Waste Connections, Inc.
Q4 2011 Earnings Call Transcript

Published: 8 Feb 2012

[Operator:]

Good morning. (Operator instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call, Mr. Ron Mittelstaedt, Chairman and CEO. Please proceed.

[Ron Mittelstaedt:]

Thank you, operator, and good morning. I’d like to welcome everyone to this conference call to discuss our fourth quarter 2011 results and provide a detailed outlook for the first quarter and full year 2012. I’m joined this morning in our new corporate office in The Woodlands, Texas by Steve Bouck, our President, Worthing Jackman, our CFO, and several other members of our senior management team. We are extremely pleased with the results in the fourth quarter as stronger than expected pricing and special waste volumes, together with continuing tight cost controls, enable us to offset most of the revenue, margins and EPS impact from higher than expected declines in recycled commodity values. We are also extremely pleased with our full year results in 2011. On a 14% increase in revenue, adjusted operating income before depreciation and amortization grew 15%. Adjusted EPS increased almost 20% and free cash flow per share increased more than 20%. Free cash flow as a percentage of revenue was almost 17% for the year. This strengthened free cash flow enabled us to deploy almost $500 million in acquisitions, share repurchases and dividends during 2011 while maintaining low two times leverage and plenty of capacity for additional growth opportunities. Looking at 2012, we are pleased to affirm again today what we have said since our call in October. That is a combination of at least $80 million of acquisition rollover growth, expected core pricing growth at least equal to what we achieved in 2011, and relative stability in municipal solid waste volumes should position us well in the new year. We’re also pleased that OCC prices are up about 10% from their November lows. Finally, we also believe the acquisition activity across the sector could remain strong over the next few years, potentially eclipsing the record levels we have experienced in three of the last four years. Before we get into much more detail, let me turn the call over to Worthing for our forward-looking disclaimer and other housekeeping items.

[Worthing Jackman:]

Good morning. We must inform everyone listening that certain matters discussed in this conference call are forward-looking statements intended to qualify for the Safe Harbors from liability established by the Private Securities Litigation Reform Act of 1995, including statements related to expected volume and pricing trends, including recycled commodity prices, contributions from closed acquisitions, potential acquisition activity, share repurchases, dividends, available borrowing capacity and anticipated capital expenditures, as well as our first quarter and full year 2011 outlook for financial results. Such forward-looking statements are subject to various risks and uncertainties, which could cause actual results to differ materially from those currently anticipated. These risks and uncertainties are set forth in the company's periodic filings with the Securities and Exchange Commission. Stockholders, potential investors and other participants are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are made only as of the date of this conference call and the company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. On the call, we will discuss non-GAAP measures such as adjusted operating income before depreciation and amortization, adjusted earnings per share, and free cash flow. Please refer to our earnings release for a reconciliation of such non-GAAP measures to the most comparable GAAP measure. 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, Worthing. As noted earlier, we are extremely pleased with our performance in the fourth quarter. Revenue was $379.8 million, up 13% over the prior year period. Internal growth in the quarter was 3% broken down as follows

[Worthing Jackman:]

Thank you, Ron. In the fourth quarter, revenue increased 13% from the prior year period to $379.8 million, 10% from acquisitions and 3% from organic growth. Adjusted operating income before depreciation, amortization in the quarter increased 12.5% from Q4 2010 to $119.7 million. As a percentage of revenue, this was 31.5% in Q4 or a 20 basis point decrease from the year ago period. On a reported basis, the following are certain line items that moved a notable amount from the year ago period as a percentage of revenue. SGNA, net of acquisition cost, decreased 80 basis points due primarily to the impact of both the County Waste acquisition, with its lower SGNA percentage, that reduces many line items as a percentage of revenue, and a reduction in the amount of incentive-based compensation costs in the period, and direct labor supervisor maintenance cost decreased a combined 70 basis points. These improvements as a percentage of revenue were more than offset by the following

