Waste Connections, Inc. (NYSE:WCN) Q3 2023 Earnings Call Transcript

Waste Connections, Inc. (NYSE:WCN) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Good day, and welcome to the Waste Connections, Inc. Third Quarter 2023 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, today’s event is being recorded. I’d now like to turn the conference over to Ron Mittelstaedt, President and CEO. Please go ahead.

Ron Mittelstaedt: Okay. Thank you, operator, and good morning. I would like to welcome everyone to this conference call to discuss our third quarter results and to provide a detailed outlook for the fourth quarter as well as some early thoughts about 2024. I’m joined this morning by Mary Anne Whitney, our CFO, as well as other members of our leadership team. As noted in our earnings release, we are extremely pleased by the durability of our financial and operating results in the quarter, with momentum for continued outsized margin expansion, solid operational execution drove adjusted EBITDA margin of 32.5% in the third quarter as expected, up about 140 basis points sequentially and up 120 basis points year-over-year, in spite of over $15 million in unforeseen headwinds.

Moreover, normalizing for recycled commodity values from just over a year ago underlying adjusted EBITDA margin eclipsed 33% in the quarter. And this is total company EBITDA margin, not just solid waste. During the quarter, we overcame elevated levels of risk related expenses and other lagging effects of higher employee turnover in prior periods, as well as site-specific incremental operating expenses at one of our landfills in California. The expected Q4 and ongoing impact of this evolving landfill situation are currently being evaluated, along with a recent shorter-term development at a landfill in Texas, and as such, weren’t anticipated in the full year outlook we provided in August. We expect to get more clarity going forward, but currently estimate the range of outcomes in Q4 to include impacts of up to $20 million to revenue, adjusted EBITDA, and adjusted free cash flow.

We remain encouraged by the pace of improvement in employee retention, which along with our differentiated strategy and execution should provide for above average underlying margin expansion in solid waste collection, transfer and disposal in 2024. On that basis, we should be positioned for high-single digit adjusted EBITDA growth in 2024 on mid to high-single digit revenue growth, including approximately $150 million of revenue carryover from acquisitions signed or closed year-to-date, with upside potential from additional acquisition activity and any further improvement in commodity related activity. Before we get into much more detail, let me turn the call over to Mary Anne for our forward-looking disclaimer and other housekeeping items.

Mary Anne Whitney: Thank you, Ron, and good morning. The discussion during today’s call includes forward-looking statements made pursuant to the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995, including forward-looking information within the meaning of applicable Canadian Securities Laws. Actual results could differ materially from those made in such forward-looking statements due to various risks and uncertainties. Factors that could cause actual results to differ are discussed both in the cautionary statement included in our October 25 earnings release and in greater detail in Waste Connections filings with the U.S. Securities and Exchange Commission and the securities commissions of our similar regulatory authorities in Canada.

You should not place undue reliance on forward-looking statements as there may be additional risks of which we are not presently aware or that we currently believe are immaterial, which could have an adverse impact on our business. We make no commitment to revise or update any forward-looking statements in order to reflect events or circumstances that may change after today’s date. On the call, we will discuss non-GAAP measures such as adjusted EBITDA, adjusted net income attributable to Waste Connections on both a dollar basis and per diluted share and adjusted free cash flow. Please refer to our earnings releases for a reconciliation of such non-GAAP measures to the most comparable GAAP measures. Management uses certain non-GAAP measures to evaluate and monitor the ongoing financial performance of our operations.

Other companies may calculate these non-GAAP measures differently. I will now turn the call back over to Ron.

Ron Mittelstaedt: Thank you, Mary Anne. We are extremely pleased by our operational execution in Q3, driving results largely as expected, in spite of the incremental headwinds described earlier, with an adjusted EBITDA margin accelerating to 32.5% on continued price-led organic growth in solid waste, reflecting a price cost spread of 250 basis points. As mentioned earlier, underlying adjusted EBITDA margin eclipsed 33% in the quarter at commodity values of just over a year ago. As noted additionally, we overcame over $15 million in unforeseen headwinds during the quarter, primarily in two areas. First, an increase of approximately $9 million to already inflated risk related expenses. This development was associated with prior period activity and reflects the higher safety incident rates that accompanied the increased employee turnover in recent years.

