Republic Services, Inc. (NYSE:RSG) Q4 2022 Earnings Call Transcript

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Republic Services, Inc. (NYSE:RSG) Q4 2022 Earnings Call Transcript February 15, 2023

Operator: Good afternoon and welcome to the Republic Services Fourth Quarter 2022 Investor Conference Call. Republic Services is traded on the New York Stock Exchange under the symbol RSG. Please note this event is being recorded. I would now like to turn the conference over to Aaron Evans, Vice President of Investor Relations. Please go ahead.

Aaron Evans: I would like to welcome everyone to Republic Services fourth quarter 2022 conference call. Jon Vander Ark, our CEO; and Brian DelGhiaccio, our CFO, are joining me as we discuss our performance. I would like to take a moment to remind everyone that some of the information we discuss on today’s call contains forward-looking statements which involve risks and uncertainties and maybe materially different from our actual results. Our SEC filings discuss factors that cause actual results €“ that could cause actual results to differ materially from expectations. The material that we discuss today is time-sensitive. If in the future, you listen to a rebroadcast or recording of this conference call, you should be sensitive to the date of the original call, which is October 27, 2022.

Please note that this call is property of Republic Services, Inc. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Republic Services is strictly prohibited. I want to point out that our SEC filings, our earnings press release, which includes GAAP reconciliation tables and the discussion of business activities, along with the recording of this call, are available on Republic’s website at republicservices.com. I want to remind you that Republic’s management team routinely participates in investor conferences. When events are scheduled, the dates, times and presentations are posted on our website. With that, I would like to turn the call over to Jon.

Jon Vander Ark: Thanks Aaron. Good afternoon, everyone and thank you for joining us. The Republic team finished the year strong by executing our strategy designed to profitably grow the business. We outpaced expectations throughout the year, delivering results that exceeded our full year guidance, even in the face of increased volatility in the broader marketplace. During 2022, we achieved revenue growth of 20%, including a 10% from acquisitions; delivered adjusted EBITDA growth of 16%; generated adjusted earnings per share of $4.93, which is an 18% increase over the prior year; and produced $1.74 billion of adjusted free cash flow, a 15% increase over the prior year. We continue to believe that investing in value-creating acquisitions is the best use of our free cash flow.

We invested $2.7 billion in acquisitions in 2022, which includes the acquisition of US Ecology. The integration of US Ecology is going well, with cost synergies tracking ahead of plan. Revenue contribution from US Ecology outperformed our expectations by nearly $50 million for the year, with almost all of the overperformance occurring in the fourth quarter. We continue to adjust prices related to US Ecology and our broader Environmental Solutions business to better align with the capital invested and resources deployed. Pricing actions taken to date have been successful as our customers recognize the high value of service we provide. Additionally, we are building momentum cross-selling our complete set of products and services, with approximately $40 million in new sales to-date.

Aside from US Ecology, we invested $500 million in value-creating acquisitions during the year. All of these deals were in the recycling and solid waste space. As part of our balanced approach to capital allocation, we returned nearly $800 million to shareholders through dividends and share repurchases. Regarding customer zeal, we continue to enhance our culture of delivering a world-class customer experience to win new business and drive customer loyalty. Our customer retention rate remained strong at 94%, and we exited 2022 with our highest NPS scores of the year. We delivered outsized organic revenue growth during the fourth quarter, with simultaneous growth in both price and volume. Core price on related revenue increased to 8.4%, and average yield on related revenue increased to 6.7%.

This is the highest level of pricing in company history. Organic volume growth was 1.5%. Volume growth was broad-based across our market verticals and geographies. Moving to digital. In early 2022, we implemented the finance and procurement modules of our new ERP system, which streamline back-office activities and provide our local leaders with enhanced data. Currently, we are building our new asset management system, which is expected to increase maintenance technician productivity and drive better warranty recovery. We expect to implement the new asset management system beginning in 2024. We continue to make progress on deploying RISE tablets in our collection business. We finished the implementation for all large container and small container routes during 2022 and completed 37% of residential routes by the end of the year.

