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November 2007

American housing situation moderately impacts the solid waste industry on various levels
Waste companies seeking funding will face higher interest rates and tighter controls

Waste haulers have only been moderately impacted by the reduction in construction and demolition volumes due to the soft residential housing market.

As the housing crisis continues to affect the strength of the American economy, new construction continues to fall while the number of existing homes that remain unsold is high. Many homeowners cannot afford to pay the mortgages on their homes and are either having creditors seize their properties or are attempting to sell them at a loss.

While the general affect is being felt across the board, there is also a direct impact on the waste industry, especially for solid waste companies and landfill operators via the “credit crunch.”

“Although construction and demolition (C&D) volume has been weak due to the soft residential housing market,” says Stewart Scharf, an equity analyst with Standard and Poor’s Corp., “it’s a small percentage of total revenues (less than five percent), so the impact on the solid waste industry is minimal. However, if the residual effect from fewer new home sales leads to less discretionary spending, fewer jobs and, basically, a recession, the impact could be more severe.

“This business, though, is generally recession resistant, lagging an economic cycle by 6 to 12 months, especially on the residential side,” he adds, “with volume historically tracking close to GDP growth (S&P is forecasting about two percent real GDP growth for both 2007 and 2008). So an economic downturn would have to affect commercial and, especially, industrial collection volume for business to suffer a major blow.

“Nevertheless, pricing and improved operating efficiencies remain the primary growth drivers,” he adds, “so it’s unlikely that waste companies will experience a significant downturn near term.”

Scharf notes that the industry could potentially benefit by the recent fallout in the credit markets as the number of private equity firms chasing solid waste assets declines due to a liquidity squeeze.

“Although there hasn’t been a huge influx of private equity coming in yet,” he says, “there have been several deals over the past couple of years. With possibly less interest in the near future, acquisition multiples for ‘tuck-in’ deals may come down a bit.

“However, with the Fed cutting interest rates by 50 basis points in September,” he adds, “economic growth should gradually pick up and borrowing rates will also be more attractive. Solid waste companies continue to generate a lot of cash, targeted for shares buybacks, dividends, niche acquisitions and, in some cases, debt paydowns.”

For the month of August, according to the Commerce Department, housing starts in the United States dropped by 2.6 percent, resulting in a seasonally adjusted yearly rate of 1.331 million units. Economists had expected a rate of 1.35 million units.

Based on prior data, these latest statistics presented a clear picture – such a decline in housing starts has not been felt since June, 1995 (1.281 million units). Moreover, it was stated that con­struction activity has fallen 19.1 percent compared to 2006.

In an effort to lessen the impact on homeowners that are having trouble meeting their mortgage payments, the Federal Reserve reduced the federal funds rate from 5.25 to 4.75 percent in September.

In addition to the decline in new housing starts, the request for building permits, according to the DOC, declined by 5.9 percent for an annual rate of 1.307 million. Similar to housing starts, such numbers had not been experienced since June 1995 – 1.305 million.

Looking at the decline in housing starts by region, the Northeast was hit with a 38 percent decrease in August. In the West, the decline was 18 percent. These negative numbers were offset by gains of 4.2 percent in the Midwest and 11.4 percent in the South.

But as the crisis continues, many industry watchers are predicting that residential housing starts will continue to decline in the months to come.

Some economists are predicting tough times for the economy and have uttered the “R” [recession] word. Speaking before a Congressional committee in September, Professor Robert Shiller, an economist from Yale University, said that the ongoing problems affecting the real estate market have the potential to be the most harmful to the economy since the Depression and may lead to a recession.

Worthing F. Jackman, the chief financial officer for Folsom, California-based Waste Connections, Inc., says that the impact of the turmoil in the housing markets is mixed.

“Roll-off in certain markets is being impacted such as a Central California or a Denver,” he explains, “but some of our other markets are up nicely in number of pulls and are almost offsetting reductions elsewhere. Revenue per pull is up year-over-year, resulting in revenue in that line of business being up year-over-year.”

To meet the challenges of the current business environment, Jackman’s firm is redeploying any excess assets out of a weaker market and into a stronger market.

When asked what percentage of his firm’s business is dependent on the construction industry and the turmoil in the credit markets is having an impact, Jackman replied: “The credit markets remain open for strong credits such as investment-grade companies like Waste Connections. We just announced completion of a refinancing that lowered our borrowing cost and increased our capacity. Tighter financial markets may provide us additional acquisition opportunities as financially-levered private companies may decide to sell rather than remain independent with such a debt burden.”

Jeremy K. O’Brien, P.E., director of Applied Research for Solid Waste Association of North America, believes that there could be some negative impacts on the industry.

“As construction and demolition (C&D) waste represents roughly 20 percent of the solid waste stream,” he says, “the turmoil in the housing markets is likely to have a modest to moderate impact on the amount of solid waste recycled and disposed.”

Waste companies looking to secure new loans could face higher interest rates in the new year until mid-term.

“Tighter credit markets could impact the industry by raising borrowing rates and the associated financing costs for equipment and facilities,” he says. “Again, the impact is likely to be modest to moderate.”

However, O’Brien stresses that the link between economy as whole and the generation of waste must be considered.

“The overall state of the economy has a direct impact on the quantity of goods purchased, which affects the amount of waste recycled and disposed,” he says. “Waste generation rates, however, have risen over the past 25 years despite the fluctuations in the economy.