Ladies and gentlemen, thank you for standing by. Welcome to the Waste Connections Third Quarter 2015 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 call is being recorded Tuesday, October 27, 2015.
I would now like to turn the call over to Mr. Ron Mittelstaedt, Chairman and CEO. Please go ahead, sir.
Okay. Thank you, operator, and good morning. I'd like to welcome everyone to this conference call to discuss our Q3 2015 results and provide both a detailed outlook for the Q4 and some early thoughts on 2016. I'm joined this morning by Steve Balck, our President Harold Chambliss, our COO Worthing Jackman, our CFO and several other members of our senior management team. As noted in our earnings release, continuing momentum and strong margin expansion in our solid waste business drove better than expected performance in the 3rd quarter with margins 50 basis points above our outlook.
Notable increases in collection activity and double digit growth in special waste and C and D landfill tonnage resulted in over 2.5 percent organic volume growth in the period, the 5th quarter of the last 7 which our volume growth exceeded 2%. Solid waste price plus volume growth in Q3 again exceeded 5% and EBITDA margins in solid waste expanded approximately 200 basis points year over year. M and A activity as anticipated has picked up very strongly. Our share repurchases target for the year remains on track and free cash flow at almost $300,000,000 and more than 55 percent of EBITDA through 9 months is notably strong. Before we get into much more detail, let me turn the call over to Worthing for our forward looking disclaimer as well as other housekeeping items.
Thank you, Ryan, and good morning. We must inform everyone listening that certain matters discussed in this conference call are forward looking statements intended to qualify for the safe harbors and liability established by the Private Securities Litigation Reform Act of 1995, including statements related to expected growth and operating trends, crude oil prices, recycled commodity values and E and P waste activity, regulation of the E and P waste sector, expectations regarding period to period comparisons, potential acquisition activity, the timing of and contribution from acquisitions, our return of capital to stockholders, the expected impairment charge and our Q4 and full year 2015 and preliminary 2016 outlook for financial results. Such forward looking statements are subject to various risks and uncertainties, which could cause actual results to differ materially from those currently anticipated. These risks and uncertainties are set forth in the company's periodic filings with the Securities and Exchange Commission, including our most recent annual report on Form 10 ks and subsequent quarterly reports on Form 10 Q. Evaluating the forward looking statements and are cautioned not to place undue reliance on evaluating the forward looking statements and are cautioned not to place undue reliance on such forward looking statements.
The forward looking statements made herein are made only as of the date of this conference call, and the company undertakes no obligation to publicly update such forward looking statements to reflect subsequent events or circumstances. On the call, we will discuss non GAAP measures such as adjusted EBITDA, adjusted net income and adjusted net income per diluted share and free cash flow. Please refer to our earnings release 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 and other companies may calculate these non GAAP measures differently. I'll now turn the call back over to Ron.
Okay. Thank you, Worthing. As noted earlier, solid waste price and volume growth exceeded 5% in the 3rd quarter. Core pricing in the period was 2.7% with total pricing growth net of surcharge reductions of 2.5%. Volume growth increased 20 basis points sequentially from Q2 to 2.6%, led once again by our Western region where volumes were up 3.5%.
Increased solid waste collection activity was a key driver to continued strength in volume growth. Commercial revenue increased almost 6% in the period and roll up revenue on a same store basis grew 7% on higher pulls per day. Pulls per day increased 150 pulls per day. Pulls per day increased 150 basis points sequentially from Q2 with each of our 3 solid waste regions up strong single digits. Roll off pulls per day increased 8% in our Western region, 7% in our Central region and 6% in the Eastern region.
With notable growth in collection activity now into its 2nd consecutive year, we increased fleet CapEx another $6,000,000 in the Q3 to address capacity constraints in certain markets where we are positioning ourselves for continued growth. These are good problems to have given the strong incremental margins we're seeing from the volume growth. Solid waste landfill volumes on a tonnage basis increased 9% in the 3rd quarter. C and D tons increased 29% in the period, special waste tonnage grew 13% and MSW tons were up 1%. C and D volumes increased in each of our 3 solid waste regions with our central region also notably strong in special waste activity.
Recycling revenue was almost $12,100,000 in the 3rd quarter, down about $2,400,000 or 17% year over year, primarily due to lower recycled commodity values for plastics and metals. Prices for OCC or old corrugated containers averaged about $110 per ton during Q3, down 4% from the year ago period, but up 10% sequentially from Q2. OCC prices currently are around $112 per ton or slightly above the $110 per ton average in the 4th quarter. However, year over year revenue headwinds for recycling will persist in Q4 due to continued weakness in plastics and metals and to a lesser extent reduced third party recycling volumes in certain markets. Regarding E and P waste activity, as noted in our release, E and P once again was in line with our expectations in Q3.
We reported $51,200,000 of E and P revenue in the Q3 or about 9% of total revenue and consistent with our outlook of $50,000,000 to $55,000,000 for the period. Same store revenue decreased about 45% on a more than 55% decline in average rig count in the basins where our E and P operations are located. Volumes in the period were down 20% year over year and average price was down 25%. Compared sequentially to Q2, year over year volumes on a same store basis improved 5 percentage points and average price per unit decreased 10 percentage points, primarily due to a large amount of completion volumes in Louisiana, which are similar to special waste in our solid waste business and typically come in at lower average price points. Excluding these lower price volumes, average price per unit remains similar to Q2 at down 15% year over year.
