GFL Environmental Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
August 1, 2024

There are 11 speakers on the call.

Operator

Good morning all and thank you all for attending the GFL Second Quarter 2024 Earnings Call. My name is Brika, and I will be your moderator today. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end. I would now like to pass the conference over to your host, Patrick Davitti, Founder and CEO at GFL Environmental. Thank you.

Operator

You may proceed, Patrick.

Speaker 1

Thank you, and good morning. I would like to welcome everyone to today's call, and thank you for joining us. This morning, will be reviewing our results for the Q2 and updating our guidance for the year. I'm joined this morning by Luke Pelosi, our CFO, who will take us through our forward looking disclaimer before we get into the details.

Speaker 2

Thank you, Patrick. Good morning, everyone, and thank you for joining. We have filed our earnings press release, which includes important information. The press release is available on our website. During this call, we will be making some forward looking statements within the meaning of applicable Canadian and U.

Speaker 2

S. Securities laws, including statements regarding events or developments that we believe or anticipate may occur in the future. These forward looking statements are subject to a number of risks and uncertainties, including those set out in the filings with the Canadian and U. S. Securities regulators.

Speaker 2

Any forward looking statement is not a guarantee of future performance, and actual results may differ materially from those expressed or implied in the forward looking statements. These forward looking statements speak only as of today's date, and we do not assume any obligation to update these statements whether as a result of new information, future events and developments or otherwise. This call will include a discussion of certain non IFRS measures. A reconciliation of these non IFRS measures can be found in our filings with the Canadian and U. S.

Speaker 2

Securities regulators. I'll now turn the call back over to Patrick.

Speaker 1

Thank you, Luke. Our Q2 financial results continue to prove the highly predictable and recurring nature of our business model. These results are better than we expected and reflect the underlying quality of our asset base and the effectiveness of the value creation strategies that we have put in place over the last few years. Most importantly, these results demonstrate the drive of our employees to deliver consistent high quality results quarter over quarter and to make our business better every day. I want to thank each and every one of them for their dedication to Team Green.

Speaker 1

Both solid waste pricing and volume came in better than expected for the quarter and continue to trend above our initial plan. And repair and and repair and maintenance expenses. The accretive benefits of shedding low quality revenue and exiting non core service offerings are also evident in our margins. Luke will walk through more of the details for the quarter that confirm the ongoing operational excellence of the business that we have built. Consistent with our previous guidance, we deployed $89,000,000 into incremental growth investments, primarily related to recycling and RNG infrastructure that we expect will generate significant ROIC for years to come.

Speaker 1

We remain on track to deploy a total of 2 $50,000,000 to $300,000,000 into those investments during 2024 as previously guided. In the quarter, we also accelerated our exit from a portfolio of residential collection contracts in Michigan that no longer met our return thresholds. The sale of this book of business occurred at the end of the second quarter and will be accretive to our margins in the second half. We've seen continued success with the development of our book of business related to EPR in the Canadian markets. New contract awards in Ontario and Quebec have added to the $80,000,000 to $100,000,000 of incremental adjusted EBITDA we previously identified related to EPR and we now expect to generate approximately $130,000,000 of incremental adjusted EBITDA from the contracts awarded to us to date.

Speaker 1

To reiterate what I said last quarter, the contribution from these contracts is expected to start late in 2024, slowly ramp through 2025 and achieve our expected full contribution in fiscal 2026. The contribution of this work is expected to be highly accretive to the margin profile of Canadian solid waste segment and to our consolidated margins. We also remain optimistic about opportunities for further upside as EPR programs are rolled out in Quebec, Western Canada and the Maritimes. On RNG, we continue to expect that 2 or 3 more facilities will come online by the end of the year and we remain confident that we will realize the $175,000,000 of adjusted EBITDA previously disclosed once our portfolio of landfill gas energy facilities is fully operational in the coming years. In the first half of the year, we deployed approximately $500,000,000 into M and A, all of which was completed when we provided our Q1 results in May.

Speaker 1

We remain absolutely committed to our cap for the AGRID 2024 growth investments of $900,000,000 and the net leverage target that we set out late last year. While we continue to have a robust pipeline of attractive M and A opportunities in our markets, at this stage there will be likely only small transactions in the second half with the majority of the current pipeline to be executed in 2025 and beyond. The quality of our first half results with the continued strength of our business model supports an increase in our guidance for the 2nd time this year. We are increasing adjusted EBITDA to 2.24 dollars to $2,250,000,000 and adjusted EBITDA margin to 28.4 percent, a 70 basis point increase over our original guidance and 170 basis point increase over the prior year. Luke will walk through the guidance in more detail, but to be able to raise the guide 2 consecutive quarters and to have line of sight to 170 basis points of annual margin expansion certainly has us feeling very optimistic about the effectiveness of our value creation strategies.

Speaker 1

I will now turn it over to Luc.

Speaker 2

Thanks, Patrick. Revenue for the quarter of $2,060,000,000 was 11.1% higher than the prior year, excluding the impact of the solid waste divestitures. Solid waste pricing of 6.5% and minus 1.7% volume were both ahead of plan and the continued strength in recycled commodity prices also contributed to the year over year increase. Our Environmental Services segment price led growth strategy advanced and was further supported by increased oil volumes and used motor oil pricing. Large scale event driven response work around major spills and fires, the timing of which can be more variable, was lower compared to the prior year.

