Waste Management, Inc. (NYSE:WM) Q4 2022 Earnings Call Transcript

Waste Management, Inc. (NYSE:WM) Q4 2022 Earnings Call Transcript February 1, 2023

Operator: Good day and thank you for standing by. Welcome to the WM Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today at Ed Egl, Senior Director of Investor Relations.

Ed Egl: Thank you, Josh. Good morning, everyone, and thank you for joining us for our fourth quarter 2022 earnings conference call. With me this morning are Jim Fish, President and Chief Executive Officer; John Morris, Executive Vice President and Chief Operating Officer; Devina Rankin, Executive Vice President and Chief Financial Officer; and Tara Hemmer, Senior Vice President and Chief Sustainability Officer. During their prepared comments, 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. Following comments, Jim, John, Devina and Tara will be available to answer questions. Before we get started, please note that we have filed a Form 8-K this morning that includes the earnings press release and is available on our website at www.wm.com.

In addition, we have published a supplemental presentation with additional information about our multi-year plan for investments in our renewable energy and recycling businesses, and it is also available on our Form 8-K and our website at investors. wm.com. The Form 8-K, the press release, the supplemental presentation and the schedules of 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 otherwise stated, 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 fourth quarter of 2021. Net income, EPS, operating EBITDA and 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 operation. 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 investors.wm.com. Time-sensitive information provided during today’s call, which is occurring on February 1, 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 expressed 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. 2022 was another very successful year at WM. Coming into an uncertain 2022, I wouldn’t have predicted that we would grow adjusted operating EBITDA by more than 9.5% for the year, and 8.8% for the fourth quarter, all while recycling was down $59 million for the year on a sharp drop in commodity prices. That’s exactly what happened. Strong operational execution and an unwavering commitment to our strategic priorities led to our full year adjusted operating EBITDA growth of $480 million. We achieved this tremendous growth in the face of elevated inflation, a tight labor market, and a downturn in the recycled commodity price market. So, we’re very proud of our results. Our robust operating EBITDA translated into record cash from operations of more than $4.5 billion, which allowed us to return more than $2.5 billion to our shareholders through dividends and share repurchases.

As 2023 kicks off, we’re confident that our long-term focus is on sustainable growth, transforming our business through technology and automation are setting us up to meet the changing needs of our customers, our people, and our business environment, while leveraging our competitive advantages. Turning to our high-level outlook for 2023. We expect to deliver adjusted operating EBITDA of between $5.825 billion and $5.975 billion in the year ahead, representing growth of just over 7% at the midpoint, which continues the trend of robust operating EBITDA growth that we’ve delivered since 2019. Since then, we’ve grown operating EBITDA almost 26%. And at a time when the economic outlook is increasingly uncertain, we’re pleased to be anticipating another strong year of earnings growth in 2023.

The essential nature of our service, our diverse customer base, and recurring revenue streams provide stability in times of economic uncertainty. Much of the growth in our 2023 outlook comes from deliberate steps that we’ve already taken to grow revenue and efficiently manage costs. Overall, we’re anticipating between 40 and 80 basis points of adjusted operating EBITDA margin expansion in the year ahead, driven by our collection and disposal business. Moving now to our sustainability growth investment. Let me give you an abbreviated overview of the supplemental deck that was posted to our Investors website. The investment in our renewable energy business is a unique opportunity that we simply couldn’t afford to mass. You’re all aware that since the passage of the subtitle B and associated air quality regulations in the 1980s and 1990s, landfill has been required to install gas collection systems.

Historically, we’ve been collecting our landfill gas, converting much of it into electricity, which provides an earnings stream for us. Fast forward to present day, with landfill gas designated as a renewable resource, we are increasing the value of the gas that’s an inevitable byproduct of most landfills. These RNG plants are simply taking gas that’s naturally produced from the landfill and converting it into a cash-generating machine with a three-year projected payback and a far better environmental outcome than the status quo. And our returns far surpass those of our competition by virtue of our CNG fleet, which today represents 74% of our routed vehicles. As a result, we’re better positioned to close the loop and capture extremely valuable regulatory RIN credits.

