable things, not a sustainability company?

I don't think we have to define it that way. I think we're a great company offering comprehensive environmental solutions to our customers. That certainly from a lion share of the P&L, lion share of the asset base is solid waste management.

Okay. Are you -- do you think you're going to get a sustainability valuation bump?

I think it's too early to tell whether or not that's something that is possible. I do think that as we grow the renewable energy part of the portfolio, there could be a valuation accelerator for that part of the business.

Okay. So I'm going to come back to those things. I want to talk about state of garbage at the moment. There's lots of banks in the world, given all the macro things that are going on. I've always thought the business was very much a canary in the coal mine. Waste goes across the scale every single day. From a collection standpoint, I think you're north of 25%-ish. You're higher than that on the disposal side. So you have a true lens on -- and I'm speaking out of 2 sides of my mouth for the last 2 solid waste meetings. I said, I don't want to talk about volume. I want to talk about price because it's the only thing in control, but an absolute lens on activity would be what's happening in the bin. So how is the state of the U.S. economy as you look at your scale reports? And then how is the state of garbage?

So what we talk about is that our lens into the U.S. economy is multifaceted. There are parts of it that are leading indicators, and there are parts of it that will be lagging indicators. The leading parts of our business are things like solid waste volumes for special waste projects. It's construction and demolition work. Commercial volumes tend to be really good indicators. And as we said in the first quarter, all of those were even stronger than we would have predicted when we gave 2022 guidance. That being said, when we look at what's happened in April, May, June, none of that is softening, I would say, but what we are seeing is a moderation of the pace of growth. So that moderation of the pace of growth is something that we have our eye on. In terms of the lagging indicators, we think about things like housing starts, if you start to see what happens with new housing starts, new business formation, things like that. We're not starting to see any of those impacts yet. And so that leaves us optimistic. We also look at container weights and container weights still continue to be strong. And then overall, our ability to serve all of that growth and the strength in the U.S. economy has remained strong.

Okay. So you would frame at the revenue level, the state of garbage is good?

Yes.

Costs are an issue. Everybody is seeing inflation. This shouldn't surprise anyone. I mean the 2 biggies, I think, I think garbage predominantly, it's a labor conversation, and then we have secondarily an energy conversation. I think the industry has done a very good job of figuring out how to handle a pass-through on energy. Talk about where you are on your ability to absorb the labor costs through pricing, offsetting that inflation through the wage side? And where are we in either keeping pace with it or about to catch up and keep pace with it.

We took some really bold steps in early Q3 of 2021 to move wages pretty aggressively across the board. And in particular, in certain markets, you can think Atlanta, Georgia, as an example, where we just saw tremendous change. And that was, for us, exacerbated, I would say, because of the ADS acquisition and the timing of that transaction. So for us, what I would say is those actions in Q3, we feel like we've almost anniversaried the real significant labor tailwinds. And what's giving us confidence in that is that when we look at turnover stats, while they're not back to pre-pandemic levels and where we would like to see them long term, they certainly are off the peak.

So open positions are down, maybe not as low as you want, but they're down.

Yes, right. And retention is improving. And first year retention, we've talked about it all the time. And these are hard jobs. And first year retention is improving as well, but that's the place we've got to really move the needle.

Okay. So what I'm hearing is the rate of inflation is ebbed starting to ease the comparability. Where are you in the offset to it through the business model?

Yes. We started that activity, I would say, on about a 1 quarter lag. So you started to see the pricing activity more pick up steam in Q4 and really saw some of the strength of that with Q1 results, and that will continue for the remainder of the year. The year-over-year math can muddy it, but the go-to-market pricing is very, very strong, and that pace continues. Our rate resets on the revenue side, about 70% of those are completed through the first half of the year, and we've seen really strong execution there. We're seeing really strong receptivity from customers in the residential line of business, in particular for even 20-plus percent price increases. The residential line of business is the most labor intensive. And so when we look at the business as a whole, we're really happy with how we have done in terms of recovering cost inflation with price. That being said, when we look at residential, there's more work to do there.

Okay. And you did clearly see there was margin pressure in 3Q, it narrowed in 4Q, it narrowed again in 1Q. I suspect there's still some pressure in 2Q, and then maybe it's flattish to slight negative and then positive relative just to the inflation.