A reminder that risk is a lagging indicator as claims develop while turnover is a leading indicator. As we drive down turnover, risk expense will improve along with claim frequency and severity. Next, we absorbed over $6 million in additional operating expenses at our Chiquita Canyon Landfill in Southern California, where we are managing and working to resolve what is characterized as an elevated temperature landfill or ETLF event. This refers to a reaction resulting in the rapid breakdown of waste at elevated temperatures. In this case, occurring deep underground in an older portion of the landfill involving non-hazardous waste that was accepted and handled prior to our ownership of the site. While there are currently no impacts to ongoing waste acceptance at the site, the reaction has led to escalating amounts of leachate generation accompanied by odor impacts.

Since communicating this occurrence to the appropriate governing and regulatory bodies, we have been coordinating our efforts to address the odors, handle the leachate and satisfy the concerns of various constituents. The incremental costs in Q3 primarily included leachate treatment and disposal, along with engineering and monitoring costs. We expect these expenses to expand in Q4 to over $10 million, primarily as a result of increased leachate generation. Beyond that, we have determined that we are not yet currently in a position to estimate the ultimate impact or timing of resolution. We expect to have good clarity of timing and resolution by our February call. The second landfill issue noted earlier is more clearly defined and more limited, but nonetheless expected to impact Q4.

At our Seabreeze Landfill in Texas, we experienced a slope failure at the end of the third quarter that has resulted in our shutting down the landfill and redirecting tons to alternative disposal sites while we complete repairs and site work. The impact of lost revenue and increased expenses at this site in Q4 are expected to be in the range of $5 million to $10 million, depending on how quickly we are able to reopen the site, we currently expect to reopen the site in mid-December. We consider both of these landfill issues to be unusual, site-specific and non-recurring in nature, although differing in duration. While historically many analysts and investors may have adjusted for similar types of non-recurring events by adding back the impacts, these are developing in real-time and we are not currently in a position to make a final determination.

We have not included them in our outlook for Q4 or our preliminary thoughts for 2024, but in the interest of transparency are providing the estimated range of potential outcomes in Q4 to include impacts of up to $20 million to revenue, adjusted EBITDA and adjusted free cash flow. Returning to the strength of our operating and financial performance in Q3, we delivered core price of 8.8% and total price of 7.7%, including 110 basis point decline in fuel and material surcharges primarily related to the decline in diesel prices. Reported volume growth of negative 1.9% on a day adjusted basis reflected the continued impact from intentional shedding as expected with recent acquisitions. As described last quarter, rightsizing markets and improving revenue quality should be considered integral to a disciplined approach to acquisitions and therefore expected, especially given the magnitude of acquisition activity we have enjoyed over the past few years.

Moving on to the topic of acquisitions, we continue to see above average levels of seller interest and is typical some activity getting pushed to year-end. To-date, we have about $170 million in annualized revenue closed, with an additional $80 million already signed and in some cases awaiting regulatory consents, which are expected to close by year-end or very early in 2024. As such, we have visibility for almost 2% in acquisition rollover contribution in 2024, with the potential for that amount to grow from additional transactions anticipated to sign or close by early next year. Our pipeline remains quite robust across our footprint, including some opportunities to further expand our portfolio of West Coast exclusive markets. We continue to have capacity for outsized acquisition activity while we fund our differentiated growth strategy, including our sustainability related projects, and expand our return to capital to shareholders.

To that end, our Board of Directors authorized an 11.8% increase to our regular quarterly cash dividend, our 13th consecutive annual increase since the initiation of the dividend in 2012 – 2010, excuse me. While executing our growth strategy, we also demonstrated the ability to drive down emissions and show significant progress towards achievement of our sustainability related targets as highlighted in our recently released 2023 Sustainability Report. In fact, as further outlined in that update, we saw a 14% reduction in Scope 1 and 2 emissions in 2022 in spite of outsized revenue growth, resulting in a 27% reduction in emissions intensity. Moreover, we backed up that progress by doubling our targeted emissions reduction to 30% and have initiated the process of aligning our emissions reduction targets with the Science Based Target initiative or SBTi. Our updated Sustainability Report also highlights our progress on the development of incremental capacity for recycling and renewable gas or RNG generation.

