GFL Environmental Inc. (NYSE:GFL) Q3 2023 Earnings Call Transcript

GFL Environmental Inc. (NYSE:GFL) Q3 2023 Earnings Call Transcript November 3, 2023

Operator: Good morning. Thank you for attending today’s GFL Environmental 2023 Q3 Earnings Call. My name is Foram, and I will be your moderator for today’s call. All lines will remain muted during the presentation portion of the call. [Operator Instructions] It is now my pleasure to pass the conference over to our host, Patrick Dovigi, Founder and CEO. Mr. Dovigi, please proceed.

Patrick Dovigi: Thank you, and good morning. I would like to welcome everyone to today’s call and thank you for joining us. This morning, we will be reviewing our results for the third quarter. I am joined this morning by Luke Pelosi, our CFO, who will take us through a forward-looking disclaimer before we get into the details.

Luke Pelosi: Thank you, Patrick. Good morning, everyone, and thank you for joining. We have filed our earnings press release, which includes important information. The press release is available on our website. We have prepared a presentation to accompany this call that is also available on our website. During this call, we will be making some forward-looking statements within the meaning of applicable Canadian and U.S. Securities laws, including statements regarding events or developments that we believe or anticipate may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set out in our filings with the Canadian and U.S. Securities regulators. Any forward-looking statement is not a guarantee of future performance, and actual results may differ materially from those expressed or implied in the forward-looking statements.

These forward-looking statements speak only as of today’s date, and we do not assume any obligation to update these statements, whether as a result of new information, future events and developments, or otherwise. This call will include a decision – discussion of certain non-IFRS measures. A reconciliation of these non-IFRS measures can be found in our filings with the Canadian and U.S. Securities regulators. I will now turn the call back over to Patrick.

Patrick Dovigi: Thanks, Luke. In the third quarter, we once again outperformed our detailed guidance and continued strong core Solid Waste price growth of 8.8%, 230 basis points of consolidated adjusted EBITDA margin expansion, 335 basis points of expansion of our underlying Solid Waste margin, and ES margins of nearly 31%. Our ongoing focus on optimizing price and managing cost to drive higher underlying profitability continues to yield exceptional operating results and positions us for continued success in the future. Luke will walk us through some of the details, but I wanted to start off by reflecting on where we are today versus where we were when we went public almost four years ago. We have always been focused on the long-term trajectory of the business, balancing growth, profitability, and capital deployment.

This focus is shared by me, as the Founder and largest individual shareholder of GFL, as well as the entire senior leadership team, all of which whom retain significant equity in our company. Executing on our long-term strategy has proven very successful for GFL and all of its stakeholders since we founded the business 16 years ago, and we expect this strategy to continue to be the foundation of our continued success. Since we went public in March of 2020, we have more than doubled the size of the business, while at the same time shaping a platform and asset base that will now drive the execution of our differentiated growth strategy in the coming years. That included the steps we took earlier this year to divest of non-core pieces of our portfolio at multiples greater than the basis of our current valuation.

Spinning off our infrastructure business into green infrastructure partners and deliberately shedding low-quality volume that does not meet our return thresholds. With those refinements completed, we continue to focus on the same key three prongs to our growth strategy that we have communicated since going public, high-quality organic growth, harvesting the multiple self-help levers in our portfolio, and completing densified tuck-in M&A. Our business has now scaled to the point, where we expect organic initiatives to outpace M&A, as growth drivers in the years to come. Our base pricing strategies are working and will continue to mature. Ancillary services are significantly underutilized in our portfolio today, and we will see significant runway, as we implement the well-defined industry playbook in this area.

Over the past two years, we have also made disciplined capital allocation decisions to invest in the very attractive returns from organic growth opportunities from renewable natural gas and recycling under Canada’s Extended Producer Responsibility legislation, also known as EPR. These investments have the best risk-adjusted returns we have seen in the last decade and are equivalent of completing acquisitions at three times to four times EBITDA. EPR continues to be a dynamic opportunity for us, where we have a first-mover advantage based on our market expertise and best-in-class asset base. In Ontario and Quebec, we have already been awarded a significant base of new recycling, processing and collection contracts, and we anticipate incremental opportunities to be realized in the near term.

