Waste Connections, Inc. (NYSE:WCN) Q4 2022 Earnings Call Transcript February 16, 2023
Operator: Good morning, and welcome to the Waste Connections Fourth Quarter Earnings Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. Now I’d like to turn the call over to Mr. Worthing Jackman. Please go ahead.
Worthing Jackman: Thank you, operator, and good morning, everyone. I’d like to welcome everyone to this conference call to discuss fourth quarter results and our outlook for both the first quarter and full year 2023. I’m joined this morning by Mary Anne Whitney, our CFO and several other members of senior management. As noted in our earning release, Q4 topped off an extraordinary year for Waste Connections, highlighted by continuing outperformance during the period and providing a higher entry point and enhanced visibility for 2023. Strong operational execution and over 10% solid waste pricing along with acquisitions closed during the period, once again, provided for better than expected results. We more than offset inflationary pressures and commodity-related headwinds to expand adjusted EBITDA margin by 30 basis points, excluding the margin dilutive impact of acquisitions completed since the year ago period.
Looking at the full year, double-digit percentage growth in both revenue and adjusted EBITDA along with adjusted EBITDA margin expansion, excluding the impact of acquisitions, continued to differentiate our results. We overcame elevated wage, fuel and inflationary pressures and a 70% drop in recycled commodity values in the second half of the year, with an acceleration in pricing during the year, providing momentum for higher core pricing in 2023. Acquisition activity during the year also outpaced expectations for a total of approximately $640 million in acquired annualized revenues, which along with activity year-to-date, already provides acquisition contribution of 5% in 2023 with additional dialogue ongoing. In short, tremendous operational execution in 2022 has provided outside visibility for double-digit top line growth along with adjusted EBITDA margin expansion in 2023, with upside from any improvement in recovery commodity values or inflationary pressures, as well as incremental acquisition activity during the year.
Before we get into much more detail, let me turn the call over to Mary Anne for our forward-booking disclaimer and other housekeeping items.
Mary Anne Whitney: Thank you, Worthing and good morning. The discussion during today’s call includes forward-looking statements made pursuant to the safe harbor provisions of the US Private Securities Litigation Reform Act of 1995, including forward-looking information within the meaning of applicable Canadian Securities Laws. Actual results could differ materially from those made in such forward-looking statements, due to various risks and uncertainties. Factors that could cause actual results to differ are discussed both in the cautionary statement included in our February 15th earnings release and in greater detail in Waste Connections’ filing with the US Securities and Exchange Commission and the securities commissions or similar regulatory authorities in Canada.
You should not place undue reliance on forward-looking statements as there may be additional risks of which we are not presently aware or that we currently believe are immaterial, which could have an adverse impact on our business. We make no commitment to revise or update any forward-looking statements in order to reflect events or circumstances that may change after today’s date. On the call, we’ll discuss non-GAAP measures such as adjusted EBITDA, adjusted net income attributable to Waste Connections on both a dollar basis and per diluted share and adjusted free cash flow. Please refer to our earnings releases for a reconciliation of such non-GAAP measures to the most comparable GAAP measures. Management uses certain non-GAAP measures to evaluate and monitor the ongoing financial performance of our operations.
Other companies may calculate these non-GAAP measures differently. I will now turn the call back over to Worthing.
Worthing Jackman: Thank you, Mary Anne. First off, I’d like to recognize and applaud the efforts of our local teams, whose execution most notably over the past few years in the face of arguably the most challenging operating environment has continued to drive differentiated results. In 2022, our 25th anniversary year, we once again demonstrated two hallmarks of Waste Connections; sustainability, and sustaining ability. There should be no trade-off between the two. As noted earlier, we’re extremely pleased with our strong operating and financial performance in Q4 and throughout ’22 as we overcame elevated wage, fuel and inflationary pressures and a 70% drop in recycled commodity values to drive adjusted EBITDA margin expansion, excluding acquisitions in the year.
In 2022, we also delivered pricing of 9.2%, more than 200 basis points above our initial outlook and about 85% of which wasn’t core price. Moreover, given the acceleration of pricing during the year, the lagging benefit of higher CPI resets and a strong start to the New Year were already set up for pricing to increase sequentially by about a 100 basis points from the fourth quarter to 11.5% in Q1 and to average about 9.5% in 2023, essentially all in core price. We delivered adjusted free cash flow of $1.165 billion in 2022, up over 15% year-over-year on CapEx of $913 million up 23% year-over-year, reflecting a purposeful step up in CapEx during the year for opportunistic real estate purchases. Net of asset sales, CapEx was about $30 million above our outlook in spite of ongoing supply chain constraints for fleet and equipment.
