Waste Connections, Inc. (WCN) Earnings Call Transcript

Hi. Good morning, everyone. Welcome to the UBS Industrials and Transportation Conference. This is Jon Windham. I head up alternative energy and environmental services equity research here at UBS. And if you've joined us, you've joined the fireside chat with Waste Connections. Very happy to have with us today, Mary Anne Whitney, the CFO of Waste Connections, a position she's held for the last 2 years. And she'll certainly correct me if I'm wrong, but I believe all in all, has been in the Finance Department of Waste Connections for almost 15 years at this point. So she's well versed. I'm sure many of you on this call would have met Mary Anne at some point over the last few years as she's often been the face of Waste Connections with investors pretty consistently. Before we get into the Q&A, just to let people now who've joined through the website, there should be a functionality that you see on there to ask questions. And so I'll get it started with the first few in the conversation. And over the course of the 40 minutes, if you submit questions, I will try to get to them as time permits. So with that, Mary Anne, thank you very much for being here.

Well, thank you very much, Jon. And on behalf of Waste Connections, thank you for the opportunity to participate in the conference, and we're delighted to be here.

Perfect. So I got the 15 years right, then?

You did. Yes. Thank you.

Okay. Perfect. And maybe just sort of starting off before we sort of get into too many specific questions, like, give you just an opportunity to sort of level set around -- obviously, you gave a lot of information during the 1Q results on the impacts of coronavirus. Now as we sort of move into this next phase of sort of opening up, just wondering if you could help sort of level set people on where Waste Connections is, any updates on sort of more recent sort of trends and how Waste Connections is dealing with the business volatility.

Sure. So that's a great place to start. And it's amazing how long ago 1 month ago feels, but that is when we reported and we talked about on our Q1 earnings call, from a business standpoint, where we've seen the revenue impact from COVID-19 and how it's impacted our business. And we described the fact that it's primarily related to the decreased demand for collection and disposal services resulting from the closure restrictions, of the shelter-in-place orders, which, of course are varied by geography, by market, by our mix of business. And we talked about the fact that those impacts began in March as commercial, primarily commercial activity slowed down due to service reductions or in some cases, outright suspensions of business. And that the slowdown was most pronounced for us and our -- in our model in the Northeast of the United States in markets like New York City and also in Canada where you had province-wide closures. And so we then also, on that call, provided our April results, given that April was the -- what we saw as the first full month of impact. And we talked about revenue being down about 6% year-over-year and went further to breakout, to say it was about 1 point -- 1.5% down, excluding those most impacted markets. And really, what that suggested is that volumes were as low as negative 20% in those most impacted markets as compared to down about 6% to 8% in other regions of ours where we were less affected, and those would be the more suburban and rural markets, which didn't see that same kind of closure activity. On that call, we talked about the trends that were encouraging to us, where we had been tracking for the past several weeks going into that call. And now we have another 4 weeks of incremental information. And what I'd say is the trends that we found encouraging as of a month ago have all continued. And so we're seeing nice momentum. For instance, the commercial business, where we track competitive markets and we had said customers were starting to come back, I think about 11% of customers of the business was back when we talked a month ago. We now have about 1/3, about 32% of accounts, representing about 25% of revenue has come back. So meaning in markets where they had suspended or reduced their service, they've now increased and brought back some of the business, so about 25% are back. And then the 2 real-time indicators of the business, roll-off pulls and landfill tonnage, we gave folks the peak to trough activity. So roll-off pulls were down 17% of the trough, and they've since recovered about 11%. And therefore, they're still off 7% to 8% from the peak. And landfill tons, which were down about 13% at the trough, have recovered about 12%. So it is mostly back, down still 2% to 3% from the peak. So again, encouraged by the continued recovery we're seeing in each of those areas and also by the breadth of the recoveries. As we said on our call, about 70% of our locations, and we have it slightly higher than that now, have shown improvement off of those troughs.