As a result, we believe that the overall size of the EPR opportunity is even higher than our previously provided estimate of $40 million to $50 million of EBITDA. We are in the process of finalizing the negotiation of additional contracts and expect to be in a position to provide a comprehensive update on our Q4 earnings call. On RNG, our first and largest plant at the Arbor Hills Landfill is now online. While specific technical delays have us expecting the first contributions from this site to be in early 2024, the improvement in the underlying RIN pricing yield and expected annual contribution are far greater than we initially underwrote. In reference to our broader RNG portfolio, we now expect the facility to be all online by 2026 generating around $175 million of EBITDA at $2 RINs, with significant room to the upside given the current RIN market price of over $3.

We will provide more details on RNG and EPR on our Q4 call when we issue formal 2024 guidance. On M&A, we have done the large platform type acquisition that we needed to establish the base. We do not need any further platforms to execute our strategy. We have no plans to shift our focus away from our core Solid Waste and Environmental Services businesses by seeking out large acquisitions outside of the core. Instead, our focus is on smart, accretive, densifying tuck-in acquisitions that we expect to drive further improvement in return on invested capital going forward. And within the entire platform, we continue to focus on the self-help levers around fleet conversion, asset utilization, and synergy realization. We believe the combination of these growth levers will yield outsized operating leverage for several years to come.

So now let’s talk about leverage. Pre-IPO, net leverage was north of 7.6 times, with 2019 EBITDA of $826 million. Since that time, we have grown the business nearly 2.5 times, while at the same time bringing down net leverage to around 4.3 times. During that period, we have expanded consolidated EBITDA margins by 130 basis points to approximately 27%. We have achieved all of this in the face of a global pandemic, including complete business shutdowns in Canada, unprecedented cost inflation, the impacts of which continue to persist, and over 500 basis point increases in interest rates. Over the past few months, we’ve received feedback from some investors suggesting we should stop all M&A in the near term to manage to the short-term leverage target of less than four times that we shared with you in June.

We have thought long and hard about that. We have to balance the short-term objective against what we see as the opportunity for longer-term value creation. We have never shied away from doing what we think is the right thing for the business. Giving up attractive value creation opportunities in order to manage leverage by 10 basis points or 15 basis points in the short-term does not align with our long-term perspective. We believe that we have continued to execute on our commitment and to take advantage of market opportunities when we see them, so long as they are consistent with the three key prongs of our strategy that I just laid out. Taking all that into consideration, we completed 11 acquisitions in the third quarter, and another four acquisitions after quarter end.

I wanted to highlight two of these acquisitions and the highly attractive growth opportunities we are confident that they will generate for us. One of those is Capital Waste, a vertically integrated, secondary market-focused solid waste business headquartered in South Carolina, right in the middle of our already dense waste industry’s footprint. We believe Capital Waste’s four landfills, eight transfer stations, and over 200 collection vehicles have meaningful runway and self-help opportunities to drive outsized organic growth and margin expansion in the near term. The other acquisition, I want to mention is Fielding Environmental, an environmental services family business established in 1955 in the greater Toronto area, right in the heart of the largest footprint of our Environmental Services business.

Fielding has a highly complementary specialized processing capabilities and a Part B permit that will allow for the realization of material internalization and organic cross-selling growth opportunities within our existing Environmental Services network. While these deals will result in 10 basis points to 15 basis points of higher leverage at Q4 and will have a short-term impact of free cash flow conversion, we are highly confident in our ability to generate accretive returns on invested capital from these investments over the medium term, leading to even better free cash flow conversion in the future. And again, I want to reiterate our long-term commitment to deleveraging. We have delevered, and we will continue to delever, while we’re growing at above-average industry growth rates.

And in doing so, we see a path to investment-grade credit rating in the medium term. This path is not necessarily a straight line, but the trajectory is definitely downward. In our view, it has been seen in the light of all these things we have achieved in the business that I just laid out. While we are aware that the combination of the current higher for longer narrative together with our leverage levels, has not seen ideal by some. I want to reiterate that our strategy success was never predicated on operating in a low interest rate environment. We are highly confident in the opportunity to realize material credit quality enhancements in the near to medium term that will position us for improved free cash flow conversion. We’ve heard a lot of speculation on the topic of what is going to happen to our interest costs in the future, and Luke will walk you through some of the slides we have prepared.