More importantly, EBITDA margins within E and P waste exceeded 35% in the period before corporate overhead allocations. On our July earnings call, we described activity within our E and P waste business as bouncing along the bottom. Bouncing means just that, up and down. The increases we saw in the 1st part of Q3 gave way to decreases later in the period as crude oil prices fell into the low $40 per barrel range. For example, rig count nationwide so far in Q4 is down more than 11% sequentially from the highest number deployed in Q3.
This recent dip is expected to trim our quarterly revenue run rate for E and P waste to a little more than $45,000,000 beginning in Q4. We believe a sustained $55 to $60 price per barrel of crude is needed to see a positive turn in U. S. Drilling activity, especially in the Permian. While elevated stockpiles of crude oil inventories continue to weigh on near term sentiment and crude oil prices, longer term trends remain favorable for increased drilling activity and our E and P waste business.
We believe these trends include rising growth in forecasted global crude oil demand, projected declines in the U. S. Production of crude, increased waste disposal outsourcing trends and worsening economic conditions within OPEC countries as well as the potential return of geopolitical risk premium in crude oil prices associated with the rising tensions in the Middle East. We also note that in late August, several environmental groups notified the EPA of their intention to file suit over their contention that the EPA has failed to review and if necessary revise the RCRA Subtitle D criteria regulations for E and P waste as required to do so at least once every 3 years. The groups also contend the EPA has failed to meet its duty under RCRA to review and revise as appropriate its guidelines for state solid waste management plans for such waste at least once every 3 years.
We believe any overarching regulation at the federal level or increased scrutiny at the state level would be a positive catalyst for better capitalized E and P waste treatment and disposal companies such as R360. While we wait for a more sustained increase in activity, it's important to note that any remaining headwind for us is a small fraction of what we had to overcome this year. And incremental margins from volume growth when it does occur should initially exceed 75%. Given our advantageous asset positioning in the most active basins, we believe we are well positioned to benefit from any increases in activity. Moreover, even if current conditions persist, we are still targeting about a 30% EBITDA minus CapEx margin as we look at 2016 as CapEx needs in this environment should be very minimal.
Looking now at M and A. We are pleased to announce the acquisition of Shamrock Disposal, a leading provider of municipal solid waste and industrial collection and disposal services in Duluth, Minnesota as well as tuck in acquisitions of collection operations in California, Oregon and Texas. In addition, we recently entered into an agreement to acquire integrated provider of solid waste collection, recycling, transfer and disposal services with total annual revenue of approximately $75,000,000 Suffice it to say, this is a typical Waste Connections transaction, a leading collection position in several suburban and rural markets, fully integrated with multiple landfills and several long term municipal contracts making up a large portion of the revenue base. This new market transaction remains subject to closing conditions including regulatory approval. Closing is expected to occur before the year end and we'll provide additional details at that time.
These acquisitions total approximately $90,000,000 of annualized solid waste revenue, providing more than 4% incremental revenue growth in 2016. Additional transactions in the pipeline that may get completed either later this year or early next year could provide another 1 or 2 percentage points of revenue growth on top of that amount. Suffice it to say while 2015 started out slowly, it looks to be ending strong with more than $125,000,000 of acquisitions to be completed. Finally, as also announced yesterday, our Board of Directors authorized an 11.5% increase in our quarterly cash dividend, our 5th consecutive double digit annual increase since commencing the dividend in 2010. Even with this increase, our dividend remains at around 20% of our free cash flow, providing tremendous flexibility to fund our growth strategy and further increase the return of capital to stockholders.
We also remain on track to repurchase between 2% 3% of outstanding shares in 2015. In Q3, we repurchased a little more than 1,000,000 additional shares, bringing a total year to date repurchases to about 2,000,000 shares. And now, I'd like to pass the call to Worthing to review more in-depth financial highlights of the Q3 and to provide a detailed outlook for Q4. I will then provide a few early thoughts on 2016 wrap up before heading into Q and A.
Thank you, Ron. In the 3rd quarter, revenue was $547,900,000 and adjusted EBITDA as reconciled in our earnings release was $189,000,000 or 34.5 percent of revenue. We estimate that adjusted EBITDA margins within our solid waste business expanded about 200 basis points year over year or 60 basis points excluding the benefit of lower fuel prices. Fuel expense in Q3 was about 4.2% of revenue and we averaged approximately $2.80 per gallon for diesel, which was down about $0.72 per gallon from the year ago period and $0.18 per gallon sequentially from Q2. Margins in our E and P waste business declined about 11.50 basis points on a same store basis and an additional 500 basis points from the dilutive impact of lower margin acquisitions.
Looking at the consolidated P and L, the following are certain line items that moved a notable amount in the 3rd quarter from the year ago period as a percentage of revenue. Labor and supervisory expense increased 60 basis points, Repair and maintenance costs increased 50 basis points. Rail and trucker age expenses increased 40 basis points on higher intermodal activity. SG and A increased 30 basis points. Risk management insurance expense increased 25 basis points.
3rd party disposal and transfer costs increased 20 basis points. Fuel expense decreased 110 basis points, E and P related subcontracted expenses decreased 30 basis points, and recycling rebates to 3rd parties decreased 20 basis points. It's important to note that changes in many line items as a percentage of revenue were either magnified or due in part to the decline in higher margin E and P waste activity. For example, looking at certain line items within just the solid waste business as a percentage of revenue, repair and maintenance cost increased 25 basis points or just half of the consolidated reported increase. SG and A decreased 20 basis points.
