AR October 2006

Demand for heavy equipment is strong in the solid waste sector.

“The overall industry is up,” said Melissa Gauger, waste segment manager at International Truck and Engine Corp. – part of Navistar International Corp. headquartered in Warrenville, Illinois. “International is up accordingly.”

New federal air pollution control regulations that will impact diesel emissions set to start next year are causing some solid-waste customers to purchase trash trucks this year. “International is seeing some of its customers pre-buy,” Gauger said.

New regulations are only one of the considerations. Higher fuel costs are also a deciding factor for solid waste companies. “It is important for waste companies to operate waste trucks that meet specific needs of the job,” Gauger said.

Gauger said that solid-waste companies are striving to keep equipment costs in line with revenues. “Fuel prices and driver shortages are making that difficult,” Gauger said.

Peter Nesvold, an equity analyst covering truck manufacturers for Bear Stearns & Co. in New York, said emissions is a key theme in the truck equipment industry. In a research report he noted that demand for trucks is often legislated in and he predicted that emission regulations would likely get stricter and more pervasive in the years ahead.

“Our sense is that investors greatly underestimated the magnitude of the 2005-06 pre-buy,” Nesvold said. He expects truck buying to slowdown in the first 10 months of 2007. Nesvold said some companies would not buy a new truck until April 2008.

“In terms of industry-wide ‘07 builds, we expect a 45 to 50 percent decline in Class 8 and 20 to 25 percent decline in Class 5-7,” Nesvold said.

For buyers still in the market in 2007, trucks will cost more. Nesvold estimated that trucks will cost an incremental $16,400 to $33,800 on a net present value basis for the first user in 2007. “We’ve seen some estimates as high as $43,000,” Nesvold said.

Mike Cordesman, president and chief operating officer at Fort Lauderdale, Florida-based Republic Services Inc. also expects that new air pollution control regulations will significantly increase the price of trucks in 2007 and beyond.

Cordesman said that there is strong demand for equipment as waste companies across the country grow and continue to invest in maintaining a healthy fleet of vehicles. “The big three companies all have scheduled equipment replacement programs that will keep demand for equipment stable for several years to come,” Cordesman said.

Republic, with operations in 21 states, has spent an average of $175 million on vehicles and equipment in each of the past 3 years, Cordesman said.

Higher interest rates are not having an impact on capital expenditures at Republic, Cordesman said. Higher fuel costs are also not having an impact on capital expenditures. But he said higher fuel costs have had an impact on the company’s cost structure “We use a fuel surcharge to recover the higher cost of fuel. We also stay focused on good tire maintenance and effective routing to minimize our fuel costs,” Cordesman said.

Another recent change in the industry is that some private equity groups are searching around the solid waste sector, Cordesman said. That will not have an impact on the industry however. “I think the major companies are sticking to a disciplined program of searching for deals that add real value for shareholders,” Cordesman said.

Stewart Scharf, an equity analyst covering environmental services at Standard & Poor’s Corp. in New York, said that he has not heard of anything yet regarding private equity. “But certainly it is a trend overall. So it is possible. Private equity funds would pay a premium for assets, increasing acquisition multiples above the industry’s average. I don’t expect this trend to affect the major haulers near term,” Scharf said.

“Smaller haulers tend to be sellers, as they can still get a fair price in this environment and it’s more difficult for them to generate enough cash to meet regulations,” Scharf said. “The major haulers have been swapping assets, trying to improve their operating efficiencies. They’re also looking for a good fit via tuck-in acquisitions, while selling under-performing assets that no longer fit in well with their regional operations.”

In regard to capital expenditures, Scharf noted that the solid waste sector is a very capital-intensive business. “Some of the major solid waste haulers have been focusing on upgrading their aging fleets to reduce repair and maintenance costs, as well as to improve collection efficiencies with innovative vehicles,” Scharf said.

Phoenix-based Allied Waste Industries Inc. spent nearly $700 million in capital expenditures in 2005, up from $583 million in 2004 and $492 million in 2003, Scharf said. He said the company has been targeting 1,000 new vehicles per year to replace its fleet of 13,000.

Houston-based Waste Management Inc. projects capital expenditures of nearly $1.5 billion for 2006, up from $1.2 billion in 2005. Scharf said the money is slated for buying land near landfills and fleet upgrades to meet new diesel regulations mandated for 2007. It also plans to invest in landfill gas-to-energy and medical waste projects.

Scharf said rising interest rates impact these companies ability to borrow and increase interest expense. “Allied Waste is still highly leveraged, but about 77 percent of its debt portfolio is fixed. It has also recently restructured its debt,” Scharf said.

Meanwhile, higher fuel costs continue to impact results, Scharf said. “Haulers have implemented fuel surcharges and hedging programs in an effort to offset the negative effect of fuel, while also pushing through across-the-board price hikes. Improved routing is another method being used to combat the higher fuel costs as a shorter distance to the landfill or transfer station reduces the amount of fuel used.”