But at a high level, I will lay some out. We have a significant experience in the debt capital markets. This is evidenced by the quality of our current debt structure, as well as our Q3 refinancing of our TLB to one of the lowest credit adjusted spread executed in years and is in this high interest rate environment. Over 70% of our long-term debt is fixed rate with a weighted remaining average of over four years. Over 60% of our long-term debt does not mature until 2028 or later. As our key business metrics continue to improve, and our credit quality improved to reflect that, the spread component of our borrowing rates will continue to improve. Even if we were to refinance our entire debt structure under what we believe to be a reasonable range of outcomes today, which we are not planning to do, the cumulative impact to our annual interest costs would be entirely immaterial to our long-term financial model.

To wrap up, we have a long-term strategy that we are executing on. We have built a best-in-class platform and asset base that gives us multiple levers to pull to grow revenue and improve margins that we are using to continue to create long-term value for all of our shareholders. We are confident in the ability of this platform to deliver industry-leading free cash flow per share growth. At the same time, we remain committed to the trajectory of our deleveraging profile. As always, I want to thank our amazing employees, who are the key to our continued success. I will now pass the call over to Luke, who will walk us through the quarter in more detail, and then, I will share some closing thoughts before we open it up for Q&A.

Luke Pelosi: Thanks, Patrick. For the following discussion, I will refer to our accompanying investor presentation, which provides supplemental analysis to summarize our performance in the quarter. Third quarter revenue was $1.89 billion, representing year-over-year growth of 130 basis points better than we had guided. Solid Waste price of 8.8% was realized through ongoing support from both our geographies and with better than mid-single-digit pricing continuing to be realized in the typically lower priced residential collection and post-collection lines of business. Solid Waste volumes of minus 2.4% was nearly 50 basis points better than expected, as the underlying volume growth in commercial and residential collection, as well as our post-collection services offset the impact of the intentional shedding of low-quality revenue and the exiting of certain non-core ancillary service offerings.

Page 3 highlights the 250 basis point expansion of Solid Waste adjusted EBITDA margin year-over-year, a 30 basis point sequential acceleration over the second quarter. Commodities continue to be a year-over-year headwind, the impact of which is greater in our Canadian segment due to the larger relative volume of recycling activities we have in that market. Commodity prices during the third quarter were broadly in line with expectations. While October has seen an uptick in fiber pricing, we expect this to reverse by the year-end and to be back to Q3 OCC pricing levels, as we exit the year, all of which is baked into our guidance. Regarding fuel costs, while we believe that the maturity of our surcharge programs adequately mitigates fluctuating diesel costs were materially impacting our margins and profitability for extended periods of time.

The rapid rise in diesel cost during the third quarter resulted in approximately 20 basis point margin headwind to our guidance, and net fuel, as a whole impacted margins 10 basis points year-over-year. The lag in our surcharge mechanisms, which is consistent with industry norms, should see the incremental diesel costs incurred in Q3 recovered in Q4. We also continue to see additional upside from the ongoing optimization of our fuel surcharge programs. Normalizing for these items, underlying margin expansion accelerated an incremental 20 basis points over Q2 to 335 basis points year-over-year. We believe this is a strong demonstration of the effectiveness of our pricing and deliberate volume strategies and is consistent with the expected impact of the widening spread between price and cost inflation that we forecast in the 2023 guide.

Page 4 summarizes the historical performance of our ES segment. The negative volume realized during the COVID pandemic reversed in early 2021 and the double-digit organic revenue growth steadily sequentially increased throughout 2022. At the beginning of this year, we articulated that we now have the asset positioning we desire, and we transition the growth strategy for this segment to one of revenue quality over quantity, and you can see the results of the strategic shift in the acceleration of the adjusted EBITDA margin expansion. Recall that in the third quarter of 2022, we identified the impact from an outsized amount of subcontracting work performed in that quarter. Excluding that $30 million impact from the comparison, revenue grew 6.9% year-over-year.