3rd party disposal and transfer costs decreased 30 basis points and recycling rebates to 3rd parties decreased 30 basis points. Depreciation and amortization expenses for the Q3 were 12.5 percent of revenue, up 50 basis points year over year due to the impact of slightly higher depreciation expense on a top line negatively affected primarily by lower E and P waste activity and to a lesser extent reduced surcharges. Similar to what we noted in Q2, had E and P revenue been flat year over year, D and A expense as a percentage of revenue would have declined compared to the prior year. Interest expense in the quarter increased $550,000 over the prior year period to $16,400,000 due to the longer term fixed rate note offering that closed in August. Debt outstanding at quarter end was about $1,950,000,000 and our leverage ratio, if defined in our credit facility, was approximately 2 point 6 5 times debt to adjusted EBITDA.
Our effective tax rate for the 3rd quarter was 38.8%, slightly lower than our average rate due to true ups associated with tax filings in the quarter. GAAP and adjusted net income per diluted share in the 3rd quarter were $0.50 $0.54 respectively. Adjusted net income includes, among other items, the amortization of acquisition related intangibles. In addition, as noted in our earnings release, our GAAP and adjusted non GAAP measures exclude the anticipated non cash charge to GAAP earnings for impairment of a significant portion of the goodwill and indefinite lived intangible assets associated with our E and P segment. In accordance with applicable accounting standards, we evaluate our reporting units for impairment annually in the Q4 of the year or more frequently if certain events or circumstances have changed.
We currently believe that the significant and sustained decline in crude oil prices in recent months together with market expectations of a likely slow recovery in such prices, constitute a change in circumstances that makes it more likely than not that a significant portion of the $550,000,000 of goodwill and indefinite live intangible assets associated with our E and P segment was impaired in the Q3 of 2015. Any such impairment would be a non cash charge and mostly deductible for tax purposes. We are in the process of performing and reviewing such impairment testing with our auditors. Upon completion of that testing and a final determination by our Board of Directors, we expect to record the non cash, mostly tax deductible experiment charge to GAAP earnings in our Q3 financial statements included in our Form 10 Q followed with the Securities and Exchange Commission. Looking at free cash flow.
Through the 1st 9 months of the year, free cash flow was $298,600,000 or 18.8 percent of revenue. As Ron noted earlier, we increased fleet CapEx by $6,000,000 in Q3 in response to better than expected growth in our collection business. And in October, we also spent an additional $6,000,000 in landfill equipment. Due to increased discounts, we were able to negotiate with 1 manufacturer on some of its available inventory. These increases in CapEx will likely put full year 2015 free cash flow between $340,000,000 $350,000,000 and should result in next year's CapEx being about $215,000,000 excluding any additional CapEx resulting from acquisitions closed during the remainder of this year or next.
I'll now review our outlook for the 4th quarter. 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 statement and our various SEC filings. We encourage investors to review these factors carefully. Our outlook assumes no change in the current economic and operating environment. It excludes the impact of the recently signed $75,000,000 revenue acquisition and any additional acquisitions that may close during the period, along with acquisition related transaction costs and it excludes any loss or other operating charges.
Revenue in the 4th quarter is estimated to be approximately 520,000,000 dollars Solid waste price and volume growth on a combined basis is expected to be about 4% in Q4. Recycling, intermodal and other growth is expected to be about 1% as increases in intermodal activity more than offset any declines in recycling revenue. Revenue from E and P waste activity is expected to be a little more than $45,000,000 Adjusted EBITDA for Q4 is estimated to range between $171,500,000 $172,500,000 At the midpoint, this would put full year adjusted EBITDA at about $707,000,000 exceeding the outlook we provided in July. Depreciation and amortization expense for the Q4 is estimated to be about 12.9 percent of revenue. Amortization of intangibles in the quarter is estimated to be about $7,200,000 or almost $0.04 per diluted share.
Operating income for the Q4 is estimated to be approximately $105,000,000 Interest expense in Q4 is estimated to be about $16,400,000 Our effective tax rate in Q4 is estimated to be about 39.2 percent Non controlling interest is expected to reduce net income by about 200,000 in the 4th quarter. Our fully diluted share count in Q4 is estimated to be about 123,000,000 shares. And finally, similar to what we had noted for the prior two quarters, on an earnings per share basis, we estimate the year over year decline in our E and P waste business will be about a $0.10 drag to reported results in the Q4 when compared to the prior year period, fully matching revenue, margin and earnings growth within our solid waste business. And now let me turn the call back over to Ron for some final remarks before Q and A.
Okay. Thank you, Worthing. Once again, strong organic growth and margin expansion within solid waste drove better than expected performance in the quarter. E and P waste activity was in line with our expectation and remains a strong contributor to cash flow. We're on track to exceed full year adjusted EBITDA expectations we updated in July.
And with acquisition activity picking up and continuing strength in our solid waste business, we are putting additional building blocks in place for incremental growth in 2016 and beyond. Although we won't provide our formal outlook for 2016 until next February, we're able to provide some early thoughts assuming no change in the current economic environment. We believe revenue should range between $2,220,000,000 $2,250,000,000 with EBITDA between $750,000,000 $760,000,000 These figures assume about 4% to 5 percent solid waste price plus volume growth. The $75,000,000 solid waste revenue we just announced is completed by year end and E and P waste comes in around $180,000,000 for the year, which simply annualizes the estimated revenue run rate for E and P waste, which we expect to exit 2015. Potential upside to these early estimates for 2016 could come from any of the following: additional acquisitions we might close this year or next an increase in E and P waste activity should crude oil prices recover somewhat during the year and increased recycled commodity values.
