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

Everyone, thanks for joining us. I know this is the slot read before lunch. So good time always -- as always, talk about waste. We're joined here, as you know, we have 5 of the public waste companies. And today, we have the industry leader, Waste Management joining us.

And I think maybe just to kick it off because there's a lot to unpack in the story. I think with Waste Management being the industry leader, maybe we can just talk about what investors should normally expect through cycle for Waste Management in terms of what some would call like the algorithm for the outlook. So in 2019, you guys hosted an Investor Day. I know you have another event coming up in April, which we'll get to. But in 2019, Waste Management had its first Investor Day in like a decade. And you provided this long-term outlook of revenue growth, I think it's 4% to 6%, EBITDA growth, 5% to 7%, free cash flow growth, 5% to 7%. Obviously, since 2019, we had pandemic. We've had a spike in inflation. So just when we think of the guide rails of how Waste Management manages their business through cycle, how should we think about it now, especially after we've seen higher-than-normal inflation?

Yes. So I would say it's you framed it, right, since we offered the outlook, we've gone through a -- or suffered to a pandemic, and we have had historically high levels of inflation. And throughout all of that, we were actually able to deliver on the higher end of those targets, right? I think we did that because we were very disciplined about using pricing to offset the impacts of inflationary costs. We try to expand our margins that way. We were also differentiating our service offerings during that time to really try to drive volume growth. And I think you can add to that, that about 5 years ago, we really began to invest heavily in automation and optimization and technology in general. That was sort of the catalyst behind being able to do what we did, which was really remain keep our margins from the grading during those tough time periods. I think to answer your question specifically, I would say I wouldn't think of our ability to deliver any differently in a recessionary environment.

I think it really speaks to the strength and resiliency of the underlying fundamentals of the business model. If you think about all that we've been through in the last 3-year time period to deliver results like that. Looking forward, we're really well positioned for whatever comes next.

And just to quickly follow up, is the components of how we get there slightly different, maybe just volume versus price, if you kind of touch on that a little bit? Because you were saying how you guys were growing volume in that period. Now it's much more price-focused. Just curious if the makeup of that shift has changed at all?

Yes. I think that there's a couple of things we learned through the pandemic which if you think about it as sort of a parallel to a recession, actually, much more compressed to a time frame, right? And so what we learned is that, one, more than ever, we reaffirmed the word central business, the always business and essential business; and secondly, that the volumes within our own enterprise will shift, and we have to be very nimble in being able to capitalize on which pockets the volumes are going to come from, i.e., residential versus commercial versus industrial. I think how you look at our pricing is simply we got to be disciplined across all those lines of business. And you've actually seen us step up our residential pricing meaningfully and reeducating municipalities, in particular for that index-based pricing on what it really takes to receive the quality service they expect.

Makes sense. And since you just brought up pricing, I mean, Waste Management reported some of the highest pricing in the company history. Pricing typically breaks down into the open market and then you said like index. So when we think of those 2 buckets, how are those buckets trending when we are exiting 2022 into 2023 and maybe even some visibility on that index side for 2024.

Yes. So banner year in '22 for us, generating about $1.1 million, actually a little bit north of that $1 billion in core price. Really for '23, we expect to get near that mark. Again, it's going to be necessary for us to do that in order to not only cover inflation but also begin to expand the margins, right? If you -- for the core price on a percentage basis that we're building into our -- or we've built into our plan is somewhere between 6.5% and 7%, yielding about 5.5%. To your point about the different types of business that we have about 60% of our business, which is open market and about 40%, which is index-based. The index-based portion of our business is expected to be a tailwind in '23 because of the high levels of inflation in '22, not so for the open market that we see moderating, particularly as inflation eases on the backside of '22 -- I'm sorry, of 23%. So if you really think about it, that index-based pricing is expected to contribute about 5.5%, right? So that means that what we -- that remaining 60% of the business is expected to contribute higher than that level of the average.

And are you seeing any -- on that open market because that does -- that's not index based, you have to go out and get it, and so far, it's sticking. Are you seeing any pushback so far in some of those price increases that you guys have been able to put this...

Really, our rollbacks have been an all-time low throughout '22, and we don't see that changing so far in '23 either.