Contaminated soil volumes, which are levered to primary markets and tend to be more economically sensitive were approximately $15 million less than our plan in Q3, a trend that presents a headwind to margins that we are now expecting to continue for the balance of the year. The realization of over 400 basis points of margin expansion, inclusive of this headwind is a testament to the operating leverage we are realizing in this segment. At the consolidated level, adjusted EBITDA margins of 28.1% represent a 230 basis point expansion over the prior year. Adjusted free cash flow for the quarter was $276 million versus our guidance of $275 million, which included cash taxes of approximately $250 million related to the recently completed divestitures.

We expect to pay the balance of the cash taxes and the divestitures in the fourth quarter. Cash interest was $20 million greater than guidance, more than half of which was a timing difference arising from the repricing of our term loan, with the balance attributable to the impact of the recent acquisition spend. As a result of this recent M&A, we now expect cash interest for the year of approximately $515 million to $520 million. Gross purchases of property and equipment were $276 million, the low end of our guidance and inclusive of approximately $130 million of reallocation of proceeds received from the recent divestitures into incremental growth investments, as previously described. We still anticipate full year gross purchases of property and equipment, it would be between $1.05 billion and $1.15 billion.

We have left our 2023 guidance largely unchanged other than a modest increase in expected revenues. Page 5 of the presentation outlines the moving pieces and illustrates that the impacts of FX and recent M&A drive revenue to approximately $7.48 billion. The adjusted EBITDA contributions from these two items are offset by the delay in contribution from the Arbor Hills RNG facility coming online, as well as the reduced view on contaminated soil volumes through year-end, resulting in the maintaining of our $2 billion EBITDA guide for 2023. Page 6 bridges net leverage from Q2 to Q3. Recall that Q2 benefited from the delay in the payment of taxes on the divestitures. Also, the weakening of the Canadian versus the U.S. dollar has a translational impact.

Normalizing for these two items, the organic deleveraging of the business more than offset the net leverage impact of incremental M&A during the quarter. And then on Page 7, we have illustrated how these impacts to net leverage carried through to the end of the year. The base business is still anticipated to delever to the sub-four times level we previously guided. But with the incremental acquisitions and the translational FX impact, we now expect to exit the year with leverage in the low-4s. Notwithstanding this slightly higher launch off point, we still expect that we will delever the business to mid-3s by the end of 2024, as previously communicated. As Patrick said, we have included some additional slides on the potential impact of various scenarios on interest costs.

Page 9 shows our current effective interest rate of 5.2% versus our current variable rates of between 7.1% and 7.8%. The intent of this page is to illustrate that while our current spread above treasuries is significantly better than when we assembled our current debt complex, it is still multiples of the spreads incurred by our investment-grade peers. While we do not know where underlying treasury rates will go, we believe that as our credit quality improves, our current spread of 175 basis points to 250 basis points should reduce more than 115 basis points, as we migrate towards the spread of our peer group. So with that, on Page 10, we have presented the math of what the impact on our annual cash interest could be using various different interest rates.

The first row shows the incremental cash interest if we were to recalculate our entire debt structure at our current highest variable rate of 7.8%. Considering the long-term tenure and current trading levels of our debt, we in no way perceive this as a likely outcome in the current rate environment, but have included the math for illustrative purposes. The subsequent row shows the equivalent math under a range of other possible scenarios that contemplate various degrees of improvement to our credit spread and the underlying benchmark. As we expect our credit quality to improve gradually over time, the actual outcome in the intervening years is likely a combination of multiple scenarios. In our view, the point of this analysis is best highlighted on Page 11.

The left side of the page summarizes the cumulative impact to what 2029 annual cash interest would be if recalculated at a range of interest rates. Note that what is not shown on this page is the tax impact of any incremental interest that would partially mitigate any free cash flow impact. The right side shows the growth of adjusted EBITDA over the same time period, assuming a range of historical growth rates for the industry. This is meant to be illustrative. But as you can see, any incremental cash interest is relatively immaterial to the magnitude of the illustrated 2029 EBITDA range of $3.2 billion to nearly $4 billion. As Patrick said, regardless of the refinancing outcomes, we remain highly confident in the long-term equity thesis. I will now pass the call back to Patrick for some closing comments before Q&A.

