Waste Management, Inc. (NYSE:WM) Q3 2023 Earnings Call Transcript

Waste Management, Inc. (NYSE:WM) Q3 2023 Earnings Call Transcript October 25, 2023

Operator: Good day, and thank you for standing by. Welcome to the WM Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Please be advised, that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Ed Egl, Senior Director of Investor Relations. Please go ahead.

Ed Egl: Thank you, Victor. Good morning, everyone, and thank you for joining us for our third quarter 2023 earnings conference call. With me this morning are Jim Fish, President and Chief Executive Officer; John Morris, Executive Vice President and Chief Operating Officer; and Devina Rankin, Executive Vice President and Chief Financial Officer. You will hear prepared comments from each of them today. Jim will cover high-level financials and provide a strategic update. John will cover an operating overview, and Devina will cover the details of the financials. Before we get started, please note that we have filed a Form 8-K that includes the earnings press release and is available on our website at www.wm.com. The Form 8-K, the press release, and the schedules in the press release include important information.

During the call, you will hear forward-looking statements, which are based on current expectations, projections, or opinions about future periods. All forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Some of these risks and uncertainties are discussed in today’s press release and in our filings with the SEC, including our most recent Form 10-K. John will discuss our results in the areas of yield and volume, which, unless stated otherwise, are more specifically references to internal revenue growth or IRG from yield or volume. During the call, Jim, John and Devina will discuss operating EBITDA, which is income from operations before depreciation and amortization. Any comparisons, unless otherwise stated, will be with the third quarter of 2022.

Net income, EPS, operating EBITDA margin and SG&A expense results have been adjusted to enhance comparability by excluding certain items that management believes do not reflect our fundamental business performance or results of operations. These adjusted measures, in addition to free cash flow are non-GAAP measures. Please refer to the earnings press release and tables, which can be found on the company’s website at www.wm.com for reconciliations to the most comparable GAAP measures and additional information about our use of non-GAAP measures and non-GAAP projections. This call is being recorded and will be available 24 hours a day beginning approximately 1:00 PM Eastern Time today. To hear a replay of the call access the WM website at www.investors.wm.com.

Time-sensitive information provided during today’s call, which is occurring on October 25, 2023, may no longer be accurate at the time of a replay. Any redistribution, retransmission or rebroadcast of this call in any form without the express written consent of WM is prohibited. Now I’ll turn the call over to WM’s President and CEO, Jim Fish.

Jim Fish: Thanks, Ed, and thank you all for joining us. Our third quarter results are a testament to our team’s ability to deliver on the priorities we set for 2023, including increasing profitability through disciplined pricing and optimizing our cost structure. Against the challenging backdrop, we have remained focused on the things we can control and this diligent focus is evident in our third quarter results. Adjusted operating EBITDA grew by more than 6% and margin expanded 100 basis points to 29.6% when compared to Q3 of 2022. Our strong results in the quarter were powered by our solid waste business. Organic revenue growth in the collection and disposal business remains solid and is tracking well against our expectations.

Third quarter core price of 6.6% reflects robust price performance across all lines of business. We’re also pleased with the resilience of our solid waste volumes as commercial volumes turned mostly positive and special waste growth improved from the second quarter. And what really stands out for this quarter is our success in managing the middle of the P&L. We continue to drive SG&A leverage and we’re also gaining momentum on operating cost optimization and efficiency gains. Our long-term focus on using automation and technology to optimize our cost structure is paying off, as we’re choosing not to replace certain high turnover difficult-to-fill positions. Since January of 2022, we’ve leveraged attrition and technology to reduce headcount by 1,650 positions.

We continue to be focused on the full opportunity of 5,000 to 7,000 position eliminations through attrition and technology over four to five years, and we’re pleased with this progress to date. You’ll hear more details about our cost performance from John and Devina. Putting it all together, our focus on price, efficiency and cost control translated into the strong operating leverage we produced in the quarter. Turning to our strategic investments in sustainability growth, the investment proposition for growing our renewable energy and recycling business remains strong and our project execution is tracking well. Our seventh renewable natural gas plant and the third of 20 facilities in our growth program is expected to be in service in January.

And we have another four facilities on track for completion in 2024, including two of the largest projects in the portfolio, Fairless in Pennsylvania and Orchard Hills in Illinois. On the recycling front, we’ve completed technology and automation upgrades at two facilities in the quarter. And we have two more upgrades at a new facility in Nashville slated to begin service by the end of this year. Our automated network continues to drive great results by pushing our labor and processing costs lower, improving throughput and driving enhanced material quality, which benefits the recycling business in any commodity environment. Yet again, in the third quarter, we saw materially lower labor cost per ton at our automated facilities at about 35% below the rest of our recycling network.