At the same time, the recently enacted Inflation Reduction Act will provide tax credits and benefits that served to amplify the value creation of WM’s renewable energy business. The supplemental presentation to the earnings press release provides details on the investments and our projections for cash flow and operating EBITDA growth. But suffice it to say, we view this as a very strong positive for shareholders. We have a number of attractive options for our renewable energy portfolio. Internally, we said there are three possible outcomes from this opportunity, good, really good or great. And we’re heading down the great path by owning the landfill gas and renewable energy facilities, generating RINs through our CNG fleet and maximizing the value of new tax benefits to increase the resulting earnings and cash flows.

We’re also advancing our planned recycling investments and have provided more details in the supplemental presentation on our website. Our portfolio of projects to automate existing and build new material recovery facilities have three key financial benefits; reduced labor costs, improved product quality that commands a price premium and capacity growth. In the fourth quarter, labor costs per ton at our single-stream automated MRFs improved by 35%. The automation of these plants enabled us to reduce 137 positions through attrition in 2022. And in 2023, we expect to reduce labor dependence by another 200 positions. By the end of 2023, we’re anticipating about a 15% increase in processing capacity from our automated facilities and new markets.

We will host a virtual information session for investors on April 5th to provide even more insight into our recycling and renewable energy growth plans. Devina will discuss our 2023 capital allocation plans in more detail, but I want to emphasize our confidence in our ability to continue to allocate capital to all of our priorities, including investing in these high-return sustainability growth projects, returning cash to shareholders through dividends and share repurchases and acquiring accretive businesses. In closing, I want to thank the entire WM team for another fantastic year. We look forward to 2023 as we continue to execute on our operating plans and progress our investments in renewable energy, recycling and automation to drive growth.

I’ll now turn the call over to John to discuss our operational results.

John Morris: Thanks, Jim, and good morning, everyone. Jim described our fantastic results in 2022 and that all begins with our collection and disposal business. In the face of some of the highest inflationary cost pressures, our collection and disposal business delivered double-digit in adjusted EBITDA for the full year. During the fourth quarter, collection and disposal results were even more impressive as adjusted operating EBITDA grew more than 11% and margin expanded 40 basis points. This momentum sets the stage for continued growth in 2023 and strengthens our conviction that the investments we’re making in our people in automation and in differentiating our service offerings are the right decisions. The growth in our collection and disposal business starts at the top of the income statement with robust organic revenue growth.

Full year core price was 7.8% with collection and disposal yield of 6.7% and volume of 1.8%. As we work to keep pace with decades high inflation, our revenue management teams delivered record core price in 2022 in every one of our lines of business, led by 10.5% in our commercial line of business. We talk often about our focus on generating appropriate returns in our residential and post-collection lines of business. And in 2022, we delivered core price of 6.5% in the residential line of business, 6.4% at our landfills and 5.9% at our transfer stations. Our revenue metrics demonstrate that our customers’ receptivity to our pricing remained favorable through the fourth quarter. Our rollback percentage was almost 400 basis points better for the full year, while new business pricing increased more than 6% in our commercial line of business.

The results clearly demonstrate our ability to manage cost pressures through continued pricing discipline and momentum, while maintaining our focus on customer lifetime value. As we move into 2023, our disciplined pricing programs combined with the strong momentum from 2022 and are expected to deliver core price of between 6.5% and 7% with yield approaching 5.5%. Our expectation is for strong rollover of 2022 price performance. Given the acute inflationary environment in 2022, we increased certain fees that we don’t expect to step up again at the same level. We remain committed to securing pricing that outpaces our cost inflation, which is demonstrated by the operating EBITDA margin expansion that we’re anticipating in 2023. Shifting to volumes.

In the fourth quarter, event-driven volumes remained strong with special waste and C&D volumes growing double digits. Our commercial and industrial volumes were positive for the full year. However, we saw some softening in the fourth quarter. Given these recent trends, we are tempering our volume expectations in the year ahead. Our guidance includes 2023 collection and disposal volumes that are relatively flat with 2022. We continue to see the rate of labor increases easing in our business, and we remain focused on managing our operating expenses and flexing down costs, flexing costs down with the changing volumes. In our collection and disposal business, we are seeing improvements in our labor costs as inflationary wage pressures are easing.