Patrick Dovigi: Thanks, Luke. As a quick preview on 2024, we’re feeling very good about our launching off point. We’ll give our detailed guidance in the New Year, but we are expecting top line organic revenue growth to be better than mid-single digits with M&A rollover for deals already completed of over 2.5% before considering the impact of the divestitures from earlier this year. By continuing to apply the tried-and-true lever that drove the margin expansion this year, we expect adjusted EBITDA margins to have another outsized year of expansion, which should drive low-teens EBITDA growth or at least 10% when considering the impact of the divestitures. We are highly confident that the actions we have taken over the past couple of years have created a material equity value for you.

While this may not be reflected in the market today, I assure you, at some point, it will be. We look forward to hosting an Investor Day in 2024, where we will share more details on the role of our strategic plan for the next three years. I will now turn the call over to the operator to open the line for Q&A.

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Stephanie Moore with Jefferies. Stephanie, your line is now open.

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Q&A Session

Stephanie Moore: Hi good morning. Thank you.

Patrick Dovigi: Good morning.

Luke Pelosi: Good morning.

Stephanie Moore: Just my first question is just on M&A and leverage. As you noted, you said back in July that you would exit 2023 at less than four times leverage, but due to the acquisition of capital and maybe the other, your leverage has clearly ticked up slightly. So my question is, did you know that you would be doing the deal when you gave the net leverage target?

Patrick Dovigi: So the short answer is no. This was – this asset was something obviously, we had our eyes on sort of over the last sort of number of months. But what I would say is, we know the business extremely well. We knew the business extremely well. We knew the shareholders extremely well. And Brian Yorston, who’s the COO is the brother of our COO, Greg Yorston. So the long sort of history with the business. The reality was we were not selected, as the preferred bidder. So it wasn’t contemplated. The reality is the company that was selected the higher bidder, it became very clear and apparent that they were going to have a longer time period to get to the DOJ and the shareholders were looking at this for certainty.

And then they came back to us to acquire the business at a lower price with certainty around the DOJ process. So that sort of came. We’d already done a lot of diligence on it. So the time for us to get that done, it happened pretty quickly. And it’s a business obviously we love. It’s right in our backyard in the Carolinas, that touches Georgia that exactly in the areas that we want to grow in the sort of fast-growing markets in the U.S. But that’s sort of the history around sort of capital lease.

Stephanie Moore: Okay. Got it. That’s helpful. And then just as a follow-up, how would you characterize the pace of M&A anticipated next year to get to that mid-three times target? And how does that kind of compare to prior years? Thanks.

Luke Pelosi: Yes. So Stephanie, it’s Luke. I’ll just say, if you think about as we’ve historically said and continue to say the normal course organic deleveraging that we’re anticipating is somewhere around sort of 60 basis points to 75 basis points. Now there’s some outsized growth opportunities, the EBITDA from margin expansion are just normal course growth, that number increases. So organically, joining the year at sort of a low-4s number, you’re going to get to a sort of mid-3s. Now M&A, as we’ve articulated, with the size and scale of the business, the relative impact to net leverage from M&A becomes much more muted. And I think we’ve provided some analysis that even if you’re spending $750 million to $1 billion a year into M&A, the impact there on is sort of measured in 10 bps to 15 bps.

So the cadence of how that would work, look, as Patrick, I think, just articulated in his response, we manage – actively manage a pipeline and would love to attempt to slot it in perfectly throughout different quarters, but just doesn’t tend to work out that way. So it’s going to be difficult for me to comment on the actual intra-quarter cadence. But I think overarchingly, what our message is to be is the leverage is going in one direction, in one direction only, and that’s down. And I think with the size and scale and the opportunities we have organically, we feel highly confident regardless of the M&A opportunities to end the year in that range.

