Waste Management : WM USQ Transcript 2022 10 26

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EDITED TRANSCRIPT

WM.N - Q3 2022 Waste Management Inc Earnings Call

EVENT DATE/TIME: OCTOBER 26, 2022 / 2:00PM GMT

OVERVIEW:

Co. reported 3Q22 total Co. revenue of above $5b and expects 2022 revenue to grow approx. 10%.

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OCTOBER 26, 2022 / 2:00PM, WM.N - Q3 2022 Waste Management Inc Earnings Call

C O R P O R A T E P A R T I C I P A N T S

Devina A. Rankin Waste Management, Inc. - Executive VP & CFO

Edward A. Egl Waste Management, Inc. - Director of IR

James C. Fish Waste Management, Inc. - President, CEO & Director

John J. Morris Waste Management, Inc. - Executive VP & COO

C O N F E R E N C E C A L L P A R T I C I P A N T S

David John Manthey Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

Jerry David Revich Goldman Sachs Group, Inc., Research Division - VP

Michael Edward Hoffman Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Group Head of Diversified Industrials Research Michael J. Feniger BofA Securities, Research Division - Director

Noah Duke Kaye Oppenheimer & Co. Inc., Research Division - Executive Director & Senior Analyst

Patrick Tyler Brown Raymond James & Associates, Inc., Research Division - MD

Sean D. Eastman KeyBanc Capital Markets Inc., Research Division - Senior Equity Research Analyst

Toni Michele Kaplan Morgan Stanley, Research Division - Senior Analyst

Walter Noel Spracklin RBC Capital Markets, Research Division - MD & Analyst

P R E S E N T A T I O N

Operator

Good day, and thank you for standing by. Welcome to the WM Third Quarter 2022 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Ed Egl, Senior Director of Investor Relations. Please go ahead.

Edward A. Egl - Waste Management, Inc. - Director of IR

Thank you, Katherine. Good morning, everyone, and thank you for joining us for third 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; and Devina Rankin, Executive Vice President and Chief Financial Officer. You'll hear prepared comments from each of them today. Jim will cover our high-level financials and provide a strategic update. John will cover an operating overview, and Devina will cover the details of the financials.

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. The Form 8-K, the press release 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 to the SEC, including our most recent Form 10-K. John will discuss our results in the areas of yield and volume, which unless stated otherwise, are more specifically referenced 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 third quarter of 2021. Net income, EPS, operating EBITDA margin and SG&A expense results

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OCTOBER 26, 2022 / 2:00PM, WM.N - Q3 2022 Waste Management Inc Earnings Call

have been adjusted to enhance comparability by excluding certain items that management believes do not reflect our fundamental business performance or results of operations.

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 p.m. Eastern Time today. To hear a replay of the call, access the WM website at www.investors.wm.com. Time-sensitive information provided during today's call, which is occurring on October 26, 2022, 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.

James C. Fish - Waste Management, Inc. - President, CEO & Director

Thanks, Ed, and thank you all for joining us. Our team delivered strong results in the third quarter, growing adjusted operating EBITDA by 11% compared to last year. The outperformance is driven by the strength and resiliency of our collection and disposal business. In a quarter where the preponderance of macroeconomic discussion is centered around signs of a slowing economy, WM's collection and disposal operating EBITDA grew by more than 12% and margins expanded 60 basis points.

Collection and disposal organic revenue growth was 8.8%, elevating quarterly total revenue -- company revenue to above $5 billion for the second consecutive quarter. The growth was delivered -- excuse me, the growth we delivered was driven by delivered steps to grow revenue and efficiently manage costs, which together, position us to overcome inflationary pressures.

Our solid results through the first 9 months of the year position us well to achieve the updated guidance provided last quarter, even with a recent downturn in recycling commodity prices. An important contributor to our improving trend in operating expenses and overall cost structure is the strategic decision to leverage, through automation, the tight labor market and high attrition. John will touch on this as he discusses our significantly improved turnover in more detail.

By the end of 2022, we will reach almost 1,000 full-time positions in difficult-to-source job categories that we've chosen not to refill, putting us well on our way to reducing our labor dependency by 5,000 to 7,000 jobs. We're pleased to see early benefits from our investments to reduce our cost to serve while also differentiating WM by enhancing the customer experience.