Okay. Great. And maybe just to dive into a little more. I want to sort of talk through how investors should be thinking about, first, the revenue side, and then we'll get to the cost side in a moment. But on the revenue side, I think a lot of people, at least in their minds, have this idea that there's going to be a significant pause in terms of price increases on the commercial side, at least one of your -- the other -- one of the other large firms within the industry is actually giving 1 month of no fee service to specific commercial customers that were heavily impacted. How should we be thinking about commercial pricing on one side in terms as we get back to normal, assuming we are? And then two, with the increase in residential volumes, is there an opportunity to maybe push harder as contracts roll in the residential side? Just wondering if you could talk a little bit about those 2 things on the revenue side.

Sure. So maybe I'll take it in reverse order. So you mentioned the residential side, and what people have talked about in the industry is the fact that on the residential side, we're -- you're typically paid a fixed monthly amount for the service. And it's not volume dependent. And what you've seen, given the number of people working from home and the dynamics of less activity at commercial establishment, the more coming out of residentials, you have more -- higher weights on containers on the residential side. Interestingly, other companies have put more of a focus on this than we have. We have seen those container weights up, but perhaps not to the same degree they have or perhaps that was in a line of business where I know at least 1 of our competitors had already earmarked it as a place they wanted to focus on price increases for a variety of reasons, including recycling and just core quality of revenue in that particular line of business. So again, from our perspective, we've seen slightly higher rates. Interestingly, you have offsets from lower rates on commercial. So it's not as though disposal is that much of an issue. But I think to your point, Jon, which is, can you recover any of those costs to the extent there are any change in the dynamic, how do you go about recovering it? And I would say, first of all, in our model, we had to have a couple of levers that we can pull and one is that there's a portion of that business which is subscription, meaning we're not limited by a contract. And therefore, when we deem it appropriate, we have the flexibility to impose incremental prices there. And then the other mechanism would be that there's a portion of our residential business, which is on the West Coast in return-driven markets. As you may recall, a portion of our franchise or exclusive business has a return component. And so in the aggregates, between those 2 pieces, there's about 40% of our residential revenue where we have the flexibility, either in the current environment or next year in those exclusive markets, where we're entitled to higher pricing when we have cost pressures that we have absorbed this year. So next year, we could see slightly higher pricing in those West Coast markets to the extent we're hit with higher costs. So that's the residential piece. On the commercial side, the commercial side, what you're seeing there in terms of pricing is -- sort of to take a step back, just recall that most of our pricing was already done coming into the year. And that is because of the way we approach pricing. And I'll just do -- to take a step back, we guided to pricing of around 5% and we typically think about it in the aggregate as opposed to by line of business. But we traditionally have a price-driven organic growth strategy. And that's no different this year. And in fact, we've been coming to a period of arguably outsized pricing, given the headwinds from recycling and labor pressures and other cost pressures that we've talked about in the past few years. And the reason I mentioned those prior headwinds is because about 40% of the pricing you see in 2020 is rollover contribution from last year. The next biggest bucket is the price increases we do in January and in Q1, which basically takes you to about 85% of our PIs, our price increases, being done by the time we exit Q1. And I mentioned all of that because you asked, Jon, if the environment changes on commercial pricing given what's going on. And I would just point out that most of the pricing is already in place. To the extent we have some price increases scheduled, arguably for Q2, what we've said is that in the depth of a pandemic, in all likelihood, we wouldn't be putting through the same level of price increases. So we might push them out for later in the year or forego them in this environment. And for that reason, we said, rather than think in terms of 5% total price increase in 2020, we were thinking more in terms of 4.5%. So in terms of your thinking high level in terms of revenue contribution this year, I would encourage people to think of 4.5% pricing and then we gave potential full year numbers of $5.25 billion, which implies that the negative volumes we're seeing in Q2 that we talked about on our call that we put April at around negative 12%, we're suggesting that as the economy opens up and the shutdown orders are decreased, we would see increase in activity to mitigate some of those negative volumes. Meaning they would become less negative in Q3 as compared to Q2 and further in Q4. So some improvement, but certainly not a snapback, which leaves our revenue still down 2% to 3% year-over-year by the numbers we described on our Q1 call.