So Ed and I are going to take a really close look at that with Q2 results. When we gave '22 guidance, our expectation was a 100 basis points of margin compression in the first half of the year, 100 to 140 basis points of margin expansion in the back half of the year. With what we've done on pricing, I absolutely still believe that holds. The cost side of the equation is a question mark, right? And when we gave that guidance, we certainly didn't predict Ukraine and what's happening with fuel. The fuel impacts are about a 40 to 60 basis point impact to margin in and of themselves that was not accounted for. And then you have the alternative fuel tax credit impacts, which also will impact margin if those are inactive.

They will not, but to say -- yes.

They have not. We -- our current outlook would be that, that doesn't get fixed until Q4.

The other thing I would point out, Michael, is that on the cost side is the inflation we're seeing in Brent's business for our brokerage side, for the commodity side, that's impacting our margins negatively as well. Not part of our pricing activities, right? That's done completely separate, but we are seeing margin pressure from Brent's business.

And so -- and I want to disaggregate a couple of things. I mean, we've got an EBITDA number out there that I think you all are very confident in the dollar number. The dollar number is not moving and -- and more likely has upside to it than not. It's -- and so yes, there is this market focus and almost sort of slavishly on a margin number. I mean I think the industry gets that when there's pass-throughs, you got to show the market what they are, so they can and for a long, long time, everybody understood fuels pass-through, therefore don't freak out. For some reason, they seem to have forgotten that a little bit right now. But you will do that job. You'll disaggregate it, show everybody, here's where the starting number is, here are the puts and takes, and this is the pass-through influences versus the real true incremental cost pressure.

Absolutely.

And maybe when the dust settles, there might be some are not incremental, absolute there are absolutely are going to be headwinds related to pass-throughs.

Yes. What we try and do as a business because managing the business is about what we're seeing in sequential trends, not year-over-year comparisons. And we are really happy with our sequential trends, both on the cost side and on the revenue side. So we're doing what we need to keep pace with inflation and overcome it for the long term. What I can't make up for, though, is Q2 of 2021 was the very best margin quarter this business, I think, has ever had in its history. And so I have that year-over-year comparison. But what we look at is the fundamentals of how the business is performing and it's improving.

Right. And everybody should on the garbage business follow it sequentially because it's really the pattern of the recurring -- the operating leverage of the recurring revenue base. I'm not forgetting you, I'm on a whole conversation about recycling. I just want to knock all these things on the head. We still got 20 minutes. So I'll get to you, I promise you.

I'll try to get you to Brent, sorry.

Yes. No, no, I've got a whole conversation there. So the last piece is within the context of the business model, where are you in the opportunity for self-help, whether it's automation, it's -- what's calling an inning? Or is there a dollar number? There was a time you -- John, would talk about a dollar number, you had the sort of $150 million number that was -- this a couple of years ago. But where are we in -- and I don't want to revisit whether the $150 million is right or any of that. It's more of -- I think you have self-help opportunities. And not because you're badly run. I just think there's things you can do.

This is a business that is grounded in continuous improvement and hard work. And so that's what I would say that we call the self-help part. That -- I think the catalyst for that today is different than the catalyst for it before. I think the catalyst in the past was a lot of just knowing we can continue to run harder, smarter, faster. Now we know we can use technology differently. We know that labor is a different dynamic in this work environment than what we would have ever anticipated or have seen. And so the catalysts are what we're seeing in labor, we know that we can do some things to use technology very intentionally in order to automate certain parts of our business and the residential line of business is prime. In terms of innings, I would say we're in the very beginning of this next phase of self-help as you've pointed. In terms of what we've accomplished over the years, you go back to 2015 margins and look at where we are today, we've made tremendous progress. Can we repeat that level of margin expansion and efficiency from the business. That's what we're shooting for. I think, Brent, and this is probably a good segue because what Brent has accomplished in the recycling line of business, in particular with regard to what we can do with automation, really served to propel us down this path and seeing a 30% reduction in labor costs at certain of our facilities already is a good sign of things ahead.

Okay. We're going to ask that question. I have one just -- you had once talked to me about you would contemplate segmenting differently than regionally, which means your business would stand out. You would have a garbage recycling and then renewable energy. Is -- are we going to do that?

We're looking at options. What's difficult for us is if we do that, it would be probably solid waste in its totality because of the vertical integration of that business? And then can you carve out recycling and renewable energy separately. We're evaluating still too early for me to say whether or not we get there.