Continuing on this discussion of our 2023 and beyond strategy, we're very pleased with our investments we're making in both renewable natural gas and recycling businesses. On RNG, we continue to make great progress on building out our new plants as we expect 2023 to be the heaviest capital investment year. We're on track to see meaningful earnings contributions from 2022 and 2023 investments in 2024, with full incremental operating EBITDA contributions coming in 2026, which are conservatively estimated at $400 million.

Our recycling business not only provides an important service that our customers want and need, it continues to be a profitable business generating solid returns. We worked hard to adjust our business model over the last several years and saw the results of that in the third quarter, particularly in our automated facilities. Our 5 fully automated MRFs are now delivering differentiated results relative to our single stream network, with about 30% lower labor costs, 13% lower total operating costs, nearly double the operating EBITDA margin and most importantly, a 40% improvement in key safety metrics.

We're on track to complete 4 automation projects and add one new MRF in 2022. The significant investments that we're making in growing and automating our MRF network are strengthening the business by reducing costs, increasing throughput and improving product quality. As with our R&D investments, 2023 will be the heaviest year of capital spending and the rebuilding of our single-stream MRFs was the biggest increase in incremental earnings coming in 2024 and 2025 as the majority of the rebuild and new MRFs come online.

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OCTOBER 26, 2022 / 2:00PM, WM.N - Q3 2022 Waste Management Inc Earnings Call

Additionally, as part of our commitment to growing our recycling business, we announced that we are acquiring a controlling interest in Avangard Innovative's U.S. business. The planned acquisition will grow our plastics recycling capabilities by delivering circular solutions for films and clear plastic wrap used commercially. We expect to receive investment returns comparable to our recycling automation investments yet on a more prolonged horizon, given that operations are in the early stages of scaling. We plan to provide a more detailed update during our fourth quarter earnings call once the deal closes.

Also on the M&A front, we completed more than $200 million of acquisitions in the third quarter, putting us well on our way to our full year expectation of $300 million to $400 million. We closed 2 nicely-sized solid waste tuck-in acquisitions in Indiana and Arizona during the quarter. These acquisitions are a complement to our existing operations, and we expect to generate solid returns and earnings contribution in 2023.

And finally, I'm pleased to share that earlier this month, we released our 2022 Sustainability Report, providing details on our ESG performance and outlining our new 2030 priorities. These new priorities are strongly linked with our overall company strategy and directly support expansion of our recycling and renewable energy businesses. Even as we celebrate continued progress in our sustainability journey, we're already focused on driving improvements in the future.

In closing, I want to thank the entire WM team for their hard work and dedication. We're focused on finishing 2022 strong while continuing to progress our investments in recycling, renewable energy and automation to drive growth. I'll now turn the call over to John to discuss our operational results for the quarter.

John J. Morris - Waste Management, Inc. - Executive VP & COO

Thanks, Jim, and good morning. Exceptional organic revenue growth continued to be a key contributor to our strong results in the third quarter, led by collection and disposal yield of 7.1%. Robust core price across every line of business led to third quarter core price of 8.2%, up (inaudible) basis points from the second quarter. We continue to prioritize customer lifetime value in our pricing strategies, and we maintained third quarter churn of 8.7% when adjusted for steps we took to intentionally shed 3 large unprofitable contracts.

We remain focused on disciplined pricing in the fourth quarter, positioning us to achieve our full year revenue growth guidance of about 10%. In the third quarter, volume remained at healthy levels as workday adjusted collection and disposal volume grew by 1.7%, including special waste volume growth of nearly 15%. Commercial volume adjusted for the contract losses I mentioned was 1.4%. We continue to grow volumes as our team's focus on differentiating WM as a preferred service provider.

In addition, our teams in Florida are rising to the challenges from Hurricane Ian, taking care of their teammates and communities. While there were increased costs from business disruption and property losses in the quarter related to the Hurricane, we are well positioned to handle store and volume as clean-up activity ramped up in fourth quarter. We remain focused on controlling operating costs. Adjusted operating expenses were 62.2% of revenue in the third quarter, in line with prior year. And while we still see high single-digit inflation, our operating expenses as a percentage of revenue in the solid waste business improved 70 basis points compared to last year.

