Ladies and gentlemen, thank you for standing by. Welcome to the Waste Connections 4th Quarter 2018 Earnings Conference Call. During the presentation, all participants will be in a listen only mode. Afterwards, we will conduct a question and answer session. As a reminder, this conference is being recorded Thursday, February 14, 2019.
I would now like to turn the conference over to Worthing Jackman, President of Waste Connections. Please go ahead, sir.
Okay. Thank you, operator, and good morning. I like to welcome everyone to this conference call to discuss our Q4 2018 results and provide a detailed outlook for both the Q1 and full year 2019. I'm joined this morning by Mary Anne Whitney, our CFO and several other members of our senior management team. Unfortunately, Ron Mittelstaedt, our CEO and Chairman of the Board is unable to participate on this morning's call due to an immediate family member's medical matter.
Ron appreciates everyone's concerns and sends his best. As noted in our earnings release, 2018 finished on a high note, as financial results for the Q4 exceeded expectations on better than expected solid waste organic growth, E and P waste activity and acquisition contribution. We are also extremely pleased with our results for the full year as adjusted EBITDA as a percentage of revenue expanded 30 basis points and adjusted free cash flow increased 15.2%. Increases in both solid waste pricing growth, which was up 130 basis points year over year to 4.5% and E and P waste activity enabled us to overcome the precipitous decline in recycled commodity values and certain cost pressures during the year. The strength of these results continues to reflect the benefits of our purposeful culture, differentiated strategy and disciplined execution.
2018 was also noteworthy for the continuing elevated pace of acquisition activity. Our acquisition of American Disposal in the 4th quarter for total annualized acquired revenue to more than $360,000,000 for the year with rollover revenue contribution of approximately $200,000,000 in 2019. Along with continued strong pricing growth, this already positions us for high single digit revenue growth and another 30 basis points adjusted EBITDA margin expansion in 2019 with any growth in solid waste volumes, E and P waste activity or additional acquisitions providing further upside. We have increased adjusted free cash flow per share at a compounded rate of more than 15% per year over the past several years and expect continuing double digit adjusted free cash flow per share growth in the upcoming year. Our strong financial profile continues to afford the flexibility to fund outsized acquisition activity and increasing cash dividend and opportunistic share repurchases.
Before we get into much more detail, let me turn the call over to Mary Anne for our forward looking disclaimer and other housekeeping items.
Thank you, Worthing, and good morning. The discussion during today's call includes forward looking statements made pursuant to the Safe Harbor provisions of the U. S. Private Securities Litigation Reform Act of 1995, including forward looking information within the meaning of applicable Canadian securities laws. Actual results could differ materially from those made in such forward looking statements due to various risks and uncertainties.
Factors that could cause actual results to differ are discussed both in the cautionary statement on Page 3 of our February 13 earnings release and in greater detail in Waste Connections' filings with the U. S. Securities and Exchange Commission and the Securities Commissions or similar regulatory authorities in Canada. You should not place undue reliance on forward looking statements and information as there may be additional risks of which we are not presently aware or that we currently believe are immaterial, which could have an adverse impact on our business. We make no commitment to revise or update any forward looking statements in order to reflect events or circumstances that may change after today's date.
On the call, we will discuss non GAAP measures such as adjusted EBITDA, adjusted net income attributable to Waste Connections on both a dollar basis and per diluted share and adjusted free cash flow. Please refer to our earnings releases for a reconciliation of such non GAAP measures to the most comparable GAAP measure. Management uses certain non GAAP measures to evaluate and monitor the ongoing financial performance of our operations. Other companies may calculate these non GAAP measures differently. I will now turn the call back over to Worthing.
Thank you, Mary Anne. In the Q4, solid waste price plus volume growth was 4.9%, exceeding the high end of our outlook for the period by almost 100 basis points and volumes turned positive for the first time in 2018. In the Q4, solid waste pricing growth was our highest reported price in a decade at 4.8%, up 30 basis points sequentially and up 120 basis points year over year. As noted in prior quarters, our pricing strength reflects the differentiation of our market model and intense focus on execution as we implemented and more importantly retained additional price increases during 2018 to address recycling headwinds and certain cost pressures including third party logistics and fuel. Once again in Q4, our pricing range from approximately 3% in our more exclusive markets in the Western region to an average of about 5.5% in our more competitive regions.
Reported volume growth in Q4 turned positive for the first time since we began intentional shedding of lower quality revenue and unsafe to service accounts acquired in the Progressive Waste transaction. Volumes were up 10 basis points and well above the high end of our expected range for the period. We continue to believe it prudent to be cautious on volume growth in this environment with anything positive being upside. Looking across our regions, volumes were driven most notably by our Western region, which was up over 3% in the quarter, while Canada and our Southern region, though showing some improvement sequentially, were both down year over year between 0.5% and 1.5% as we continue to anniversary the mostly completed intentional shedding in those regions. Looking at 2019, we expect pricing growth to continue to average about 4.5%, likely starting higher than that on a reported basis early in the year, and we expect reported volumes to be down about 50 basis points due to the remaining purposeful shedding of poor quality revenue, with underlying volumes about flat year over year.
We believe that our 2018 results are indicative of the effectiveness of a price led organic growth strategy and as noted earlier, we will continue to view any increases in underlying volumes as upside. Looking at year over year results in the Q4 by line of business on a same store basis, commercial collection revenue increased approximately 6.5% mostly due to price increases. Roll off revenue increased approximately 3.5% on higher revenue per pull. In the U. S, pulls per day decreased about 1% and revenue per pull was up 3%.