Okay. So let's talk about your business because there's 2 angles on the side of your business. I want to tackle. You are an enormous percentage of the disposal market. The marketplace often goes out, you're a slave to the landfill. It's got to go on the landfill. And I keep trying to disabuse them and go, all you really care about is that you control the collection. And you're completely indifferent to what you do with it. Talk about that part of that what you do with it in your model and the significance of what can be done, not only to improve the profitability, but to open up a window of if the customer says I want to divert and I'm a willingness to pay, what you're doing to be able to address that.

Right. so the material management section is what's really important to WM as we control material going into our landfills today, they have value could, they could be and should be in the recycling bin to gain the most value. And then we have our core recycling customers that currently have that material value. As we've already looked at this recycling business in terms of how we make money on it and not rely on commodity prices as we've gone to cost -- contracts have gone to a cost-based model. So we're essentially telling our customers, we're going to charge a processing fee. We're going to recover our cost to operate plus the margin. If there's money left over, we'll share that with the customer base. So there is still some volatility if prices go up or down in that share portion, but if prices are below that processing fee then the customer pay for those services. And so part of our flag is taken -- saying would be we want commodity prices to increase so that our customers can have profitable recycling programs. They can continue to recycle more material. And so that's where the demand stuff has really taken off recently, where we've seen states pass minimum content laws, states pass extended producer responsibility laws. And what this means is brands are now going to be required to use a certain amount of recycled material in their product and packaging that they put on the shelves today. You also see corporations have sustainability goals, which in the years past, they may have just been put out there, a nice to have. I think now investors are going to hold those corporations responsible and accountable for meeting those targets. And so we're getting those companies come to us and saying, hey, I need more recycled materials. So the demand we're seeing now is far greater than what we've ever seen in the past. And so that's why part of the equation on new investments really makes sense for us to do today.

Okay. So help everybody frame you're $19-ish billion revenue company. What percent of that is this business you run?

Yes. So it's roughly 10% today. We're going to -- we're growing that business as we have expanded our facilities, our footprint. We've got 3 facilities we've automated, a small, medium and large one, one in Raleigh, Salt Lake City and in the Chicago facility. Those are heavily automated facilities, and we've got about a year to 2 years under our belt to realize we can cut at least 30% labor out when we automate these facilities. The other 2 benefits are expanding the capacity and improving the material quality. So as we're rolling out this portfolio of automation in the next 3 to 4 years, we're going to see more opportunities for us to get more materials, to recycle more material, put that into the marketplace that fit the needs of those end users -- that had the high demand for recycling today, specifically on the plastic side is what we're seeing a lot of.

Okay. And I'm not trying to get too precise here. It's more of a price issue. So how about round numbers $2 billion approximate margin and then the opportunity to improve it?

Yes. I think that we've said in -- we released margin numbers?

No, not really.

My goal is to make the margin numbers, so they're accretive to WM margins -- is that fair? It's...

The good point to look at here, Michael, is that recycling business currently is the second highest return on invested capital we have in our portfolio of assets. So that's the way to take a look at it. But renewable energy is probably what we mean is going to -- might become our second highest, but we're investing money in the recycling business because it is great returns.

And that was the point I wanted to make. And the way you framed the question, I think what's really important is people think about the landfill network and the landfill business as being kind of the kingpin within garbage.

It's always focused on it being high margin...

Because it's high margin. When I look on the return on invested capital and we drive return on invested capital decisions within WM today, in a way that we should have been doing a decade ago, but we are better at it today in every decision we make and the return on invested capital in recycling far exceeds the return on invested capital in landfill. So anything we can divert to the recycling part of our business.

If that's true, then you have a mid- to high teens return on invested capital in your business?

So it's good enough that Devina has given us more money to say, hey, continue to invest in this automation, right? So that should tell the story there...

So everybody understands if there's $2 billion of revenue. What am I seeing is that EBITDA and cash.

And I almost think about as simple as this, right? Today, a water bottle is worth about $1,000 a ton to recycle. Why would we everyone put that to landfill at whatever disposal rate for a ton...

It's $50 a ton. Right. Is the cash conversion then percentage of the EBITDA better than the garbage business?

Yes.

Yes. And from a -- all-in garbage is about roughly $4-ish of capital for dollar revenue, $50 kind of equivalent is the way to think about alternatives to disposal? I mean, that's sort of the way to think about it is...

No, I haven't thought about it that way, and we can use more precise math to get there. But what I would say is that we think of it in terms of the recycling facility is it's a perpetual landfill. And so that capital investment will have a much longer tail in terms of revenue generation and cash flow generation than the landfill capital dollar does.

