Waste Management Inc (WM) — Q3 2018 Earnings Call Transcript

Thank you, Amanda. Good morning, everyone, and thank you for joining us for our third quarter 2018 earnings conference call. With me this morning are Jim Fish, President and Chief Executive Officer; Jim Trevathan, Executive Vice President and Chief Operating Officer; and Devina Rankin, Senior Vice President and Chief Financial Officer. You'll hear prepared comments from each of them today. Jim Fish will cover high-level financials and provide a strategic update. Jim Trevathan will cover price and volume details and provide an operating overview. And Devina will cover details of the financials. Before we get started, please note that we have filed the Form 8-K this morning that includes the earnings press release is available on our website at www.wm.com. The Form 8-K, the press release and the schedules to 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. Such 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. Jim and Jim 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.

Thanks, Ed. And thank you all for joining us this morning. The recurring theme for the first two quarters of 2018 was one of historically strong solid waste more than overcoming a weak recycling market. In the third quarter, we generated strong operating EBITDA growth and we expect that growth to continue and accelerate into the fourth quarter and into 2019. We executed very well on our plans to refine our recycling pricing model and pass on the higher cost of contamination to customers and we saw tangible benefits from the investments we're making in our employees. Our collection and disposal business generated strong organic revenue growth of 6.4% in the quarter. With the exception of last year's fourth quarter, which had significant hurricane-related volumes, this quarter was the strongest core price-and-volume quarter in our company's history. And our commercial and industrial volumes continue to show steady growth trends, which we view as clear indicators that the overall economy remains on solid footing. Our operating EBITDA margin was 29% for the third quarter, and our collection and disposal operating margins improved by 40 basis points from the same quarter of the prior year. When you combine this with our disciplined cost control on the SG&A line, we delivered solid growth in our income from operations and operating EBITDA, despite $22 million of continued recycling headwinds, about $17 million of unexpected third-party transportation and disposal costs, along with other inflationary cost pressures. We fully expect to pass those cost increases through to our customers with price increases in late Q4 and early Q1. Our current quarter operating EBITDA growth of 3.4% outpaced our second quarter growth of 3.1%, leaving us confident that we will deliver full-year operating EBITDA growth of approximately 5% in 2018. Overall, in the third quarter, we generated EPS of $1.15. Given the outstanding performance in the solid waste business and a lower than anticipated tax rate, we're once again increasing our 2018 adjusted EPS guidance. Our new EPS range is $4.13 to $4.15. With respect to our full-year operating EBITDA guidance, we expect to meet or exceed analysts' current 2018 consensus of $4.204 billion and we're narrowing our range to $4.2 billion to $4.22 billion.

Thank you, Jim, and good morning. 2018 has been a great year. So, in this case, we don't mind sounding like a broken record when we say that our traditional solid waste business is firing on all cylinders. For the sixth quarter in a row, revenue growth from both price and volume exceeded 2%. We continue to see strong organic revenue growth this quarter from the collection and disposal business, driving $200 million of incremental revenue or a 6.4% increase compared to the third quarter of 2017. Jim's earlier statement about the historic significance of this quarter is our company's best-ever core price-and-volume result in a quarter without storm volume is worth repeating. Our laser focus on customer service is showing up in our results. Churn was 8.9% in the third quarter, a 110-basis-point year-over-year improvement. Rollbacks improved 210 basis points year-over-year and 410 basis points sequentially to 21.1%. Service increases exceeded service decreases for the 19th consecutive quarter and new business exceeded lost business for the 14th consecutive quarter, reflecting both our continued focus on our customers and the strength of the economy. Turning to internal revenue growth, our collection and disposal core price was 5.4% in the third quarter, a 70-basis-point improvement from last year. And yield was 2.5%, up 50 basis points. Traditional solid waste volumes grew 3.4%, while total company volumes improved 4.4%. The strong growth was driven by our most profitable lines of business: commercial, industrial, and landfill. We also saw transfer station volumes increase by 24%, primarily due to the New York City disposal contract. Strong volume growth was achieved despite the additional volumes we received from hurricane cleanup and a competitor outage in the third quarter of 2017. As a reminder, our volume comparisons in the fourth quarter will be tougher due to the significant volume increases we saw from those two storms last year.

Thanks, Jim, and good morning, everyone. Our third quarter operating and financial results were solid, positioning us well to finish 2018 strong and start the New Year with momentum for continued growth. As Jim mentioned, we are going into the fourth quarter confident that we will deliver on our 2018 guidance for EPS, operating EBITDA, and free cash flow. As has been the case throughout 2018, our third quarter results were driven by strong organic revenue growth in our traditional solid waste business, as well as our focus on controlling costs through operating efficiencies and our efforts to manage discretionary spending in SG&A to respond to other cost pressures. Together, these things positioned us to deliver another quarter of increased cash from operations. In the third quarter of 2018, cash from operations was $874 million, compared to $853 million in the same period last year. The growth in cash from operations was primarily driven by the strong operating EBITDA performance that Jim discussed.