In Canada, pulls per day decreased about 1.5% and revenue per pull increased about 7.5%. Solid waste landfill tonnage increased about 1% on increases in MSW tons, up about 3% led by increases in the Northeast and California and C and D tons, up about 4% on increases across several markets led by the Northeast and Texas. Special waste tons were down about 4% in Q4, a smaller year over year decrease than in prior quarters as tough comps began to ease a bit. Recycling revenue excluding acquisitions was about $20,000,000 in the 4th quarter, down $8,000,000 or almost 30%, the smallest year over year decrease in 2018 due to easier comparisons on prices for OCC or old corrugated containers and a slight increase sequentially. OCC prices in Q4 averaged about $93 per ton, which was down 23% from the year ago period and up 6% sequentially from Q3, fixed paper revenue ex acquisitions declined approximately 45% year over year as values remain between $0 $5 per ton.
We believe that the flow through from changes in recycling revenue was similar to prior quarters with decremental margins of approximately 95% due to the combination of lower fiber values and higher recycling processing costs resulting in an impact of about $7,500,000 in EBITDA and about $0.02 per share of EPS in Q4. OCC prices currently average about $85 per ton reflecting some recent weakness. This is down about 10% from Q4 and down about 15% from last year's average of $102 in the Q1. We expect recycled commodity values to remain around these levels for the full year. Looking at E and P waste activity, we reported $64,000,000 of E and P waste revenue in the 4th quarter, up 20% year over year and down slightly sequentially from Q3, reflecting a lower seasonal decline than typically seen.
We have not experienced a notable impact in activity levels resulting from weakening crude prices in late 2018. That said, we remain cautious in our outlook for E and P waste activity and will let any increases in activity or ramping of newly constructed locations be upside in the year. Looking at acquisition activity, as noted earlier, we closed the previously announced acquisition of American Disposal in December, which along with other acquisitions completed earlier in 2018 provides rollover acquisition contribution of about $200,000,000 in 20 19. Coming off of 2 years of outsized activity during which we essentially completed 4 years worth of acquisitions, we continue to believe that the factors that were viewed favorably by sellers are still relevant. That is sellers continue to note the strength of their underlying businesses, the clarity around taxes as a result of tax reform and higher reinvestment rates as drivers for transactions.
Dialogue remains active and the pipeline continues to be robust. In short, we believe 2019 could be another year of outsized acquisition activity. In 2018, we deployed over $1,000,000,000 in acquisitions and returned over $210,000,000 to shareholders, including opportunistically buying back stock during December sell off, and we remain well positioned for potential continued outsized capital deployment in the upcoming year. Now I'd like to pass the call to Mary Anne to review more in-depth the financial highlights of the Q4 and provide a detailed outlook for Q1 and full year 2019. I'll then wrap up before heading into Q and A.
Thank you, Worthing. In the 4th quarter revenue was 1.26 $1,000,000 over the prior year period and about $37,000,000 above our outlook due to higher organic growth in solid waste and E and P waste as well as contribution from closing the American Disposal acquisition in December. In total, acquisitions completed since the year ago period contributed about 66 $500,000 of revenue in the quarter or about $61,400,000 net of divestitures. Adjusted EBITDA for Q4 as reconciled in our earnings release was $397,200,000 about $11,200,000 above our outlook for the period on higher than expected revenue and up over $36,000,000 year over year despite an estimated hit to EBITDA from recycled commodities of approximately $7,500,000 Adjusted EBITDA as a percentage of revenue was 31.5% in Q4 in line with our outlook and up 30 basis points year over year. Excluding the margin dilutive impact of acquisitions contributing in the period, adjusted EBITDA margins were up about 80 basis points in Q4 despite the impact of lower recycled commodity values.
Looking at the full year, EBITDA margins were up 30 basis points on the strength of price led organic growth and E and P waste activity in spite of the 70 basis point impact from recycling. Fuel expense in Q4 was about 3.7% of revenue, up 10 basis points year over year. We averaged approximately $2.65 per gallon per diesel in the quarter, which was up about 0 point $4 from the year ago period and down about $0.07 sequentially from Q3. Depreciation and amortization expense for the Q4 was 14% of revenue, up 10 basis points year over year due to increased depreciation and expense from acquisitions closed since the year ago period. Interest expense in the quarter increased by $2,700,000 over the prior year period to $35,200,000 due primarily to higher total borrowings as compared to the prior year period.
However, this increase was partially offset by $1,500,000 in higher interest earnings from invested cash balances. Net of interest earnings, interest expense in the period was $31,700,000 up $1,200,000 year over year. Debt outstanding at quarter end was about $4,200,000,000 approximately 23% of which was floating rates and our leverage ratio as defined in our credit agreement ended the year at 2.45 times debt to EBITDA with cash balances of almost $320,000,000 Our effective tax rate for the 4th quarter was 20.3 percent slightly lower than expected. GAAP and adjusted net income per diluted share in Q4 were 0 point net income in Q4 primarily excludes the impact of intangibles amortization and other acquisition related items and impairments. As noted earlier, the impact to our adjusted net income per diluted share from recycling was a drag of about $0.02 in Q4.