And they're less capital-intensive on a capital spending basis, too. So the percentage of -- so one of the things I keep saying when everybody else would be like, oh you are preserving your landfill, I said, you realize if you took 10% of the volume out of the landfill put it somewhere else, they put less capital in, they'll spend less capital, doing cell development, you'll end up with more free cash flow when it's all set and done.

Yes.

And all that's coming back to shareholders through dividend buyback and growth. I mean that's an absolute accurate statement, and I think there's evidence in that in improving cash conversion of the model.

Yes.

Okay. The other side of -- we don't really do Q&A, but the other side of the recycling issues is that there -- I agree with you. I've been reading sustainability reports for 20-plus years and for 17 of them, they said really cool things and never really had anything substantive behind it. About 3 or 4 years ago, pre-COVID, the tone changed. The recycle America initiative that started getting the signatories, you're starting to get legitimate public content commitments. And then a follow-on in saying we said, excellent, here we are. Would you agree with me that, that actually is a secular change in that marketplace that that's -- there is our true content commitment?

Yes, absolutely. You're seeing the highest level executives reach out to our highest level saying, hey, we're really serious about this. Where years ago would have been the procurement person saying, hey, we may put this in a report and nice to have this content. Now they're saying, we're building facilities, they can only handle recycled content. We have to have commitments, you guys can't fulfill those recycled materials on to build these new facilities to go into their new products and packaging. So I would say they're very serious about it today. And as we saw a recent trend up in plastic prices last year, a natural milk jug is worth over $2,000 a ton, right, more than aluminum cans were, that just showed you that the brands were actually going out and testing that supply chain to see how much can we get and what happens with the price as we demand more.

So there's 2 ends of this conversation about the success of this is you all have initiated an effort to educate the customer, and I want to tie this back to digital. It's sort of that 2-way communication. So I came back from IFAT last week. And one of the things that absolutely was clear there is that, that the European industry is working very aggressively at a almost 50-50 dialogue. It's -- they want you to talk to them as a customer as much as they're talking to you. Where are you in the reeducation of the contamination, that's part of your problem. And -- but the other part of it is, where do you need to be from a quality of the bail and where are we in that part of the model from a standpoint of being able to upsell the recovered materials as opposed to downsell?

So what we're doing with education now, and we've got a few pilots working on now, but we're finding out that when you give these customers new cards and when we go into new markets, education is critical, right? And there's a certain dollar per household that we'll have to spend on education and make sure that, that's recurring and they're putting the right items in the bin. We've also realized that through technology is we have to be able to handle a certain amount of contamination because that's just the way things are going to be, right? Let's just assume things can't get better. So when we do these investments, we're going to invest so that we can handle contamination. Now we're going to charge the customer appropriately for that contamination. Just part of the education campaign as well. On the outbound side, the material quality, China started years ago, right? They were the wake-up call to the industry saying, hey, we need cleaner material coming into our paper mills over here in China. And so the industry reacted to say, hey -- while China was the first one to come out, whether we're selling material to China, to Southeast Asia, into Europe or to Louisiana, the customers expect higher-quality material. That's what they're paying for, right? And so what we're doing is trying to separate ourselves and say, hey, listen, these new facilities can make a much higher grade of paper, much higher grade of plastics. We can actually send you the reports to show you how clean they are. In the automated facilities, the material quality is so much better now that we're getting a bump essentially in what we sell for on average.

Okay. Need to switch gears. We're running into the latter part of this kind, let's talk about this renewable energy issue. I'm all in on you who control the gas.

You say issue, I say opportunity.

Yes. I don't mean it pejorative. That wasn't meant to be pejorative. I meant it more as it's the flavor of the month conversation in the marketplace. That's the -- and I want to put it in perspective first is there's a real economic opportunity, absolutely, I'm all on board on that. What -- and you are an early mover announcing we're going to pick up the pace and take advantage of it. There's been a sea change in a market dynamic from my perspective. The development world is sitting on piles of capital, and they have to have development projects, you control the gas. I get doing it, but why not use other people's money?

We've done a really good job of managing our weighted average cost of capital. And I think that the returns on these investments justify using our capital in order to do it ourselves. And anything that we would do to use other people's money means that we're giving away some of that return. And I think what's best for our shareholders is ensuring that we use our capital to do things that provide great returns and are aligned with what our customers expect from a good, strong solid waste business over the long term, and that's doing what we can to manage the methane that's naturally produced from...