Our investments in developing the blueprint for a modern recycling facility sets us apart within the communities we serve and are unlocking further growth opportunities. With one quarter remaining in the year, we’re well positioned to deliver on the 2023 financial outlook we provided last quarter, including adjusted operating EBITDA growth of 6% at the midpoint. We continue to expect a margin run rate exiting the year of about 29%, underpinned by 62% operating expenses as a percent of revenue and 9% SG&A as a percent of revenue. We’re pleased with our results through the first nine months of the year. Our team is very focused on price discipline and cost optimization to deliver a strong finish to the year and lay the groundwork for further growth in 2024.

I want to thank each of our team members for their commitment to our customers and their many contributions to our success. I’ll now turn the call over to John to discuss our operational results for the quarter.

John Morris: Thanks, Jim, and good morning. I’d like to open by highlighting the strides we’re making in optimizing our cost structure. In the third quarter, operating expenses as a percentage of revenue improved 90 basis points year-over-year to 61.3%. The collection and disposal business contributed 70 basis points of this improvement due to the strong operating leverage provided by our cost optimization efforts. In addition, we achieved pricing leverage as core price exceeded cost inflation by an estimated 100 basis points in the quarter. We’re pleased with the progress we’ve made in managing our labor costs, as well as expenses related to repair and maintenance. Our efforts have resulted in a meaningful decline in WM’s underlying cost of inflation since the beginning of the year to mid-single-digits in the third quarter.

Our focus on efficiently managing labor expenses is yielding positive results. So far this year, we have automated 141 residential routes and have a target to convert more than 400 routes in 2024. As we shift to more automated routes, we’ve seen a nearly 14% decrease in the number of helpers needed in our residential business. In addition, our focus on reducing turnover continued to produce improvements in Q3, building on the consistent progress we’ve made over the past 12 months. Our collection efficiency has also exhibited steady progress throughout the year with commercial, industrial, and residential business line showing improvements every quarter. All these focus areas on managing our business are contributing to the improvement in labor costs.

Turning to repair and maintenance expenses. Despite some lingering effects of inflation and the timing of fleet deliveries, we’re making progress. For the first time in several years, we expect to get an allotment of vehicles that aligns with our fleet replacement strategy with more than 1,200 received to-date. This has allowed us to remove older trucks from our fleet and also reduce rental truck usage by over 40% since the start of the year. Furthermore, our spending on third-party technicians has been reduced by two-thirds compared to the second half of 2022 and continues to improve. With the progress we’ve achieved in the third quarter, we believe we’ve turned the corner on this expense line and are optimistic about ongoing improvements as we close out the year.

Turning to our revenue growth. We continue to execute on our revenue management programs to recover cost increases and improve margins. Our third quarter organic revenue growth in the collection and disposal business was 5.7% on a workday-adjusted basis. This growth was led by core price of 6.6% with collection and disposal yield of 5%. Our differentiated service offering is generating value with our national account customers as well as commercial customers. We continue to focus on maximizing customer lifetime value and our Q3 churn of 9% remains at the low end of our historical range, demonstrating the positive momentum we are seeing with customers valuing our service offerings. Looking at volumes. Third quarter collection and disposal volume grew by 0.7% on a workday-adjusted basis.

Our landfill business drove most of the volume growth as special waste grew 11.1% on a workday-adjusted basis in the quarter. As a reminder, we do not separate special waste into yield in volume and in Q3, we benefited from several high-priced projects that drove the increase. So, we’ve highlighted in previous conversations, the timing and pricing of special waste projects is subject to variability due to their discretionary nature. However, our project pipeline remains robust. In addition, Workday adjusted MSW volumes were up 1.7% in the quarter. Our overall collection volumes were down modestly due to the intentional steps we continue to take to price every contract to achieve acceptable returns as well as the impact of lower volumes from our roll-off business.

Yet both revenue and operating EBITDA continue to grow in each line of business, demonstrating that we are prioritizing profitable volume growth. Net new business and net service increases remained solidly positive and growth in our strategic accounts business, driven by our differentiated offerings, continues to outpace our expectations. Thus, overall collection and disposal organic growth is on pace for the year. With regard to recycling and renewable energy, our third quarter results were in line with our expectations and our recently automated recycling facilities are delivering strong results. As Jim discussed, our sustainability growth projects are tracking well and we’re confident that our operating EBITDA expectations for the year remain in the range provided last quarter.

In closing, I’d like to express my gratitude to our frontline teams for their dedication to providing safe and dependable service to our customers and communities each day. I’ll now turn the call over to Devina to discuss our financial results in further detail.