Adjusted free cash flow in 2018 was $879,900,000 or 17.9 percent of revenue and approximately $20,000,000 higher than expected than anticipated due to better than expected collection activity on the final day of the year, essentially pulling some 2019 cash flow into 2018. I will now review our outlook for the Q1 and full year 2019. Before I do, we'd like to remind everyone once again that actual results may vary significantly based on risks and uncertainties outlined in our Safe Harbor statements and filings we've made with the SEC and the Securities Commissions or similar regulatory authorities in Canada. We encourage investors to review these factors carefully. Our outlook assumes no change in the current economic and operating environment.
It also excludes any impact from additional acquisitions or divestitures that may close during the remainder of the year and expensing of transaction related items during the period. Looking first at the full year 2019, revenue in 2019 is estimated to be approximately $5,310,000,000 dollars For solid waste, we expect organic growth of approximately 4.5% with volumes down about 50 basis points due to the remaining shedding of poor quality revenue, primarily the impact of the New York City Department of Sanitation Marine Terminals Operations contract with a third party. Underlying volumes are expected to be essentially flat. Adjusted EBITDA in 2019 as reconciled in our earnings release is expected to be approximately $1,705,000,000 or about 32.1 percent of revenue, up about 30 basis points year over year in spite of over 30 basis points of dilutive margin impact from approximately $200,000,000 in rollover acquisition already in place for the year. Regarding tax rates, we noted in our earnings release that late in December 2018 the IRS released proposed regulations associated with the Tax Act that we believe if finalized could impact our current effective tax rate of 21.5%.
Depending on the final form of any proposed regulations, we estimate that our resulting effective tax rate for 2019 could range between 21.5 percent 26.5 percent. The proposed rigs are not anticipated to be finalized until June or thereabouts if they do indeed get approved at final and that timing will impact our effective tax rate from quarter to quarter during the year. For example, our 1st quarter tax rate in 2019 is not expected to be impacted from these proposed regs and should be about 20% in the period. Excluding these proposed regs, our effective rate for Q2 through Q4 would average about 22% for a full year effective rate of 21.5%. However, for the full year, our outlook assumes that some form of the proposed regs is enacted and reflects the midpoint of our expected range or a 24% effective tax rate.
Adjusted free cash flow in 2019 as reconciled in our earnings release is expected to be approximately $950,000,000 or about 17.9 percent of revenue. To be clear, the potential tax rate impact from proposed regulations as noted earlier has already been considered in our guidance for adjusted free cash flow. Turning now to our outlook for Q1, 2019. Revenue in Q1 is estimated to be approximately 1 point $24,000,000,000 We expect price growth for solid waste to be in the range of 4.5% to 5% in Q1 with volume of approximately negative 1%, about half of which is due to the purposeful shedding including the impact of the New York City Department of Sanitation's marine terminals operation contract and additional impact from severe winter weather conditions. Adjusted EBITDA in Q1 is estimated to be approximately 30.9 percent of revenue or about $383,000,000 down forty basis points year over year, but up 25 basis points when adjusted for the 65 basis point margin dilutive impact of acquisitions.
This impact is most pronounced in Q1 due to the timing of deals in 2018. Depreciation and amortization expense for the Q1 is estimated to be about 14.1 percent of revenue. Of that amount, amortization of intangibles in the quarter is estimated to be about $30,600,000 or $0.08 per diluted share net of taxes. Interest expense net of interest income in Q1 is estimated to be approximately 35,000,000 dollars Our effective tax rate in Q1 as noted earlier is estimated to be about 20% subject to some variability. The effective rate for the period includes about a $4,000,000 benefit to the provision related to excess tax benefits associated with equity based compensation.
And finally, non controlling interest is expected to reduce net income by about $200,000 in the Q1. And now let me turn the call back over to Worthing for some final remarks before Q and A.
Okay. Thank you, Mary Anne. 2018 was truly remarkable year considering the challenges that we overcame and the results we delivered to drive our 15th consecutive year of positive shareholder returns. Completing another outsized year of acquisitions, overcoming the headwinds of recycling, certain cost pressures and lower margin acquisitions to drive reported margin expansion and further reducing the frequency of safety related incidents will be noteworthy in any environment, but even more so when facing the constraints of low unemployment in many markets. These accomplishments would not have been possible without the tireless efforts of our over 16,000 dedicated employees.
At Waste Connections, we believe that accountability is integral to everything we accomplish and is ultimately what sets us apart. Given the headwinds that we were able to overcome in 2018, we appreciate the greater visibility we have coming into 2019 with high single digit revenue growth already in place, continuing adjusted EBITDA margin expansion another year of targeted double digit adjusted free cash flow per share growth. And again, any increases in solid waste volumes, E and P waste activity or additional acquisitions would provide further upside. We appreciate your time today and we'll now turn this call over to the operator to open up the lines for your
Our first question comes from the line of Brian Maguire with Goldman Sachs. Please proceed with your question.
Hey, good morning Worthing and Marianne and Ron, if you're listening, hope all is well. Hope to hear some good news. Guys, just trying to put aside the quarter and the outlook, just kind of a bigger picture question for you to start off. It seems like consumer sentiment and mood around single use plastics, single use consumable items has been shifting a lot in the last year or so. In Europe, it certainly has moved a lot of our packaging companies are seeing the impact of that.
And you guys seem to be sort of part of the solution potentially with your recycling operations. There's been sort of a push to increase recyclability of single use items. But obviously, the economics of that aren't really great, especially these days. But potentially, this could morph into more than just a war on plastics, could become more of a war on waste. And just thinking about how do you guys really think about that impacting your business over the longer term?
