MARCH 2008

Economic slowdown could affect solid waste sector
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Casella Waste operates in two regions which should help them through the slowdown.

An economic slowdown is no longer in debate. A growing number of economists are now forecasting that the economy will enter a recession this year in the United States.

Whether it is a recession or merely a slowdown, solid waste companies should expect to see waste volumes decrease thanks to a drop in construction activity.

“We have experienced solid waste volume contractions over the past year and a half. The construction slowdown and the soft economy continue to negatively impact our collection business,” said Ned Coletta, director of investor relations at Casella Waste Systems, Inc.

Vermont-based Casella Waste operates in New England and New York, which might help the company fare better than some in other regions, Coletta said.

“Without ever experiencing high paced growth in the last several years we do not expect an economic trough to be as deep in the Northeast,” he said. “Despite the softening economy, we remain disciplined on pricing and have been able to offset most of the volume losses.”

Construction of new homes across the country fell by 14.2 percent in December, according to the Commerce Department. It fell by 30.8 percent in the Midwest, 25.8 percent in the Northeast, and 19.6 percent in the West. The decline in the South was a smaller 3.3 percent. For all of 2007, new home construction was down 24.8 percent.

Many economists do not expect the housing sector to rebound until 2009. Most economists blame the current economic weakness on problems that first started to appear last summer in the sub-prime mortgage market. Years of low default rates led to looser credit standards and a surge in home building. Property values increased along with consumer spending

Now that the economic cycle is turning, more Wall Street investment banks are forecasting the slowdown will turn into a recession, including Goldman Sachs Group, Inc., Morgan Stanley and Merrill Lynch & Co., Inc. Others, including J.P. Morgan Chase & Co. and Lehman Brothers Holdings, Inc., predict the economy will muddle through, avoiding a recession.

Along the way, financial institutions have announced billions in losses due to the sub-prime meltdown. The government is using both monetary and fiscal policy to boost the economy. The Federal Reserve cut interest rates 1.25 percent over two weeks in January. Legislatures, meanwhile, are working on a $150 billion stimulus package to boost consumer spending.

Brian Butler, an analyst with Friedman, Billings, Ramsey Group, Inc. in Virginia said that economists at his investment bank have increased the estimate probability of an economic recession from 60 to 70 percent for 2008. “Clearly the market believes we are headed into a slower economic period,” Butler said. “While price growth may be slower in 2008, I believe the public waste group can and will maintain pricing discipline in the coming year.”

Butler said the solid waste sector has seen weakness in residential construction. However, non-residential construction has offset some of the decline.

Total construction spending for 2007 was down 2.6 to $1.161, according to government data. Total private construction was down 1 percent. Public construction was down 1.5 percent.

“A fear in the marketplace is that non-residential construction volumes will follow residential volumes and slow,” Butler said. “If both volumes are declining this will test the group’s pricing discipline.”

To fight the rising costs of diesel to fill the fuel-hungry fleet of trucks, Casella Waste along with other solid waste companies have adopted a fuel surcharge. The surcharge at Casella Waste is adjusted monthly and is based on numbers reported by the Department of Energy. “The surcharge generally recovers the rising costs to service our customers,” Colleta said.

Stewart Scharf, an analyst with Standard & Poor’s Corp. in New York, said fuel surcharges and other hedging programs at solid waste companies have helped to offset costs. He noted that haulers have also been successful at implementing across-the-board price hikes.

“Operating margins should benefit from cost controls and a focus on higher-margin volumes, as haulers divest unprofitable assets. The major players will seek to offset challenging markets with improved productivity and customer service to retain customers,“ Scharf said.

“A further significant economic downturn could lead to municipalities generating less tax revenue, thus being more reluctant to accept price increases when their contracts expire.”

Despite this threat, Scharf said that he views the solid waste sector as somewhat recession-resistant, lagging economy swings by six to nine months. He said that he expects volumes at the solid waste companies to soften throughout 2008 as consumers curtail their spending.

Leone Young, an analyst with CIT Group, Inc. in New York trimmed her 2008 profit estimates for the major solid waste players by between 1.5 percent and 3.5 percent. She cited “greater economic uncertainty and sluggishness” in the economy in a note to investors.

Young said that most of the volume weakness in the sector is contained to the roll-off/construction and demolition segments, which totals 10 to 15 percent. The commercial and residential household segments, which total 85 to 90 percent, are more defensive in nature.

“We believe the solid waste industry is particularly attractive in this current economic market environment, as it is late-cycle and defensive in nature, which makes it less sensitive to small changes in gross domestic product or an economic slowdown,” Young said.