Turnover trends are improving and the investments that we are making in automation are showing benefits. These improvements were on display in the fourth quarter €“ in our fourth quarter results as we saw operating expense margin improved by 30 basis points despite still stubbornly higher maintenance and repair costs. For the full year of 2022, operating expenses increased 50 basis points as a percentage of revenue, but that was largely driven by negative impacts from higher fuel costs and recycling commodity prices that together impacted the measure by 80 basis points. This increase was partially offset by lower labor and related benefits costs in our collection and disposal business and improved risk management costs. Putting it all together, when you combine our pricing efforts with our progress on cost containment, we expect 2023 operating expense as a percentage of revenue to improve between 30 and 50 basis points for the full year, with those improvements beginning in the second quarter of 2023.

In the fourth quarter, our recycling operating EBITDA remained solidly positive even with the sharp decline in commodity prices to about $47 per ton. Over the last several years, we have intentionally taken steps to shift the business to a fee-for-service model that has reduced our sensitivity to commodity market changes. When we started this journey in 2017, commodity prices were 60% higher than what we are anticipating in our 2023 outlook, yet 2023 operating EBITDA is expected to be about 13% higher than in 2017. This clearly demonstrates that our business model is profitable and generate solid returns in any economic environment. As we look to the future of recycling, we remain focused on advancing automation across our MRF network, which we have proven can lower the cost of process material, achieve better quality while enhancing recycling profitability.

Our employees delivered strong results in 2022, and I want to thank the entire WM team for their commitment to providing the best customer service while focusing on improving our operations. The team has done an exceptional job, and I know that this will continue in the year ahead. I’ll now turn the call over to Devina to discuss our 2022 financial results and 2023 financial outlook in further detail.

Devina Rankin: Thanks, John, and good morning. Once again, our solid waste business was at the center of WM’s strong quarterly results, capping off a great 2022. Our team delivered strong organic revenue growth with a diligent focus on leveraging core price to offset cost inflation, while prioritizing customer service and customer lifetime value to minimize customer churn, all resulting in record high yield. When combined with strong cost control, these efforts delivered an 80 basis point expansion of operating EBITDA margin in the fourth quarter. Importantly, we achieved these excellent results while investing in technology and sustainability growth that will benefit WM for years to come. Full year adjusted SG&A was 9.6% of revenue, a 40 basis point improvement over 2021 as we achieved back-office operational efficiencies through standardization and process improvement that enabled us to reduce more than 600 positions through attrition.

You can clearly see our strong performance and the record cash flow from operations that we achieved in 2022, which grew 4.6% to $4.536 billion. The increase in cash allowed us to accelerate investments at year-end, which brought full year capital spending to the high end of our expectations. 2022 capital expenditures totaled $2.587 billion with $2.26 billion of that related to normal course capital to support the business and the remaining $561 million related to the strategic growth of our recycling and renewable energy businesses. Putting these pieces together, 2022 free cash flow was $1.976 billion despite an increase in cash taxes of $370 million. During 2022, we returned a record $2.58 billion to shareholders, paying $1.08 billion in dividends and repurchasing $1.5 billion of our stock.

In addition, we spent $377 million on traditional solid waste and recycling acquisitions to grow our business. We accomplished all of this while accelerating our sustainability and growth investments and achieving our targeted leverage ratio of about 2.75 times. Our balance sheet is well-positioned for growth through capital investments in our business or strategic acquisitions. Moving to our 2023 financial outlook. As John mentioned, we anticipate organic growth approaching 5.5% from yield. Given an expectation for a little more than 1% revenue growth from acquisitions, and a decrease in revenue contributions from recycled commodity sales and fuel surcharges, we anticipate total revenue growth of between 4% and 5.5%. When combining our plan to deliver strong organic revenue growth with a focus on optimization and cost control to drive 40 to 80 basis points of operating leverage, we expect to generate adjusted operating EBITDA of $5.825 billion to $5.975 billion in 2023.