Obviously, not something that probably is going to impact 2019 or maybe even 2020. But do you expect that we'll see tighter regulation on landfill expansions? Or could states and municipalities sort of view expansion of landfills as encouraging more waste? Any efforts you guys can do to increase the recyclability of items or are we really just dependent on getting some government help for things like that?
Well Brian, you stopped your year count at 2020 and I suggest you probably have to go well beyond 2020 before you'd see any impact notable within our business. I mean clearly bifurcation and separation of the waste stream at the source is a growing trend. Obviously, we applaud that because it helps the purity of what's going through our facilities. I mean obviously what folks are also realizing when you try to do increased source separation to improve recycling and recovery is that cost more money. And so you do have this intersection of desires to recycle, maybe reuse, intersecting with the likely increase in cost to do so.
But I'd say in the near term, which Easley is looking at over the next decade or more, I don't think you'd see a notable impact in anything within our business. Now are we always looking at new technologies to improve our processing capabilities within our facilities? Absolutely, but that's evolutionary. It's not revolutionary.
Okay. Appreciate the color. Just switching gears then, Worthen, your comments on the M and A environment, certainly encouraging. I guess, you obviously mentioned you've done a lot of deals over the last 2 years. Just wondering how you would balance the need to integrate those deals effectively and the risk involved with that versus the opportunities that you've got in front of them?
And you think 2019 is going to be more of a year of just integrating what you've already done and digesting it? Or could this be another front forward year where we see something similar to what we saw in 2018?
Well, obviously, it's hard to predict the ultimate amount we do in 2019, but I back up your first question around integration. These are some gold plated companies that were acquired in 2018 with fantastic management teams. In fact, if you start with the biggest transactions and work your way down from the bigger transactions, the existing teams that were running the businesses have stayed with the businesses. And so it's required very few heads on our side to relocate into these operations. And so it's not stressed our bench at all.
What I'd say on how are they doing, I'd look no further than the initial company we purchased in 2018 Bay Disposal. And you look at the integration of Bay Disposal and the adoption of our culture, Beta disposal led our company last year in an incident reduction down almost 70% and exiting the year with a single eye rate moving forward. Again, so I think we don't wait, sit around and hope integration happens. I think the team hops on that early on. I think the support that we give acquired companies is second to none.
It's not like we buy a business and all of a sudden start believing that we can jam them with emails and jam them a request. What we do is we flood them with people to support and grow and develop the business and integrate the business immediately, not the other way around. So I'd say the success in 2018 and the amount of activity done in the past 2 years is no way precluding us from what we could do in 'nineteen. And again, we remain well positioned should 'nineteen become another outsized year.
Okay, great to hear. I'll turn it over now. Thanks.
Thank you. Our next question comes from the line of Hamzah Mazari with Macquarie Capital. Please proceed with your question.
Good morning. Thank you. My question is on M and A as well. Could you maybe talk about how you're managing to keep returns on capital on these deals similar to what you've done historically, just given valuations have stepped up in the private market. So any thoughts on returns on deals?
Sure. And as we've said before in prior calls, clearly multiples have gone up a half a turn to a turn or so over the past couple of years, but that's a combination of things. I mean initially it was combination of very high quality companies we're buying with high quality assets, meaning companies that had over invested in years up to sale. And obviously that means if you're looking at returns on a cash on cash basis, those returns benefit from lower CapEx required early on after acquiring the business. By the way, the inverse happens too and we take that out in valuations if someone's under invested and we think we have to over invest post closing.
So that's what initially drove it a couple of years ago. Obviously, the change in tax law with regards to lower tax rates in the U. S. And immediate expensing of acquired capital based on how the deals are structured. That also accelerates obviously cash flow and lower tax rate puts more cash flow in our pocket too.
And so we haven't seen a major change in targeted IRRs. It's just the fact that the other changes that affect how we deduct our purchase price, how we can accelerate cash flow delivery as well as the quality of the assets also drives those returns.
Great. And just a follow-up question. On the volume side, is your commentary just incrementally more cautious or is it just conservatism? I guess underlying volumes are flat, but it feels like the U. S.
Consumer is still pretty strong, the job market is strong, GDP is up. So just any disconnect in sort of your volume commentary? Is it a comp issue or just any thoughts there?
No, I wouldn't say any disconnect or change in what we're seeing. I would start by reminding that we always come into every year pretty cautious after coming off. We had 5 years in a row of very strong volumes last year not on a reported basis because of the shedding, but continued strong underlying volumes as we've discussed in places like the West Coast, which we highlighted in Q4. The other thing I would note, Hamzah, is in the last two quarters, we've guided to volumes being down 50 to 100 basis points and we've beaten by on that by almost 100 basis points in both cases. So as we come into this year and we saw the weather in January and of course we have already described the purposeful shedding that we already know about that's hitting 2019.
We think it's prudent to guide to volumes being flat and letting volumes be upside. But to be clear, no change in what we're seeing out there.
Yes, Hamz, as we've been saying all along, we think the U. S. Economy generally is in that 1% to 2% range and the Canadian economy somewhere in that 0% to 1% change growth from on an underlying basis. And I'd also point out, I mean, you can slice and dice stuff as much as you want. You can say it tongue in cheek.