I just want to just as we wrap up the pricing discussion because sometimes it depends on the week if inflation is rolling over, if inflation is accelerating. But if we do see, as we go to 2024, and I'm not asking for guidance, but if you do see that CPI start to moderate, inflation moderate, what do you do on the open side? Are you still pushing price? Obviously, not maybe to the same degree? Do you give it back? How should we think about how pricing in more of a normalized environment?

Well, we're not going to give price back, anecdotally, that's not something we're going to do. I think there's a couple of things that we haven't talked about in the -- in our pricing dynamics that are also important from a fundamentals perspective and landfill pricing. You've seen what we've done on landfill pricing over the last several years, and we absolutely think that's something that's going to continue. We view these assets as very unique, and we're seeing declining landfill capacity in some markets. So that's something that fundamentally will continue. And then on the residential side, we've been very prescriptive about shedding unprofitable contracts. And also while we're doing that, we're really pushing price so that we can grow our margins and recoup our investments in that more capital-intensive business. Those are all things that are going to continue in any environment.

I would say too that over the last few years with our investment in digital and in technology, we've really pushed data and analytics hard. And so our decisions on pricing are much better informed and really drive customer lifetime value so we can deliver the dollars not only this year, but keep on delivering them moving forward.

And then just the part of the pricing discussion always has to come with cost, right? So obviously, labor is one of your biggest costs. But just curious what you're seeing on the inflation side as you kind of exited 2022, as we start 2023, any signs of inflation easing in some areas, still stubbornly high, accelerating? How should we think of some of those buckets on the cost?

So I'd say that in Q4 last year, we began to see inflation ease in some of the major categories, particularly direct labor. We probably -- I think if memory serves me right, we had about a 30 basis point improvement on that -- on the OpEx side. Where we saw it continue to linger stubbornly was in maintenance and repair costs and then subcontractor costs. And exacerbating the piece of the maintenance and repair comes where supply chain issues really caused us to not receive more than 57% of our usual allocation for fleetlink placement. So that was difficult. We see that moderating throughout the course of the year. The majority of the impact of inflation we see happening in Q1. And then with sequential improvement the balance of the year for a total of about maybe a little bit over 4% is what we think the impact of inflation is going to be.

Makes sense. And then Terry, we have a big day coming up in April. Waste Management is making a big effort growing and really building out verticals that are related to solid waste with investments in recycling and renewable natural gas. Last you guys outlined at the time of $1.8 billion growth CapEx figure over the next few years. I think we should try to tackle it in 2 buckets. So maybe we'll touch on recycling first. How big is out of that $1.8 billion is going to recycling? What type of investments are going there? And what can we think we can yield from those investments to the bottom line for EBITDA in the next few years.

So first off, I love the way you framed the question because unequivocally, these businesses are our core business. They are related to our unique asset base. The recycling business is something that our customers are increasingly demanding, and we think those trends are going to continue long term. And our renewable natural gas business, we've been in the renewable energy game for really almost 40 years. And so this isn't new to us. This is where we're optimizing something that happens at our assets in a way where we can drive meaningful value for WM. So what we announced in our Q4 earnings call is actually a $2.2 billion investment from '23 to '25. And the way that unpacks it's $1 billion investment in recycling and 1 point -- a little over $1.2 billion on the renewable natural gas side. On the recycling side, that $1 billion investment is going to really transform over 43 facilities across our network, and 31 of those will be automating existing assets that we have today and 12 will be investments in new markets. And what's exciting about that, that $1 billion investment, we believe, will generate $240 million in incremental EBITDA by 2026. And that incremental EBITDA from the investments that we're automating, we're going to get some of that benefit from labor savings, and we're seeing labor savings of over 30% at our automated facilities, better revenue quality. And those are pockets of opportunities that operate independent of any commodity price environment. And then on the new market side, this is a great example of where we're capitalizing on broader trends, not just in the recycling space. But if you think about how people have moved over the last 3 years. The example I always use, we're making an investment in Fort Walton Beach in the Florida Panhandle. During the pandemic, we had folks who were moving from northern states to southern states, northern states that have recycling as a service they get to these new locations. There's no recycling, no recycling infrastructure, and that's an opportunity for us to develop assets where we can differentiate WM and drive greater share in our more traditional core businesses.