We expect to allocate $1.1 billion to capital investments in recycling and renewable natural gas growth projects in the coming year and 2023 is expected to be the peak investment year for each business. While these investments are reported as a component of our capital expenditures, and therefore, reduce our traditional measure of free cash flow. We view these investments as better than an acquisition dollar as they will produce even higher return growth as a strong complement to our existing business. Our normal course capital to support our business is expected to be between $2 billion and $2.1 billion in 2023. And free cash flow is projected to be between $1.5 billion and $1.6 billion, including the impact of sustainability growth investments.

Our outlook anticipates an increase in cash interest and taxes of $175 million to $215 million and about an $80 million headwind from working capital due in large part to the timing and amount of incentive compensation payments. As Jim discussed, even as we step up our investment in high-return recycling and renewable energy growth projects, we remain well positioned to allocate our cash among all of our capital allocation priorities, including returning cash to our shareholders. Given the Board of Directors intended 7.7% increase in the 2023 dividend rate, we expect dividend payments to total about $1.1 billion in the year ahead. We also expect to continue our share repurchase program in 2023, as the Board recently provided authorization to repurchase up to $1.5 billion of our stock.

While our guidance does not specifically include acquisition growth, we will continue to be opportunistic in pursuing the right deals at the right price. In closing, we are proud of what we achieved in 2022, and we’re excited about the opportunities that lay ahead for 2023 and future years. I want to thank our hard-working team members for all of their contributions to our success. With that, Josh, let’s open the line for questions.

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Q&A Session

Operator: Thank you. Our first question comes from Jerry Revich with Goldman Sachs. Your may proceed.

Jerry Revich: Yes, hi. Good morning, everyone.

Devina Rankin: Good morning.

Jerry Revich: I’m wondering, if you could just talk about the puts and takes around the guidance. If recycled commodity prices remain tough over the year. That should be about a $ 50 million drag to EBITDA, give or take. And in that scenario, I’m wondering if we should be thinking about yield that’s above the 5.5% target that we’re laying out here this morning as we think about the potential for the yield number to move higher over the year as we’ve seen over the past couple of years?

Jim Fish: Jerry, let me tackle the first question first on recycling, and then I’ll touch on yield overall. Recycling, obviously, fell off the table there at the end of the year. I think a lot of it had to do with China itself, even though China isn’t a big customer of ours anymore, they still affect the overall market, particularly when we think about OCC. And their zero COVID policy certainly destabilize the market. I think as they’ve reopened, we’ve started to see some stabilization there. So that should help, and that’s part of why we are a bit more optimistic in ’23 with pricing starting to climb back up. It did climb up a bit in December, and we think it will continue to climb, albeit not back up to where it was for the year in 2022.

To your question about yield in general and 5.5%, yield is doing exactly what we thought it would do. It’s doing exactly what we said it would do last year. I kind of felt like we yield and cost, we’re in a fistfight for the last 18 months with really no winter. And what we said was that we hope that when inflation moderated, which it is, that we would start to be able to use yield to not only cover costs, but also put a few points on the board in terms of margin. And that’s exactly what’s happening. So, we think that 5.5% yield number is absolutely the right direction. We’re sensitive to customers. I mean, some of our yield numbers last year were double digits. And when inflation comes back down to 4%, 4.5%, I don’t expect to take commercial increases at the 11.5% range.

So I think we’re pleased with the projection, and we’re pleased actually with the fact that costs are starting to moderate and we can actually apply a little bit of our yield to the margin line.

Jerry Revich: Super. And Jim, maybe just to expand on that last point, given the margin cadence over the course of the year to get the margin expansion that you’re targeting for 2023, it looks like you’re going to be exiting the year with margins up maybe closer to 100 basis points year-over-year in the fourth quarter, just given the seasonality and cadence. Can you just comment on that and whether that momentum could continue into early 2024?

Devina Rankin: Yes, Jerry, I think that that overview that you provided is spot on in terms of how it is that we’re looking at margin for the year ahead, 60 basis points of margin expansion at the midpoint indicates our confidence that the momentum that we saw in the back half of 2022 should continue into 2023. We expect some of the margin pressure from the recycling part of the business to continue in the first half. So we are seeing strong fundamentals in the solid waste part of our business that should help to offset that as they did in Q4. That being said, some of the cost execution, we really are laser focused as a management team on what we’re doing on the cost side of the business. And that’s not just looking at inflation and responding to it but being proactive in terms of what we can do to manage it appropriately.