Over last year, we made significant investments in our people, including proactive wage adjustments, an improved benefit package and increased training. Those investments are paying off as driver turnover improved 410 basis points in the past 3 months, and sequentially, the rate of increase in labor costs improved more than 400 basis points. Maintenance and repair costs remain elevated and are being impacted by the slowdown in truck deliveries, a tight labor market for technicians and higher cost for parts and third-party services.

The impact of higher fuel costs increased operating expenses as a percentage of revenue by 50 basis points. This increase was completely offset by the alternative fuel tax credits realized in the third quarter related to the first half of 2022. While cost inflation appears to be easing, the inflationary environment only serves to reinforce our commitment to using technology and automation to reduce our labor dependency across the business and lower our cost to serve.

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OCTOBER 26, 2022 / 2:00PM, WM.N - Q3 2022 Waste Management Inc Earnings Call

As Jim discussed, we continue to have strong conviction in our recycling business. While global markets drive the value of recycled commodities, the steps we've taken over the past few years to shift around 85% of our third-party volumes to a fee-for-service model provides protection on the downside. So while there is a level of earnings variability, the recycling business is profitable and generate solid returns in any economic environment.

Our blended average commodity rate in the third quarter was about $94 per ton. We are assuming a blended commodity value of about $50 per ton for the fourth quarter of 2022, which compares to $132 in the same quarter of 2021. These recent commodity market [moves], combined with persistent cost inflation, are expected to be about a $50 million year-over-year headwind to operating EBITDA in the fourth quarter. We're very focused not only managing costs in recycling business but also invest in the automation across our MRF network to structurally lower the cost of processed material and achieve better quality, which further enhances the protections afforded by our fee-for-service model while providing profitability lift even in the toughest markets.

In the renewable energy business, we continue to see strong performance with operating EBITDA in the first 9 months growing $24 million. The second of our 17 new RNG plants announced at the beginning of the year is on track for completion at the end of the year and is expected to begin generating revenue in the third quarter following EPA certification to generate RINs credits.

In closing, we are very pleased with our third quarter results, and we continue to operate our business with notable focus on disciplined cost control and responsible revenue quality improvements. I want to thank the entire WM team for their invaluable contributions to our success. I'll now turn the call over to Devina to discuss our financial results in further detail.

Devina A. Rankin - Waste Management, Inc. - Executive VP & CFO

Thanks, John, and good morning, everyone. As we've seen all year, our team delivered strong results in the third quarter, driven by organic revenue growth, diligent cost management and proactive steps to automate the business. We continue to see improvement in our collection and disposal business as our strategic focus is on fostering a people-first culture and investing in automation, are driving nearly tangible results.

Adjusted operating EBITDA in the collection and disposal business grew $174 million in the quarter, which contributed to total company operating EBITDA margin expansion of 50 basis points to 28.6%. Performance in the collection and disposal business, net of fuels, drove 120 basis points of margin improvement. Operating EBITDA margins also benefited 50 basis points from the passage of the Inflation Reduction Act, which secured alternative fuel tax credits through 2024. These 50 basis points relates to the catch-up adjustment we made in the quarter to recognize the benefits of these credits for the first half of 2022.

Partially offsetting these very strong results were headwinds of 50 basis points from recycling commodity prices, 30 basis points from the impact of higher fuel costs, 20 basis points from increased technology and automation investments and 20 basis points from damage to some of our facilities and vehicles caused by Hurricane Ian.

Proactive management of SG&A continues to be an important element of our business optimization efforts. In the third quarter, SG&A was 9.2% of revenue, a 50 basis point improvement over the same period in 2021. Through the first 9 months of the year, SG&A was 9.6% of revenue, which is consistent with the full year outlook we provided last quarter.

Year-to-date cash flow from operations increased more than 4%, driven by operating EBITDA growth of nearly 10%. Cash flow from operations growth is muted relative to operating EBITDA growth due to higher cash taxes, higher bonus payments, a delay in cash benefits from alternative fuel tax credits and some moderation in working capital benefits from last year when we saw significant benefits from our new source to pay system.

Through the first 9 months of the year, capital expenditures have totaled $1,725,000,000 with just over $1.4 billion of that related to normal course capital to support the business and the remaining $322 million related to the strategic growth of our recycling and renewable energy businesses. As I mentioned in July, we were starting to see some encouraging signs of improvements in truck deliveries, and we're gaining traction on our sustainability investment project. These early indicators continued throughout the third quarter, and we're pleased with the increased pace of

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