Is there a balance between some wholly owned and some like where you'd use -- I mean, they're literally your economics are, you're putting up very little incremental equity for a high percentage. I mean, it's 2:1 kind of ratio is going to 3:1, it might even get greater of equity versus the equity ownership.

We've looked at a number of different alternatives, and we will -- we're not closing the door on any of this. We'll continue to evaluate them, but we don't want to slow down our progress to evaluate third-party capital resources because we have capital available to ourselves.

Okay. So I'm all in on there is an alternative buyer of credits, that's a nontransportation buyer. What I can't figure out because I don't think there's just -- there hasn't been any meaningful contracts written. How -- are they committed really for the multiyear and that they're going to show up again and again and again, and you can keep -- next year you can write contracts and year after that, you can write contracts, whether they're 3 or 5 or 10 that takes out some of the volatility. And the nontransportation to me for the room would be institutions, utilities that don't have a renewable energy portfolio -- property managers?

So education, international -- and we have executed, we've already reported that we've executed 10-plus year contracts in those spaces because there are nontraditional buyers. What we're looking at, though, is how much of -- it's effectively like buying an insurance contract. You're giving away the volatility, having a level of predictability. And we think that, that's appropriate to some extent. We're in the process of evaluating how much of that we really want tied to those long-term contracts, how much we think is appropriate in spot markets and how much should be tied somewhere in between. We're evaluating that and the market's evolving as those evaluations are ongoing, but we're pleased with where we are with the portfolio that's being built.

So at its simplest level, if I go back pre-national -- or the middle of national sort as it was happening, you had a $0.06, $0.08 share -- earnings per share move for a $10 move in a commodity, right? That kind of volatility. I would hate to see us transitioning now you're down at $0.01 to $0.02, you've managed this that well that I've transitioned that volatility into it's in the energy book. Can we keep the volatility where it's a low number?

I think it depends. This part of our business is growing. We've talked about $400 million of incremental EBITDA by 2026. So volatility on that $400 million base. And I do think there's upside to what that reported number is. Volatility on that relative to the overall WM portfolio will still create some level of noise for the consolidated results, whether or not it's the $0.06 to $0.08 that we saw on recycling, too early for me to tell.

Okay. Is there -- there's no way to financially hedge this yet. Nobody has done that. Are you hearing of anybody who's starting to tackle how to financial hedge this?

I'm a purist there, and I know that I pay for that. And so I just struggle to give someone else, my shareholders' value. And so we'll contemplate that. And if the markets get deep enough that the premium to give away the volatility...

It comes out as a low friction cost, yes.

If we can get there, it will definitely be something we evaluate. But Brent and I have worked together for 20 years, and there was a point in time we had a trading desk for our recycling part of the business and it never made any money. There's a reason. And so...

You told that to coke industries. They're still doing it.

Yes. But we'll continue to evaluate those things -- but -- if we have to pay too much of a premium for the value we're creating, at some point, I do think that there's a way for us to recognize that the cash flow generation of the solid waste business provides tremendous support to some level of volatility to a smaller part of our business.

Right. Yes. I agree to at low friction. I was just more curious, is anybody starting to actually have a conversation that they might start creating financial instruments.

We're not seeing anything that has any depth.

Okay. Last conversation we have to have is that you -- we've touched on without calling it that you've accelerated the spend around both these topics. There's a lot of consolidation going on in solid waste right now. You all are participating in this just at a more muted level. I mean, we're not missing the natural buy, the tuck-in that ought to be the densifying of some market.

We're certainly not missing tuck-in opportunities. There will always be a part. We have a board member who says that that's the favorite -- his favorite dollar that we spend, right? So we are certainly focused on ensuring that we are part of those tuck-in conversations. The place that we are struggling right now is a lot of those businesses are up for sale because they're having labor problems and they're having contract compliance problems and buying someone else's problems is something that we're going to be careful not to do.

Okay. But you can be -- you would buy them if you can buy them right. That's you're not, I mean you know...

Absolutely.

I had an opportunity to spend time with Joe and he says he's busy. So I'm...

He is certainly busy.

Yes. Okay. So you're not doing acquisitions, you're just being very picky about because it's back to the returns analysis.

Absolutely.

Okay. Well, we've exceeded our time and I've been doing that all day.