Earnings Call Transcript - GFL Q1 2022

Operator, Operator

Welcome to the GFL Environmental Q1 Earnings Call. My name is Ruby, and I will be the moderator for today's call. I will now turn over to your host, Patrick Dovigi, Founder and CEO, to begin.

Patrick Dovigi, CEO

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

Luke Pelosi, CFO

Thank you, Patrick. Good morning, everyone, and thank you for joining. We have filed our earnings press release, which includes important information. The press release is available on our website. During this call, we will be making some forward-looking statements within the meaning of applicable Canadian and US securities laws, including statements regarding events or developments that we believe or anticipate may occur in the future. These forward-looking statements are subject to a number of risks and uncertainties, including those set out in our filings with the Canadian and US securities regulators. Any forward-looking statement is not a guarantee of future performance, and actual results may differ materially from those expressed or implied in the forward-looking statements. These forward-looking statements speak only as of today's date, and we do not assume any obligation to update these statements whether as a result of new information, future events and developments, or otherwise. This call will include a discussion of certain non-IFRS measures; a reconciliation of these non-IFRS measures can be found in our filings with the Canadian and US securities regulators. I will now turn the call back over to Patrick.

Patrick Dovigi, CEO

Thank you, Luke. Once again, we started this year with impressive first-quarter results that set us up for another exceptional year. The positive impacts of price, volume, acquisitions, and portfolio rationalization are all surpassing our expectations and positioning us to continue to exceed our industry-leading growth objectives. Organic revenue growth for the quarter was over 11% with double-digit growth in both our Solid Waste and Environmental Services segments. Solid Waste pricing accelerated to the mid-6s, the highest in our history and ahead of our own expectations. Our ability to adjust our pricing strategies to reflect the changing operational landscape in real time is a testament to both the quality of our business model and the capabilities of our team. We continue to see our opportunity for price and surcharges as we optimize our book of business, and we'll be focused on that for the rest of the year. With the strength in the first quarter and our expectations for the balance of the year, we feel confident in our ability to exceed the high end of the guidance for our base business that we previously provided. Volume trends were also up across all of our geographies and business lines in the first quarter, excluding onetime MrF volumes from the prior year that we knew were not going to recur. This increase in volume is impressive because we achieved it even with the acute impacts from Omicron at the start of the year and the severe winter weather conditions that we experienced in many of our Canadian and Northern U.S. markets. Given that backdrop, we think that there is a positive read-through of this trend for the rest of the year. We've been anticipating the full recovery of our Environmental Services sector that we saw this quarter. We saw our customers reengage services that had been deferred or reduced during the pandemic, with the result that revenues in this segment were ahead of our own expectations by over 15%. As a result, we think we're going to be able to prove out the thesis in this segment faster than previously expected. Adjusted EBITDA margin was 25.3% for the quarter, a result we're really proud of considering the inflationary factors at play. You'll recall our previous comments that a year-over-year margin comparison will be less relevant this quarter because of the uniqueness of the prior period. Luke will unpack the puts and takes. But when you peel it all back, the results demonstrate the exceptional foundation of our business model that allowed us to leverage price to more than cover the cost inflation while driving operating leverage through our improved asset utilization. The significant and sudden spike in fuel cost was a headwind for the quarter, but we think we should be able to recover most of that lost margin by the end of the year. With Canada finally moving on from its COVID-related restrictions by the end of Q1, we're also very optimistic about the positive impact that this lifting of restrictions will have in our Canadian business for the balance of the year. Complementing our strong base business performance was the continued implementation of our portfolio rationalization. In April, we finalized the spin-off of GFL Infrastructure into Green Infrastructure Partners. GIP then acquired the COCO Paving business to create a leading Canadian provider of vertically integrated infrastructure services. As we said last quarter, this transaction demonstrates GFL's commitment to rationalizing our balance sheet to maximize the value of our asset base. We think that the brand recognition of GIP, together with a highly supportive macro backdrop of infrastructure projects over the near, mid and longer terms, will create a compelling organic growth opportunity. We also see consolidation opportunities in the fragmented Canadian infrastructure services market, and we believe that our investment in GIP will result in meaningful value creation for our shareholders. We also continue to execute on our M&A strategy, completing 21 acquisitions year-to-date, representing approximately $300 million of incremental annualized revenue. As we announced earlier this week, one of our acquisitions we completed was Sprint Waste Services. Sprint, a vertically integrated regional Solid Waste business based in Texas with a footprint that strongly complements GFL's existing footprint, has achieved industry-leading margins for over 15 years under the ownership of Joseph Swinbank and his family. We're excited that Joseph and his sons Will and Reagan are showing their support for the combined GFL opportunity through their continuing investment as shareholders of GFL and as consultants to the business. In addition to Sprint, we closed 20 smaller tuck-in acquisitions, nine in the quarter and 11 subsequent to the quarter. 13 of those acquisitions were less than $5 million in enterprise value, and all contribute to further densifying our footprint. Our pipeline remains robust, and with the strength of our start to the year, we see another year of continued outside M&A opportunities. On R&D, we continue to progress on the development opportunities that we highlighted to you earlier in the year. The project is expected to start to come online mid to late next year. In Q1, we deployed around $12 million of capital into these projects and are encouraged by the pace of development. We continue to expect that our share of incremental free cash flow from these sites will be in the range of $115 million to $125 million per year. On the ESG front, we continue to focus on biodiversity with a new pollinator project at one of our landfills in Canada. On Earth Day, our employee engagement activities across GFL centered around increased awareness of local at-risk species. On the governance front, we appointed Jessica McDonald to our Board in the quarter and have committed to increasing female representation on our Board to 30% by the time of our 2023 AGM. I will now pass the call back over to Luke, who will walk us through the details of the financial results, and then I will share some quarterly perspectives before we wrap up.