Speaker 2

Adjusted EBITDA margins were 28.7% for the quarter, 90 basis points ahead of the prior year and 20 basis points ahead of our guidance. Underlying solid waste margin expansion of 100 basis points reflect the positive impact of price cost spread, higher commodity prices plus M and A that came in and accretive EBITDA margins, offset by the dilutive margin impact of the increased cost of risk as well as the absence of onetime benefits related to the prior year divestitures and insurance proceeds received in Q2 2023. Consistent with the Q1, elevated price cost spread, the positive margin impact of our deliberate volume strategies, RNG and favorable commodity price contribution as well as incremental operating leverage are all contributing to margin expansion ahead of expectations. Environmental Services adjusted EBITDA margins were 29.6%, in line with expectations and inclusive of nearly 100 basis point cost of risk headwind, indicative of the success of our price led growth strategy. Adjusted free cash flow was $185,000,000 in the quarter, dollars 177,000,000 greater than the prior year period and approximately $20,000,000 better than guidance.

Speaker 2

The contributions to the outperformance came from CapEx, working capital and other operating items, which are all expected to be timing differences that will normalize by the end of the year. Net leverage at the end of the quarter was 4.29, ahead of expectations and consistent with the quarterly cadence on which our year end net leverage target was based. During the quarter, we were successful in refinancing 1 of our 2025 bonds with a new bond maturing in 2,032. After the end of the quarter, we also successfully refinanced our Term Loan B in a transaction that both reduced the borrowing spread by 50 basis points and extended its maturity to 2,031. We have one additional bond that becomes callable at par in the Q3 of this year.

Speaker 2

The debt markets remain highly constructive and we expect to opportunistically refinance this bond when a market window presents itself. After we complete that expected refinancing, over 90% of our non revolving long term debt will have a maturity date of 20 28 and beyond. As Patrick said, the success of our first half results sets us up to increase guidance for the 2nd time this year. Revenue is now expected to be approximately $7,900,000,000 to $7,925,000,000 driven by solid waste pricing of 6.25 percent to 6.5 percent and solid waste volumes of negative 1.25 percent. Incremental revenue from in year M and A is more than offset by the Q2 asset sale, which is now expected to reduce our original expectations for second half revenue by just over $110,000,000 on account of seasonality.

Speaker 2

Additionally, in light of the lower volume of large event driven work in our ES segment in the first half of the year, we are taking a more conservative view for the back half of the year and the newest guidance assumes this trend continues. If large scale event driven work picks up in the back half, there should be upside to the guide. The contribution from any additional M and A completed in the back half of the year will also provide upside to the guide. Adjusted EBITDA guidance increases to $2,240,000,000 to $2,250,000,000 a $30,000,000 increase over our original guide, a result of the described changes in revenue together with ongoing expansion of adjusted EBITDA margin, which as Patrick said, has increased to 28.4%. Adjusted free cash flow increases to $810,000,000 a $10,000,000 increase driven by the incremental adjusted EBITDA and partially offset by $25,000,000 of incremental interest costs, which are now expected to be $500,000,000 for the year.

Speaker 2

So in summary, revenue increases pro form a for the divestitures, adjusted EBITDA increases again, adjusted EBITDA margin expands an additional seventy basis points on top of the original 100 basis points guide and adjusted free cash flow increases as well. As it relates to the 3rd quarter, we expect consolidated revenue of approximately $2,055,000,000 to $2,060,000,000 with a similar split between solid and ES revenues as what we saw in the second quarter. Keep in mind that the Michigan residential contract sale results in a sequential revenue step down from the 2nd quarter. In terms of margin, we expect consolidated adjusted EBITDA margin of 30.25 percent, over 200 basis points higher than the prior year and the first time in our history achieving a consolidated margin of over 30%. The guide then contemplates margin stepping down in the 4th quarter as per the typical seasonal cadence of the business.

Speaker 2

Those revenue and margin expectations equate to approximately $625,000,000 of adjusted EBITDA for the 3rd quarter. Additionally, we expect $230,000,000 of net capital expenditures, dollars 165,000,000 of cash interest and close to a nil impact from the recovery of working capital offsetting other operating items. For our Q3 adjusted free cash flow of approximately 225,000,000 In terms of net leverage, we expect a reduction of approximately 15 basis points throughout the quarter to end the quarter at just above 4.1 times and then a larger reduction in the 4th quarter to end the year within the previously stated range of 3.65 to 3.85. Adjusted net income is expected to be $125,000,000 for the 3rd quarter. I will now pass the call back over to Patrick, who will provide some closing comments before Q and A.

Speaker 1

Before we open it up for Q and A, although we don't generally comment on market speculation, I want to address some of the headlines that you have all seen lately. We believe that the business today is significantly undervalued when you consider the quality of our assets, the capabilities and track record of our team, the near term growth prospects, especially around EPR and RNG and the deleveraging trajectory we're currently on. In my view, the current valuation does not make sense. With the current disconnect in valuation, we are buyers of GFL, not sellers. Based on the non core asset sales we completed last year at mid teens multiples and the recapitalizations we completed in 2014 2018 as a private company at 13 times to 14 times EBITDA, we have demonstrated that GFL's assets are worth more than was reflected in our current stock price.

Speaker 1

And since then publicly traded waste multiples have continued to expand. So while selling the entire business is not on the table today, there could be merit in selling a portion of our business and valuations that are more in line with what we believe is fair value of the business. A sale of high quality assets such as our ES segment could easily attract mid teens multiples. We have had significant inbound interest from both strategic and financial sponsors that support this valuation perspective. Such a sale could serve the dual purpose of accelerating our deleveraging and most importantly allowing us the opportunity to buy back a significant amount of stock at an attractive valuation.

Speaker 1

To make a decision around such a significant sale would require a full auction process to ensure we are maximizing shareholder value and achieving the best use of proceeds. We are absolutely exploring all of our options and have begun to implement the steps necessary to prepare for potential transaction. Since we went public, I believe that we have clearly demonstrated that we are dynamic, roll up our sleeves management team that can and will implement the appropriate strategies to ensure that we are maximizing long term value creation for all of our shareholders. We have no intention of deviating from that strategy with the opportunities we now have in front of us. I will now turn the call over to the operator to open up the line for Q and A.