Devina Rankin: Thanks John, and good morning. Our third quarter results reflect our continued focus on the fundamental value drivers of our business, disciplined revenue growth and cost optimization. Executing on these fundamentals positioned us to deliver WM’s best ever operating EBITDA margin in the third quarter at 29.6%. This is a 100 basis point improvement compared to Q3 of 2022 and it can be attributed almost entirely to 70 basis points of margin expansion in the collection and disposal business. SG&A leverage provided the remaining expansion. We’re pleased with the team’s focus on optimizing costs and reducing discretionary spending, which together positioned us to deliver SG&A costs as a percentage of revenue of 9%, showing that this long-term goal is not just achievable, it is largely in hand.

While the current quarter result has some benefit from lower current year incentive compensation costs, we see this level of SG&A is sustainable, particularly as revenue grows. While there were a number of other margin impacts in the quarter, mostly related to fuel, energy and commodities, these items basically offset each other, giving us confidence that this quarter’s results are based on the steps we are taking to price our services above inflation and to permanently reduce our cost structure. Through the first nine months of 2023, we have expanded operating EBITDA margin by 40 basis points to 28.5%, putting us squarely on track to achieve our full year target of operating EBITDA margin of 28.4% to 28.6%. Our operating performance has translated into robust cash flow from operations.

Through the first three quarters of the year, cash flow from operations exceeded $3.3 billion, positioning us to deliver more than $4.5 billion of cash from operations for the year. As we expected, cash flow associated with operating EBITDA growth in 2023 has been largely offset by higher interest, taxes and incentive compensation payments. Despite these known headwinds, our conversion of revenue dollars to cash from operations and operating EBITDA dollars to free cash flow in the base business were both near peak levels in the quarter, demonstrating the sustainable value creation from our diligent focus on optimizing the middle of the P&L and/or capital expenditures. Capital spending in the first nine months of the year totaled almost $1.9 billion with $1.456 billion related to normal course capital and $397 million of spending on sustainability growth projects.

We now expect sustainability growth capital spending of about $750 million in 2023. The $150 million decrease from prior expectations is based on a shift in the timing of spending across the next two to three quarters. As a result of this lower anticipated capital spending, 2023 free cash flow is expected to be $150 million above our prior expectations and in the range of $1.825 billion to $1.925 billion. Free cash flow through the first nine months of the year was $1.552 billion, and free cash flow before sustainability growth investments was $1.949 billion. We’re confident in our ability to achieve our full year targeted free cash flow before sustainability growth investments of between $2.575 billion and $2.675 billion. Year-to-date, we’ve returned $855 million to shareholders through dividends and repurchased $990 million of our stock.

Our leverage ratio at the end of the quarter was 2.73 times, which is at the midpoint of our target ratio of between 2.5 times and 3 times. 9% of our total debt portfolio is at variable rates, our pre-tax weighted average cost of debt for the quarter was 3.9%. Our balance sheet is strong, and we remain well positioned to fund growth opportunities. Looking at our full year expectations. Our solid operational performance in the first nine months of the year positions us to achieve the operating EBITDA guidance we provided last quarter of $5.775 billion to $5.875 billion. This strong result will be achieved with continued focus on pricing our services to recover cost inflation differentiating WM’s value proposition with customers to maintain and grow the right volumes and optimizing both operating costs and SG&A.

We expect full year revenue growth to be modestly below the midpoint of our July 2023 guidance of 3.25% to 4.25%. Most aspects of our revenue outlook remain intact, but we have seen lower revenue than planned in our recycling brokerage businesses. Given the relatively small operating EBITDA impact from the brokerage business, this refreshed revenue outlook does not impact any other component of our guidance. To sum it up, we’re pleased with our performance throughout 2023. We firmly believe that leveraging technology and automation to enhance our operations and investing in our sustainability businesses are positioning us for future success. We’re grateful for the hard work of the entire WM team. Their dedication to safely serve our customers and communities will ensure we finish the year strong and move into 2024 even stronger.

With that, Victor, let’s open the line for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question will come from the line of Bryan Burgmeier from Citi. Your line is open.

Bryan Burgmeier: Good morning, and thank you for taking the question.

Jim Fish: Good morning.

Bryan Burgmeier: Thinking about some of the underlying guidance components, volume is maybe a little bit better than your original view and on that maybe points to a little bit of upside on recycling and renewables versus the guidance you put out in July. I guess, A, do you agree with that to be – it will seem like we maybe could be pointing towards the higher end of the EBITDA range? I think you said 6% EBITDA growth at the midpoint, which is maybe a tough higher but that is towards your model. Any detail you can add there? Thank you.

Jim Fish: Yes. So I guess a couple of – you mentioned volume, then you mentioned the EBITDA range. So I’ll tackle volume first here, Bryan. When we looked at volume, we were obviously pleased with a couple of things, special waste, as I mentioned, was slightly better. Some of that was rate related, really. But for the most part, volume was as we expected, which was fairly flat. We said at the beginning of the year that volume would be flat. And it’s been fairly flat all year. Third quarter was slightly better than the first two quarters. I think the collection volumes have been flat pretty much all year long. It’s been a – it’s different from one line of business to another. Resi almost really by design has been down probably for a couple of years at roll-off was probably the more disappointing of the lines of business and then commercial might have been the one that was more encouraging.

