Adam Redling
Michael Hoffman is the managing director of St. Louis-based Stifel. For more than three decades, Hoffman has been an analyst specializing in the waste and environmental services sector.
In anticipation of Waste Today’s upcoming Corporate Growth Conference, Hoffman talked with the publication about the strength of the industry, merger and acquisition (M&A) trends and what operators can expect over the next several years.
Waste Today (WT): How would you categorize M&A activity in the waste sector?
Michael Hoffman (MH): I’ve been doing this for 32 years, and the garbage industry has been in a constant state of consolidation for all of that. How I describe what’s happening currently is the pace at which the seller is getting to “yes” is meaningfully faster than it has been for all of the prior 21st century. From 2000-16, M&A activity was happening at pretty consistent pace, and then in 2017 until now, the pace just accelerated. And I think this is because of a combination of several things—not the least of which is the business cycle that we’ve seen.
In 2009-10, we saw a significant volume decline because of the economy. Then it was slightly negative or neutral for a couple years. In 2013, housing starts began to show signs of life, and in 2014, the economy was back. So, if you’re a waste business sitting there in 2014, and you’re looking out eight or 10 years thinking you’re going to be a seller, you expect a recession some time in the middle of that window, so that by the time the recession is over, there will be an upswing in numbers and it’ll be the perfect time to sell. But now, it’s five years later, and we haven’t had that recession, and you’re sitting here thinking we’re probably due for a downturn, and you might miss your window of good margins, good profitability, good multiples, etc. That’s why I think sellers have been pulling these deals forward in order to get them done faster.
That’s the big reason I think M&A activity has accelerated in recent years. I also think it’s because most businesses selling aren’t C Corps, they are S Corps or LLCs, and didn’t benefit from a permanent change to the tax rules. The greater probability for them is tax rates are probably going to go up, so it makes it an attractive time to sell.
WT: generally, how would you gauge the strength of the solid and industrial waste sectors?
MH: The state of garbage is very good. Fundamentals are the best I’ve seen in my whole career. We have broad-based pricing leverage. You have very good operating discipline around asset utilization, and companies are very focused on cost controls. So, in the solid waste industry, things couldn’t be better.
Industrial waste is in its third year of an economic recovery coinciding with that of the industrial economy. That economy is slowing, but it’s still growing, and companies in the sector are starting to see the benefits of what happens by the time you get to the third year of growth in an economic cycle—you start to see some of that discretionary project work come online, and you’re seeing real price volume and average selling price rise.
WT: With pessimism over the economic viability of recycling, how do you see it trending?
MH: The short answer is we’re still facing depressed commodity values, but I would say what we’re seeing lately has nothing to do with China and everything to do with a slowing overall economy and an oversupply of paper, broadly. Recycled commodities are getting swept up in these trends. What needs to happen now related to commodity value is the paper-making industry has to rationalize supply. And as they do that, we’ll start to correct some of this imbalance, and you’ll see a recovery of pricing. I’m not suggesting prices will go back to a high—they will just be higher on the low end of the spectrum. But from a business standpoint, this is the second full year where we’ve seen an aggressive push to change the business model. There is absolutely a clear sign that the service side of the industry is having a huge impact on this.
The most telling example would be what we saw recently in the city of Boston. The city went out to market looking for bids while insisting on a traditional commodity-based pricing model for their recycling services. All the waste management companies participating in that process, including the incumbent handling disposal in the city, raised their hands and said, “If you insist on a commodity-based pricing model, we won’t bid.” Nobody did, which was wise. Gradually, all these contracts will move away from a commodity-based model to a process-fee model because the industry doesn’t have any business taking that kind of commodity exposure.
WT: How concerned should waste companies be over talk of a pending recession?
MH: The consumer engagement that exists in the U.S. economy today—which is a consumer-driven economy—remains stable, healthy, and people are engaged. The data around the consumer market is good, they’re not over-levered, and there is real wage inflation despite what you may hear in the media. We’re at full employment in the U.S. If you ask any business, they’ll tell you wages are going up 4-6 percent, and underlying inflation is running at about 1.5 percent, so there’s real wage growth going on, and it shows.
As it pertains to looking at the next cycle, you can just look at the garbage business, which is as well-run as any. Waste companies have gobs of data, they have tremendous insight on pressure points of the business world, and the one thing they get every single day they choose is confirmation of consumer activity, because 100 percent of the trash that is collected goes across the scale. The reality is waste companies are not seeing changes in scale reports. The next recession we’re going to have is going to be consumer-led. So, if garbage companies look at scale reports on clustered commercial collection—that’s pertaining to things relative to discretionary commercial events, for instance, people who are spending on entertainment of some sort—you’re not seeing any reduction in volume. There’s no recession coming based on that data.
WT: What trends do you expect to see in waste over the next 12-24 months?
MH: Fundamentally, I think the messaging will be centered on more of the same. You’ll see the organic growth combination of price and volume settle into a 3 to 5 percent range fairly consistently.
With acquisitions, we’ll still run at 2 to 4 percent, and so these companies are going to be growing in the upper single digits to possibly low double digits on the top line. That’ll translate through. There’ll be scale related to income statements, cashflow statements and to both profit and cash. From a consolidation standpoint, there’s likely to be a greater probability somebody will come to the market and access capital markets and become public versus another big round of consolidation once the Advanced Disposal deal gets done with Waste Management. I would say within another five years, you could see another round of activity with some of the bigger pieces potentially moving.