Operator

Thank you. We will now begin the question and answer session. We have the first question from Sabahat Khan with RBC.

Speaker 3

Great. Thanks and good morning. Maybe if we could just start with those closing comments. So maybe give you an opportunity to maybe share a little bit more color on maybe the type of interest you've seen, the type of invest or the type of parties that are looking at it. Do you have like a lower bound on the multiple you're willing to sell, timelines?

Speaker 3

And just sort of your decision making what the market should expect what the market should expect over the next little while and how you're maybe arriving at that decision? Thank you.

Speaker 1

Yes. I think Saba from my perspective, again, we've spent 17 years building this business, right? So again, it's sort of near and dear to our heart. It's been it was a core portion of the strategy historically. And again, as it sort of came to light over the last little while, and again, as I said, from my perspective, there is a very sort of large valuation gap today.

Speaker 1

And it's not necessarily to the peers, but it's also just in general in terms of what I would say private investors are prepared to pay for these assets and the IRR that they can drive out of each and every one of them. So where I sit today, obviously, I think as we started engaging in this process, there was multiple different avenues available to us on the table and it was sort of narrowed down very specifically. And I think to get alignment from Board and specific sort of large shareholders, it was a process that we sort of had to go through. I think given the amount of inbound interest that we've seen from investors as well as strategic. I think where we landed is that we need to run an auction to sell this.

Speaker 1

And we've been taking the steps over the last couple of months to prepare for that. And I think what you'll see is a process launched after Labor Day sometime over the month of September to determine what the actual true value of the business is. I have no reason to believe that the business today isn't worth significantly higher than what GFL is sort of trading at today. I think if you look in the market, if you look at recent trades of Covanta, Circum, if you look at Heritage Environmental that was recently sold to EQT, If you look at U. S.

Speaker 1

Ecology that was sold to Republic, the recent Stericycle trade with Waste Management. I mean, I think you can see that all of these traded in that range. And I think when you run a model and you run a private equity model on this business, I mean, I don't care what model you run, it's very sort of simple growth algorithm, right? You have top line growth of sort of high single digits, bottom line that flows down to EBITDA at sort of just low double digits, put on sort of 5, 5.5 turns of leverage, model in a bit of M and A. I mean, in a base case, you get to sort of a 15% IRR and then upside case, you can underwrite 23% to 25%.

Speaker 1

And I mean, again, I go back to this is what GFL did in recaps for a number of years. Go back to our 2014 recap, HPS, when they recapped that business, our business, they paid 14 times for that in 2014. And they left with an equity return of 3.6 times their money in 4 years. You look at VC Partners, they came in, played close to 14 times for the business in 2018. Look where their equity is marked today, they're at already 3 times their equity and massive sort of runway in front of us.

Speaker 1

So there's no reason to believe that again a private equity investor wouldn't view this the same way. And with our discussions that we've had with them, we can definitely stand behind those models. But again, there was significantly more interest than I thought from more parties. And I think that's the only way for sort of us to maximize value. But most importantly, if you look at remain coal and yes, we can look at GFL trading around 12, 12.5 times 2024.

Speaker 1

But the reality is let's not look at 2024. We need to look at 2025 and 26. And you can take conservative views on what 2025 and 20 6% are. We've given you the breadcrumbs of what RNG and EPR are as you sort of roll out to 26%. Percent and we have our existing shareholders.

Speaker 1

This is solely a trade for me as the largest shareholder. If I can sell something in mid teens and buy back a significant amount of our stock and I can end up owning 12.5% or 15% more of the company at these values and taking out a lion's share of the overhang that exists from some of our PE partners and not having to come back to the market and sort of buy death by a 1,000 cuts of them selling every 6 months, that absolves all of that. So that's how I thought about it. To get those shareholders on-site took time, but I think we've made a decision as a Board that that's what we're going to do. Those shareholders are on-site with that process.

Speaker 1

And I think now there's no there'll be limited overhang left in the market. If you want to own GFL stock, you're not going to wait for secondary because there isn't going to be one because we're going to own the stock and we're going to own 50% more of it. And that's simply how I sort of thought about it. And then the secondary aspect of it is, leverage will be reduced. You'll have a war chest of capital to go out and do the things you want to do in your sort of core service offerings.

Speaker 1

And there will be no impediment to doing the things that we want to do in the markets we want to do while growing the solid waste business. So I think it's a win win.

Speaker 3

Okay. I appreciate that color. Maybe just shifting over to the guidance. It's probably a question for Luke. There's a few moving pieces in the update to the guidance.

Speaker 3

I think you called out the environmental services, I think solid waste doing a little bit better at some FX benefit. If you can maybe just parse out the puts and the takes in the 'twenty four guidance update, please?

Speaker 2

Yes. Saba, great question. It was the one thing that maybe contemplated we should provide a deck, but we think once you hear the details, it will be sort of straightforward enough. Look, at a high level, the EBITDA line, a starting 22.15 guidance number. If I think about that, if I think about exogenous factors of FX and commodities, that's giving me a little bit greater than +30 to the good.

Speaker 2

And then you have this ER volume, right? The large scale event driven stuff, the new guide assumes about $100,000,000 less of that. So the margin on that effectively offsets the benefit you're getting from FX and commodity, right? So then we think about M and A, and right, we did early in the year, we did those couple of deals. And we have the positive contribution of that offset by the Michigan portfolio sale.