If you exclude all the negatives, volume is nicely positive. So I mean, you got to be careful about what you want to exclude and trying to lead a message, but think it's always better to be cautious and let volumes be upside.
Got you. Just last question, I'll turn it over. The proposed regs that are impacting taxes for you, sort
of
common for most companies? Thank you. Yes. Is this sort of common for most companies? Thank you.
So Hamzah, to answer your question about the proposed reg, they do include some potential limits on the deductibility of interest in the United States which could impact us if they get promulgated as proposed. And so that's why we mentioned them and think it's prudent in our guidance to include that midpoint of the range of where they could end up. But again to be clear nothing's happened yet and they won't impact Q1.
It affects all companies with cross border intercompany financings. Obviously, capital is flowing across countries. This could get caught in. So it's any company with multinational operations.
Got you. Thank you.
Thank you. Our next question comes from the line of Tyler Brown with Raymond James. Please proceed with your question.
Hey, good morning guys.
Hey, good morning, Tyler.
Hey, our thoughts go out to Ron. But hey, Mary Anne, I appreciate the Q1 guide. Sorry, excuse me. But could you guys put a finer point on the progression of the change in EBITDA margins as the year progresses? It sounds like you're going to be most burdened with the rollover of M and A early in the year and then that abates as the year progresses.
Is that the right way to think about it?
That is Tyler. Yes, as I said it's over 30 basis points for the full year and the cadence would be as follows. It's about a 65 basis point margin dilutive impact in Q1 and that increase decreases to about 40 basis points in Q2, steps down to about 20 in Q3 and mostly gone by Q4, but about 10 basis points in Q4. So that overall that works out to be between 30 35 basis points for the year.
Okay. Very helpful. And then Mary Anne, I know this is very fluid, but what is your expectation for cash taxes as a percent of that 24% book accrual?
Yes. So the expectation for cash taxes as a percentage of book is about between 60% 65%.
Okay.
And does that change as time goes on? Will that go higher?
As we said, to be clear, our $950,000,000 in free cash flow guidance already incorporates a consideration for our expectations around taxes.
So obviously it does. If you go all the way out to 2023 when loan depreciation expires, obviously you start at 60%, 65%, starts migrating above 85%, 90%, especially when you intersect into 2023 when most of your CapEx outlays over the prior 5 years have been fully expensed.
Okay. And then Worthing, this is a conceptual question, but you guys are guiding to say 60 basis points of core solid waste margins on a very healthy 4.5% price. Your larger competitors are guiding to give or take, say, 30 basis points of margin expansion with 2% to high 2% pricing. So where do you think the disconnect is? Is it that you are being conservative or do you have some sort of differing unit cost inflation set up?
Am I reading too much into this or just any thoughts broadly there?
Well, look, I don't know what's driving the outlook of other companies in the space. All we can address is how we look at things. Look, if just look at our experience quarter in and quarter out or year in and year out, we try to put numbers out there in February that provide enough cushion as we look at the entire year for the proverbial unknowns that can hit you. And obviously, if we're able to dodge more of those unknowns, you'll see nice upside to our outlook. Putting numbers out there and then re crafting the truth as you move through the year to try to reinterpret people's perceptions.
It's not what we try to do during the year. We just lay it all out there and let our numbers speak for themselves.
Okay. That's helpful. And then just one last one. Mary Anne,
I think you mentioned 2 spot 4, 5 debt to EBITDA today. Curious, can you talk about what you view as your optimal capital structure? Where do you kind of want that leverage ratio long term? Thanks.
Sure. We're certainly very comfortable being higher than that and sort of in the 2.75% range we think is a good place to be because what we know is that we could then with the ability to take leverage up to 3.5 times or even higher for an outsized deal to the extent that opportunity were to present itself. But what we know is we'll delever dynamically about half a turn within a year and we like staying in that 2.75 to 3 times range.
All right guys. Thank you very much.
Thank you. Our next question comes from the line of Derek Spronck with RBC. Please proceed with your question.
Good morning Worthing and Mary Anne. Thank you for taking my questions. Just on the proposed changes, tax changes, should we assume that the cash flow impact would be the differential of the effective tax rate of 24% from 21.5%?
Well, as I said, Derek, we think of it more that this impacts GAAP and really is less a matter of cash. And that's why we tried to give you free cash flow guidance that says, look, don't worry about that. We've already factored that in. It's really a GAAP issue.
So technically, there wouldn't be much of a if the regulation didn't come through, there wouldn't be much of a free cash flow tailwind. Is that correct?
Yes. As you know, we try to come into the year with some visibility on what we think we can deliver and that's how we factored in the $950,000,000 So at this point, we'd leave it at that. And I think what's helpful is we'll know more in April when we're on this call and we'll be able to give clearer guidance.
Okay, great. Remember we apologize for over delivering in 2018. So let's don't start raising $950,000 on us right now.
Okay. That's the opposite of what I usually do is over promise, under deliver. But just moving on to some of the items in the 10 ks, you have 14 landfills that you're seeking expansion and it also indicated around 10% of your workforce is going through or will be going through a collective bargaining agreement in 2019. Is this just a standard business for Waste Connections? Or is there any risk that could be tied with those 2
developments?
No, I'd say pull out all the prior case and you'll see similar ratios. This is just standard fare of solid waste business. When you have a large portfolio of landfills, every company is going through episodic expansions. That's common. Obviously, when you have a large workforce and multiple underlying contracts with unions, we're negotiating those all the time.