We increased our operational offsets by 8% in 2022, driven primarily by an 18% increase in recycling tons bring our annual total to over 2 million recycled tons. And looking ahead, we are positioned to significantly expand our biogas recovery through development of additional RNG facilities, including three new facilities expected to open in 2024. Moreover, we continue to expect incremental annual EBITDA contribution of $200 million by 2026 from a comparable level of investment to that end, including approximately $125 million to $150 million of capital outlays on RNG facilities anticipated in 2024. We continue to pursue the development of other RNG projects, including at our most recent acquisitions, which we believe will be additive to these amounts as we look to 2026 and beyond.

Continued investment in sustainability related projects is consistent with our objective of value creation for our stakeholders and along with enhanced disclosure and demonstrated progress indicative of our commitment to the environment and the communities we are truly privileged to serve. And additionally, we continue to invest in our most important asset, our people, and anticipate additional margin expansion opportunities from innovative approaches to further improve employee retention and engagement. We are encouraged by the progress we have made in employee retention efforts in Q3, with voluntary turnover stepping down sequentially for the fourth consecutive quarter, as compared to the peaks we saw in 2022, voluntary turnover is now down over 20% and open position requisitions are down over 30%.

We look forward to seeing these trends continue and supporting the efforts of our local leaders with resources to facilitate that progress. We characterize our efforts as doubling down on human capital, as we renew our focus on empowering leaders for success in our decentralized operating model. Changes include revamping recruiting through upgraded technology offerings and more than doubling training focused on frontline employees. We’ve initiated a pilot program for our own training academy for drivers and are coordinating efforts for a diesel technician school offering. We’re excited about our progress to date and we look forward to seeing continued improvement as we enter 2024, when we should realize the lagging effects from improving retention rates during 2023 and into 2024.

As noted earlier, while we deliver industry-leading margins, we are still absorbing the residual effects of higher turnover in previous periods, which include elevated reliance on third-party services, as well as the increased overtime and associated equipment wear and tear, which ultimately have an impact on safety incident rates and the associated costs of risks. The good news is that the progress and retention we’re seeing today sets us up for future benefits from improving costs and risk, labor and maintenance as the same cycle should play out in reverse when incident rates and severity decline along with turnover. And now I’d like to pass the call to Mary Anne to review more in depth the financial highlights of the third quarter and to provide a detailed outlook for Q4.

I will then wrap up with some thoughts about 2024 before we head into Q&A.

Mary Anne Whitney: Thank you, Ron. In the third quarter, revenue of $2.065 billion was above our outlook and up $185 million or 9.8% year-over-year. Acquisitions completed since the year ago period contributed about $103 million of revenue in the quarter net of divestitures. Core pricing of 8.8% ranged from about 6.5% in our primarily exclusive market western region to a range of approximately 8% to 10% in our competitive regions. As expected, core pricing stepped down sequentially from Q2 as a result of both the typical cadence of seasonality on reported price and the waning impact of outsized pricing activity from 2022 as compared to previous quarters. The Q3 volume decline of 1.9% on a day adjusted basis was in line with Q2 and similarly spread across residential collection with the non-renewal of certain municipal contracts.

Commercial collection from opportunistic shedding of lower quality accounts, and in post-collection in reduced transfer volumes directed to third-party disposal outlets. Our most impacted markets were in our eastern region, where we have had outsized acquisition activity over the past few years, looking year-over-year at other lines of business. Roll-off pulls per day were up about 1% on revenue per pull up about 6%, and landfill tons were up 5% year-over-year, largely driven by higher special waste tons up 17%, with C&D tons up 2% and MSW tons up 1%. The increase in special waste activity in Q3 followed two down quarters and was the result of a few jobs either getting delayed from Q2 or likely pulled forward from Q4, a reminder of the event driven nature and inherent lumpiness of these projects.