Speaker 2

And the net of those 2 is roughly about $15,000,000 to the good, right? So if you think about those as the broad based sort of external factors, it leaves you with about sort of $15,000,000 to $20,000,000 of just pure underlying guidance raise. And it's really coming out of, as you said, solid waste and solid waste margin as we're seeing the effectiveness of our strategies just come through even greater than anticipated.

Speaker 3

Great. Thanks very much. I'll pass it on.

Operator

Thank you. Your next question comes from Stephanie Moore with Jefferies. You may proceed.

Speaker 4

Hi, good morning. Thank you. Good morning. Maybe first touch on the 2024 guidance. Good morning.

Speaker 4

Then maybe just first starting on the 2024 guidance. Your updated guidance has margins expanding 170 basis points year over year. This appears to me the highest margin expansion amongst your peers for the year. Can you comment on what's driving this? How much do you attribute to just the quality of your asset base for self help initiatives?

Speaker 4

And then can you update us just on what innings you are in, on your self help initiatives? Thanks.

Speaker 2

Yes. Good morning, Stephanie. It's Luke. We're certainly impressed with the headline number of 170 as well. But I think the starting point is exactly what you said.

Speaker 2

It's the quality of the assets and the market selection in which we've gone on. We've always said that we have, I think, a best in class asset portfolio in the right markets. And that's what's allowing us to now sort of execute on our strategies. And so you think about the price cost spread that we talked about at the beginning of the year and the ability of that to sort of come in better than anticipated. You think about the synergy realization of all the pieces that we've put together historically and starting to get the benefit of that.

Speaker 2

You think about the self help levers that sort of pulling on. And all of these are sort of coming to fruition and you're seeing the benefit come through in the margins. And so it's not any just specific one thing. Yes, commodities give a little bit of an incremental impact. And certainly, our intentional shedding and those deliberate volume strategies are helping and the Michigan sale sort of accelerates that even more.

Speaker 2

But for actual quantify, you think the base guide of 100 basis points, if you recall, that was effectively all organic, right? Because the M and A was actually a net drag going into the year. So now with that, we have new M and A this year and improved commodity price that's adding roughly 35 basis points of incremental. So the 70 basis point raise, half is coming from those two pieces. And then the other half is just the ongoing success of our strategies, both on the volume and just the underlying margin.

Speaker 2

And so I think it's a great testament to all of the things we've been saying for the past couple of years as we bring these pieces together and what the opportunity is in front of us. And the most exciting part is we really think this is just getting started.

Speaker 4

Great. Thanks, Luke. Appreciate it. Patrick, you noted in the release and in your but given the way it's worded, could we assume that there are other But given the way it's worded, could we assume that there are other assets that could also possibly be for sale? No.

Speaker 4

Thanks.

Speaker 1

No. Thank you.

Operator

Thank you, Stephanie. We now have Kevin Chaim with

Speaker 5

CIBC. Hey, good morning, everyone. Maybe just looking at your solid waste performance, I guess I've noticed a bit of a divergence. I won't say divergence, it's more the Canadian solid waste organic growth has been tracking at a decent positive spread versus the U. S.

Speaker 5

Organic growth. I'm just wondering if there's anything you'd call out there that you're seeing in Canada versus the U. S. I'm not sure if it's just the timing of how some of the M and A comes through when it rolls through after year 1 or if there's something specifically happening in the Canadian landscape versus the U. S.

Speaker 5

Landscape?

Speaker 2

Yes. Good morning, Kevin. It's a great question. If you think about solid waste organic growth being price and volume, recall our Canadian business was sort of behind the 8 ball on pricing, if you will, when we really sort of embarked on price discovery, call it, sort of 5, 6 years ago. And so I think that upside that we've always articulated as to catching up with industry norms in terms of pricing, a lot of that existed in the Canadian book and you're seeing that sort of come through.

Speaker 2

I think additionally, we're starting to see some of the benefits of these investments we've made in the recycling, EPR and other initiatives in the Canadian landscape, which are helping support sort of overall volumes there. And then the offset is while the U. S. Pricing discipline has been sort of more mature, certainly have more runway there, but it wasn't as much steep of a ramp as we saw in Canada. Some of our intentional shedding has been more focused in the U.

Speaker 2

S. Market where we've done larger quantity of M and A and therefore inherited larger volumes of books of business that no longer meeting our return threshold. So I think it's a combination of those two things. Certainly, we're seeing very robust organic growth across both the segments. But you're absolutely right, when you sort of pick it apart, you do see a bit of that sort of divergence.

Speaker 2

But as we go forward, we're feeling highly confident in the organic growth prospects on both price and volume in both of those segments.

Speaker 5

No, that makes a ton of sense and I appreciate the color there. I'm sure there'll be a ton of questions through this call potentially divesting of ES. Maybe I'll just ask one on

Speaker 6

it is a

Speaker 5

portfolio of assets you have within ES. I guess when you think of potentially divesting of this, do you think of divesting all of it or none of it? Or is divesting parts of it also part of the, I guess, the review you're going through today?

Speaker 1

No, beyond block. For ES, it would be it would just be you would be selling the entire portfolio. I mean, the one piece that's in there is the solar remediation piece. So that I would say that's the one piece that could potentially not go with it. If we wanted to keep that just given the exposure to the GTA and sort of GIP, but everything it's a small piece of environmental services.

Speaker 1

But for the most part, it would be en bloc both Canada and the U. S. Obviously, as you know, almost 80% of the revenue from you guys comes out of Canada, 20% under the U. S. So yes.

Speaker 5

Yes. That makes sense. That makes sense. That's it for me. Thank you for taking my questions.

Speaker 1

Thanks,

Speaker 2

Kevin.