The remaining residential routes are scheduled to be complete by mid-2023. This is a key component enabling further connectivity with our customers, including real-time service notification. The adoption of RISE has helped drive operational efficiencies and cost savings worth approximately $50 million annually. Sustainability is core to our strategy and one of our differentiating capabilities. We believe Republic Services is in a unique position to leverage sustainability as a platform for profitable growth, while making a positive impact on the environment. For example, our polymer centers are advancing circularity of plastics. This is the first time a single US company will manage the plastic stream from current site collection to delivery of high-quality recycled content for consumer packaging.

Development of the first center in Las Vegas is on track and is slated to come online in late 2023. Development of our second polymer center is already underway. This facility will be located in the Midwest and will serve as a hub for aggregating and processing recovered plastics in the region. This center should come online in late 2024. The investments we are making to develop these polymer centers is being absorbed through our normal capital expenditure process. Additionally, the development of our renewable natural gas projects is progressing well. All 57 of these projects are being co-developed with partners, with the majority structured as a joint venture. We expect 4 of these projects to come online by mid-2023. As part of our approach to sustainability, we continually strive to be a workplace where the best people from all backgrounds come to work.

Employee engagement improved to a score of 85, with 97% participation. Turnover rates in the fourth quarter improved to the lowest level we’ve experienced in nearly two years. As a result, we are better staffed to capitalize on growth opportunities in the market. Our comprehensive sustainability performance continues to be widely recognized as Republic Services was named to the Dow Jones Sustainability Index for the seventh consecutive year. Our 2022 results clearly demonstrate our ability to create sustainable value and strengthens the foundation from which we will continue to grow our business. Looking forward, we expect to deliver high single-digit growth in revenue, EBITDA, and free cash flow in 2023, even with the headwinds from lower recycled commodity prices and higher interest rates.

More specifically, we expect 2022 revenues in a range of $14.65 billion to $14.8 billion. This represents high single-digit growth compared to the prior year. Adjusted EBITDA is expected to be in the range of $4.275 billion to $4.325 billion. This represents high single-digit to low double-digit growth compared to the prior year. We expect to deliver adjusted earnings per share in a range of $5.15 to $5.23 and generate adjusted free cash flow in the range of $1.86 billion to $1.9billion. Our acquisition pipeline continues to support outsized levels of activity in both Recycling and Solid Waste and Environmental Solutions. We are targeting at least $500 million of investment in value-creating acquisitions in2023. Our 2023 financial guidance includes a rollover contribution from acquisitions that closed in 2022.

I will now turn the call over to Brian, who will provide details on the quarter and year.

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Brian DelGhiaccio: Thanks Jon. Core price on total revenue was 7.4% for the fourth quarter. Core price on related revenue was 8.4%, which included open market pricing of 10.4% and restricted pricing of 5.1%. The components of core price on related revenue included small container of 11.8%, large container of 8.6%, and residential of 7.8%. Average yield on total revenue was 5.9%. Average yield on related revenue was 6.7%, an increase of 40 basis points when compared to our third quarter performance. In 2023, we expect average yield on total revenue of approximately 5.5%. We expect average yield on related revenue of approximately 6.5%. This is an increase of 80 basis points over our full year 2022 results. Fourth quarter volume increased 1.5%.

The components of volume included an increase in small container of 1.6%, an increase in large container of 60 basis points, an increase in residential of 1.2% and an increase in landfill of 3.9%. For 2023, we expect organic volume growth in a range of 50 basis points to 1%. Moving on to recycling. Commodity prices were $88 per ton in the quarter. This compared to $218 per ton in the prior year. Recycling processing and commodity sales decreased revenue by 180 basis points during the quarter. 2022 full year commodity prices were $170 per ton. This compared to $187 per ton in the prior year. Current commodity prices are approximately $95 per ton. We believe that current commodity prices are temporarily depressed due to a global supply/demand imbalance and that prices will recover in the second half of the year.

Accordingly, we are assuming average recycled commodity prices of $125 per ton in 2023, with prices starting at $95 per ton in the first quarter and steadily increasing throughout the year. At $125 per ton, this would result in a decrease in full year 2023 revenue and EBITDA of $45 million when compared to the prior year and a 30 basis point headwind to EBITDA margin. In the first quarter of 2023, this would result in a year-on-year decrease of nearly $30 million in revenue and EBITDA and a 70 basis point headwind to EBITDA margin. Next, turning to our Environmental Solutions business. Fourth quarter Environmental Solutions revenue increased approximately $320 million over the prior year, which primarily related to the acquisition of US Ecology.