[Ron Mittelstaedt:]

Thank you, Worthing. We have much to be proud of in 2011. Further improvement in our safety statistics, record financial performance and acquisition activity, continuing return of capital to stockholders via share repurchases, and an increased quarterly dividend, an upgrade of our credit rating to Triple B, which is now among the highest in our sector, and a strong balance sheet with tremendous access to capital. Adjusted EPS grew almost 20% in 2011. Free cash flow per share increased over 20% and 2011 marked our eighth consecutive year of positive stock price performance for stockholders. We believe these successes are a direct result of our disciplined execution of a differentiated strategy, attention to the details, and a unique corporate culture that embraces servant leadership, having fun, as well as accountability. There is no doubt that 2012 will be a challenging year given comparisons to such a successful 2011, but we enter 2012, our 15th anniversary, with strong visibility on pricing, high single-digit top line growth already in place, and increased free cash flow. Additional acquisitions, volumes from an improving economy, or a continuing increase in recycle commodity values could provide further upside and more favorable comparisons to 2011. We appreciate your time today. I will now turn the call over to the operator to open the lines for your questions.

[Operator:]

Thank you. (Operator instructions) Our first question will come from the line of Scott Levine with J. P. Morgan. Please proceed.

[Scott Levine:]

Hi. Good morning. You guys have previously guided to volumes for 2012 and have been since late last year at flat to down one. We’ve seen a lot of data signaling improvement in the US economy, and I’m wondering what you’re seeing within the business and whether that would lead one to maybe favor the higher end of that range, or whether you’re encouraged by what you’ve seen in recent months, or whether you haven’t seen much change at all system-wide.

[Ron Mittelstaedt:]

I think, Scott, that the reality is we just haven’t seen much change. I think to get into a place where we are seeing consistently positive volumes as a sector, we’re going to need to see a rebound in the construction industry, both residentially and commercially. Now, one could argue you’re starting to see the beginning of that, because special waste has been improving for a few quarters and that tends to lead a recovery because it’s generally speculative for real estate development of one type or another, but overall, we’re just seeing what I’d say a non-construction recovery, and that’s, I think, what’s needed to boost us to a positive volume environment.

[Scott Levine:]

Does your guidance, given the strength in special waste, is that a notable headwind to volumes as your guidance currently lays out right now? Notable being maybe 100 basis points or more?

[Worthing Jackman:]

I wouldn’t say it’s 100 basis points or more. We baked in probably closer to half a point. Again, speculative waste is just that. We don’t control the outcome there, so we’re somewhat cautious in how we incorporate that into our outlook.

[Scott Levine:]

Got it, and then maybe turning to fuel, you noted commodities as a headwind to margins in recycling. What is embedded within guidance for diesel and cure, minus what your hedge position currently is?

[Worthing Jackman:]

We’ve assumed current pricing for fuel throughout the year. Our financial hedge is about 5 million gallons. We also have some additional fuel that’s contracted with purchase agreements in the field. That puts our all-in hedge closer to the 7 million or 8 million gallon level, which is almost 30% of our fuel needs. Right now we’re using about 24 million gallons per year for fuel.

[Scott Levine:]

What price, roughly, is that hedge at?

[Worthing Jackman:]

It’s slightly higher, about $0.03 higher than what we incurred in 2011.

[Scott Levine:]

Got it. One last one on the acquisition pipeline. Ron, you obviously are clear with regard to your thoughts on Veolia, but leaving Veolia aside, would your expectation be that you guys would be looking at a typical year at minimum, or maybe better or less than average? What would your thoughts be on a general acquisition landscape and maybe comments on valuation as well?

[Ron Mittelstaedt:]

To the latter part, I don’t think valuation has -- at least valuation for us, as we look at things, has changed. You’ll continue to see deals in that 5.5 to 6.5 times EBITDA for the vast majority of the transactions that we do. I would say that, again, a typical year, as you described, has been in that $40 million to $60 million level of acquired annual revenue. I would be confident that that level is achievable, and hopefully somewhat conservative if a couple things fall our way.