Yes. You touched on it. I'm curious if you can kind of flesh it out. Obviously, the commodity portion of recycling has kind of gone down 50%, 60% in just a few months period. So it's kind of at a 10-year low bouncing on the bottom. So I'm just curious, how has Waste Management restructured maybe recycling to be able to make these big investments even at these low levels of commodity prices? And what are you guys seeing on the commodity price? Do you see that recovering through the year? Do you need that to justify some of these investments?

So this is where I love myth-busting this a little bit because WM today, our recycling business is profitable. And one of the reasons it's profitable is because over the last 5 years, we've been very intentional about fixing the business model to be a fee-for-service model where we get paid for our processing first. And we have a lot of proof points on that. But in 2017, as an example, commodity prices were 60% higher than they are today, but our 2023 expected EBITDA will be 13% higher than what it was in 2017. So we've fixed the fundamentals of the business, over 85% of our contracts operate in a fee-for-service model and what's left are just longer-term agreements as they roll, we will be fixing them as well. So that really underscores the fundamentals of us investing in the business along with what we're seeing broader sector trends. CPG companies who are increasingly interested in circularity and decarbonizing their platforms, and they want recycled content back. We've seen minimum content legislation get passed in California and other states, and companies are not going to build their supply chains solely for California, and there's going to be a halo effect across all of North America. And we're really, really optimistic and bullish on the demand for Recycling-as-a-Service. So it's not just about these facilities that we're investing in. We're also using this as a platform to partner with customers on recycling as a service on the collection side as well.

Maybe one add on to that. I think some of the upside on that line of business is also tied to extended producer responsibility. And a lot of the legislation is pushing in Canada and some other states, California, like -- made in the United States, it's considered a Fee-for-Service model. So it plays right into the strategy to begin with.

Can you actually just flesh that out why that matters? Because we're hearing -- we had a panel yesterday with a bunch of different players from Dow to AMP Robotics, talking about that there does seem like there's a little bit more of an inflection point happening, I think probably coincides with some of your investments. So how does some of this legislation actually help drive this to be more of an economic model rather than just doing something for ESG purposes?

Well, recycling only works if there's demand for the product. And I think because you had this panel, those entities all are driving the demand curve. If you think about millennials today, they care about the products that they buy and the content of material that's in them, and they will make decisions with their wallet based on that and CPG companies are seeing that. So we're having those same conversations how can we capture more material. And our automated facilities, they help capture more material that would have otherwise gone into the residue. So if there's sort of stranded recyclables in there, we're much more efficient at capturing them. And we can also be much more nimble as this evolves and it's going to evolve, really using that equipment to search for other material types. We're investing in automation. We're also investing in film recovery as an example because we know film is something that doesn't have a whole lot of solutions today, but companies like Dow are looking for it and we have an arrangement with them where in Chicago, they're taking our film that we're capturing from that market.

Yes, they mentioned it yesterday, how be able to secure that feedstock is really important. For solid waste, which is normally viewed as like a very mature industry. There's a lot of buzz around landfill gas to renewable natural gas as a growing market. Why -- just help for people that are new to it, why are we now starting to hear about this? Why didn't we hear about this 4 or 5 years ago? What's been the inflection point to drive your investments? And why we're hearing a lot of other waste companies stepping up on these investments and projects?

Yes. So while there's been a lot of buzz over the last 3 to 4 years, I think what's important to note is WM has been in the renewable energy game, like I said earlier, for over 40 years. We have a network of landfill gas to electricity plants that we've had for close to 30 years now. And we built our first renewable natural gas plant back in 2016, and that was really when EPA first came up with this framework to basically tie the production of renewable fuels from biogas like landfill gas to transportation fuel and generate a RIN and that sort of lifts up the economics for investment. For WM, what's very unique to us is we have 4 things that no other company has. They might have 3 of the 4, but not 4 of the 4. And first off is we have the largest network of landfill gas -- landfills in North America, that's number one. Number two, we have the largest fleet of compressed natural gas vehicles in the United States, and that's just not in the waste sector, that's in any sector. So we're able to close the pathway and retain 100% of the value. We have a team that knows how to do this. And like I said earlier, we built 4 of these plants. We understand the economics. And those plants have transformed to the landfills that they're on. And then finally, we have the balance sheet. We generate a lot of free cash flow as our investors know, and we can put that cash to work in very high-return projects. These projects generate returns in 3 years.