Operator

Thank you. We now have Devin Dodge with BMO Capital Markets.

Speaker 6

Thanks for taking the questions here. I just wanted to come back to the 2024 margin guidance. Look, the face of increase really steps up in the second half compared to the first half. I know the sale of the operation in Michigan is part of it, but can you help us better understand that sequential improvement?

Speaker 2

Yes, Devin, it's Luke speaking. And again, I think it sort of goes back to my sort of prior comments to Stephanie of the overarching margin. And it's sort of all of these things coming together, right? So you continue to have price cost spread similar to what we've seen all throughout the year. The cost of risk headwind that's been a big drag all year is moderating as you get to the second half.

Speaker 2

And the benefits of intentional shedding and other deliberate volume strategies are improving as we sort of go forward. And you're going to have the M and A contribution as well. So it's not any sort of one thing. I mean, the guide does contemplate solid waste margins expanding. I think it's roughly 200 basis points over the prior year for in terms of Q3.

Speaker 2

And if you break that apart, the Michigan sale would give you 80 basis points to 90 basis points of that and commodities give you 70 basis points of that. Cost of risk is going to be again not as impactful as the first half, but call that another 30 to 40 basis point headwind against you. So it's still sort of when you take the puts and takes speaking to this underlying 100 basis points of solid waste margin expansion, which is we've been consistently seeing. And again, I think is a function of all of those pieces we've said, starting with the market selection in the assets, getting the synergy realization as these businesses are really sort of starting to gel, improved asset utilization and all of the like. And so I think it's all of those pieces.

Speaker 2

And obviously, culminating in a 30% consolidated margin for Q3, which is the first time in our history of printing that, is something that we're pretty excited about.

Speaker 6

Okay. Okay. Thanks for that. And then another question we get asked occasionally, corporate costs. We've seen this drift higher as a percentage of sales over the last 2 or 3 years.

Speaker 6

Can you speak to some of the drivers behind that? And if you have line of sight into when you could be in a position to start leveraging those corporate costs and add to the margin expansion of the underlying businesses?

Speaker 2

Yes, Devin. It's another great question. It's something we sort of look a lot at. If you look over the last 3 years, I mean, at a high level, half of that is salaries, which sort of accretes up at normal course sort of wage inflation. Now from going to being a public company and doubling our size, we did increase some of the support, particularly around ESG and some of these other departments that weren't full fledged.

Speaker 2

So you did have an investment in resource there. Another significant component of the non size is IT costs. As we articulated that sort of 2 years ago, massive investment to move a lot of our infrastructure into the cloud and just sort of prepare for ongoing scalability. Now some of that IT shows up in CapEx, obviously, but a large portion of it just sort of sits in that sort of corporate bucket. I think the 3rd item to consider is there's actually been between the divestitures of last year and now Michigan again some chunkier amounts of revenue dispositions, which obviously is foregoing some of the leverage that you're getting on that number.

Speaker 2

But when you think about it today, I think the resource investments have been made. I think the IT spend is there. And I think what you now are going to have is leveraging that as you go forward and grow our revenue base off of a corporate cost number that should sort of grow more just at a sort of normal course cost of inflation.

Speaker 6

Okay. Thanks a lot. I'll turn it over.

Operator

Thank you, Devin. We now have Jerry Revich with Goldman Sachs. You may proceed, Jerry.

Speaker 7

Yes. Hi. Good morning, everyone. I wanted to ask your margins in the second quarter were up, call it, 1.5 ahead of normal seasonality, really strong performance. And the guidance for the Q3 is for another outsized margin move of a point versus normal seasonality.

Speaker 7

Can you just talk about what level of sequential price increase are you folks implementing to deliver that level of outperformance? And what are the sequential trends in unit costs that you're seeing that drove the beat in 2Q and again, outperformance in 3Q guide?

Speaker 2

Yes. Thanks for the question, Jared. Calls, this is a year that's returning back to sort of normal cadence of pricing action. What I mean by that is the vast majority of pricing actually occurred already. And so as a result, we're seeing a normal course step down.

Speaker 2

We started the year sort of high this quarter at 6.5% and you're going to be at a high fives number in Q3 and then stepping down a little bit further in sort of Q4. So why I give that color and cadence is because that margin is not being achieved by us going out and implementing a whole host of incremental price increases. It's simply all of the things that we have said coming together. So yes, you're getting pricecost spread because although Q3 will be high fives, you're going to be against a moderating cost inflation, still probably getting somewhere of 100 to 150 basis points of spread sort of on top of that. But that moderating cost inflation is also accelerating.

Speaker 2

If you look at labor rates last Q2, labor rates year over year would have been up sort of a mid- to high single digit number versus now it's sort of sub-five percent and that's sort of continuing to trend in the right direction. I mean R and M is obviously another sort of key cost that's been driving. I mean if you look at R and M as a percentage of revenue, I think we're sort of at 10 plus in Q1. Well, I'll be in the lower seasonally revenue, but then that stepped down to a high 9s number in Q2. Going to step down to sort of a low to mid-9s as a percentage of revenue in Q3.

Speaker 2

And so you're going to be getting the sort of torque coming out of that as well. I mean the commodity prices and the ramp in the first half of the year is certainly helping the Q3 margins, as is the incremental impact from the exiting the Michigan portfolio, which as I said, that's sort of 80, 90 bps is going to help you in the quarter. But it's not any of these one things, Jerry. It's all of the things coming together. And as I said, it's going to yield the 30% margin for the first time in our history.

Speaker 2

And we think there's a lot more room to run as we go forward into 'twenty five and 'twenty six and beyond as you really start getting the benefit of EPR, RNG and all those margin accretive pieces that we've been talking about for the last couple of years.