And truck delivery trends are favorable now relative to where we started 2022, and that should give us some relief both in repair and maintenance and in truck rental costs. Our frontline retention efforts are showing really strong benefits, and we expect that to continue in 2023. We’re managing down professional fees, particularly in our SG&A. And then on the SG&A front, we’re also leveraging technology to automate our processes, which is improving the customer experiences and reducing our cost to serve. So all of that gives us confidence that it’s our strong execution on the cost side of the equation that will complement the yield that Jim just spoke to in terms of delivering that margin expansion and exiting 2023 with 100 basis points above kind of this current run rate feels like the right target for us.

Jerry Revich: Super, Devina. Thank you. And can I just sneak one more in. I really appreciate the landfill gas disclosures. I’m wondering, Tara and team, can you just give us an update on Offtake Agreements. A quarter ago, you were at one-third of your Offtake Agreements were done. Can you just give us an update on where that stands today and whether the pricing point on Offtakes in the market is still in the 20s or if that’s come in, given the pullback in Henry Hub gas. Thank you.

Devina Rankin: Yes. So Jerry, in 2022, we were at 30%, and we’re projecting in 2023 to be at 40% of our Offtake in fixed. And I think what’s important to note here is we really took a look at this back in early 2022, looking at the volume ramp of our R&D, and we were pretty intentional about thinking through how to tap into those voluntary markets. So those markets today, we’re seeing them be quite robust. If you think about large public utilities and industrial end users. This is a great way for them to tap into a low-carbon fuel and we’re not seeing any price back at the moment. We’ll give a bit more detail in April on what it looks like longer term as well.

Jerry Revich: Super. Thank you.

Operator: Thank you. One moment for questions. Our next question comes from Toni Kaplan with Morgan Stanley. You may proceed.

Toni Kaplan: Thanks so much. Wanted to start out on renewable energy. Thanks for all the details in the supplemental presentation. I know you had previously talked about 2023 as an elevated year for investment. But it seems like maybe you decided to accelerate it and expand even more. So, I guess what sort of — why is this the right time? And maybe just cadence of the investment during the year. And maybe just — does this mean that M&A will be lower this year versus last year? Thanks.

Jim Fish: We didn’t really give guidance on M&A. Historically, we’ve said $100 million to $200 million, so it’s likely going to be kind of in that range. But the reason to your point that we’ve decided to accelerate some of this is just simply the opportunity itself. I mean I mentioned it in my prepared remarks, but it really is part of our solid waste business. This is gas as a result of Subtitle V and Air Quality Regulations that’s coming to us anyway. About half of that gas has been monetized over the last, I don’t know, 20 years, but we still have half left and we’re certainly not monetizing the full amount when you look at that deck, but that, that we are monetizing we’re effectively paying kind of a three times multiple instead of what you might pay for an acquisition, which would be kind of eight to 12 times.

So, that’s why we’re feeling so good about it. And we’ve modeled these at very conservative numbers. Right now, we’re well above those. So, I think the opportunity just started to present itself through the designation of this gas as being renewable. The markets themselves opening up and now with an opportunity which Tara can go into about electricity. In those cases, we don’t even have to add capital if we already have electric facilities generating facilities out there.

Tara Hemmer: The only other thing I would just add to what Jim said regarding the acceleration of the investment is the investment tax credit and the fact that, that is a really strong pathway for us to get some tax credits on our investments and there’s a timeline associated with that. And we feel really positive about where we are in our ability to capture those tax credits. We’ve modeled about $300 million, which you see in the deck. Regarding our broader portfolio, I mean, this is one of the reasons why we talk about this opportunity being so great because we preserved so many options for WM because we own the gas. We own our projects. We announced 20 projects. There’s a whole pipeline that can come after that. And then with the e-RINs pathway, if you look at our legacy landfill gas to electricity projects, we can create an earnings stream with no incremental capital, and that’s not in our numbers today.

So, that’s upside long-term. So, we’re really optimistic about what we have in front of us here.