These upsides could add another 2 to 4 percentage points of top line growth in 2016 mostly at accretive margins. Again, we expect to have better visibility on this in February when we provide our formal outlook for the upcoming year. We appreciate your time today, and I will now turn the call over to the operator to open up the lines for your questions. Operator?
Thank And our first question comes from the line of Al Kastock of Wedbush. Please proceed with your question.
Good morning, guys.
Good morning, Al.
I just want to Ron, on the Subtitle D commentary, could you just elaborate a little bit? Is this something you're expecting waste volumes to come in 2016? Or what's the what are you putting us on alert for here?
Well, all we're putting you on alert is that there has just recently in the last few weeks been litigation filed that is challenging the EPA under it's under RCRA to update both federal and state requirements regarding how E and P waste is handled throughout the U. S. And under its charter, the EPA has committed to review that every 3 years as a minimum. It's been over 20 years since they have updated that. And so the lawsuit alleges that the EPA is severely delinquent in updating the handling of that waste.
And it asks that it be updated to be handled in Subtitle B facilities, which all of our E and P facilities are. So, all we're pointing out is that and we don't know how that lawsuit is going to go or how long it's going to take. But I think suffice it to say there's a lot of discussion at the federal and several of the state levels to incrementally increase how the regulation around how E and P waste is handled and to limit if not completely eliminate the use of reserve pits. We have said all along that that alone would more than double the volumes that are available to be handled throughout our basins. So while we don't know when that will happen or if it will happen, we're just pointing out that if it does, it could be even in the absence of incremental crude oil prices increase, it could lead to quite a bit of additional volumes for handling in the future.
Very helpful. If I may transition to CPI or the index contract markets for a second, obviously some headwinds there. You guys continue to do an excellent job and relative to your competitors. But is it fair to say that you're seeing some increased pressure there on the top line and the ability to get 2%, 2.5% is sort of a consistency with what you're guiding for 2016 or preliminary outlook for 2016?
Yes. I mean, as you know, Al, approximately 50% of our solid waste business is indexed to a CPI or a similar metric. And that business we're currently getting, I mean around between 1.5% and 1.8% or so. That tells you we're getting 3.5% to 4% and the other 50% of our business that's competitive to yield the approximately 2.5%. We expect that there could be 20 basis points to 40 basis points depending on the market area of pressure next year relative to this year on the indexed portion of that business, meaning that CPIs could be 1 to 1.4, not 1 4 to 1.8.
And we believe that through the rate making process where we get a return on invested capital and operating ratio as well as through ratcheting up nominally our competitive markets, we can offset some of that 20 to 40 basis points. It still may be that pricing is nominally down next year, but we wouldn't expect that to be more than in that 20 to 30 basis points at most.
Great. And then finally, if I may, just on the acquisition front, given how you valued in the market, would you not care to be more aggressive on M and A? And then secondly, particularly on the MSW side, but secondly, can you comment on the nature of the Minnesota deal, given to me a perception anyways that there a landfill market is the 3rd alternative in terms of waste in that particular market?
Yes, let's tackle the second part of that first because it's easy. You are correct that in Minnesota, landfilling is not the preferred, if you will, method of handling of ultimate waste disposal. However, that is predominantly a Hennepin County and a Twin Cities issue. So that is basically a Minneapolis, St. Paul and the Greater Hennepin County issue.
This is well north of that in Duluth, where there are not burners and incineration capacity such as there is in and around the Twin City area and disposal there is the predominant method of handling of waste there. So from that standpoint, when you're talking about the Duluth market, very different market than the Hennepin County market. We know Hennepin and the Twin Cities very well. Secondly, to your first question, the reality is that we believe the reason that we are fortunate enough to have the multiple, the trading multiple that we do is that because investors trust us to invest the capital that we get wisely. If we were to invest at our multiple, we could not get the type of value creation that we've demonstrated over the years.
Let's be honest, there are companies out there doing that at R multiple that don't have R multiple. And it's created value destruction for them unfortunately. So we view that we get one chance to spend capital. We look at it on a return on invested capital basis. Our multiple really has little to do with that in the equation.
It obviously affects the weighted average cost of capital. But other than that, it doesn't have a lot to do with it. It's really what we can earn on the capital we're going to invest. So we don't look at it on a multiple basis. Yes, deals get down and can be backed into on a multiple basis.
But ultimately, it's an all cash in, all cash out analysis and what kind of return can we get on that capital relative to our weighted average cost of capital and is that a wise investment. That's ultimately how we look at it.
Yes. As you recall, Al, if you normalize the companies in our space on a free cash flow basis, the fact that we can convert 45% to 50% of EBITDA to free cash and many other companies will do 30% or so of EBITDA to free cash, All things being equal, if we all trade at a similar multiple of free cash flow, that then results in what appears to be a higher multiple of EBITDA to your point about EBITDA multiples again. But everything we do, we look at on a cash flow basis. And again, I know many investors don't look beyond the income statement. But again, you got to look beyond the EBITDA multiple and look at the free cash flow being generated.
Very good. Thanks, guys, and good luck.
Thank you.
Our next question comes from the line of Michael Hoffman of Stifel. Please proceed with your question.