Got it. And then maybe moving a little bit to the cost side. And then specifically, around people. I think the industry, I think, sort of proved out, certainly, and how people talked about what happened in April and the impact of -- to margins, that there was a lot of natural flex in the cost base, right? Less traffic on the roads, so got higher asset efficiency and less time doing stops as well as we've been dealing with, for a number of years as an industry, very high demands on labor, difficulty getting labor. And I think there's a fair amount of overtime being worked by both drivers and mechanics. And the natural flex for some of the players in the industry was to take down that overtime. So I was just hoping you could talk to a little bit about how Waste Connections dealt with this sort of flexing and demand on labor's time. Was there a substantial amount of layoffs? Was it more done by flexing people's hours? And then how do you then start to ramp that up? Or do you see challenges in ramping that back up?

Well, even back on our call a month ago, we said we'd actually seen the ramp-up starting again because we felt like we had seen the trough already. And by the numbers I've just also provided earlier on this call, it tells you we've continued to ramp up. So we had already, like other companies, we tracked, of course, labor hours. Of course, it's over time, which is where you start. And we have seen those numbers come down 25%, 30%. And they were on their way back up again, given that the business was coming back, which is a good thing, right? So to answer your question, there are only a few cases where we had markets where we did furloughs or layoffs given the dramatic decline in the business and an example of is in New York City, where you saw volumes down about 50%, and so -- on the commercial side, that is. And so for the most part, what we've seen is not only holding on to people and yet cutting over time as you're running reps faster, as you point out, which is where the costs naturally go away, right, because you have shorter route hours, as you're going that, less wear and tears on your trucks. So certainly, consumables go down. Anything that is on a per ton basis, like third-party disposal goes down, your brokerage costs, your franchise fees, they're costs that naturally or dynamically come out of the business. And labor is part of that as you're reducing the hours. And as I said, you certainly start with overtime. But the other focus we've had in this environment is taking care of our employees. And so we've been very clear about the fact that we have incremental costs associated with things like supplemental pay, which we had added for all of our frontline employees and contract laborers, by the way, and then also steps that we had taken very early on to provide, arguably, a safety net for our employees and providing for sick employees to stay home and not having their PTOs, for instance, be impacted. And so we took a number of steps, which arguably increased costs. But yes, to your question, you certainly dynamically take costs out of the system as your business slows down. And then you'll see costs come back as the business returns.

Got it. I want to pivot now to sort of a different topic. And maybe, I think, longer term, a much more important topic and certainly one that I encourage investors to really think through when they're thinking about investing in individual municipal solid waste names, and that is how capital gets redeployed. I know you've heard me say this before, Mary Anne, but I would say, being the CFO of Waste Connections, you have challenges. They're good challenges but there's challenges. And that's mainly how to redeploy what is routinely more than $900 million a year in free cash flow. And the dividend only eats up about $200 million, $220 million of that a year. And then I'd like to remind people that there's actually more cash flow than that. Waste Connections right now is a little bit less than 2.5x net debt-to-EBITDA. If you sort of keep a constant leverage ratio, there's another $300 million or $350 million a year in balance sheet capacity. So it's really even post-dividend, how do you redeploy $1 billion of capital? And what are the sort of priorities in terms of how management is approaching that over the next, not just 12 months, but thinking longer term, 3 to 5 years?