As noted in our press release, we’ve been navigating the uncertainties in manufacturer delivery timing, and now expect to take delivery of an additional $50 million in fleet in 2023, that was originally expected in 2022. Our 2022 CapEx also included about $75 million for sustainability related projects, which was about $25 million less than we originally had expected, primarily for the two R&D facilities and two recycling facilities we’ve previously discussed, that will total about $150 million ones completed. Our 2023 sustainability CapEx is expected to be up from 2022 due to the timing of some of the expected 2022 outlays that drifted into this year, as well as the expected initiation of development of an additional large R&D project at a recently complete acquisition.
Photo by All Bong on Unsplash
As we have described previously, these R&D facilities are strategic investments with attractive paybacks at range of values for recovered resources. With the additional project noted, our aggregate capital outlays for owned R&D projects are now approaching $200 million between 2022 and 2025. These projects, along with over a dozen others we’ve partnered on are conservative to — are conservatively estimated to generate an incremental $200 million of EBITDA in 2026 or about a $1 of EBITDA per dollar of CapEx. Provisions in the recently promulgated Inflation Recovery Act would further enhance expected returns and could provide tax-related benefits as soon as 2023 as one of the new plants is scheduled to be online and start contributing in the second half of this year.
As we have consistently emphasized in our approach to ESG, these projects are integral to our business, consistent with our focus on value creation and additive to our growth strategy, not something in lieu of acquisitions. Looking next to acquisitions, in 2022, we closed approximately $640 million in annualized revenue. We completed 24 acquisitions all in solid waste and spread across the US and Canada, in both franchise and new competitive markets, including integrated markets, new market entries, and a number of tuck-ins to existing operations. This robust activity in 2022 capped six consecutive outsized years RAC acquired annualized revenue, totalling over $2.1 billion since 2017, and we’ve had another strong start to the year in 2023. As always, we maintain a discipline approach to market selection, the risk profiles we accept and evaluations we determined to be appropriate.
Since year end, we’ve closed another integrated West Coast franchise with over $35 million in annualized revenue, which along with the rollover contribution from deals completed in 2022 already provides for 2023 acquisition contribution of over 5%. Continued dialogue sets up the potential for another outsized year of activity for which we remain well positioned, having entered 2023 with leverage below three times, in spite of acquisition outlays of over $2.3 billion during 2022. Our balance sheet strength and free cash flow profile provide flexibility for continued elevated levels of investments in our organic solid waste growth strategy, along with renewable energy projects and solid waste acquisitions, while also increasing our return of capital to shareholders.
In 2022, we returned $668 million to shareholders through dividends and opportunistic share repurchases, up nearly 20% from the prior year and we invested over $3.2 billion in CapEx and acquisitions for future growth. Now I’d like to pass the call to Mary Anne to review more in depth the financial highlights of the fourth quarter and provide a detailed outlook for Q1 and full year 2023, all then wrap up before heading in the Q&A.
Mary Anne Whitney: Thank you, Worthing. In the fourth quarter revenue of $1.869 billion was $24 million above our outlook and up $245 million or 15.1% year-over-year. Acquisitions completed since the year ago period contributed about $153 million of revenue in the quarter or about $150 million net of divestitures. Total Q4 price of 10.6% included 9% in core price, which stepped up sequentially by 70 basis points from Q3. Reflecting our highest levels in 2022, Q4 total price ranged from about 6% in our mostly exclusive market Western region to between about 11% and over 13% in our competitive markets. The pricing acceleration in competitive regions during 2022 along with the lagging benefit from higher CPI linked market increases in ’23 positioned us for about 9.5% total price in 2023, essentially all core, with over 75% of that pricing already largely in place at this time for now.
Solid wastes volumes in Q4 were down 1.7%, excluding 80 basis points from the final quarterly impact from the purposeful non-renew renewal of two municipal contracts noted throughout 2022. Volumes were in line with our expectations in spite of the severe winter weather in late December. Looking at year-over-year results in the fourth quarter on a same-store basis, commercial collection revenue was up 14%, mostly due to price, roll off polls per day were about flat with revenue per up 9% and landfill rates per ton were up about 7.5% on daily tongues, down about 2% with MSW and special waste each down 3% to 4%, partially offset by higher C&D waste up 7%. And finally, E&P waste revenue of $53 million was in line with the prior quarter and up more than 50% year-over-year.