Patrick Dovigi: And then Stephanie, just on the point you made – to us, it’s sort of false precision on sort of leverage 10 basis points up or down doesn’t materially change the financial profile of the business. And I’m not going to forgo long-term value creation opportunities for the sake of a small movement sort of intra-quarter. But we are committed to – we are not taking leverage materially up from here. We’ve committed – we have delevered, and we’ve committed to delevering, and you’ll continue to see the business delever over the sort of short, medium and long term into the ranges that we stated. So again, we can keep talking about this. This is not an issue. It will never be an issue. So, I would like to sort of move on from the point.

Stephanie Moore: Fair enough. Thanks guys.

Operator: Thank you for your question. Our next question comes from the line of Kevin Chiang with CIBC Wood Gundy. Kevin, your line is now open.

Kevin Chiang: Hey guys, thanks for taking my question. You gave a little bit of a prelim outlook for 2024, and you called out, I guess, some of your peers, 2024 should see another year of outsized margin expansion. You’ve – outside of Q1 of this year, you’ve obviously been seeing some pretty good margin expansion already. I suspect Q4 is going to be pretty good. And if I just ballpark, you’re probably going to be, let’s say, 125 basis points, 150 basis points up year-over-year on a consolidated basis. When you think of 2024, do you think you’re better than that, just given some of the company-specific leverage you continue to have or outside just relative to kind of the industry average of 30 basis points, 40 basis points of typical margin expansion you see in a normal cost environment.

Luke Pelosi: Yes. Kevin, it’s Luke. I’m going to refrain from getting too details on 2024 until our Q4 call. But I think you’re thinking about it right, and it is both of those things. So, I think the overarching widening of price versus cost should give rise to a margin expansion opportunity in excess of that historical industry average. And then in addition, as we’ve articulated, we have significant opportunities for self-help that we continue to avail ourselves of that we think should drive something in excess of that. So when you put both of those things together, I think you end up directionally, where you’re speaking, but we’re going to hold off until Q4 to get a finer point on that.

Kevin Chiang: That’s fair and that’s great color. And just maybe my second question, just on some of those levers. You obviously implemented a fuel surcharge program. I think pretty quickly from where you started off at the onset of rising diesel prices, I think you have a number of other levers in the pricing category, other fees that your peers implement that you’re still looking to push through. Can you give us an update on that in terms of where you sit and maybe the timing of getting all that through.

Luke Pelosi: Yes. So Kevin, at the pricing, I mean, we’re very proud of the job that we did at fuel. But as we articulated, we still see meaningful room to go on that. It’s a function of we grab the low-hanging fruit that we could, but there is certain components of our book of business that were restricted and precluded us from moving. So while we really move the needle there, there’s still a meaningful prize. And you could see that in this quarter, where particularly in the month of September, we probably had $3 million or $4 million of incremental cost against us that the non-optimized aspect of our fuel surcharge program precluded us from being sheltered from. So we still see room even in that bucket. And then if you take that further, just the ancillary service charges that we sort of mentioned is just another area or another lever at the pricing level, but the industry, I think, has done a good job to making sure that we’re getting appropriately paid for the work that’s performed.

What we mean by that is items for such as blocked cans or overflowing cans or the other areas, where we’re contractually entitled to charge an appropriate return, where we are not as sophisticated or comprehensive in our billing practices in order to capture that opportunity. And so, there’s real dollars being left on the table there, and that’s going to be the next fulsome focus in that sort of ancillary or surcharge type environment. I mean, the base pricing, as we talked about, just the relative recency of our price discovery versus our peers, we just see a lot of runway there. And you’re seeing it in our continued strength of our core pricing, and we expect that to sort of continue to be at levels in excess of what may be a more mature book of business is able to achieve.

So we see a lot of the pricing level. And it’s for the sake of time, I’m not going to get into the details on the cost, but we’ve articulated a lot of that at our Investor Day, and we intend on updating our progress there. But by and large, summarize many of the levers the industry that’s pulled to bring their operating margins to where they are today, we’re in the immature stages of realizing a bunch of that. So we see a bunch of opportunity and that’s going to tuck into the comment I made previously of the idiosyncratic margin expansion opportunities that we think we will realize over the coming years.