Speaker 7

Super. Appreciate the color. And on the RNG point, Luke, can you folks just weigh in on your updated views on the attractiveness of voluntary markets versus D3 RIN markets? Do you view the Chevron ruling as any uncertainty for the D3 RIN market? Can you just weigh in with your updated thoughts on spot versus potentially locking in those volumes longer term?

Speaker 1

Yes. We haven't again, nothing has moved and all the smarter people that are not definitely on the RINs haven't certainly don't have that perspective that Chevron decision will affect anything. But from our perspective, again, market continues to be very stable, being able to push as much as we can sort of in the transportation market given sort of RIN pricing. Voluntary market continues to creep up. So I think as more volume continues to come online, I think there's going to be the opportunity to move some of that definitely into the voluntary market.

Speaker 1

And I think our strategy, long term strategy really hasn't changed. So I think we're again, just highly focused on keeping that balance. Again, longer term, we want to be we still have the view that we want to be 60% into the sort of into the voluntary market and then play the spot market on the other sort of balance of 40%.

Speaker 7

Super. And last question on ES, you folks have expanded margin significantly from when you folks acquired those businesses. Can you just talk about what the tax position and the tax basis looks like for those assets if you do move towards a sale, anything we should keep in mind on U. S. Versus Canadian position?

Speaker 1

Yes. So you think about the business, I mean, we did a couple of things. I mean, as people know, the Canadian government changed the capital gains rates earlier this year. So we were able to do a reorganization within the existing business to preserve the old capital gains rate in that business unit. So again, we had that we had the ES business in its own entity.

Speaker 1

I mean, if you look I mean, the irony of this and the funny thing about it is, when you look at ES, which sort of mentioned to the Board yesterday, you look at that business, 2010 we got offered $100,000,000 for our ES business. 2018 we got offered $800,000,000 for our ES business. And I think you've seen some of the numbers that are out there today. And again, we've done we're going to the management team has done an amazing job. I mean, they printed north of 29% margins in Q2.

Speaker 1

I mean, it's an amazing business, an amazing margin profile with a lot of sort of runway sort of sitting in front of it. That being said, it would be basically fully taxable in the U. S. For the 20% piece. We do have a significant number of sort of losses that we could use in Canada.

Speaker 1

So I mean, I think depending obviously on the purchase price, but you could think about a tax bill sort of in the $500,000,000 to $600,000,000 range.

Speaker 7

Okay, super. I appreciate it. Thank you.

Operator

Thank you, Jerry. We now have James Shneur with TD Cowen. Your line is

Speaker 8

open. Hey, good morning guys. Nice quarter. Most of my questions have been answered. Maybe just one for me.

Speaker 8

Know it's way too early for 2025 guidance, but just at a high level with price cost spread opportunity plus some RNG and EPR contributions. Could we see another 100 basis points plus improvement to EBITDA margins next year? And then just thinking longer term about the volumes, what they could do next year, could those be flat to marginally up next year? Or do you still have a lot of shedding ahead

Speaker 3

of you?

Speaker 2

Hey, James, it's Luke speaking. I mean, I think where we sit today, I'd say it's a definitive yes that we're expecting next year to be another 100 plus. We'll obviously unveil the full guidance to go forward. But I think you're absolutely thinking about that correct. And if you do the math, you actually don't need to believe a lot to get to a number like that.

Speaker 2

In terms of the deliberate volume strategy, look, as we said previously early this year, this portfolio of residential contract submission was like the last big chunk. I mean, there's always going to be pieces. And as you do M and A, there's stuff around the edges. But I think the lion's share of that strategy that was actually moving volume and overshadowing actually underlying positive volume is largely sort of behind us. So I think we'll hold until the end of the year or early next before we give a final view on volumes for 2020 5%.

Speaker 2

But certainly think we're not going to be printing at the minus 3% that we did at the beginning half this year, and it's certainly something sort of closer to flat with a path to being up.

Operator

Thank you, James, and thank you, Luke. We now have Brian Butler with Stifel.

Speaker 9

Hi, good morning. Thanks for taking my questions. First one, just on EPS timeline, I guess you talked about after Labor Day kind of starting the auction process. I guess what's your thoughts on and maybe appetite on how long that process runs? I mean, does that go through the end of 2024, maybe into 2025?

Speaker 9

Or is there an expectation to try to do that sooner rather than later?

Speaker 1

I mean, from our perspective, we want to get it done as soon as we possibly could. Again, just it'll be a question of how fast we can move. I think for most of us that know us, I generally don't think we waste a lot of time. And I think the beauty of this business is, this is not a 100 person auction. This is, I would say 8 to 10 sophisticated buyers that have played in this space over and over again.

Speaker 1

So there's not a typical learning curve about assets, markets, etcetera. So, listen, from our perspective, I think it will move very quick. But again, you never know. I think the biggest thing for us is again just getting the cargo financials done particularly if it's a financial sponsored buyer. Obviously, we've been a public company.

Speaker 1

We reported the segment independently. But for someone to get financing, a part of what we have to do is get carve out financial. So that's in process. But other than that, I don't see my goal would be clearly to get it done versus when we report Q4 at the latest. But hopefully, we get we're able to come up with a path one way or another within calendar year 2024.

Speaker 9

Okay. And then maybe on the M and A spend for the back half and then maybe thinking about the pipeline going into 2025. Obviously, it's moderating in the back half of 2024 to be at the leverage target. But when you think about the opportunities still in front of you in your pipeline, should we think about 2025 M and A? And then maybe if the sale of ES happened, could that be much, much larger?