Luke Pelosi, CFO

Thank you, Patrick. Before I begin the discussion, I want to note that we have excluded the contributions from the now-divested GFL Infrastructure division from our results analysis. All comparisons I mention are on a like-for-like basis. As Patrick mentioned, we started the year very strong with Solid Waste organic revenue growth of 10.3%, fueled by 6.6% from price and surcharges, 1.1% from commodity prices, and 2.6% from volume. When excluding the nonrecurring Merck volumes we anticipated in our original guidance, volumes grew by 3.1%. The outperformance stemmed from both price and volume, with organic growth surpassing expectations in both of our geographies. Our price outperformance was due to higher price increases, improved retention, and the timing of price increases in certain markets. Incremental fuel surcharges recovered about 20% of the fuel cost increase we experienced during the quarter, some of which is due to timing that will eventually be recovered. Nonetheless, we see significant potential in this area within our existing customer base. Many of our industry peers have successfully managed rising fuel costs, and we believe there is considerable upside as we align our practices more closely with industry standards. As I pointed out, we were pleased to see growth in volumes across both regions. Solid waste collection volumes were positive across all service lines, though the strength of our commercial segment faced challenges due to roll-off pulls in some of our northern markets, which dealt with a wave of Omicron at the start of the year, as well as significantly harsher winter weather compared to the first quarter of last year. Post-collection volumes were strong across most areas, especially in some of our newer markets. Although volumes started a bit slowly this quarter, we observed accelerating momentum as we moved past March, particularly in Canada. The impact of recent COVID restrictions has been evident, especially in our Environmental Services segment, which achieved nearly 20% organic revenue growth as our customer base resumed or increased service intervals. We believe the effects of government-mandated market openings and closures have altered the typical seasonal patterns for our Canadian business, and we likely pulled forward some work into this first quarter. Nevertheless, the results provide a very positive outlook for the remainder of the year. The contribution from M&A was 16.2%, surpassing our expectations and largely due to the ongoing strong performance of businesses acquired in the latter half of 2021. In terms of profitability, adjusted EBITDA margins were 29.9% for Solid Waste, 20% for Environmental Services, and 25.3% for the entire company. Although this represents a decrease from last year, we had communicated that the quarter-over-quarter margin comparison would be less relevant this quarter given the unusual strength of the first quarter of 2021. To recall, Q1 2021 saw Solid Waste margins in Canada increase sequentially from Q4 2020 and the highest margins of the year in our U.S. segment, both of which were atypical outcomes resulting from a mix of organic and inorganic factors. Looking at our guidance at the beginning of the year, we anticipated Solid Waste margins to decrease, Environmental Services margins to rise, and the overall company margin to finish the quarter in the high 25's. The combined impact of diesel costs and changes in segment mix presented a 70 basis point headwind relative to our guidance, yet we view Q1 performance as ahead of our expectations, excluding these two factors. Although cost inflation was higher than we expected, we responded with additional pricing and see a pathway to continue doing so throughout the year. We anticipate quarter-over-quarter margin comparisons to stabilize as the year progresses, and we are confident in our ability to achieve margin expansion across both segments and for the company overall by year-end. Adjusted free cash flow was $119 million, compared to $117 million in the same period last year. Keep in mind that the comparable period was burdened by $42 million of cash interest, tied to refinancing activities that affected the timing of cash interest payments in 2021. Our adjusted free cash