We just got a couple finished earlier this year already. And so that's just part of the day to day blocking and tackling.
And I would
just add, Derek, that a number of the landfills with the shorter lives are very small. And probably one of the largest is one that's been on there literally for years where we have another landfill right in the same market,
originally it was originally it was around 15%, but it was a sustainable run rate. 2017 was 16.5%, 2018, 18%. It looks like 2019 is shaping up to be in and around 18%. Is that largely from the changes in the cash tax regime? Or is it partly due to the you leveraging economies of scale?
Or how should we think about that ratio on a sustainable basis here?
Well, we've always said, don't own us for 55 percent EBITDA to free cash flow conversion. That will be coming down over time. It will probably go the low 50s not the mid 50s. And so we fully expect that to come down over time. Obviously, as we talked before, as cash taxes go up as bonus depreciation expires in 2022.
And so that will always move down over the course of time. But as we sit here today, we don't see anything lowering that bringing that below 50% anywhere anytime soon. But again, as you know, as we've always said, as you look at EBITDA to free cash flow conversion, we always say that not only EBITDA creates the same amount of free cash flow. That's a combination of obviously the financial profile and the performance we have on our collection side of the business, which again is 60 plus percent of revenue. It's a combination of and that's lower asset intensive business.
It's a combination of how we structure acquisitions and looking for our basis and transactions and that impacts cash taxes. So there are a host of things that drive comparisons against other companies. But again, for us, 55% don't model that long term. We've been consistently saying that for some time now. We'll enjoy 55% we can do it, but that's not a long term number.
We have pretty good visibility though at the 2020 though that should be in and around that level, is that correct?
Yes, we try to have visibility beyond that.
Okay. Thank
you very much. I'll leave it there.
Thank you. Our next question comes from the line of Noah Kaye with Oppenheimer. Please proceed with your question.
Hi, good morning. First, just a quick math question on the recycling. So assuming the basket is down 15% year over year and that sort of decrementals continue, this is about a $10,000,000 to $15,000,000 EBITDA headwind for 2019, is that right?
No, I mean that's mostly a Q1 thing we're talking about here because Q1 was the toughest comp year over year. Once you get past Q1, it's nominal.
Okay. So the full year headwind,
we're talking about double digits? Couple of 1000000. Okay.
Okay. And then just to piggyback off of earlier cash tax question. So essentially you had a very low accrual in 2018. You go into 2019 and basically you're looking at cash taxes at about a $70,000,000 or so headwind year over year. So essentially what I read into this is that underlying free cash flow growth is in the double digits.
Is that a fair statement?
Again, we did point out that we essentially over delivered in 2018. And so I do think if you back that out, you do see nice underlying growth beyond what we're showing here. So yes, you're right. We had the big over accrual coming into 2018. And so on a reported basis, our cash taxes will be up about $75,000,000 year over year and we'll continue to deliver free cash flow.
So that is fair.
Okay, great. And then maybe one last one. I walked past Waste Connections hauling truck this morning in New York City. And after reading a lot of press around plans for New York City to move towards commercial zone franchising and the experience that LA has had so far. I guess generally do you see this as a medium term trend in more of your urban markets?
And if so, how positive or negative do you think it is for Waste Connections?
No, we don't see this as a trend. I mean, LA was late to the party relative to most markets in the West Coast. New York City, it's just something that makes sense in that tight operating environment. Dozens of trucks shouldn't be crisscrossing each other on crowded streets at all times of the day. And the risk profile is just too high for many operators.
The quality of the equipment that they can pick on the street is very low because of the financial positions they're in. And so it makes sense in New York to follow on the heels of LA. Now how New York structures it in the end still remains to be seen, but we don't see this as a trend in other markets.
Okay. Thanks very much.
Thank you. Our next question comes from the line of Michael Hoffman with Stifel. Please proceed with your question.
Hi, Worthing, Mary Anne. Thanks for taking my questions. If you do no deals in 'nineteen, can we continue to think about the structural organic growth of solid waste is in between 4% 5%?
Yes, we've been consistently saying it's between a 4% 6% number, especially with this CPI and this pricing environment being 4.5% plus.
Okay. And then again no deals in 2019, how long does it take to recover that 30, 35 basis points of 'nineteen's dilution from deals?
Recover, again, what you have is the acquisitions would then be embedded in the base calculation. And so then you're looking at a jumping off point, again, up 30 basis points year over year coming out of 'nineteen. Then obviously, if you don't have the rollover of any dilutive transactions in the year, Again, you're looking at that typical 30 to 40 basis point type margin expansion in 2020, albeit let's wait and see how the economy is. But no, again, when you've got the such a large denominator right now, it's rare that acquisitions move the needle on a notable basis. But when you have a deal as large as American at 3.5 percent of revenue coming in at comparative margins down 6 100 basis points because it's collection oriented, that's about a 20 basis point impact to consolidated margins.
But again, if it depends on the size of the year for acquisitions, obviously, if you do no deals, which we've never done, then you don't have that influence on the reported margins going forward. As Mary Anne said, as you begin to anniversary the deals we did last year, you see less and less of a drag in the reported numbers. And therefore, the printed margin expansion will be a lot higher as you move through the year relative to how we start the year.
Right. I was just trying to draw that out. And then to be clear, you see no line of business weakness, no regional weakness, prospects of probably flat housing, consumer remains engaged?