Through nine months, special waste tons are up 1% year-over-year. Moving next to revenues from recovered commodities. Excluding acquisitions, recycled commodity revenues were down 27% year-over-year in Q3 and down 6% sequentially, about as expected, due to a sharp decline in the value of plastics during the quarter, partially offset by improvements in old corrugated containers or OCC, which averaged $88 per ton. Landfill gas sales were up 7% year-over-year in Q3, due primarily to higher renewable energy credits or RINs, which averaged about $3. And finally E&P waste activity. We reported another increase in E&P waste revenue to $59 million in the third quarter, up 6% sequentially from Q2 and up 10% year-over-year. Adjusted EBITDA for Q3 as reconciled in our earnings release, increased by 14.1% year-over-year to $671.2 million, again, above our outlook.

At 32.5% of revenue, our adjusted EBITDA margin was up 140 basis points sequentially from Q2 and up 120 basis points year-over-year, all from solid waste. As we delivered the outsized margin expansion that we projected in our updated outlook provided in August. And as Ron noted, that achievement was in spite of the $15 million in unforeseen cost headwinds overcome in Q3. In fact, underlying solid waste margins arguably expanded by 150 basis points year-over-year on a normalized basis, as headwinds from the incremental landfill cost in Q3 accounted for about a 30 basis point drag to reported margins. Within solid waste, price led organic growth drove margin improvement across many areas, with outsized improvement in third party logistics and disposal, and with offsets most notably from higher risk costs.

Beyond solid waste, commodity impacts were awash, 20 basis points benefit from higher E&P waste activity, plus another 20 basis points from lower fuel rates were offset by recycled commodity values, which, although improving were still a 40 basis point drag to margins. Net interest expense of $66.2 million reflects a weighted average cost of about 4% on a mix of approximately 80% fixed and 20% variable rate debt with an average tenor of over ten years. Leverage remained unchanged in the quarter at about 2.75 times debt to EBITDA. And our Q3 tax rate was slightly lower than expected at 21.6%, due primarily to the impact from lower foreign exchange rates for the Canadian dollar. Year-to-date, we have delivered adjusted free cash flow of $969.3 million, or 16.2% of revenue, on track for our full year adjusted free cash flow outlook of $1.225 billion, excluding the ongoing landfill impacts Ron outlined earlier.

I will now provide our outlook for the fourth quarter of 2023. Before I do, we’d like to remind everyone, once again, that actual results may vary significantly based on risks and uncertainties outlined in our safe harbor statement and filings we’ve made with the SEC and the Securities Commissions or similar regulatory authorities in Canada. We encourage investors to review these factors carefully. Our outlook assumes no significant change in underlying economic trends. It also excludes any impact from additional acquisitions that may close during the remainder of the year and expensing of transaction related items during the period. And finally, it does not reflect the two landfill situations described earlier, which could result in impacts in the quarter of up to $20 million in revenue, adjusted EBITDA and adjusted free cash flow.

Revenue in Q4 is estimated to be approximately $2.04 billion. We expect core price of about 8.5%, and total price plus volume of 5.5% to 6%. Recycled commodity values and RINs are projected in line with recent levels, and adjusted EBITDA in Q4 is estimated at approximately $658 million or 32.3% of revenue. Depreciation and amortization expense for the fourth quarter is estimated at about 12.6% of revenue, including amortization of intangibles of about $39.5 million, or about $0.11 per diluted share net of taxes. Interest expense, net of interest income in Q4 is estimated at approximately $68 million, and finally, our effective tax rate in Q4 is estimated at about 23%, subject to some variability. And now, let me turn the call back over to Ron for some final remarks before Q&A.

Ron Mittelstaedt: Thank you, Mary Anne. Again, we are extremely pleased with our year-to-date performance and our positioning for 2024, particularly given the strength of execution throughout 2023 and the improving dynamics in employee retention. Although, we won’t provide our formal outlook for 2024 until February, we are able to expand on the early thoughts we provided in August, assuming no change in the current economic environment. We continue to have visibility for outsized adjusted EBITDA margin expansion, resulting in expected high single digit adjusted EBITDA growth in 2024, unexpected mid to high single digit revenue growth, including price led organic growth in solid waste, plus almost 2% from acquisitions signed or closed thus far in 2023, with the potential for that amount to grow by early next year based on our current pipeline.