Sure. And you're right. Admittedly, it's a high-class problem to have. And I would say, we're thankful to have such a high-class problem in an environment like this, where understandably people's first question is about liquidity. And we think that's an appropriate question to ask, and we feel good about having $2 billion in liquidity and think that it's prudent in a period like we've come through and arguably are -- before -- certainly before you know how much stimulus money and how much of the safety net will be out there, it's good, I think, to take those steps to conserve cash. Now that being said, you're asking a longer-term question, which is how do we think about this free cash flow generation, which we're fortunate to have and the high conversion of EBITDA to free cash flow. And the fact that, for starters, we have a dividend that consumes about 20% of free cash flow. Well, so I'll start there. Our dividend, which we've grown double-digit per share percentages every year since initiating it in 2010, I would expect that to continue. And so I can see that 20% growing to 25% to 30% over time. Acquisitions, what we would describe as kind of our typical or average year of deals would consume arguably maybe another 30% to 40% of our free cash flow. So arguably, that leaves another 30% to 40% available for either the episodic outsized year of acquisitions or we'll put it towards share repurchases, which I remind folks who've known us for a long time, we routinely did prior to 2015. We were buying back 3% to 4% of shares in spite of also doing deals. And we certainly came into this year with a mindset that everything was on the table and we expected another busy year of acquisitions. But we also said we'd be back in the market buying net shares opportunistically. And you saw us do that in Q1, really, pre the depths of COVID when we made this decision to take our foot off that particular lever at that point in time. We still maintain the optionality to look at that as part of the overall strategy this year. And we still maintain that acquisitions are our highest and best use of cash, but that we don't dictate the timing of deals. And that is with -- we have this high cash generation rate, you will see us doing more share repurchases as part of the overall mix. What we've said about deals for this year is that thinking about it as sort of a typical year, the $125 million to $150 million in acquired annualized revenue is the right way to think about it. But what we also know is that events like this can free up, can create more opportunities for M&A to the extent that that brings more sellers off the sidelines. And we've certainly seen that in prior downturns. And during the great recession, for instance, we did outsized M&A. And we like the fact that, to your point, Jon, we are very well positioned, relatively low leverage and a lot of running room to execute on our terms. And we look forward to that opportunity if and when it's presented.

Yes. I believe it was the first quarter of this year was, I don't know, the largest share repurchases you guys have probably done in -- even proportionally to the size of the company since the Progressive deal. It seems like really since Progressive, that safety valve is what I always call them, the share repurchases, that if there's M&A there to be done, fantastic, that seems to be the best use of cash, as you said. And then the share repurchase is kind of the safety valve, if you would. It's typically a very good redeployment of capital, not always the best, but it might be the best available in some time. So when we're sort of thinking of it as the company grows, it's fair to then for investors to think that maybe the last 3 or 4 years and the pace of share buybacks is probably a little lower than you could expect over a longer period of time in the future?

So yes. And that's consistent with what we said coming into this year, which is that you could expect us to get back to that 3% to 4%. As you know, since pre-Progressive, since 2015, when in Q3, we turned the buyback off because we had that deal on the horizon. And then we arguably had this period of outsized activity. We would expect to get back to that 3% to 4%, again, when deal activity slows down. So I guess the question remains, what does this year end up looking like? And we'll know more as the year unfolds.

Yes. And then maybe on a related topic, maybe if you could spend a little time talking about the leverage, which -- there's another sort of, let's call it pool of capital, if you would, to be deployed over the next 12 or 18 months. And that is taking the leverage perhaps back to sort of more in line with the peers, which is closer to 3x. So how do you think about running the leverage below 2.5x? What's sort of the optimal area you'd like to be in? And then how long would you be willing -- or do you think management and the Board is willing to run at sub-2.5x?

So I think in terms of the range being 2.5x to 3x, very comfortable being there. To the extent we're running below that. As we've said, we've been in a period of outsized activity and arguably, given COVID, it feels good to be at the low end of the range or arguably below it in this environment. And as you said, a 2.3x on a net debt basis, 2.9x because we've been holding higher cash balances. And again, we thought that was appropriate, given the uncertainty of the environment. And so we like the fact that we came into this period with that flexibility. So I don't think it's a question of how long the Board will be comfortable. They understand the different drivers that will put us at the low or high end of that range or episodically being below it. And again, that could be an expectation of outsized deal activity or some conservatism around our balance sheet, given that -- the environment we're just coming through. But again, the message is, we certainly, again, believe that M&A is the highest and best use. We don't dictate the timing of deals. And we're not -- people will ask, what would you look outside of your core? About $3.5 billion to $4 billion that we've said fits our market model, right in this -- right down the center here, the fairway. And so we don't see any need to deviate. And we're better off returning that capital to shareholders and let them go buy some other company that's investing in a different business.

Got it. And when we say $3.5 billion to $4 billion, just so I'm clear, you're referring to revenue there?