So commercial was up slightly, roll off down and then resi by design. And then within the landfill line of business, not anything really unexpected there other than maybe special waste and maybe C&D a little bit. C&D has a little bit of a mix there. And in particularly when you get to the fourth quarter, C&D is really going to be a difficult comparison because of the hurricane last year. But overall volume, I think is not – it’s not going to be a big change when you get into the fourth quarter. And honestly, what you’re going to see in 2024, and we’ll give, of course, our guidance when we get to the next quarter, but 2024 is going to sound pretty similar to 2023, I think, when it comes to volume. I guess when it comes to the EBITDA range – and we anticipated that there would be a question of, okay, so nice performance on EBITDA.

So why not give us a number in the higher end of the range. And I would just tell you, there’s going to be a natural level of conservatism here because whether it is – not that we’re affected much by geopolitics, but there’s a lot going on right now that makes it a little bit hard to see out into beyond a month or two. I think that’s why 2024 is still a question for us. How does 2024 look? We’re going to wait three months before we really try and put a pin on 2024. But for 2023, we’re comfortable with the range. We feel comfortable with the quarter. And to the extent that it ends up where we expect, then we were right to not change it. If it’s higher than we expected, then it beat us up at that point.

Bryan Burgmeier: Understood. Yes. Thank you for all the details, Jim. Last question for me. If I heard you correctly in the prepared remarks, I think you said you’re looking to bring four or five RNG facilities online next year. I think that would be essentially in line with your original plan from January. Is it fair to assume that most of the construction delays that we’re seeing in the CapEx line are related to recycling? Can you put a finer point on the facilities might be coming online to 2024? Or is it a little bit too soon to speculate, right? Thanks, and I’ll turn it over.

Tara Hemmer: Sure. This is Tara Hemmer, Chief Sustainability Officer. I think there are two key takeaways that we want you to hear from us related to our sustainability-related investments. And the first is our level of confidence in our 2026 EBITDA projections, the $500 million for renewable energy, the $240 million for recycling. We’ve spent a lot of time really looking at our projects and we’re very confident in our ability to deliver those numbers in 2026. The second thing that is important to note and it’s one of the reasons why we have this level of confidence is in 2024, we expect to have about 40 projects under active construction. So that gives you a sense of the momentum that we’re building within the platform. If you look at the capital related to some of the shifts, it is related to both recycling and renewable energy.

It’s not just specific to recycling. So I want to leave you with that. But the important thing to remember is these capital shifts that we see, we see something similar in our traditional business where construction projects really don’t know calendar years. And so some of this is about shifting some things from Q4 into Q1 and Q2.

Bryan Burgmeier: Understood. Thanks a lot.

Operator: Thank you. One moment for our next question. And our next question will come from the line of Tyler Brown from Raymond James. Your line is open.

Tyler Brown: Hi. Good morning guys.

Jim Fish: Good morning.

Devina Rankin: Hi.

Tyler Brown: Hi. John, I know it’s early, but it does feel like unit cost inflation is starting to ease. I’m just curious, you said mid-single-digit unit cost inflation in the quarter, but can you be a little bit more specific on what that was? And two, just any early thoughts on how you guys are thinking about core price into next year in order to offset unit cost inflation to get to that 29% margin that Devina talked about.

John Morris: Yes. Good question, Tyler. I would tell you, let me start with wages because that’s 1 I’ve used as a barometer. When you look at where we were beginning of the year Q1, it was double digits. It was 10%, 11%. And when you look sort of right, the big buckets of labor drivers, technicians, have equipment operators. Those numbers are down between 5% and 6% in Q3. So almost half of where they were. So that’s part of what we’re seeing from inflation moderation. I think on the M&R side, too, maintenance and repairs, part of my prepared remarks is we got 1,200 trucks, and we’ll end up with about over 1,300 for the year and we’re seeing the same kind of progress in our maintenance and repair expenses. When you look at it in whole dollars or on a percentage basis, we’ve sort of gone from the mid-teens down to low double digits and now we’re in the 6% to 7% range for Q3.

So as Devina said, we’re not claiming victory there yet. But I think the combination of us getting assets, some moderation in the big buckets, labor being one of them, are what you’re seeing translate to the 61.3% in the quarter from an OpEx perspective. On the core price side, I mean, Jim said in his opening comments, it’s not really been so much about the core price going through. It’s about what are we retaining. And I think when you look at the margin expansion you saw relative to the OpEx. And you heard in my prepared remarks about us making margin and EBITDA improvements in all lines of business. I think that’s the end result we’re shooting for. So our pricing strategy holistically is working, and I don’t think you’re going to see any change in that.