To the extent that we see further improvement in recycled commodity values or easing of inflationary pressures during the year, those impacts along with additional acquisitions completed throughout the upcoming year would provide upside to these preliminary thoughts, as would the benefit from RNG facilities coming online by 2024. Adjusted free cash flow conversion would be expected to remain in the current range of 45% to 50% of adjusted EBITDA, excluding the outlays for RNG projects described earlier. We look forward to having better visibility on the tone of the economy, the pace of acquisitions, expected commodity driven activity, and the projected resolution timing of the landfill situation when we provide our formal outlook in February.

As we continue to grow towards revenue of $10 billion and more, we maintain that our decentralized operating philosophy and therefore, our people are a greatest differentiator. Our results to date and our outlook for 2024 are a reflection of their commitments and accomplishments. We recently celebrated our 26th anniversary as a company and had the opportunity to be together as a team with our local leaders for the first time since the pandemic to renew the relationships that we know drive our results and to reinforce the vision and values that have guided waste connections since its inception. Safety, integrity, accountability, customer service, servant leadership, and being a great place to work. In short, it’s about both relationships and results.

We appreciate your time today. And with that, I will now turn this call over to the operator to open up the lines for your questions. Operator?

Operator: Thank you. [Operator Instructions] And today’s first question comes from Toni Kaplan with Morgan Stanley. Please go ahead.

Toni Kaplan: Thank you so much. Very strong pricing quarter once again. I was hoping you could maybe give some initial thoughts on pricing in 2024, maybe just kind of ballpark. How should we think about the trajectory? Would you expect sort of price to come down as inflation comes down or are you not really expecting too much of a drop at all? Thanks.

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Q&A Session

Mary Anne Whitney: Sure. Thanks, Toni. So in terms of pricing, I’d start with, you’ll recall that about 40% of our pricing is CPI linked and therefore there’s that lagging impact. And so the CPI you see this year informs us about how to think about what that pricing looks like for next year. And then beyond that, we think in terms of that spread to drive margin expansion. And so as Ron described, the preliminary thoughts for 2024, saying mid to high single digits, including the 2% acquisition contribution, sort of informs you as how we’re thinking about price plus volume, making up the other piece to get you to that mid to high. And then in terms of the cadence during the year, the typical cadence, Toni, is that pricing on a reported basis is typically highest in the first quarter and steps down over the course of the year, because of the denominator growing.

And so – but most of the pricing gets done early in the year, so we have good visibility by the time we report Q1.

Ron Mittelstaedt: And Toni, this is Ron. What we strive for continually is to be about 150 to 200 basis point spread to the CPI on an ongoing basis. So sort of whatever you would assume is the CPI for next year. If you’re assuming that’s 3.5% to 4%, I would add 150 to 200 basis points plus to that assumption for the price, as is this quarter, we did 250 basis points better than a cost spread, but we certainly strive to be in that 150 to 200 at least on a regular basis.

Toni Kaplan: Terrific. Very helpful. I also wanted to ask, you did a nice job describing the issues that you’re seeing with the landfills in California and Texas. You talked about it being not recurring and site specific. I was just wondering, are there always issues like these, but these are bigger, so they have to be called out or is there a reason why there are a couple of issues at the same time and just trying to figure out as we go forward if we’re going to see some additional issues. I know these are supposed to be sort of one time, but maybe just talk about if anything has changed.

Ron Mittelstaedt: Sure. So, first off, Toni, nothing whatsoever has changed. First off, we have well over 100 landfills in the company, and in 26 years, we’ve never once at any of our landfills had one of these elevated temperature events. So that tells you how rare and how unique they are. They definitely happen within the industry at probably any given time. There’s five or maybe ten of these going on nationwide with various owners, but we have never had one before. And so that is unique. It is also in Southern California and Los Angeles, which makes it a little bit more complicated because of the density of the population. So that’s one. The second one, the Texas issue, and these are completely unrelated and coincidental in timing.