flow reconciliation includes about $90 million in proceeds from additional asset disposals completed during the quarter. As you may remember, our strategy with these disposals is to reinvest the proceeds into attractive organic investment opportunities within our core markets, effectively working toward our net CapEx target. Since inflows and outflows don’t always happen in the same period, timing differences may affect the net number in any given quarter. We began this process last year and expect to complete it by the end of this year or early 2023, remaining confident we’ll balance our net CapEx by the end of the program. We’ve also included our investments in joint ventures, reflecting our contributions to RNG projects in our free cash flow reconciliation. It seems our partners in developing these projects may deploy capital faster than originally expected, potentially pulling forward $2023 revenues into this year. We’re excited about this outcome, and we’ll be able to cover any additional investment with proceeds from disposals we received in the first quarter. As Patrick mentioned, we invested $67 million in nine tuck-in acquisitions during the quarter. After the quarter ended, we put additional dollars into 11 more acquisitions, including Sprint Waste Services. A part of the consideration for Sprint was equity, which not only brings the Swinbanks into our shareholder base but also demonstrates our commitment to manageable leverage levels. We expect that the revenue contribution this year from these acquisitions will be around $200 million, out of a projected total of $300 million on an annualized basis, before considering any divestitures this year. As we indicated, GFL Infrastructure was classified as held for sale at quarter end and was divested at the end of April. The consideration we received included $224 million in cash and approximately a 45% equity interest in GIP. Due to the structure of the transaction and GFL's previous approach to financing acquisitions related to GFL Infrastructure, we took a charge to reduce the carrying amount of the net assets divested to align with the proceeds from the spin-off. Going forward, GFL's interest in GIP will be accounted for using the equity method. Regarding the $224 million in cash proceeds from the spin-off, we have reinvested this into M&A, and therefore, these will not be included in our adjusted free cash flow reconciliation moving forward. Our net leverage at quarter-end improved slightly compared to Q4 2021. Pro forma for the post-quarter-end M&A, leverage sees a slight increase. We still expect the business to reduce leverage by the end of the year, albeit at a more tempered pace due to M&A. Finally, before we return to Patrick for closing remarks, I want to announce that we are raising our fiscal 2022 guidance. I want to clarify that we are not providing updates regarding our base business – the area for which we gave guidance at the year's start. We are not seeing an increase in the base business that would warrant an update because we are not expecting one just yet, but we prefer to wait for another quarter before we adjust our views. The strength of the M&A early this year reinforces that we should surpass our initial guidance at least by the additional M&A contribution. Thus, we have updated our revenue, adjusted EBITDA, and free cash flow estimates only for that aspect. The updated figures reflect the new M&A's net impact less the contribution or loss from the $90 million of divested assets. With that, I will now pass the call back to Patrick.

Patrick Dovigi, CEO

Again, this quarter, our more than 18,000 employees deserve all the credit for our exceptionally strong start to this year. The dedication and capabilities of this team couldn't make me prouder, and a big catalyst for our upcoming Investor Day is to showcase to you the exceptional talent that drives GFL. You've all heard me say before, Luke and I may be the face of GFL for most of you, but we are fronting a best-in-class management team that continues to deliver our industry-leading results. We're excited for you to see firsthand the quality of Team Green and hope to see you all in New York later this month. I will now turn the call over to the operator to open the line for Q&A.