Hi. Thank you all for taking my questions. Ron, how would you frame in solid waste, the post recession volume trend? And I'm presuming we're thinking about it, it's got a longer cycle and it's a shallower curve, but it hasn't hit a level off point yet. What's your thoughts about where you are in that?
Well, as we said in the release, Michael, or on the call, excuse me, that we've had greater than 2% volume growth now for 5 of the last 7 quarters. So clearly, we are well into a recovery. It's continued to improve. We've really seen that with our Western region, which is our largest region, last into the recession, certainly last out of the recession. Probably, they felt at the deepest because of the housing collapse on the West Coast.
And that's where we're getting the greatest lift in our business as noted 3.5% to 4%. So I would tell you that I think we're well into it. All of our indicators, whether it's roll off calls per day, whether it's incremental landfill volumes, both MSW, C and D and special waste or net new business and service increases over service decreases, all of those improved incrementally in Q3 over Q2 and well year over year. So I can't tell you that we're 80% through it and there's 20% left, but we clearly don't see that things should slow right now in 2016. The building blocks continue to be there from everything we're seeing that it should stay at about this level through 2016.
Yes, the rate of growth could decelerate a little bit just because of tougher comps. Absolutely. But that doesn't mean there's a slowing down in the macro.
Right. So we can still describe the volume line as an upward slope. It hasn't leveled yet. That's what I was trying to get at too is your thoughts about when it hits a level point. It's not a that's not a negative.
It's just we've hit the sort of economy's ability to sustain a rate of change.
Yes, because what yes, you're right. I mean, what will happen is in the West Coast, which again has been the big driver of volume growth this year at 3.5% to 4%, when that anniversaries itself, if it reverts just to a 2% mean, then the company overall starts reverting to 1.5% to 2% volume growth environment, perhaps with further upside from there depending on the macro. But again, the ability to continue to replicate 2.5% or 3% volume growth if you try to raise the bar on us, it gets more difficult as the comps get tougher.
Right. So in thinking about if you look out with a long view on the model 2016, you hold the sort of a 2 it's a 2 plus 2 and there's some variability between the price and the volume of what creates the upside to the 5. 2017, it's still a 2+2 is the place to start, but maybe the volume becomes a 1.5 to 2 and the price is a 2 to 2.5 and that's how you get the 2 plus 2?
So you've just finished our budget through 2017. So we thank you for that.
You're welcome.
And if it only works like that.
Yes, I realize that. But that's the way to think about it. Is that the right way to think about it?
We think it is. We think it is, Michael. We can certainly comment on 2016. Obviously, we did today saying that we expect 4% price and volume growth in solid waste and another approximate 1% in intermodal and other. So we just said almost 5% top line from organic for 2016.
Obviously 2017, it's a little early for us to call, but assuming there's no change in the macro environment materially, we would expect it to be in that 2 plus or minus range on both price and volume.
Okay. And then what type of equipment are you buying that's being supported by the extra CapEx for the truck side? I could say landfill equipment side, I get. But what's is it front end loader, side loader, rear loader roll off? Yes.
It's across
the board. It's across the board. It's different by market obviously, Michael, but it's front end loaders, it's side loaders and it's roll offs as well in certain markets.
Okay. And then switching gears to E and P, if for whatever reasons all of the hopes and dreams that 40 to 50 become doesn't become 50 to 60 on oil, what do you do differently if 40 to 50 is the brave new world for a while, 3 years in that business? How do you think about that business differently?
Well, number 1, that's how we are preparing for things, what you just said. And we've
And what we've baked into our 2016 guidance.
And what we've baked into our 2016 guidance at this point. Michael, right now we're running between, we just reported approximately 35 percent EBITDA margins on that business. We believe next year even on the business down approximately $30,000,000 on an annualized revenue basis, dollars 30,000,000 to $40,000,000 down, that will deliver almost the same amount of EBITDA. So we are expecting to take somewhere between 300 basis points and 500 basis points of costs out of the business between now and next year and run that business at a 35% to 38% EBITDA margin. We believe we can do that on a sustained basis next year or at least next year.
Now, if it dips below the $40 level and that reduces drilling even more, we'll obviously have to revisit it. But we've taken about 18% to 20% of the headcount out of that business out this year so far. And there will be more. There are also other cost reduction initiatives that we believe collectively, like I said, take another 300 to 500 basis points out of the cost side of the business.
Michael, you remember that business also has a couple of tailwinds as it goes into next year from an EBITDA standpoint. We anniversary the $4,000,000 or so of costs we had in Q1 of this year for some cleanup facility cleanup costs and start up costs. And we also have the 3rd party water disposal savings once our well that we're drilling in New Mexico comes online and those collectively are $7,000,000 to $8,000,000 of EBITDA tailwinds going into next year. So as Ron's point, our target is to increase, maintain or increase EBITDA in business next year, but more important looking at that on a cash basis, the CapEx in that business ought to easily be less than 5% or 4% of revenue, which again means we can hold 30 percent plus EBITDA minus CapEx margins, which again is very attractive on a cash basis.
Okay, great. Thanks. And then on the deal side, the $75,000,000 transaction, when you think about 3 years, that's a $100,000,000 business because of the opportunity to consolidate around it? Is that the way to think about it? Yes.
I think that's a fair statement, Michael. We think that 3 to 5 years, that's $100,000,000 to $120,000,000 platform at approximately a 35 percent EBITDA margin.