As I said earlier, there's nothing that's changed that would influence our volume outlook. We think it's pretty consistent with the way we've been communicating volumes for the last two quarters. And again guiding down and then delivering better than that and we'd prefer to start the year the same way.
As you know Michael this is such a fixed bill system business that if you have a high market share model, generally it's the tone of the underlying economy that's going to drive volume growth in reported numbers. Our business is not about market share grabbing. It's about servicing the underlying markets that we operate in.
Yes. And my question wasn't specific about volume, it was about a macro view. You're not seeing line of business weakness, you're not seeing regional weakness, housing, I'm assuming you're saying, do you think it's going to be flattish and you still see the consumer engaged? That's what I was asking.
That's all a fair statement. We saw that in January to confirm at least 1 month of 2019.
Okay. And then just two more questions just to clarify something. If you're doing double digit per share growth in free cash flow, obviously you're going to be pretty active in the buyback because you got to average at least 2%. That's the right way to think about that, right?
Yes. I mean as we've always said, if you look back the past several years, the numerator has been what's they've been a key driver to high teens CAGR on free cash flow per share growth. But as a lot of large numbers proceed, you've got the combination of higher numerator and lower denominator that eventually comes into play because we're just spitting out more cash flow than we need to deploy in acquisitions because again we're cash funding all acquisitions, delevering the balance sheet, we've got more than enough capacity and flexibility to affect the numerator and the denominator going forward.
Right. And then last for me, just to be clear about an earlier question, Waste Connections is completely indifferent about what they would do with the trash once they collect it as long as you generate a reasonable return on the capital you deploy it. So whatever changes may come slowly, you'll be able to react to because you'll control it at
the curve in the loading dock?
No one around here is changing our drives, Michael. That's right.
Okay. All right. Great. All right.
Thanks. Thank you. Our next question comes from the line of Chris Murray with AltaCorp Capital. Please proceed with your question.
Thanks. Good morning, folks. Just following on maybe on Michael's question a little bit around the free cash flow guidance. So the number year over year looks to start at around 8%. And so I guess a couple of pieces of this.
First of all, expecting kind of high single digit revenue growth, you would have expected it would have been higher. What's the drag embedded in that number from the tax change? I guess the first piece of that. And then second, if I think about you think about your target leverage, you're sitting, call it, dollars 300,000,000 in cash. You're going to have the free cash flow generation.
Should we start thinking about maybe a change in how you approach either the buyback or something like that? I mean, historically, 2% to percent of shares bought back, but is there any opportunity to maybe step up that number as that free cash flow number expands?
As you know everything's possible. Again that's the flexibility that we have. Again if you look at the free cash flow, we look at it as actually a double digit growth because again last year we were talking about $860,000,000 and looking at 2019 of $950,000,000 that's a little over 10% growth in free cash flow on a dollar basis. We've already apologized for giving $20,000,000 more in 2018 and delivered $880,000,000 instead of $860,000,000 But again, it's too early to change the target of $950,000,000 In fact, what that means is probably could have done $970,000,000 or more of that $20,000,000 cleared the bank on January 2 instead of December 31. And so to the where the difference of the day make, that's a difference of the day makes.
We're less focused on that. That's just a timing issue when some checks cleared.
And I guess the other piece of it regarding leverage and the ability to do more in terms of buybacks, as Worthing said, there are a number of things that are possible and we have so much flexibility. We continue to believe we're in a period of outsized M and A activity as Worthing has said. And so that will continue to be our highest and best use of cash. But again, we exited the year at sub-two-five with over $300,000,000 in cash on the balance sheet and guided to 9 $15,000,000 free cash flow. So that's $800,000,000 after the dividend.
So we have ample firepower to do what we did last year.
Yes. As you know also Chris, we're the ultimate owner of our stock. So we'd be very patient when we pick the time to go into the market and buy. We bought in February's dip last year. We bought in December's dip last year.
And so I think our average repurchase price was around $71 And so it's that in addition to deploying over $1,000,000,000 in acquisitions, again, we spent over $1,200,000,000 on M and A and we returned the capital to shareholders and our leverage declined. So again, we just feel fortunate to be in this position to 1st and foremost deploy our capital on strategically consistent and appropriately priced M and A opportunities and then that because the runway is so long for us on that opportunity and then dabble in the stock market optimistically. Now if for whatever reason the seller expectations over inflate and deal activity slows down a little bit and cash is building up. Obviously, we don't sit on cash. We'll pick up spots in the market and step in, in a larger way.
Okay, fair enough. And sorry, just the what was your expectation, the tax change on the 9.50 guide?
Again, what we've tried to say is that we think this is a GAAP matter and that on the free cash flow guide, we've already factored in the changes to taxes. So it's not a free cash flow impact.
All right,
great. Thanks. Just going back to some of the timing as we think about the purposeful shedding, particularly in Canada, I mean, a 6.2% price number, you got to be thinking that that's got to step down a little bit as you anniversary the shedding and maybe flatten out the volume number even if you're going to go to a 0 number. How should we think about the cadence as we move through 2019 in terms of call it the normalization of that price growth?
Yes. You're right Chris. And certainly what you saw in Q4 on that continued high price in Canada a lot of that is because of price increases that were put
in, in late 2017 and into 2018.