Looking at Q4 revenues from recycled commodities, excluding acquisitions, recycled commodity revenues were down about 70% year-over-year, about as expected due to the precipitous decline in values since July, which has continued through November. Prices for OCC or old corrugated containers declined about 60% sequentially from Q3 to average, about $56 per ton in Q4. OCC pricing has been relatively stable since November in the range of $55 to $60 per ton with some recent indications of improvement. Finally, looking at year-over-year landfill gas sales and renewable energy credits for RINs, landfill gas revenues were up nominally in Q4 with lower RIN values offset by higher values. RIN values averaged about $2.65 cents in Q4 and have since declined to levels around $2.
Adjusted EBITDA for Q4 is reconciled in our earnings release was $564 million up 13.8% year-over-year, and about $11 million above our outlook, driving adjusted EBITDA margin of 30.2%, a 20 basis point beat to our outlook. Margin in the quarter was up 30 basis points year-over-year, excluding the impact of acquisitions, as we more than overcame the toughest quarterly comparisons, including almost 150 basis points in headwinds from lower recycled commodity values. Moving to full year adjusted free cash flow; we converted over 52% of adjusted EBITDA to adjusted free cash flow above our outlook at $1.165 billion or 16.2% of revenue. We over-delivered in spite of an incremental $30 million in CapEx as we opportunistically made certain real estate purchases during the year.
As Worthing noted, our 2022 CapEx is also noteworthy for what it doesn’t include, that is about $50 million in fleet due to manufacturer delivery delays, as well as about $25 million in sustainability related outlays, all of which were expected in 2022 and are now included in our outlook for 2023 CapEx. I will now review our outlook for the first quarter and full year 2023. Before I do, we’d like to remind everyone once again that actual results may vary significantly based on risks and uncertainties outlined in our state harbor statement and filings we’ve made with the SEC and the Securities Commissions or similar regulatory authorities in Canada. We encourage investors to review these factors carefully. Our outlook has assumes no change in the current economic environment.
It also excludes any impact from additional acquisitions that may close during the remainder of the year and expense of transaction-related items during the period. Looking first at the full year 2023, revenue in 2023 is estimated at $8.05 billion. For solid waste, we expect pricing of about 9.5%, essentially all core and volumes in the range of flat to down 1%, plus about $360 million of estimated revenue in 2023 from acquisitions already completed and E&P waste activity and values for recovered commodities assumed in line with recent levels. Adjusted EBITDA 2023 as reconciled in our earnings release is expected to be approximately $2.5 billion for about 31.1% of revenue, up 30 basis points year-over-year in the face of approximately 100 basis points in headwinds from recycled commodity and RIN values.
Said another way, adjusted EBITDA margin guidance is up 130 basis points year over year, excluding those two commodity drags. Any moderation in inflationary trends, increases in the values for such recovered commodities or an EMP waste activity or additional acquisitions closed during the year, would provide upside to our 2023 outlook. To be clear, our outlook does not assume any improvement in recycled commodity values from earlier this year, which for instance, would add $10 million in annual revenue for every 10% move in price levels, or in RIN values, which would add approximately $5 million in annual revenue for every 10% move-in price levels, both of which with very high flow through. We’re encouraged by the improvement we’re hearing about in February for recycled commodities with prices in some markets reported to already be up more than 10% from recent lows.
That said, we have not factored any such pickup into our outlook. Interest expense is estimated at approximately $255 million, and our effective tax rate for 2023 is expected to be approximately 22% with some quarter-to-quarter variability. Adjusted free cash flow in 2023 as reconciled in our earnings release is expected at $1.225 billion on CapEx of $925 million, including $50 million in delayed fleet delivery in the prior year as noted earlier. We also expect about $30 million in asset sale proceeds primarily associated with excess facilities we’ve either replaced or exited. Given the expected timing of CapEx and other outflows this year, adjusted free cash flow is expected to start the year relatively lower in Q1 and ramp higher in the subsequent quarters.