The second one, the Texas issue, was a slope failure. That was actually our error caused by us. We could have prevented that, but we missed a few things. And we have only had two of those out of over 100 landfills in 26 years, one about 14 years ago and smaller and we never needed to call it out or did call it out. The other reason we’ve called out these two is because there has been press coverage of these in the media. And because of that, we felt it would be inappropriate not to communicate it to investors and other listeners when it is in the press. So that’s how I would characterize these two as to why many would add this back is because of their non-recurring nature and we’ve really never had either of these before.

Toni Kaplan: Super. Thank you.

Operator: Thank you. And our next question today comes from Kevin Chiang with CIBC. Please go ahead.

Kevin Chiang: Hi, thanks for taking my question, and good morning, everyone. I appreciate – I guess, the uncertainty and how you’re going to deal with some of these costs relate to the landfill, both specifically in Q4. But if I look at Q3 and if I – and Mary Anne mentioned it, if you back that out, you saw solid waste margin expansion of about 150 basis points. Does that change how you think about the launching point for 2024, excluding these issues and if we treat them as one time, it does feel like you’re entering 2024, maybe a little bit higher than maybe what we would have thought a quarter ago. I’m not sure if you’d agree with that.

Ron Mittelstaedt: Yes. I mean, I think, Keven – so number one, it does not change how we think about the launching point. Look, and it has been raised by some of your peers in conversation. Look, we beat our guidance in Q3 and EBITDA, and we overcame $15 million. So we really would have beat by $17 million. So some have said, hey, this is up to $20 million in Q4. Why wouldn’t you just not acknowledge that? And you could probably beat it. And what we would tell you is, look, we didn’t expect to beat Q3 by $17 million in EBITDA. Good things happen. Rough things happen sometimes. So we’re being transparent on the rough things we know, and we do believe they’re non-recurring completely. The Texas will be over in Q4. The California will not be over in Q4, but we believe it still will be non-recurring.

And so, no, we don’t think of the launch off point or the jump off point as any different with these than we had, which is why in our comments, we’ve said we have outsized margin expansion. Look, we are now up 250 basis points between Q1 and Q3 in margin, okay? And we have just guided Q4 up substantially over last year’s Q4. So the jump off point is clearly higher than was anticipated earlier in the year.

Kevin Chiang: That’s helpful. And then when I think back to the second quarter call, you gave a lot of color on some of the stuff you’re doing on addressing labor turnover. And I think one of the comments you did make was as you get turnover lower, that could yield about 100 basis points of margin improvement over the next call it, 18 to 24 months. You called about $9 million of experience costs that weren’t expected in the third quarter. Does that change how you think about the margin opportunity that you laid out back on the second quarter, whether it’s the magnitude of the margin improvement or maybe the timing of realizing those?

Ron Mittelstaedt: No, it really doesn’t, Toni – excuse me, Kevin. I apologize. It really doesn’t. And here’s why. Because in the $9 million of incremental risk expense, that’s really a one-time issue on prior claims, okay? A part of it is forward looking, but the smallest part of it is forward looking. So the reduction in turnover and the improvements in labor and risk and other areas will offset that will more than overcome that. And we stand by that margin impact. One of the reasons we reiterated, hey, we just had a year ago commodities we’re already north of 33% is to show you that with that 100 basis point improvement over a few years, the 34% EBITDA margin visibility is really pretty clear right now.

Mary Anne Whitney: The other thing I would add, Kevin, just to put some numbers around it, when we think about the cost of risk and coming, how it was playing out in 2023 and specifically in Q3, our expectation was that it was a headwind. It was just a greater headwind. So it ended up being a 90 basis point headwind to reported margins. We had expected it to be a 40 to 50 basis point. So my point is that has been a factor throughout 2023, but it is one of those examples of as turnover goes down, the lagging benefits that should accrue to us over 2024 and 2025 potentially that’s one of the items that we’d expect to improve.

Kevin Chiang: That’s great color. I’ll leave it there. Thank you very much and best of luck as you close out the year here.

Ron Mittelstaedt: Thank you.