Okay. And then I appreciate the commentary on the RCRA observation, but it I mean, on a practical basis, lobby that has successfully put in the E and P and mining exemption is a pretty powerful lobby. So we shouldn't all get too excited about this. Nice to know that there's an effort here, but this has withstood the test of time for almost 50 years.
It certainly has withstood it. There's no question. I think the difference now, Michael, is your point is that the lobbying has affected the legislation. This is going at it through the judicial system. And whether or not a court takes a different position that the EPA is in violation of its own rules, That's what could be.
I'm not saying will be, could be different because whether or not lobbyists can influence the judicial decision is a very different issue than a legislative decision.
And under and in a Clinton administration, it'd be interesting to see how it plays out.
Where are you moving the corporate office then?
It was nice in Ireland, wasn't it?
They've got really low corporate tax rate too. Okay, I get it. And EPA over the last 10 years has used the courts for a predominant amount of its changes versus going through the legislative process. So this is consistent with a pattern we've seen. Okay, fair enough.
Thank you very much. Nice quarter.
Thank you, Michael.
Our next question comes from the line of Joe Box of KeyBanc Capital Markets. Please proceed with your question.
Hey, good morning, guys.
Hey, Joe.
Question on capital allocation for next year. Clearly, you guys executed on the deal pipeline this quarter. Curious if that's been harvested now and maybe we should think about share buyback being maybe a little bit more likely in 2016. And is that $2,000,000 to $3,000,000 share target for this year, is that potentially applicable for next year as well? Or are there still some looming deals out there that could give you pause on that front?
Yes, Joe, there's really no pause on any of the fronts. I mean the strength of the free cash flow, again not only funds the dividend and the dividend increases you've seen, also can consistently fund a 2% to 3% of outstanding share buyback as well as fund kind of a $75,000,000 to $100,000,000 of acquired revenue without really affecting the balance sheet because of the strength of the capital structure on the balance sheet. So there's it would have to be a very large unexpected optimistic transaction that will give us any pause on the share buyback side. So again, I think as I look at next year, I would hope it's the same sort of outlet you see this year, which is funding all 3.
Okay. Appreciate that. And you guys spent some time earlier on just tough comps in general, but I'm guessing your toughest comps are probably at the landfill with MSW now up 2 plus years. Can you maybe just talk to your outlook on MSW at the landfill and if that has any positive or negative reads on what tip fees may do?
Well, as far as the tip fee portion of the question, Joe, I mean, we look to raise tip fees between 2% 3% on a consistent basis annually. That's baked into our price. Some markets are a little higher, some are a little lower, but we feel confident in that for 2016 as well. We noted that although landfill volumes were up very strongly in the quarter, MSW was up 1%. It was not up as strongly because of just what you said, tougher comps.
That's in the 3rd year actually.
And it's actually our 3rd year of increased MSW volume. So certainly the comps are tougher, but we would expect again because when you see very high roll off volumes, again, that's a good portion of that is C and D related or special waste related, that translates should continue to translate in incremental landfill volumes going forward. So we continue to believe that will be strong. But there's no question as the denominator gets larger, the same amount of growth is a lower percentage just mathematically and that certainly will happen.
Joe, what you're seeing in the numbers as we've moved to the last couple of quarters and looking ahead, collection increased collection activity is driving more of the reported volume growth than the prior 2 years. Because remember in the early phases of recovery to the extent that we've got more waste in the containers, that's just increasing internal cost. So that landfill volume might increase, but again, you're not seeing the volume growth on the collection side until you change container sizes, change frequency, etcetera. We're seeing that now flow through. So collection is now contributing more of the top line growth than disposal volumes.
Understood. Thanks. And then just a clarification, Ron, did you say that the $750,000,000 to 760,000,000 dollars of preliminary EBITDA, does that include or does that exclude the acquisition that you guys announced this morning?
It includes.
It does include. Okay. Got you. And some guess and is it about $20,000,000 of EBITDA that's going to come from the
Approximately $25,000,000
$25,000,000 Okay, great. I'll hop back in queue. Thanks.
Our next question comes from the line of Tyler Brown of Raymond James. Please proceed.
Hey, good morning guys.
Hey, good morning Tyler.
Hey, first off, nice quarter. But Ron, I was curious about the commentary on the C and D and special wayside. Again, it's very strong there. I totally get the West Coast housing market, it's pretty solid. But I think you mentioned some notable strength in the central region.
I'm just curious if you have any thoughts about what's driving that. Was it coal ash by chance?
No, it was not coal ash. We have not we are working on some projects in both our central and our eastern region for coal ash, but we have not commenced any of those. So none of that is yet in the numbers should we get it. Our Central region was just a variety of things, certain cleanups in various areas, not one specific state or one specific issue.
Okay. No, that's very helpful. And then I know there are probably some more questions about E and P, so I'm only going to ask one. But Worthing, can you give us what you are expecting to spend in 2015 E and P CapEx and what that might be in 2016? I mean, if you're targeting 30% EBITDA less CapEx, I would think you're talking low single digit CapEx to revs for E and P next year?
That's right. That's right. What we've said is it's probably in that 3% to 4% of revenue range. So put that in kind of the $6,000,000 to $8,000,000 at most of CapEx.
Okay. And is that part of the thoughts about call it the brave new world of this $45 oil where you might be able to kind of reprieve the CapEx somewhat?