[Scott Levine:]

Got it. Thanks. Good luck in The Woodlands.

[Ron Mittelstaedt:]

Thank you.

[Operator:]

Our next question will come from the line of Hamzah Mazari with Credit Suisse. Please proceed.

[Hamzah Mazari:]

Good morning. The first question is on the Veolia deal. I think you were pretty clear, Ron, but maybe if you could just highlight in which unique circumstances do you think you’ll get your hands on the Veolia business, and if you would care to comment on what your view is of valuation on that asset.

[Ron Mittelstaedt:]

As far as under what scenario we might be able to be successful in some of the assets, obviously, we don’t know that yet. We have yet to see any book or any outline of a process yet on Veolia, so I think it would be too early for us to say what would happen or what wouldn’t. A number of their markets, the old Superior Services, a number of the original BFI assets that were divested in the Allied/BFI merger, a number of those fit our profile very, very well, more suburban type markets with strong market share. We know their assets fairly well, but we do not yet know what process they’re going to go through, so it would be too early to speculate on that. Again, as far as valuation, Hamzah, and from our view, somewhere probably in that 6 to 6.5, maybe a little north of that, their EBITDA, I think when you start to get north of that too much, it’s certainly outside our appetite.

[Hamzah Mazari:]

That’s helpful, and then maybe if you could comment, I know you spoke about the dynamics in the LA marketplace for you guys with the muni landfill closing. Could you maybe frame for us the upside there on either EBITDA or how you see that playing out and the timing of that?

[Ron Mittelstaedt:]

Sure, Hamzah. We currently handle roughly 4,000 to 4,500 tons a day in the LA market, and that today is a market that’s about a $25 to $30 a ton market. Our permit allows us to handle 6,000 tons a day of municipal solid waste plus unlimited amounts of C&D and special waste. Our hope would be that as you come out of ’13 and go into ’14, that we would be able to ramp our site comfortably up to the 6,000 tons a day, which is an additional 1,500 tons a day, and I think it’s reasonable to expect that pricing is going to go up in the roughly $10 to $15 a ton range across the spectrums. You look at about 4,500 tons a day moving up, let’s say, maybe up to $10 a ton and you look at an incremental 1,500 tons a day coming in at around $40 a ton, it’s a pretty substantial upside if it flows through in that manner.

[Hamzah Mazari:]

That’s helpful, and just a last question on pricing. What are you guys assuming for a competitive versus franchise in your guidance?

[Ron Mittelstaedt:]

We’re assuming about 2.2% on the franchise side, up a little bit year over year, which was about 1.9% to 2% in ’11 and it’s moving up to about 2.2%, 2.3% in ’12, and the competitive is running between roughly 3.5% and 4%.

[Hamzah Mazari:]

Okay, great. Thank you very much.

[Operator:]

Our next question will come from the line of Bill Fisher with Raymond James. Please proceed.

[Bill Fisher:]

Good morning. Is it nice to get another extra couple hours of sleep before this call?

[Worthing Jackman:]

Yes.

[Ron Mittelstaedt:]

Now we know why everybody was always in these time zones.

[Bill Fisher:]

That’s good. Just a couple things. Ron, you did give a lot of color on acquisitions and whatnot, but you mentioned capital gains taxes. Is that under discussions with acquisition candidates? Is that coming up more than it has in prior years, or is that just about the same?

[Ron Mittelstaedt:]

I think it has clearly of late come up more because there’s been more rhetoric about it, obviously since the President’s recent speech, and also certain states increasing their capital gains, such as the state of California. So, it is certainly coming up more. The offset to that, the dampening, if you will, to that is that it still remains a very low, obviously, interest rate environment and sellers who look to redeploy their after-tax proceeds, it’s hard for them to get the type of cash flow that they were getting out of their business, so it remains a balancing act between those two.