And when all of last year that price stuck better than we expected and volumes took longer to go away than we would have expected when we really started that in earnest in 2017. What you should expect to see during 2019 is that price will start stepping down. As Worthing said even on a reported basis when we guide to 4.5 percent for the full year it will start higher than that. I mean we exited Q4 2018 already higher than that. You should expect it to be higher than that in Q1 and step down over the course of the year.
I would expect Canada in particular to follow that same pattern over the course of 2019.
Okay, fair enough. All right. And just one last one for me. Just kind of following up. You'd mentioned you're spending some CapEx on some E and P landfills, and I think they're supposed to be operational towards the middle of this year.
I guess, first of all, I just want to confirm or update where we are with those projects. And then anything we should think about, and I know you had previously talked about some EBITDA margins, but anything that's going to be odd in the start up of those? Or should we just assume that as they start taking volumes that we should see fairly, call it, normalized margin profiles on the way in? Or will there be some sort of dilution that we should expect in the back half of the year?
Obviously, it depends. The initial cost ramp, you won't notice in our overall consolidated business because it's nominal compared to the size of our business. But obviously, the first revenue that comes in dollar for dollar will cover costs, right? And once we start exceeding that cost because of the fixed cost nature of that business, then you start seeing the incremental flow through become a lot higher. It all depends on the speed of the ramp with regards to timing.
1 of our landfills will likely start doing its trial start during Q2. And so we're ahead of schedule on that one. Another project that we it's still under construction right now that no, it's again, and what we've tried to say is that, look, the ramping of that, So no, it's again and what we've tried to say is that look the ramping of that of either of the new projects and the other ones we're working on, we look at that as being just potential upside to the way we've guided for the full year.
All right. Thanks very much folks.
Thank you. Our next question comes from the line of Sean Eastman with KeyBanc Capital Markets. Please proceed with your question.
Hi, guys. Thanks for taking my questions. I was hoping to get an update on the labor capacity and wage inflation challenges, perhaps relative to when you guys reported in the fall, I was just hoping to get some context on things like turnover, safety incidents and whether those things have stayed in check or worsened or maybe improved a little bit. And perhaps just what the main sort of goal and focus area is in terms of addressing these challenges in 2019?
Sure. So I can start. Certainly, first of all, with respect to safety, as Worthing noted, safety did continue to come down in 2018. You saw high single digit decrease on our incident rate in 2018. We're in the dead of winter and had January with severe weather that certainly impacts safety and was certainly mindful and paying close attention to it in Q1.
In terms of turnover, really remained in that. We've been in that kind of 25% to 26% or 7% range on turnover. Haven't seen a market change there. What we've really said all of last year is that we were pleased that it wasn't getting much worse given the constraints on labor. And what we saw with real wage increase in Q4, it was about where it was maybe a little higher than in Q3, high 4s between 4.5% 5% would be the same employee wage increases of course that's mitigated or muted in the P and L by the turnover, but that's what the wage increases are.
And as we think about 2019, as I think we've communicated, we've taken a look at things like our benefits and increased our 401 match and done some things to make sure that we remain the employer of choice and have the benefits that we think are appropriate for our employees. And those costs are factored into our guidance for 2019.
Yes, Sean. To Mary Anne's point about higher 401 contributions and the matching that we're doing, we anticipate that and included in our outlook that's about a 30 basis point headwind year over year. So while we guided a 30 basis point improvement in margins, obviously if I adjust just for the anticipated increase in 401 contributions that would have been a 60 basis point margin expansion for the full year, but we're anticipating again increased participation and folks to be deferring more of their eligible compensation for that.
Really helpful. And my next question is just going back to the M and A. I was hoping to you guys are indicating an elevated environment continuing this year. I assume there's a pipeline of targets that are sort of in negotiations getting close. And out of those targets that are in advanced stages, I was hoping to get a sense for the mix of kind of collections only versus integrated or maybe non solid waste to get a sense for what could be added this year?
Again, like most years, we've got a couple of integrated, meaning collection and landfill. But then there's a large number that are collection only that either tuck into our existing operations that could be internalized in our facilities or new market entries as well. So it's just it's a standard mix as we sit here right now. And it's all solid waste oriented right now.
Okay, got it. And just lastly from me, I'm trying to get an idea for what the risk to this acquisition environment is. Is there potential for more private equity to swoop in?
What could choke off some
of this elevated deal activity?
Well, obviously, as we talked about our last call, I mean episodically, you've got whether it be PE or PE backed companies that come in and take a different look, value things on EBITDA, not cash flow. Sometimes that's an interruption sometimes and we don't get all the deals we think we might get. That's fine. I mean our view has always been you can never recover from overpaying. So that's obviously a potential interruption.
We're fine with that. I mean again we're taking a long view here. As we know companies that pursue growth for growth sake don't end well. The debt can get paid off and the banks are safe, but the equity is always at risk. And so we got to play the long game here.
Equity is always at risk. And so we got to play the long game here and not be tempted into doing foolish things. And again, I think the track record you've seen over 21 plus years validates that.
Excellent. Thanks so much for your time.
Sure.
Thank you. Mr. Jackman, there are no further phone questions at this time.
Well, great. Thank you. If there are no further questions, on behalf of our entire management team, we appreciate your listening to and interest in the call today. Mary Anne and I are available today to answer any direct questions that we did not cover, that we are allowed to answer under Reg FD, Reg G and the applicable securities laws in Canada. Thank you again and we look forward to speaking with you at upcoming investor conferences or on our next earnings call.
Thank you.
Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.