Well, also again to the extent that aerospace has already been constructed and volumes have slowed down, we're getting longer lives out of what's already been constructed. So it kind of pushes the need for a lot of cell construction out of 2016.
Yes. Okay, perfect. And then again, thanks so much for the read on 2016 and I'm more than I'm hoping you can indulge me here. But kind of bridging it, if I was to look at that $707,000,000 to $755,000,000 midpoint, just thinking about the big puts and takes for 2016. So on the solid waste side, it seems that you guys have internal growth, I don't know, maybe comes in at 40%, 45% incremental.
You probably got a few $1,000,000 of a fuel savings benefit rollover. It's kind of whatever we think about recycling. And then you've got the incremental EBITDA from the 90,000,000 acquired revenue. Is that kind of the bridge on solid waste?
That's a good bridge on solid waste.
Okay. And then on E and P, it's kind of whatever we think that linear footage maybe pricing does. You got call it, I think you noted $8,000,000 of savings from the water well and the startup cost that don't recur. Is there anything else that we're missing big picture?
Not big picture. I mean, you got to factor in that if we do do 180 on a reported basis, that's about a $40,000,000 decline in revenue. So you got to take the decrementals off with the revenue before you put the comebacks on the tailwinds.
Yes. Okay. No, perfect. Thanks guys.
Our next question comes from the line of Corey Greendale of First Analysis. Please
I just had a couple of quick ones. So first of all, in the E and P segment, been looking at the $45,000,000 plus in Q4. Is that all volume driven or what are you assuming or what are you seeing on
price? That's all volume.
Yes, it's mostly volume. Again, as you look at the again the comps get tougher as you move through the year. And so while same store was down about 45% or so in Q3, we're assuming about a 50 percent or so decline on a same store basis in Q4.
Okay. And it sounds like things are going well across your geographies, but just want to verify that you are not seeing any signs of economic weakness in the oil patch?
You mean in
You mean not in the oil patch?
No, you mean just macro in the Texas or Oklahoma or Colorado areas?
Right. I mean whether weakness in E and P is driving broader economic weakness in those areas?
No, we're not seeing that. Obviously, the one exception I'd say to that is in obviously in Williston, North Dakota. It's certainly driving economic weakness in that small micro market, but where upwards of 35,000 jobs have been lost in one market. But other than that, we are not seeing that in Texas, Oklahoma, Colorado, Wyoming, Montana, where we have E and P, we're not seeing that.
Okay. And fair to say Williston, North Dakota accounts for less than 10% of your revenue?
Same state accounts for less than 1%.
And then just a quick, since you're providing thoughts on 2016. So first of all, the Q4 4% price plus line that is down a little bit from Q3, is that conservative or can you just comment on why that would be lower sequentially?
Yes. Well, you start in Q4, you start anniversarying some of the uptick in the West region that we saw in Q4 of last year. So again, as the West region did 4% in Q2 of this year, did 3.5% volume growth in Q3, it's our expectation that the tougher comps start bringing the West region closer to that 2.5% to 3% in Q4, which effectively pulls volume down a little bit and you've got a slightly higher surcharge rollbacks in the 4th quarter that brings price net pricing down into sequentially down about 10 or 20 basis points from Q3.
Okay. And then thinking about 2016 where I think if you could just help a little bit with the quarters, should we assume on price that you start the year at the highest level and then go down from there as the comps get as you're working for a higher revenue base?
That's correct. Just as you see most years, the pricing is highest in Q the growth rate of growth on a dollar basis might be similar, but the rate of growth is always higher in Q1 than Q4 as we always sit and look at an upcoming year. And then the only other in and out next year on a quarterly basis. And obviously Q1 is the toughest comp on E and P because we did $70,000,000 of revenue this past Q1. So you'll see some movement in that line in Q1 until we anniversary that in Q2.
Okay. That's all I needed. Thank you.
And our next question comes from the line of Scott Levine of Imperial Capital. Please proceed with your question.
Hey, good morning, guys.
Hey, good morning, Scott. So
fuel obviously has been a big benefit year, a little bit of rollover effect into next year. But could you comment, you guys put any thoughts on additional hedging within that business or status quo with regard to your strategy there? And also maybe some updated thoughts on your CNG fleet investments and whether there's been any change recently?
Sure. I'll start with the hedges. We're about 40% hedged at this point through 2017. We've got some above market hedges rolling off at the end of this year that help provide that $5,000,000 or $6,000,000 or so of fuel savings already locked up for next year. I suspect you'll see us hedge about another 10% of our needs through 2017.
We're within about 0.05 dollars of a target in one of our major markets. And so I suspect as we get through into year end, we'll be about 50% hedged. And as you think about the how that plays through, in E and P waste, this past year we're down what about $80,000,000 in EBITDA and saved over $20,000,000 on diesel and solid waste side. So it's about a 4 to 1 hit on the way down. If crude does start coming back, the leverage on the upside is probably a 6 or 7 to 1 given the fact that we would have hedged about half our fuel needs through 2017.
With regards to CNG, again, our strategy there hasn't really changed. We've put some CNG in place in certain states where we've gotten some tax incentives around the infrastructure spend or in some markets where we've gotten the benefit of contracting extensions and the ability to recapture that initial higher price or higher cost outlay through the longer term life of a contract.
Got it. Thank you. And then just one quick follow-up on M and A. I don't know if you can you comment on the approximate outlay for the acquisition you announced this morning, if you wanted to factor that deal into our model and maybe just some broader commentary regarding the M and A landscape and any noteworthy changes there with regard to potential buyers evaluations or anything like that?