[Bill Fisher:]

Okay, and, totally separately, you mentioned the competitive market pricing. It sounds pretty good, the 3.5%, 4%, and I know it’s small for you guys, but bigger markets, say a Denver or Charlotte or something, is there any difference in behavior in those markets or is it pretty similar?

[Ron Mittelstaedt:]

Yes, clearly the urban markets, a Denver, you used, a Houston, as an example, they are much larger markets, multiple public companies, a lot of private companies, a lot of disposal capacity, limited organic growth, so that is just a road map for greater churn in the business, new customers coming on at lower pricing than customers are losing, and the need to rotate customers in faster than you’re rotating them out. All that leads to the lower pricing in those type markets, which is why you’ve seen Waste and Republic as an example, the two large urban companies, continually lag us by 100 to 200 basis points in pricing for the last several years.

[Bill Fisher:]

Okay, great, and then just one quick one for Worthing, on the capex. I know you’re just starting ’12, but given the accelerated truck spending this year on Alaska Waste, do you see – would ’13 be kind of exiting your acquisitions? Would that be a downdraft a bit, or any impact on the truck spending?

[Worthing Jackman:]

I think you would see increased truck spending in ’13 just based on current commitments. We have a couple of markets where we have a high CNG rollout next year. We’ll watch the bonus depreciation developments, and what you could see us do is if Congress moves to pass 100% bonus depreciation this year, versus keeping it at 50%, we will look to pull a bulk of those trucks into the latter part of this year.

[Bill Fisher:]

Okay, perfect. Thank you.

[Operator:]

Our next question will come from the line of Al Kaschalk with Wedbush Securities. Please proceed.

[Al Kaschalk:]

Good morning, guys. I look forward to you hearing next time, when you get on the call, say, “Good morning from Houston.” Anyway, to follow up on the last question there, what percentage of the new capex is CNG vehicles, or where are you at on that strategy in terms of converting?

[Ron Mittelstaedt:]

Al, first off, it’s a small percentage. It probably, for this year, for 2012, will represent approximately 20% of our truck fleet replacements, or one-fifth will be CNG. We are converting two types of markets. We are converting exclusive markets, franchise markets in the western US where we are either being asked or there is an economic incentive for us to make that conversion in terms of both contract extension and pricing improvements that justify that, and we have three markets we are rolling that out in in ’12, ’13 and ’14. Then, we are also converting certain competitive markets where there are states that have tax incentives to effectively fund the construction of the fueling infrastructure, which remains the biggest item in converting to CNG, particularly in our model where you get into a more rural or suburban setting. You’ve got to make sure the infrastructure is there, and in many of those markets, it is not yet there. If we look out five years from now, you would see probably about a fifth of our fleet would be converted to CNG, and that would be more heavily weighted to our west coast model where it would be much higher than that and then lower in our competitive market footprint that’s more rural.

[Al Kaschalk:]

Thank you, and just on the M&A side, this segment of the waste stream, are you referring there towards recycling increased interest in your part? Again, I know it’s a smaller part of the business, but just in terms of the M&A given the backdrop in the economy.

[Ron Mittelstaedt:]

Yeah, what we’re really referring to is that there are, at both the federal level and at the state level, and at the municipal level, all three levels, depending on the geography, there are different regulatory and political and consumer drivers that are segmenting the waste stream towards various types of diversion and recycling. That is a capital call, if you will, on private companies that many times, that is sort of a fulcrum for them to take a view of looking to do something with their company versus doubling down and reinvesting and diversifying their infrastructure and their fleet, so that’s what we’re referring to, that segmenting of the waste stream can be a driver to M&A activity over the coming years.

[Al Kaschalk:]

Are you feeling like those entities are being more aggressive for that capital call, or given their state, they’re maybe sitting a little bit on their hands near term?

