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A Note From The Editor:
With three of the top four solid waste companies having reported fourth quarter earnings, in this month's edition of the Circular File we recap the 2012 outlooks and our thoughts. Although the crystal ball was murky going into the reporting season, the outlooks and the accompanying conference calls did not provide any great surprises after all.
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Pricing Expectations Muted, but Volume Outlooks a Bit Brighter
Republic Services and Waste Management offered similar overall pricing guidance. Both companies gave expected ranges of 1 percent to 1.5 percent for price, and in both cases, the second half was expected to be stronger than the first half. For Republic, the first half is expected to look similar to fourth-quarter levels (sub 1 percent), but an uptick in the second half was expected as CPI-linked pricing at a number of its larger residential contracts should increase. Waste Management forecast that pricing for the year would be around the 1.4 percent recorded in the fourth quarter, but noted that a portion of the negative first half impact from the expiration of power and tip-fee agreements at several of its waste-to-energy plants would anniversary in the second half. Waste Connections, as anticipated, forecast the highest pricing, at around 3 percent, given its higher concentration in franchise markets and less exposure to the more competitive urban markets.
In general, the residential and municipal contract business was again cited as the most competitive, but continued competitive conditions in the small commercial container business were also noted by Waste Management, which is still seeing a higher level of rollbacks to retain profitable customers. Overall, all the major players are balancing price increases with retaining high margin commercial customers, as the recovery on Main Street remains sluggish. Waste Connections had the most conservative volume forecast — negative 1 percent to flat — as it remains concerned about the sustainability of special waste projects, while both Waste Management and Republic guided to an expectation of slightly positive volume, with Republic forecasting up 0.5 percent and Waste Management flat to slightly up. Both mentioned better sequential trends and improving comparisons in the underlying municipal solid waste (MSW) volumes, with industrial volumes having turned positive for Republic. Nevertheless, MSW is the bread-and-butter business that must turn positive for a sustained volume recovery.
Recycling A Headwind, Largely as Telegraphed
At the time of the conference calls, waste paper prices were off between 15 percent to 20 percent from the 2011 average, but were up about 5 percent to 10 percent off the fourth-quarter bottom. Republic and Waste Connections budgeted off December/January levels, and the 2012 headwind was forecast to be very similar to what analysts (and the Circular File) had telegraphed, roughly 9 cents for Waste Connections and 7 cents to 8 cents for Republic. Waste Management is looking for a more normal seasonal rebound in recycled paper prices after the spring, and it forecasts that 2012 pricing will be down on average $15 to $20 per ton (or 10 percent to 15 percent) from 2011, and estimated that would negatively impact the company by 3 cents to 5 cents per share in 2012, most of which would be in the first half. Although fuel will be up in the first quarter on a year-over-year basis, the relative stability of fuel in the second half of 2011 seemed to put this input on the back burner of concerns for 2012 (at least at the time of the conference calls.)
Margins Under Pressure So Earnings Growth More Anemic
With price forecasts that are below headline Consumer Price Index (at least for Republic and Waste Management), combined with the recycled commodity headwind, margins are under pressure this year. Without successfully executed offsets, margins are likely to be down. Waste Connections, with very high and consistent margins, and already running a very tight ship, indicated that margins are likely to be down 50 basis points in 2012. Republic Services guided to flat margins, but acknowledged that a number of internal productivity improvements would be necessary to maintain margins. Although Waste Management does not provide margin guidance, the inferred margins are also roughly flat. Although Waste Management should have positive offsets to the above-mentioned headwinds with its cost-reduction initiatives begun in 2011, a number of contract renewal issues and maintenance costs at its waste-to-energy subsidiary are expected to cost the company another 4 cents to 6 cents per share in the first half of the year, and as a result, its projected earnings gains are back-end loaded.
The net result of all the above is that the guidance from the two largest companies indicates earnings growth that is in the mid-single digits. Waste Connections' earnings growth is expected to be stronger, by several points, given the incremental benefits from its acquisition program in 2011, which has a rollover effect in 2012.
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Free Cash Flow Lower Assuming the Expiration of 100-Percent Bonus Depreciation
Across the board, free cash flow was ranged down from 2011 results. The primary culprit behind this is the negative impact from the expiration of 100-percent bonus depreciation, which if excluded, would imply expectations for very modest free cash flow growth. It was apparent that management teams were attempting to quell any speculation of upside in the event that 100-percent bonus depreciation is once again extended. The message seemed to be that if that extra cash again became available, it would likely be ploughed back into capital expenditures (capex), although only Waste Management noted that explicitly.
Capex Budgets Still Robust, and No Pullback in Recycling
Although free cash flow is forecast to be down, capex budgets for 2012 remain robust, generally up, with only Republic expected to be down marginally. Once again, the focus with regard to the fleet remains compressed natural gas (CNG) powered trucks, which will drive most fleet spending. Despite the decline in recycled commodity prices, the other major capital expenditure focus is recycling facilities — underscoring not only that these facilities continue to generate attractive returns, even at these lower commodity price levels, but as importantly, it is what the customer is demanding.
M&A: All Eyes on Veolia, But More Activity in Smaller Deals Also Expected
It remains too early for any meaningful update on the sale of Veolia's North American solid waste assets, and the companies' standard reply to any Veolia question was "we will remain disciplined buyers," with the hint that a private-equity player was likely to pay more in the end. However, all three have acquisition budgets — Waste Connections has confidence in at least achieving its normal $40 million to $60 million in acquired revenues, Republic has targeted $50 million to $100 million in spending and Waste Management $150 million to $250 million — but all stressed tuck-ins and recycling assets, and in the case of Waste Management, more processing and/or emerging technology investments.
Below are some articles from Waste Age which may be of interest:
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We Want to Hear From You
We would like your feedback, thoughts, suggestions, etc., as we create future issues of The Circular File. Please send questions or comments to rita.ugianskis@penton.com or lyoung74@comcast.net. Your input will be invaluable.
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