Consolidation opportunities remain

Compared with the broader macro-economic environment, the waste industry is seeing relative and absolute returns improve for the capital that has been deployed for mergers and acquisitions (M&A) over the last three years, said Leon Vayntraub, a director in the Waste and Environmental Services practice at Raymond James who is based in the company’s Chicago office. Speaking at Waste Today’s Corporate Growth Conference in mid-November in Chicago, he predicted that the durable pricing and margins and improving returns seen in the solid waste services sector will attract additional investment dollars in the year ahead, particularly from middle market companies aided by infrastructure funds and private equity.

Public company growth

Among the key publicly traded companies—Houston-based WM Inc.; Phoenix-based Republic Services Inc.; Waste Connections, based in The Woodlands, Texas; Vaughan, Ontario-based GFL Environmental; and Rutland, Vermont-based Casella Waste Systems Inc.—2022 was “a marquee year” for M&A activity, Vayntraub said.

“2021 was relatively down, but also following a marquee year, and 2023 … we think when it’s all said and done, we will have eclipsed 2021 levels but probably not reach 2022 [levels].”

He said these M&A investments have led some to question how much further the publicly traded waste companies can consolidate the industry, noting that three decades ago, the top five players had about 19 percent market share compared with 50 percent currently. However, the main players in other capital-intensive industries such as rail, airlines and telecommunications, have significantly higher market share than those in the waste industry (72 percent, 67 percent and 58 percent, respectively), Vayntraub’s presentation noted. “So, there is still runway to continue to consolidate, continue to grow and to expand market presence, both within landfills, where they’ve done a great job, but also within postcollection assets and in hauling.”

Over the last 40 years, these five publicly traded waste companies have grown significantly faster than the broader market, Vayntraub said, expanding their positions in key markets. “But, due to industry growth, the overall quantum of opportunities in the middle market, from a revenue and number of companies standpoint, has actually grown over the last 40 years,” he continued. “There’s more opportunity today to consolidate than there ever has been before.”

Regional growth focus

Going forward, Raymond James predicts regional players will grow with the help of external capital from infrastructure funds, private equity and other sources as capital seeks out returns.

“I think these are very well-run, typically institutionally backed, waste companies that are going to play a bigger role in consolidation going forward,” Vayntraub said.

He cited two reasons for this growth: possible changes to the antitrust policies of the Federal Trade Commission and the Department of Justice regarding the premerger notification rules established by the Hart-Scott-Rodino Act that have been in place for more than 45 years and new entrants to the market.

Vayntraub said it will become more difficult for the large, publicly traded firms to make acquisitions under the proposed antitrust rule changes, whereas the regional independent waste companies “don’t necessarily have the same constraints.” He said these midmarket firms will become more competitive, “especially for those larger midtier assets that the publicly traded waste companies are going to have [an] increasingly difficult [time] buying.”

Regarding new entrants to the market, Vayntraub said Raymond James advised Environmental 360 Solutions (E360S), headquartered in Aurora, Ontario, earlier this year. “They’re going to move into the U.S. in a big way,” he said.

“FCC [Environmental Services] is another player that’s very quickly become a very serious player in some of the fastest-growing, most-valuable markets in the country, Vayntraub continued, referring to the Spanish-owned firm that has operations in Texas, Florida and California. “And then we have a whole slate of private equity and infrastructure funds that have all been deploying capital into this space.”

A durable industry

The waste industry is attractive to these investors in part because of its durability.

Tyler Brown, a senior research analyst at Raymond James who covers the waste industry, said the industry’s “high moat assets” that create a considerable barrier to entry coupled with its “high necessity product or service” that also tends to be low-cost yield “durable pricing, a durable margin and a durable cash flow story.”

While signs point to disinflation in some areas, inflation overall remains “sticky,” Brown said. “But … this industry was built for this. And it’s one of the venerable characteristics about this space.”

Following the COVID-19 pandemic, he said the industry, particularly the largest publicly traded companies, has had a strong pricing response to inflation that was greater than the overall increase in the consumer price index.

While the five largest publicly traded waste companies account for roughly half of industry revenue, Brown said, “that also means that half of industry revenue is not with them. It’s still with a very large number of small regional and small mom-and-pop players (32 percent) as well as ... municipalities themselves (18 percent).”

Brown said while Raymond James thinks pricing will remain “fairly sticky” next year, it likely will slow on a year-over-year basis. “But, regardless, this story here is really all about spread,” meaning the industry’s ability to achieve unit revenue greater than unit cost inflation and to drive durable margins.

Regarding costs, he said three areas comprise about 60 percent of an integrated waste company’s costs: labor (30 percent), maintenance and repairs (15 percent) and subcontractor hauling (15 percent).

In the area of labor, Brown said the market is “past peak pain” and will see disinflation in this area.

When it comes to maintenance and repairs, he said, “this is one of those cost buckets that has gone, I wouldn’t call it necessarily parabolic, but we have definitely seen a big move up” owing to what he termed “fleet age creep” given the difficulty companies have had obtaining chassis. As the average age of fleets increases, “part failure rates rise exponentially, not linearly,” he added. Regarding subcontractor hauling, Brown said we are in the midst of a trucking bust. “Winter has definitely come for the truck markets,” with spot rates being down 40 percent year over year, excluding fuel. He added that while only 10 percent to 15 percent of trucking is bought on a spot basis, the rate per mile, excluding fuel, in the contract market also is declining by double digits, creating favorable market opportunities for companies that procure subcontractor hauling.

“So, put it all together [and] what does it mean? Well, it ultimately means that we think that the outlook for solid waste margins into ’24, probably into ’25, maybe even beyond, looks really durable,” Brown said. “We’re in a position here where unit revenues should exceed unit cost inflation, which should lead to some margin expansion. But durable margin expansion is actually not new; this is something that we have broadly seen over the course of the last 10 years.”

The publicly traded waste companies are allocating 30 percent to 40 percent of their cash flow to maintenance capex, he said, that includes trucks and landfill cell development; 15 percent is earmarked for dividends; and the remainder is “a little more fungible” and includes M&A activity as well as “green” investments in renewable natural gas (RNG) and recycling. “I do think this is going to be a use of capital that we will see continue to grow,” Brown said of those green investments.

Time to lever up

Vayntraub said, “There has never been a better time to lever up a waste business than now given what we’re seeing with the contracted and durable nature and just the natural deleveraging in the business. I think we’re seeing that also play into valuation. We’re seeing leverage levels come up.”

While he noted that funding costs have increased, “returns here are so superior, you’re seeing alternative pockets of capital move into the space and make it work, and that’s very simply due to returns.”

The waste industry outperformed the broader economy during the pandemic, he added, and has done well over the last 1 ½ years managing margins, allowing it to come out of the pandemic stronger, which has added value to small, medium and large companies in the space.

The author is editorial director of the Recycling Today Media Group and can be contacted at dtoto@gie.net.