Speaker 9

Just trying to think about where that could

Speaker 1

go. Yes. So I mean, again, backdrop is, again, we've committed to keeping leverage in the 3s. I think the goal is to get sort of leverage. Absent sort of a sale was to get leverage out in the mid-3s for $25,000,000 So I guess that would drive the M and A spend.

Speaker 1

I think when you look at that for next year, you could this year if we spend $600,000,000 to $650,000,000 on M and A given sort of some of the most recent EPR wins that we had. And again, having the hybrid balancing between M and A spends and sort of on the organic growth CapEx spends, I think next year we could step it up for sure, from $650,000,000 probably closer to something somewhere between $850,000,000,000 dollars Obviously, if we did something with the ES business, I mean that would give you ultimate flexibility to do whatever you want. I think you could certainly spend more. Leverage wouldn't really move coupled together sort of with the share buybacks. I mean, I think you'd have a lot of flexibility to even take that M and A spend higher.

Speaker 2

And Brian, it's Luke speaking. You referenced the $850,000,000 to $1,000,000,000 that you could potentially be looking at in a non ES divestiture sort of scenario. I just want everyone to recall, with this size, roughly every $500,000,000 you deploy in M and A has an impact to leverage about 10 basis points, round numbers. So if you think about the organic deleveraging model, if you're ending this year in that sort of $3.65 to $3.85 range, organically, you would delever to something well below $3.5 And even at spending that $1,000,000,000 of a level of M and A still very sort of comfortably arriving at the end of 2025 in that sort of mid-3s range.

Speaker 6

Okay. That's great color.

Speaker 9

And if I could slip one last one in there. Cutting through kind of maybe on the service or maybe sorry, not service, but the shutting of volume. If you look at service intervals on the commercial business, are you still seeing upgrades kind of outpacing downgrades in that piece of the business?

Speaker 1

Yes. I mean, it's obviously market specific, but by and large, yes, we continue to see them outpacing decline. So in market, very healthy. So we haven't seen anything sort of material. Obviously, special waste volumes continue sort of to chug sideways just given where the interest rates are sort of sitting.

Speaker 1

But I think other than that, it's been very good.

Speaker 9

Great. Thanks for taking my questions.

Operator

Thank you, Brian. We now have Rupert Merer with National Bank of Canada.

Speaker 10

Hi, good morning everyone. Thanks for taking the question. I'd like to start by following up on that last question. If you're looking to deploy capital from the sale of the ES business, what's your view on the optimal level of debt to the remaining company? Is it still the same?

Speaker 10

Is it mid-3s? Or if you have the option, could that go lower?

Speaker 1

I think when we ran our models internally with the sale, I think you would basically I mean, I think comfortably you'd move it to 3. And that's to get to IG, to make sure you're definitively square in the view of getting that sort of investment grade rating. I mean, if you're going to be that close, you might as well move to 3 and definitively get the IG rating. There's no reason to sort of teeter totter and trying to be cute with that number. So I think you would move that target leverage.

Speaker 1

You're going to move between 2.75 in sort of 3.25 for a period of time, but ultimately sort of target leverage would sit around 3 post the transaction.

Speaker 10

Okay, great. And then looking at M and A potential with any remaining proceeds, how do you see the relative price of assets in your pipeline today versus the price of your stock if you're looking at buybacks? And would the pipeline have any platform acquisition opportunities? Or do you think there's still plenty to do in tuck ins?

Speaker 1

So a couple of things in there. I mean, I think, again, from my perspective, to get an asset of this quality at this level to be again, going back to Luke's comments earlier when we talked about 25 and 26, the business is trading at sort of 12 times, 12.5 times today and you run that out to 26 times and you start in 12 to 14 months from now you're trading off of the 2026 number. This business is with EPR and RNG is trading somewhere around probably 10 times 2026 depending sort of how you model it. I mean, I don't think there's a higher and better use of capital than to buy back sort of our own stock at that level. That being said, that would be one that would be one use of capital.

Speaker 1

There is a significant amount of M and A in the markets where we already operate. I mean, again, we have a very large footprint, 10 provinces in Canada, 24, 25 states in the U. S, some high growth markets with a lot of opportunity. So again, we feel very comfortable that we can deploy that capital. And again, from a valuation perspective, again, it's hit and miss.

Speaker 1

I mean, there are some assets that are more expensive than others. But by and large valuations from our perspective, maybe they've ticked down a little bit because of the higher interest rates. But I would say that again from the competition for some of the medium sized assets, you have a little bit on the private equity side that compete with you. And as the leverage finance markets have come back even though rates are a little bit higher, this continues you can again, similar to the math I did earlier on the call, you can make the IRRs work if you believe in the sort of growth trajectory and the stability of the business. So I think nothing has really changed from a tuck in side.

Speaker 1

And again, there is a significant amount of M and A and white space within the existing footprint that we have.

Speaker 10

Great. Thanks for the color. We'll leave it there.

Speaker 1

Thank you.

Operator

Your next question comes from Tobey Sommer with Truist. You may proceed.

Speaker 6

Thanks. How has employee attrition training and safety expense trended year to date? Is there room for improvement from here? And is there a difference in trends if you look at the business geographically between Canada and the U. S?

Speaker 1

So I think there's a difference between secondary and urban markets. Secondary markets, again, employee turnover obviously significantly lower than the urban markets, which has been good. I think if you look at trailing 12 months as a business as a whole, like I said last year we were sort of we were trending sort of mid-20s. Today, we're just above 20. And we think that again goes back to sort of where we were pre COVID sort of in the high teens.

Speaker 1

So mid to high teens is what the goal is. And we are definitely on a trailing 12 month basis trending down. I mean turnover is down over sort of 4%, 4.5% over the last 12 months. So we are definitely heading in the right direction. And the opportunity is still great to continue moving again down sort of mid to high teens.