And maybe you could just flesh out how much -- how many projects you're doing part of your governance range? How much incremental EBITDA you guys are kind of expecting to yield from that?

Sure. The over $1.2 billion investment over this really 3-year time horizon, will generate in 2026, roughly $500 million in incremental EBITDA. And if you think about it today, we have now we say 5 renewable natural gas plants because 1 of the 20 in our investment portfolio came online at the end of 2022. But really 20 new plants. We had between 3 million and 4 million MMBtus of gas when we started on this journey and incrementally, we'll be adding $25 million. So you can imagine huge scaling, 8x the MMBtus that we really started well within 2021.

And has -- the framework you've just provided, obviously, since you announced these plants. We've seen wind prices kind of roll over a little bit from the $3 to [ $195.2 ] range. Natural gas prices have kind of rolled over. Has that changed any of the return criteria you guys were expecting, the payback? Has that shifted the discussion in terms of who would want to buy, who would want to consume this renewable natural gas?

The short answer is no, because our returns were predicated on $26 per MMBtu, which is roughly a $2 RIN and $2.50 natural gas pricing. And I want to be clear that $26 per MMBtu is meant to be a longer-term number. So we know that there's going to be ebbs and flows that occur in any commodity business. But looking at the fundamentals over that time horizon, we think that that's a number that can be shored up. And I think what's important to note is we have this transportation pathway that you mentioned in RINs, but there also is this emerging and likely robust voluntary market. Where if you think about it, large colleges and universities, large public utilities that have no way to move away from traditional natural gas but are looking for a low-carbon alternative, they can buy our renewable natural gas in longer-term contracts, and we're seeing very strong pricing there. So there's multiple markets that can be tapped into.

So you're saying that they're willing to pay a premium to what normal natural gas is because...

They're willing to pay a significant premium, like we're talking 5, 6, 7x depending.

And these contracts would be 10-, 15-year type...

It really depends. So there's a range.

Right. So I guess the question I want to get to is -- not to get too in the weeds, but you mentioned RINs, which is transportation, there's also something coming out. There's a proposal with E-RINs. Can you kind of explain what that is? How that fits into this whole discussion on landfill gas to renewable natural gas?

In our earnings call, our CEO said, our renewable energy business is good, very good or great, and E-RINs fall into the great category. So what an E-RIN is -- if you take our landfill gas and generate electricity from it, and you can show that, that electricity goes into a light-duty electric vehicle like an electric car, then you can generate an E-RIN and E-RIN based on EPA's proposal would be roughly the same value as a conventional RIN. Why is that important to WM? Well, we have 66 legacy landfill gas to electricity plants that we invested in years ago. And so we could generate a revenue stream through that e-RIN pathway with no incremental CapEx, and was -- that was not in any of the guidance we provided in our supplemental deck in -- at the end of Q4, although we're going to unpack that a little bit more in April.

Fair enough. And with these big investments we're seeing, is there any view on adding other verticals as waste management grows? So you have a small business of hazardous waste you're a bigger player there. There's always been discussions on medical waste and layering it on. Is it -- are these sustainability lines the focus? Do you see something in a couple of years multiple verticals to the overall environmental services portfolio?

Well, as you can imagine, we get contacted all the time about different sustainability-related businesses. And right now, if you think about what we're trying to tackle with that $2.2 billion investment, we're very focused on renewable energy and recycling. We do have a haz waste business, and that is something that's growing. So it's part of our portfolio today. We're going to focus on really strategic tuck-in acquisitions in certain geographies. And then we'll look at the fundamentals related to other verticals. But for now, I think we have a lot on our plate with those 2.

And I just want to -- just to button up the RNG discussion because it's such a big topic right now. Is there any risk of -- we just saw BP by Archaea Energy. So you're seeing big traditional guys coming in. We're seeing big CapEx announcements. Sometimes investors look at that and go. Are we getting to a peak? Is there going to be too much supply for demand? How would you answer that if we're starting to see a lot of these landfill gas projects, a lot of RNG supply coming on stream? Is there any issue of that outweighing the demand for some of this?