[Ron Mittelstaedt:]

I think that it’s different by geography, and obviously, size of the company. Al, I think it’s hard to make a generalization. Your more moderate- to decent-sized private companies, they have the access to the capital, so for them, it’s making sure that they’re getting the contracts and the deployment that they think. I think as the company gets a little smaller, that gets a lot tougher because they just don’t have the economy as a scale or the market position to really drive the capital, and in many cases, it’s being forced upon them by the municipality who is mandating, for example, a single stream recycling program, so they’ve got to go out and buy all new parts for every customer that they have. They’ve got to have a place to process that material, et cetera. That’s very hard on a small operator.

[Al Kaschalk:]

Okay, and finally, if I may, just on the color you provided in recycling and intermodal for the quarter, I was wondering from a volume perspective if you could shed some light on your expectations for ’12 versus ’11 on where you think the volume number would be up just on recycling.

[Worthing Jackman:]

Our expectations are low single digits right now. We saw a nice increase in volume last year that helped offset some of the decrease in prices that we saw, but this year we’re not anticipating a large increase or sizable increase with regards to volume on recycling.

[Al Kaschalk:]

Great operating in a tough economy.

[Ron Mittelstaedt:]

Thanks, Al.

[Operator:]

Our next question will come from the line of Mike Hoffman with Waste Connections. Please proceed.

[Ron Mittelstaedt:]

Welcome aboard, Michael.

[Michael Hoffman:]

Yeah, thanks for the job, guys. Where am I supposed to look for a house in The Woodlands?

[Ron Mittelstaedt:]

I was going to say you’re fired. You’re not here on time.

[Michael Hoffman:]

A couple questions with regards to paper. Is there anything that you’re seeing that would suggest to you that we won’t have a normal seasonal pattern, so this dip that happens in the fourth quarter settles in the first, and then you see this list kind of happening April, October, and then you repeat it all over again? Is there anything to suggest that doesn’t happen?

[Ron Mittelstaedt:]

There’s nothing that we are seeing that would imply to us that there would not be a normal seasonal pattern.

[Michael Hoffman:]

Okay, so that’s an opportunity for upside based on the way you’re giving guidance?

[Ron Mittelstaedt:]

That’s correct.

[Michael Hoffman:]

I think you may have answered this, but I’ve got to ask you just to be clear. Is there anything from -- I think it’s Credit Suisse is a banker that’s hired by Veolia. Is there anything coming from them that says they’re going to do anything like prequalify bidders and then narrow the list, things like that versus just let everybody ride all the way to the end of the process?

[Ron Mittelstaedt:]

We have not heard anything regarding that out of any bankers that are going to be managing the process. It is Credit Suisse and we have not heard anything regarding that.

[Michael Hoffman:]

Okay, and then if capital gains is a driver of behavior on the deal side, when would somebody have to say, “I’m done. I’m selling,” in the context of a regulatory process and things of that nature in your mind? When would we see the wave of this, if this is an issue, in order to get something closed by year end, and then therefore not get negatively impacted?

[Ron Mittelstaedt:]

Certainly by the beginning to the middle of the third quarter, almost at the latest, Michael. You get beyond that and, depending on the size of the transaction, you’re running the risk of it getting done, if you will, in 2012.

[Michael Hoffman:]

And then are your Washington sources telling you anything about what might happen? This is a presidential year, right? So, you’ve got to figure that Congress starts playing with this as a subject before the summer recess, and therefore, this becomes a topic of conversation politically as early as the summer?

[Ron Mittelstaedt:]

I think that’s right. It obviously is becoming a, I’ll call it a divisive, but a differentiating political topic between the parties now, and I think it will depend on what the polls say as to how close the race is or isn’t as to how blaring a topic it’ll become.

[Michael Hoffman:]

Okay, and then how would you handicap the probability that bonus depreciation goes back to 100% for 2012?