On a same-store basis, environmental solutions contributed 60 basis points to internal growth during the quarter. Fourth quarter adjusted EBITDA margin was 27.3%. This compares to 28.1% in the prior year. Margin performance during the quarter included a 130 basis point decrease from acquisitions, which included 100 basis points related to US Ecology, and an 80 basis point headwind from lower recycled commodity prices. These margin headwinds were partially offset by a 20 basis point increase from net fuel and margin expansion in the underlying business of 110 basis points. Fourth quarter adjusted EBITDA margin in the Recycling and Solid Waste business was 28.7%. This compares to 28.6% margin in the prior year or 10 basis points of margin expansion.

Margins improved in the Recycling and Solid Waste business even with an 80 basis point headwind from lower recycled commodity prices. Fourth quarter SG&A expenses, excluding transaction costs from US Ecology, were 10.9% of revenue. This included 40 basis points from additional incentive compensation expense due to full year financial outperformance. Full year SG&A expenses were 10.2% of revenue. This was favorable 20 basis points compared to the prior year and reflects continued cost management as we grow the business. In 2023, we expect EBITDA margin to be approximately 29.2%. The 10 basis points of expected margin expansion include a 40 basis point decline related to acquisitions, primarily related to US Ecology, and a 30 basis point headwind from lower recycled commodity prices.

These headwinds are more than offset by margin expansion in the underlying business of 80 basis points. While we expect full year expansion compared to the prior year, margins are expected to be down in the first half due to the impact of acquisition rollover and recycled commodity prices. This is most notable in the first quarter where these headwinds impact margin by a combined 210 basis points. Depreciation, amortization and accretion was 10.7% of revenue in 2022 and is expected to be relatively consistent at 10.8% of revenue in 2023. Full year 2022 adjusted free cash flow was $1.74 billion, an increase of 15% compared to the prior year. This was driven by EBITDA growth in the business. For 2023, we are projecting adjusted free cash flow in a range of $1.86 billion to $1.9 billion or approximately 8% growth at the midpoint.

We believe this level of performance is very strong given the expected impact from lower recycled commodity prices, higher interest rates, and higher cash taxes as bonus depreciation begins to unwind. Total debt at the end of the year was $11.9 billion, and total liquidity was $1.7 billion. Floating debt interest rates consistently increased throughout 2022, and we now expect net interest expense of approximately$480 million in 2023. This is an increase of approximately $90 million compared to the prior year. As a reminder, a 1% increase in interest rates results in approximately $33 million of additional interest expense. Our leverage ratio at the end of the year was approximately 3.1 times. We expect to revert to three times leverage by mid-2023.

With respect to taxes, our combined tax rate and non-cash charges from solar investments resulted in an equivalent tax impact of 26.1% during the fourth quarter and 25.1% for the full year. This lower than anticipated tax rate resulted in a $0.06 benefit to our full year 2022 EPS. We expect an equivalent tax impact of approximately 26% in 2023, made up of an adjusted effective tax rate of 20% and approximately $170 million of noncash charges from solar investments. Finally, we expect a majority of the EPS growth in 2023 to be back-end loaded. This results from having the toughest prior year comparisons on recycled commodity prices, interest rates, and taxes during the first half of the year. With that, operator, I would like to open the call to questions.

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Q&A Session

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Operator: We will now begin the question-and-answer session. And our first question will come from Tyler Brown of Raymond James. Please go ahead.

Tyler Brown: Hey guys.

Jon Vander Ark: Hey Tyler.

Tyler Brown: Brian, so obviously, pricing really strong here. I think full year pricing in the open market would stay just over 9% in the restricted piece, call it, 4.5%. But I am curious if we were to kind of decompose that next year, how those numbers would look? Will we kind of see a convergence in those two? Or could we actually see the restricted pricing lead with all the CPI lookbacks?

Brian DelGhiaccio: No, we would actually expect the restricted pricing to increase from the levels of where it is in the fourth quarter. So, again, on related revenue, it was 5.1% restricted in the fourth quarter. And we would expect that to improve 50 to 100 basis points in 2023. But we do expect the level of pricing to be driven by the open market, similar to what you’ve seen in 2022 and, for that matter, the prior years as well.