If you look at landfills and if every landfill developed a renewable natural gas plant, it would only represent 1% to 2% of the demand for natural gas in the U.S. So I think -- and we all know not every landfill is going to be developed. So I think it gives you a perspective that this is still a pretty small piece of the energy puzzle. It's an important piece. The other thing I would say is on those acquisitions that you mentioned, the key that we've always thought about is, this is gas that's coming off of our assets, so we control it, and we think we can drive outsized value from it, which is why we've made the decision to retain the business and build it out ourselves.

Makes sense. And I just want to touch on something you brought up earlier is, the waste industry is kind of viewed as technology light. You mentioned some robotics and some sorting. I've been to some MRF, not yours, and it's a blast from the past in some regards. So I'm just curious in terms of some of the investments you guys are making, how does that change the way the industry kind of operate? Where are you kind of seeing the low-hanging fruit guys going forward on that?

Yes. I think, quite frankly, the monitor of having a technology light industry is probably adequate or it was maybe 5 years ago. I think WM was at the forefront of sort of deciding that we needed to change that in and sort of create a pathway where we're going to enhance technology, digital space for us. You mentioned some of the mechanical, maybe physical aspects of automation and optimization, robotics, conversion of real loads to, for example, automated side loaders and the like. And we're down that path. I think if you've listened to the earnings call, Jim reaches a lot and rightly so about reducing our dependency on labor, right? So we aim over the next few years to reduce somewhere between 5,000 and 7,000 jobs that are, quite frankly, there are jobs that are turnover jobs that are very difficult to fill, and the people don't want to stay in any way. That's going to allow us to upscale some of the labor for that won't still remain with us, and it's going to reduce our cost to serve. The other piece of that is the more data-driven digital aspect of that. And we've invested heavily. Like I mentioned earlier, on customer lifetime value analytics, right, but we also have some investments on sort of end-to-end routing optimization, that is going to ultimately reduce or enhance our efficiencies, reduce our costs and allow us to generate capacity without necessarily adding trucks.

Makes sense. I mean, in 2016, I think the EBITDA margins on the headline for Waste Management was 28.3%. Consensus is kind of forecasting 2.5% this year. So the margins have stayed in this tight band in the last few years. You've gone through a pandemic, a huge surge in inflation. So based on just the investments you're seeing, should we be thinking margins are going to start to break out as we yield some of these investments?

Yes, that's a fair statement. I think just a slight correction. So in '16, I think the margin was actually like 27.2%. But your point stands, in '18, it was 28.3%, right? We went through the pandemic, and we went through the historically high inflation. We were able to keep those margins flat. I think we were able to do that because we've got some pretty strong business processes. The investment in technology has been really good. And the other thing I will add to that is that we've been -- we were able to do that sort of looking ahead to what was going to be a war for talent, quite frankly. So we invested heavily during 2021, 2022 on our people. And we introduced programs like Your Tomorrow where our employees can essentially further their education cost free to them and their relatives. And so seen that begin to translate in a higher level of retention for us and a higher talent level. Those kinds of things have no other way or nothing but to do but to enhance our margins moving forward. I will point a couple of things out. I know we're very short on time.

Go ahead.

Couple of things that during that time spend have are worth noting. One is the investment in digital and technology. That, by necessity needed an incubation period that we're going to see start paying dividends in '23 and '24, for sure. The other thing is that the ADS acquisition took place, right? And we knew that the ADS acquisition was going to drag our margins back, our EBITDA margin is about 350 basis points. And while we were able to execute very well and capture all of the synergies that we have forecasted, the one thing that we were not able to do fully and we haven't yet is really upgrade the fleet to the standards that we are used to. And part of the reason for that has been the fact that supply chain was so tight. And we only received about 80% of our truck allocation in '21, and about little less than 60% in '22. So as that begins to free up, and we're expecting actually 1,900 trucks in '23, which is going to be really good. You're going to see those costs ameliorate.

Perfect. And with that, I think we're going to wrap it up. They're around, if you want to come by, and if we missed any on the Q&A, please come down and ask questions. And I want to thank Waste Management again for being here. Appreciate it.

Thank you, Michael.

Thank you.