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MAY 2007

Solid waste industry expects moderate growth

Volumes are expected to be lower due to a combination of weaker residential construction and companies focusing on raising prices, but a good year overall.

With a focus on pricing and cash generation initiatives, executives and analysts agree: The solid-waste industry will continue to see moderate growth this year.

“Internal growth will likely be driven by price hikes at both collection and landfill operations, while collection volume will remain weak due in part to a soft residential housing market, as well as modest gross domestic product growth,” said Stewart Scharf, an equity analyst who covers the industry for Standard & Poor’s Corp in New York.

“I think operating costs will be well controlled, as waste haulers focus on reducing maintenance and repair costs, while contractual price hikes should continue to offset high, albeit stabilizing, fuel costs,” Scharf said. “Operating margins should benefit from the better fuel prices, improved efficiencies and better safety programs.”

Scharf said that major haulers would continue to use cash for share buybacks, paying down debt and paying dividends instead of pursuing major acquisitions.

S&P is forecasting United States’ GDP growth of 2.4 percent for 2007.

Bruce Parker, president and chief executive officer of the Washington DC-based solid waste trade group, National Solid Wastes Management Association, said the solid waste sector usually tends to lag overall economic growth by six to nine months.

“If the economy goes down, we’re still going to be ok,” Parker said.

The solid-waste industry is rationalizing its assets, either by selling under-performing assets or through asset swaps with other haulers, Parker said.

“Pricing has been very good over the last couple of years,” he said.

“Everybody is benefiting, even the smaller haulers who have also raised prices. The underlying economy is strong. GDP is still growing. Unemployment is low. Production is up. If you look at all the indices, things are going very well.”

This economic environment bodes well for Fort Lauderdale-based Republic Services Inc., the third-largest waste-management firm in the United States.

“We expect to grow revenue by about 4 to 4.5 percent” this year, said Jim O’Connor, chairman and chief executive officer of Republic Services.

O’Connor said the biggest issue facing the sector is escalating costs. The industry was hesitant to pass along these higher costs to consumers from 2000 to 2005, he said. “In 2006 the industry was experiencing rapidly escalating costs that it could no longer absorb and companies providing waste collection services began to raise prices.”

O’Connor said Republic Services would be able to maintain its price discipline.

“We use a number of business tools and train our employees on the use of these tools to be sure that customers are paying a rate that is fair for them and for the business,” he said.

“The cost of delivering services has increased dramatically. Over the past five years the cost of fuel, lubricants, trucks, containers, insurance and labor have all increased. In the past we were absorbing those cost hikes. I think we will continue to expect to see customers paying more for services” as costs continue to escalate.

Houston-based Waste Management Inc., the nation’s largest solid-waste company, and Phoenix-based Allied Waste Industries Inc., the nation’s second largest, did not want to comment. But previous comments by executives indicate a positive outlook.

“We believe that our 2006 achievements provide a solid foundation upon which we can continue to improve our operating results and cash flow in 2007,” said John Zillmer, chairman and chief executive officer at Allied Waste, in a statement.

“We produced excellent financial results throughout 2006 and laid a foundation on which we will build on during 2007. We remain committed to our financial goals of growing earnings, expanding our operating margins, increasing our return on invested capital, and generating strong free cash flow,” David Steiner, chief executive officer of Waste Management, told investors following the company’s latest financial report.

Leone Young, an equity analyst that follows the solid waste industry for Citigroup Inc. in New York, outlined a positive thesis for the sector in a note to clients.

1.) Solid waste companies are maintaining pricing discipline with new initiatives in landfill pricing.

2.) A focus on a return on invested capital with asset swaps, rationalization or divestiture plans in place at all the companies.

3.) The solid waste companies have more muted volume expectations, in part due to residential construction and a slower macro outlook.

4.) There is no change in positive outlook guidance.

“All the companies reaffirmed their commitment to price increases compared with 2006 levels. Landfill pricing is a focus for all the companies, but all noted that it takes longer, given the fact that 75 percent to 80 percent of landfill volumes are under contract, which must be pre-priced as they come up for renewal,” Young said in the note.

“The industry now has a consistent return on invested capital focus as well as detailed price initiatives for 2007 that drives incentive systems at both the corporate and at least to some extent the local level. All the firms have some plan of asset rationalization. We believe this focus also reinforces the drive to more rationally price.”

Corey Greendale, an analyst who covers the industry at First Analysis Corp. in Chicago, said he also thinks that everyone is going hold the line on pricing.

“I think it is going to be a good year in terms of margins,” he said.

Greendale said that he expects volumes to be lower due to a combination of weaker residential construction and companies focusing on raising prices.

“But by and large, I would say that it is shaping up to be a good year in general. They (major solid-waste companies) are not seeing a pushback in terms of a big increase in customer churn. They certainly are holding the line on prices,” Greendale said.

Greendale said the main question last year was about whether solid waste companies would be able to raise prices. He said that this year the big question is about what is happening with the economy. Is it going to stay the same or get worse?

In previous economic cycles it was tough because there was chaos in terms of pricing, Greendale said. “There was not a centralized push on pricing. Each field operation was doing its own thing. I don’t think that is going to happen this time around.”

Greendale said he expects some of the more incremental, more cyclical volumes will get pushed away to smaller companies. “But those aren’t the really high margin things anyway. The bottom line is that I think everything should be ok,” he said.


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