Turning now to our outlook for Q1 2023, revenue in Q1 is estimated at approximately $1.895 billion. We expect price plus volume growth for solid waste of 10.5% on pricing of about 11.5% and E&P waste revenue of approximately $45 million, reflecting typical seasonality. Recovered commodity values are expected to remain in line with recent levels. Adjusted EBITDA in Q1 is estimated at approximately 30% of revenue, or $568 million in what sets up as the toughest quarterly comparison in 2023 for recycled commodities and RINs. Depreciation and amortization expense for the first quarter is estimated to be about 13.2% of revenue, including amortization of intangibles of about $38.5 million or $0.11 per diluted share net of taxes. Interest expense, net of interest income is estimated at approximately $67 million, and the tax rate is estimated at about 22%.
And now let me turn the call back over to Worthing for some final remarks before Q&A.
Worthing Jackman: Thank you, Mary Anne. Our results in 2022 and positioning into 2023 are testament to the culture of accountability that has been the cornerstone of Waste Connections’ 25-year history of outperformance and value creation. We are proud of our accomplishments in 2022 and grateful for the commitment of our over 22,000 employees whose tireless efforts positioned us not only to overcome the challenges of 40-year high inflation, compounded bio-dramatic drop-off in recycled commodity values during the year, but also to emerge a more cohesive and resilient team. Moreover, their efforts have positioned us for double-digit revenue growth, along with the adjust EBITDA margin expansion in 2023 with industry-leading free cash flow conversion.
And to be clear, that’s all without any assumed improvement from multi-year low recycled commodity and RIN values, causing an expected 100 basis point margin headwind. We’re encouraged by indications that we may already be off those lows and look forward to realizing upside from sustained improvement in these recovered commodities, as well as any moderation in inflationary pressure or additional M&A activity, again, sustainability and sustaining ability. We appreciate your time today. I’ll now turn this call over to the operator to open up the lines for your questions. Operator?
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Q&A Session
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Operator: Thank you. We’ll now begin the question-and-answer session. First question will be from Jerry Revich, Goldman Sachs. Please go ahead.
Jerry Revich: Good morning. I wonder if you folks can just expand on the margin cadence, implied by guidance. So just looks like, with the first quarter outlook you’re setting up to be exiting the year with margins up, call it 80 basis points year over year in the fourth quarter and seasonally adjusted margin rate that’s closer to 31.5%. And I’m wondering, as we think about what ’24 might look like, it looks like you’ve got some natural momentum even before thinking about what commodity prices do to drive a year of outsized margin improvement in ’24. I’m wondering if that cadence is consistent with how you’re thinking about the flows.
Worthing Jackman: Well, I’ll start with the ’24 observation and hand it off to Mary Anne for the quarterly progression in the year. But I think you’re right with regards to ’24, as much as we said this year is an outsized margin expansion year, excluding the headwinds from recovery commodities, obviously they have a 100 basis point headwind and guide up 30 basis points, it means the underlying is up 130 and we typically talk about being up to a targeted 20 basis points to 40 basis points, not 130 basis points. If you move into next year, again, you’ve got the franchise markets printing, pricing for next year, office CPIs we’re seeing during the year this year by mid-year and so obviously the pricing within the franchise markets should stay in that 6% plus or minus range.
We’re printing seven this year as inflation moderates into next year, if inflation does average like the pundits think three to 4%, what you’re seeing next year in the franchise markets is really more of the recapture of what we couldn’t get in ’22. So that becomes an outsized year. And again, as you know, within our overall pricing structure, we typically exceed CPI by about 150 basis points or more. And so, next year should stay that combined with, again, improving recycling values if it steps up during the year, should provide for another above-average margin expansion for the full year above the typical 20 basis points to 40 basis points, now with regards to the flow during the year.
Mary Anne Whitney: Sure. Thanks Worthing. So Jerry, when you think about the flow during the year, I think that most instructive way to come about it is to look at what the headwinds do. And if you look at that 100 basis point headwind over the course of the air from recycled commodities and RIMs, it’s heavily weighted to the first two quarters. So if you have about 150 basis points headwind of each of the first two quarters, that gets about cut in half in Q3 and essentially goes away by q4. If you just played that through, you can see how, to your point, you’d have the toughest comparison earliest in the year, and we’ve already guided to Q1, which by the way, pretty similar the way we guided Q4. And then you’d see the improvement, you’d see the ramp over the course of Q1 to Q4 of course with the overlay of seasonality and your highest reported quarter still being Q3 would be the likelihood could be, the cadence there is Q3, Q2, Q4, Q1 in terms of seasonality.
But the most important thing, I think about ’23 is the headwinds diminishing over the course of the year, even before we see any improvement.