Speaker 6

Thanks. Could you discuss any cross selling or historical benefits that we should have in mind between solid waste and ES that you've generated with those businesses together that might not be a feature of the RemainCo?

Speaker 1

Yes. So I think if you look at it, I mean the model that had a solid weight need, right, not in the sort of reverse. So yes, there was cross selling opportunities, but the way it's structured today is you basically have a solid waste salesman and you have a liquid waste environmental services salesman, right, so or saleswoman. And I think when you look at that, we basically incorporated effectively a buddy buddy system. So in every region, each of the sales people on the respective sides of the business has a buddy buddy that can cross sell between the two lines.

Speaker 1

In a transaction, I think that is valuable to both companies. And my inclination today and sort of discussions with certain prospective buyers that would sort of stay in place. I don't we don't think that that would change in any material way because it's a benefit to sort of both companies. Today, they're getting 2 separate invoices regardless, one for each service. So again, that wouldn't be something we have to decouple.

Speaker 1

So from our perspective, I think that would be ongoing and it's beneficial to both of us.

Speaker 6

Thanks. Appreciate that.

Operator

Thank you, JB. And we now have Chris Murray from ATB Capital Markets.

Speaker 6

Yes. Thanks folks. Good morning.

Speaker 1

Maybe turning around to call it

Speaker 6

the more boring blocking and tackling stuff. We talked in previous calls about some of the margin enhancements and improvements and we touched a little bit on labor and turnover management. But just wondering how you're making progress on kind of core waste margins and some of the initiatives. I think we talked a little bit about rolling out things like tablets in the trucks some of the other pricing initiatives. Just wondering if there's any color on kind of the walk into higher margins as we go through the next few quarters?

Speaker 2

Yes. It's a great question. Something that as we look at the margin profile of what we're being able to deliver expansion year over year, it's very evident that these strategies we've been talking to are being sort of highly successful. And again, Chris, I think it's all of the above coming through in the beginning stages of what those ultimate run rates could be. I mean, you mentioned the tablets and the trucks.

Speaker 2

I mean, that is a new initiative for this year that's in the nascent stages. And yes, there's a little bit of modest contribution, but nothing compared to once that's fully ramped with the implementation completed towards end of Q4 into Q1 of next year. And so that's going to be another lever that's going to be sort of additive. We talked about the RNG, and this year we have a very modest amount of it. But as the full portfolio comes online, you think about the margin accretive nature of that is.

Speaker 2

EPR, you heard Patrick talking about we now have sort of roughly $130,000,000 of EPR contracts in hand. You're going to have, I think we said $5,000,000 to $10,000,000 of contribution in this year, but then that ramps up through $25,000,000 and $26,000,000 and recall that's all accretive margins, which unto itself is going to take our Canadian solid waste margin up to low 30s and be accretive to both the consolidated solid margins and the consolidated business as a whole. Continuing with the benefits and the rollover of now this exiting of the Michigan portfolio contracts, there'll be rollover effect into next year. And you have really all of these pieces coming together. I mean as we start talking with the next layer down of CNG conversion, improved asset utilization from routing technologies, This is the sort of next leg up that we anticipate being able to see.

Speaker 2

And Chris, what I'd say is, we're actively engaged over on this side, looking and figuring out how to prioritize all of these value add levers in front of us. And we hope to do as an Investor Day later this year, tee this all up and articulate what the next couple of years could look like. But as you heard it from Patrick, I mean there's a lot of focus on 2024. But from our perspective, I think we're sort of missing the forest for the trees when you think about what this looks like in sort of 'twenty 6 and beyond. And so we do look forward at our Investor Day at the end of the year sort of to piece out and quantify what all those buckets could be.

Speaker 6

Okay, great. Along those lines though, the other question, just in terms of being able to receive things like new vehicles, technology, things like that. I know there's been some supply chain issues and but it seems like a lot of stuff is starting to feel better. How are you finding kind of things like truck supply, things like that in terms of your ability to get kind of newer trucks into the system, help you avoid some maintenance costs, things like that?

Speaker 1

Yes. So we were shooting at around 70% of what we wanted. If you go back sort of a year and a half, 2 years ago, I think that's trended sort of like 85% to 90%. And I think we could be 100% of where we want to be absent again some of these big new EPR contracts that we'd have to reallocate units coming off the floor to these because of the contract start date of those. But I think, yes, the logjam has definitely subsided and we're moving to a point now where we can get exactly what we want.

Speaker 6

Okay. Good. And then one quick one just to clean up. Just in terms of the EES business, is there any back office systems or anything? I know Patrick you talked about sort of the sales front end.

Speaker 6

But is there any back office or common areas that you'd have to split up or anything that would make a kind of a sale complicated from an operation perspective?

Speaker 1

Not really. Obviously, there's a little bit in treasury and there's definitely a little bit in HR or the 2 big sort of overlaps. But by and large, it's very it will be one of the simpler things we've done in our history. So again, nothing that would be an impediment to making it happen.

Speaker 2

Chris, the divestitures we did last year were more sort of inextricably linked with the business than ES would be. Just as a point of reference, this would be a cleaner sort of extraction than that was.

Speaker 6

All right. Okay, folks. I'll leave it there. Thank you.

Speaker 2

Thank you.

Operator

Thank you, Chris. I would now like to hand it back to Patrick for some final remarks.

Speaker 1

Thank you, everyone, for joining us this morning, and we look forward to speaking to you after Q3. Thank you very much.

Operator

Thank you all for joining the GFL Second Quarter 2024 Earnings Call. Please enjoy the rest of your day and you may now disconnect from the call.

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Earnings Conference Call
GFL Environmental Q2 2024
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