Tyler Brown: Yes. Okay. Okay, that’s helpful. And then on the shape of kind of how the yields will progress, will we have amore, I’m going to call it, historically normal cadence where pricing — and I’m talking total pricing, say, above 5.5% and then it tapers off below 5.5% as the year finishes out?

Brian DelGhiaccio: Yes. Listen, I guess you’re talking about then on total revenue, so I’ll give you that piece. So, yes, it starts highest — actually, our high watermark is in the first quarter based on our expectations. And then it sequentially declines from there, but we’re expecting that pricing remains above 5% in all quarters.

Tyler Brown: Yes. Okay. All right. That’s helpful. And just real quick, how much M&A rollover is in the guide? And just to be crystal clear, the $0.5 billion that you expect to spend, none of that is included in guidance. Is that right?

Brian DelGhiaccio: Yes. So, I’ll answer your second question first. That is correct. We have not included that. So, what is included are deals that closed by the end of the year. It’s $440 million worth of revenue or 300 basis points of growth, that’s the rollover, and most of that being US Ecology.

Tyler Brown: Right, okay. Thank you very much.

Operator: The next question comes from Noah Kaye of Oppenheimer. Please go ahead.

Noah Kaye: Thanks for taking the questions. So, with the US Ecology outperformance of $50 million, can you give us a breakdown of how much of that outperformance was price versus volume? And then maybe you can tell us what you’re expecting in terms of ES segment growth specifically for 2023.

Jon Vander Ark: Yes, it was a mix of both price and volume, but more pricing to come, right? We’ve taken a lot of pricing action, but we still have some contracted portion of that business and fully seen that. So, you’re seeing both the cross-sell that we talked about, and you’re seeing the pricing hit with really strong performance. And the plans for 2023, that business is performing ahead of our plan, more broadly about the US Ecology acquisition. The broader ES space, I think, is going to be a very positive contributor.

Brian DelGhiaccio: Yes. So, if you think about — Noah, I was just going to add. A good portion of the growth, right, that you’re going to see year-over-year is coming vis-à-vis the acquisition rollover. But if you think about total contribution from an organic perspective, right, we’re expecting 50 basis points on total revenue. So, that’s about, call it, $70 million, and that would be just at the point when US Ecology anniversaries forward. So, that’s still kind of a high single-digit type organic growth.

Noah Kaye: That’s very helpful. Thanks. And then since you mentioned the synergies were tracking ahead of plan, can you quantify that for us? And I guess, any chance you could give us an updated cost synergies number as to where you think this will get to within the timeframe?

Brian DelGhiaccio: Yes. So, just to give you an idea, when we actually provided the guidance when we closed the deal, we said we thought we’d get about $5 million worth of synergies in 2022. We actually got closer to $13 million, $14million. So, you can see nice outperformance there. And a lot of that was just actually getting the integration activities done quicker than we originally anticipated.

Jon Vander Ark: And we said total synergies would be $40 million. Cost synergy was $40 million. I think that number wound up closer to $50 million.

Noah Kaye: Perfect. I’ll give it back. Thanks.

Operator: The next question comes from Walter Spracklin of RBC Capital Markets. Please go ahead.

Walter Spracklin: Yes. Thanks very much. Good afternoon everyone. I want to just focus on the M&A there in the $500 million guide. What drives your target for $500 million? Is that on a leverage basis that you’d like to keep yourselves close to? Or is it more just your best guess as to what kind of deals in your — in the target areas that you want to do are available in 2023?

Jon Vander Ark: I’d say it is based on a passionate view about intrinsic value, right, and driving intrinsic value over time and conservatism, right? So, we never want to put out a number that people go and they have to hit, and therefore, we start chasing deals. So, I want the team to feel comfortable at any point in time passing on a given deal because it doesn’t mean a return criteria or there’s a set of terms or business conditions or practices that we’re not going to want to be owners of over time. And so I think we’ve always put out a number over the last three or four years, I think you’ve seen a pretty steady beat against that number. My expectations for the team, I think, are slightly higher than that. But we always want, again, put out a conservative numbers the team feels no pressure to reach.

Walter Spracklin: And has there been any shift in valuations, be it with higher interest rates, be it with more deals having been done? Is there more difficulty? Is there — has valuations come off? Has availability changed? In other words, the pipeline that you look at going into 2023, is it very much different than what you saw in 2022, excluding obviously, US Ecology?

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