[Worthing Jackman:]

As far as the handicap, I think we’ll get better clarity by the end of this month when they go to re-up the current tax program.

[Michael Hoffman:]

Okay, and then do you have a bias to slow fill versus fast fill on the refueling?

[Worthing Jackman:]

We’ve generally gone toward slow fill, Michael.

[Michael Hoffman:]

Okay, and lastly, on the dividends, worked out over a five-year period, how would you want to characterize the dividend as a percentage of your free cash flow trend over that five years?

[Worthing Jackman:]

It depends on the slope of the growth of the company, but right now, at approximately $40 million payout on $250 million, $260 million of free cash flow, call it one-sixth or so of the free cash flow. I think over time you would see that increase to perhaps one-fourth of the free cash flow over the next three to five years.

[Michael Hoffman:]

Okay, and based on Ron’s statement, “I’ll double the company in ten years,” that’s kind of a 7.5% growth rate. That’s sort of consistent with that, then, in your mind?

[Worthing Jackman:]

Yes.

[Michael Hoffman:]

Okay. Great. Nice quarter, again, managing expectations. Thanks.

[Ron Mittelstaedt:]

Thank you, Michael.

[Operator:]

Our next question will come from the line of Tony Bancroft with Gabelli. Please proceed.

[Tony Bancroft:]

Yes, good morning, gentlemen. Just to piggyback on Bill’s question regarding acquisitions, you mentioned in the press release about some of the drivers, i.e. sellers’ wealth preservation, capital costs, recycling, increased competition, municipality, maybe privatization. Could you rank the drivers for me and what’s the, for last year, the $200 million in revenue, and maybe how you perceive the future? How would you rank those drivers, and on the flipside, for you, what kind of seller do you want? What gives you the best prospect as far as margins and regard to that? Thank you.

[Ron Mittelstaedt:]

Okay, there were a number of questions there. Obviously, I’ll try to answer as many as I can and can remember. As far as for us, I’m not going to say there’s any type of number one best seller. Every deal is unique, but obviously, legacy transition issues, lineage transition issues, tend to be good times where a company is in a good position to transition ownership. It’s somewhat expected by both employees as well as customers as well as the community, and that positions the company pretty well for new potential ownership in a lot of ways. Those tend to be the better transactions that we do. When a company is broken, when it’s a fire sale, when it’s an auction, when it’s a distressed asset, those are not the type of deals we tend to do. We find that poor companies in this business are poor for a reason, and it’s usually some sort of broken market or their asset positioning within the market, and we cannot fix all of those two things. There are companies out there that buy those and they believe they can and many of you have seen the results of that. But, that’s not what we do. As far as the ranking of what drives, again, obviously, different things drive sellers. We would always tell you, and we have said for years, that it’s really not valuation, it’s really not tax increases, segmentation of the waste stream. Those are all secondary items. The number one issue that drives deals in our model in our business is what we call lineage transition issues—estate planning, death, disability, disease, divorce—those are the kinds of things where there is something going on within the ownership, and that’s why most deals that we close, we’ve been talking to for four, five, six, seven years of relationship building and know what is transpiring within the ownership of that company. That’s a long-winded soapbox answer to your question, Tony, but that’s sort of how it works for us.

[Tony Bancroft:]

That’s great. Thank you so much.

[Operator:]

(Operator instructions) At this time, I show that we have no further questions in queue. I would like to turn the call back over to Mr. Ron Mittelstaedt for any closing remarks.

[Ron Mittelstaedt:]

Thank you, operator. If there are no further questions, on behalf of our entire management team, we appreciate your listening to and your interest in our call today. Worthing, Steve, and I will be here today to answer any direct questions we did not cover that we are allowed to answer under Regulation FD and Regulation G. Thank you, again, and we look forward to speaking with you on our next earnings call or at an earlier upcoming investor conference.

[Operator:]

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day, everyone.