Well, let's start with the latter part of your question first. As far as the M and A landscape, we believe it's continuing to improve. And I think that really is just a function of one thing to be very honest and that is just that people have lived with higher taxes and lower interest rates, both of which affect their after tax reinvestability of their proceeds tremendously. They've lived with it now for 3 now going into 4 years. And so there's just some pent up demand for deals.
In addition, the economy has helped their business get back closer to where it was pre contraction as well. So the combination of both those things, Scott, I think is helping deal flow. We have looked at more deals and made more offers this year than any time I can think of in the last 7 to 10 years. We're having to look we're having to go through deals more finely than ever because there's quite a gap at times between the ask, the bid and the ask, let's say that. And so and we are trying to be very prudent with the capital we have to spend.
So we have not our hit rate is lower this year than it has been because we're staying disciplined. But we most of the time when we're losing a transaction, we are not losing a transaction to another buyer. We're losing it to the seller keeping the business. Incidentally, the transaction, the larger transaction that we signed yesterday and announced last night, talked about today, that is a company that I personally have followed for 21 years and this is the 5th offer I've made them in 21 years. So it finally worked.
And that was because of some changes in the estate lives of those particular sellers, which as we say is often one of the things that drives things. To your first commentary to your first question about valuation, this is a large integrated standalone new market entry for us. And the valuation is somewhere in that 7.5 to 8 times EBITDA range for the large acquisition. The others that we did, the valuation was closer to the 5.5 to 6. So the blended average for the $90,000,000 was probably around 7 to 7.5 times.
Got it. Thanks and congrats on getting that deal done. I guess persistence pays off there.
Sometimes.
Our next question comes from the line of Tony Bancroft of Gabelli and Company. Please proceed.
Good morning, gentlemen. Hey, Tony. Hey. On the E and P side, with the sustained low crude prices and customers constrained cash flow, are there any updates? I guess we've talked about it before, but any updates with pressure for any contract renegotiations?
Because of the reduction in crude and therefore the reduction in fuel?
Well, just
as noted in our script, the pricing environment didn't change Q2 to Q3, nor do we see a change looking ahead either. Got
it. Okay.
We have not seen that pressure is the direct answer to that question, Tony.
Got it. Okay. And then with So there's really no one
left to ask us for a concession.
With your long term
E
and P view that you laid out earlier and along with the potential EPA changes you mentioned, does it make sense to I know we've talked about again in the past, but look at E and P M and A and if not now, would it or when would it potentially make sense in the markets you're in or like to be?
Yes. I mean, I think the answer is it does make sense, Tony, and we are looking at something. Could it get lower? Certainly, it could. Could it get a lot lower?
We don't believe that it could do that. But there are some one off smaller deals where there would be some asset improved asset positioning improvement that if we could get that at an appropriate valuation and by the way, appropriate valuation right now to us is 3 to 5 times run rate EBITDA in this environment. If we could do that, then you know and we are looking at some, then we would take a hard look at that.
Thank you. I appreciate it.
And our last question comes from the line of Alex Osheff of Goldman Sachs. Please proceed.
Thank you very much. Good morning, guys. Couple of quick questions for you. Morning. How are you thinking about OCC over the next 12 months?
And what are your latest thoughts on coal ash and implications for the industry, if any?
Well, as far as OCC, right now, I think we said in Q4, we're trending at about $112 a ton. If we assume that our thoughts are that next year it sort of stays in that $100 to $115 range and if it does that, it's flat on a year over year basis, dollars 16 over $15 So it's not a headwind and it's not a tailwind either. It's really hopefully a neutral event. That's where we believe OCC is based on what we know today. As far as coal ash, look, as I mentioned in my earlier comments, we have not yet taken any or certainly any to speak of.
We are working on some projects that if they are successful could be very material and we would obviously call them out. A singular customer could be 1.5% to 1% in volume on their own in a year. That's how large these potential coal ash customers and jobs are. You're talking about sites that have millions of tons that need to be cleaned up over a period of time. So in some cases, jobs are large enough that it could require it would take all of the airspace we would even have at certain landfills.
And we're obviously not willing to do that because of the municipal commitments we have. So we're working through with various companies on that issue. We would hope to have some success in 2016. These are long negotiations, long process. They have 15 to 20 years to clean these up.
But it is going to start. We just are not sure when.
Got it. Thanks a lot for that color.
Okay. And our last question actually comes from the line of Barbara Novarini of Morningstar. Please proceed with your question.
Hey, good morning guys. Just a quick one for you. With jobs flowing out of the oil patch, is it getting any easier for you guys to find labor on the MSW side drivers and such?
Bob, that is a good question. And in and around those shale areas, yes, it is. It is getting a little easier in the Oklahoma. It is getting a little easier in the upper Midwest, in and around the Dakotas and into Minnesota and into South Dakota. So in certain areas, yes, it is a little bit easier.
Okay. Thanks.
And there are no further questions at this time.
Okay. Well, if there are no further questions, on behalf of our entire management team, we appreciate your listening to and interest in our call today. Worthing and Mary Anne Whitney are available today to answer any direct questions that we did not cover, that we are allowed to answer under Regulation FD and Regulation G. I thank you again, and we look forward to speaking with you at upcoming investor conferences or on our next earnings call.
Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation and ask that you please disconnect your