Waste Industry Collecting Cash

Pressures in the recycling business didn’t negate revenue growth across the municipal solid waste space during the first quarter of 2018, and the pace of operating-income and free-cash-flow expansion remains solid. Valuations could be more attractive, but dividends look strong, even though we’d like to see lower levels of financial leverage.

By Brian Nelson, CFA

Waste Management (WM) kicked off first-quarter earnings season for the big three garbage haulers in the municipal waste space April 20. Though recycling revenue faced pressure during the period, Waste Management’s first-quarter results had everything we’d be looking for. Core price advanced 4.9%, and traditional solid waste internal revenue growth from volume was 3%, helping to drive total reported revenue higher by 2.1%.

The solid top line expansion translated well into 9% operating-income expansion and a robust 12% increase in operating cash flow, to ~$809 million. Free cash flow came in at ~$423 million in the first quarter of 2018 versus ~$397 million in the year-ago period. The trash taker paid out ~$206 million in cash dividends during the period, revealing nice dividend coverage with free cash flow. Waste Management CEO Jim Fish had the following positing things to say about the industry backdrop:

The traditional solid waste business is in exceptional health, and we achieved outstanding results despite significant challenges presented by external market factors in the recycling line of business. The great start to 2018 shows how well we are executing upon our strategic plan, and we will continue with the focus and discipline required to produce strong results in the face of the challenging recycling environment.

On May 2, Republic Services (RSG) may have reported better first-quarter results, at least from a cash-flow standpoint. Core price advanced 3.8%, while volume advanced 2%, helping to drive total revenue growth of 1.5% on a year-over-year reported basis ($2.43 billion versus $2.39 billion in the year-ago quarter). Cash provided by operating activities leapt to ~$581 million in the quarter versus ~$444 million in the year-ago period, while free cash flow, as measured by cash flow from operations less all capital spending, expanded to ~$318 million, up from ~$221 million in last year’s quarter, representing an increase of 44%+. Republic Services returned ~$114 million back to shareholders in the quarter through dividends, revealing strong coverage of the dividend with traditional free cash flow generation.

Waste Connections (WCN) put up a nice first-quarter report of its own May 2. Reported revenue advanced 4.4%, despite weakness in recycled fiber pricing, while adjusted net income per share advanced more than 14%. Waste Connections has always been the smaller, more-agile player in the waste space, one that is more aggressive with respect to acquisitive activity. Net cash provided by operating activities improved to ~$307 million from $287 million in the prior-year quarter, while capital expenditures were effectively flat, revealing nice free-cash-flow expansion. The company’s dividend yield isn’t as attractive as that of its larger peers, Waste Management and Republic Services, but Waste Connections continues to be active on the buyback front, repurchasing $42 million of common shares during the period. Waste Connections CEO Ronald Mittelstaedt had the following to say about the quarter:

Better than expected solid waste price growth and E&P waste activity drove strong performance in the period and position us well for the remainder of 2018.  Adjusted EBITDA* margins in the first quarter increased 80 basis points year-over-year in spite of both the precipitous decline in recycled fiber values and weather-related impacts across a majority of our operational footprint.

All in, we continue to be huge fans of the waste industry, and we’re hoping that we get the opportunity to add one of the top three players to the relevant simulated newsletter portfolio at the right price. Value will always be an important consideration, even if we do like the dividend profile of entities in the solid municipal waste industry, despite the high degree of financial leverage on their books. Waste Management, Republic Services and Waste Connections yield ~2.3%, ~2.1%, ~0.8%, respectively. We’re sticking with our fair value estimates across the group following the strong first-quarter performance.

Environmental Services: CLH, CVA, CWST, DAR, ECOL, RSG, SRCL, WCN, WM