Hey. Good morning. And Jim Trevathan, congratulations, way to go out on top. So, just a couple of questions. In terms of the narrowing of the guidance and taking down the high end. I think you're saying primarily that's because of kind of labor cost pressures that you expect to recover with pricing going until 2019, but can you just elaborate on that?

Yeah, I mean, look, I think here is the point, Corey, and I want to make sure this comes across clearly. When we sat in this conference room a year ago and we're building our 2018 plan, that plan did not contemplate $135 million that I mentioned. It didn't contemplate a $2,000 bonus that was $70 million. It didn't contemplate the labor cost increases and it did not contemplate a – it certainly expected a downturn in recycling. But it was kind of in the $0.10 range, $0.08 to $0.12. It did not expect recycling to be $60 million worse than that. So, all of that is kind of about $200 million in EBITDA.

Yes. Understood. And just trying to understand the moving pieces. So, since you're talking about 2019, without giving guidance, I'm assuming it's somewhat fair game. So I know you said you think you're positioned to accelerate bottom-line growth in 2019. So, two questions about that. Have you already thought about what – and you're probably not going to announce anything now, but what you're going to do as far as like the bonus in 2018, are you going to do something like that in 2019, or how are you going to address that? And secondly, do you expect that if you just look at the solid waste business, could bottom-line growth – do you expect it would accelerate in 2019?

Yes. So, a couple of things in 2019. First of all, we haven't made a decision on the $2,000 at this point. I wouldn't expect to make this $2,000 a recurring payment over a period of years. But we have not made a specific decision around the $2,000. I do think that when you look at solid waste, when you look at the operating cost piece, that $135 million over and above our annual merit increase, we will look at that bucket and say how much of that are we going to spend, how much do we need to spend to remain competitive in the marketplace from a labor standpoint? Don't know the answer to that yet. And we'll scrub that as we get closer to February when we actually give guidance.

Great. Thank you. Good morning. The first question is just around the potential impact of U.S. housing slowdown on your business. I know you're not seeing it right now, but maybe if you could talk about past cycles when the housing has slowed, how has your business reacted? And maybe what you're seeing currently as it relates to business indirectly or directly impacted by U.S. housing potentially continuing to slow?

Yeah. Good morning, Hamzah. Good question. Look, let me say this about housing. First of all, our business is quite a bit different than it was in 2008, 2009. We had 10 years ago a lot more exposure to the residential housing market. Today, our exposure to the residential housing market we think is kind of in the $100 million to $150 million per year in revenue range. And so let's say, housing let's say dropped off the table and was down by 20%, which by the way it's still growing today, it's just growing at a slowing rate.

Jim, to that point, the commercial business has always been a really good indicator of what's going on in that sector because as you build out houses in new neighborhoods, you get that commercial growth that surrounds those new neighborhoods. And, Hamzah, if you look back, I mean we were positive in commercial volume through every quarter of 2016. Since the first quarter of 2017, it's been over 2.5% and we're past 3% right now on the commercial line of business. This is our most profitable line of business from a margin view and from a return on invested capital view. This looks like a really strong economy.

And Hamzah, I would just add on that the other two things that should provide lift to that gross margin you're speaking of in 2019 are disposal pricing focuses that Jim spoke about last quarter that we're going to continue to execute upon in the year ahead. And also as we integrate these businesses and optimize them that we've acquired in 2018, we expect those to provide some lift for us in 2019.

Overall, I think we're optimistic looking out to 2019 as our internal indicators point towards sustained strength in the overall economy. We'll give our detailed guidance in February, but suffice it to say that our base case for operating EBITDA growth in the year ahead is a repeat of the strong 5% growth we've seen in 2018 with real potential for an acceleration of that growth in 2019.

So, in 2018, we will have invested over $135 million of compensation benefits in our employees, over and above our ordinary merit increase. That $135 million has come in the form of the $2,000 hourly bonus, which is unique in our industry, market-driven wage adjustments, and full absorption by the company of healthcare increases in 2018. Additionally, we've spent significant dollars in training, equipment, and facilities upgrades this year, all aimed at providing our employees a safe and effective work environment.

We continue to deliver strong financial and operating performance and have promoted strong leaders to continue our high standard of operational excellence. With the hard work our employees have demonstrated so far, I'm confident that we can achieve our goals for the remainder of this year and set the stage for an even better 2019.

And it's been an honor and a privilege to be on this team with leaders who have vision and have proven that they can execute on that vision. And more importantly, they're just excellent people who I call friends. I'm confident that when I retire as an employee at the end of the year and yet remain a shareholder, Waste Management will continue to be in excellent hands, working hard to create more value for all of us.

We wish you both the very best in your coming retirements and we expect to see you guys at our Phoenix Open in February.