Operator, Operator

Our first question is from Michael Hoffman of Stifel.

Michael Hoffman, Analyst

I could dig into growth and kind of walk through the pieces just to feel like I understand where we are, cadence. So really a good place, I get it, you made a comment in your script. What's the exit momentum? If you did 6.3 an average, what did you exit the quarter? How do I think about what I'm entering 2Q with?

Patrick Dovigi, CEO

Yes, Michael. So a lot of our base Q1 surcharges and pricing happens on Jan 1, right? So you really have a big January number that's starting that. And then if you looked at the guide on the normal cadence of what we were anticipating, you would have been ratably stepping down through the year just by virtue of the math. Now as we commented and intend to do, we think there's incremental pricing and surcharges that we need to go out and get after. And so if the normal cadence would have been a step down from the Q1 level to Q2 of sort of 50 to 70 basis points, I think the incremental price and surcharge that we're now going after is going to temper that stepping down. Still the expectation today, absent material net new pricing, is going to be a step down, but at a lower cadence than we would have previously anticipated.

Michael Hoffman, Analyst

So it's got a handle on it or very high 5, low 6.

Patrick Dovigi, CEO

I think that's exactly right in the way we sit today, Mike.

Michael Hoffman, Analyst

So volume is 3.1 excluding the MrF, and I understand that. You mentioned regional aspects. Is there a delay in the recovery pace for Solid Waste Canada? It's not to be dismissive, but people are observing that after a harsh winter, summer is almost here. Many are planning to return to the office in the fall because summer is so brief in that region. As a result, some of the potential benefits are still ahead of us, making the 3.1 even more significant.

Patrick Dovigi, CEO

I believe it's crucial to distinguish between urban markets and secondary markets. Secondary markets are returning to relatively normal levels. However, the major urban markets in Canada, including Vancouver, Edmonton, Calgary, Winnipeg, Toronto, Ottawa, Montreal, and Halifax, are still significantly below pre-pandemic levels. This situation is largely influenced by people returning to offices and resuming normal work schedules. These results reflect the impact of a complete shutdown in Canada during January due to Omicron, which caused a delay in recovery until February, with most restrictions lifted by the end of March. Presently, life in Canada is returning to normal, with restaurants and sporting events operating as usual. I completely agree that as we move into summer and fall, assuming there aren't any new waves and the Canadian government maintains its COVID strategy, which has been consistent, we can anticipate an increase in volume. This has already been observed in the Environmental Services sector, which we expected to rebound significantly after the January Omicron shutdown, specifically in late February and March. We are well-positioned for this growth and feel optimistic about the outlook, although we want to be cautious in our expectations given the unpredictable nature of developments. That said, we believe we are on the right track now and have made substantial progress.

Luke Pelosi, CFO

Michael, the other point on that, that I'd highlight is if you think about Q1 over Q1, Q1 '21 was negative 3.2% volume. And so here we are printing the 3.1% positive ex MrF. If you think about Q2 of 2021, I think it was plus 5% or plus 5% and change. So arguably a much tougher comp there. Our original guide contemplated being close to flat by virtue of that tougher comp. I think for all the reasons Patrick just said, we see upside to that number. But because of the math on the comp, I think it's going to be something less than what the print was in Q1.

Michael Hoffman, Analyst

If I could address the M&A, there were 21 deals, while you initially anticipated 25 to 30. I understand that Sprint is a significant part of this, with $200 million of the $300 million in revenues coming from Sprint and $100 million from the other 20 deals, 14 of which were quite small. Can you provide some insight into the sizes of the acquisitions in that portfolio? Additionally, have all the smaller acquisitions been fully integrated yet? I imagine Sprint will take around 90 days, but could you discuss the integration process?

Patrick Dovigi, CEO

Yes. So I think that's a good question that certainly is important to unpack the M&A. If you look at the 21 deals, like you said, Sprint is large and will be integrated between now, fully integrated between now and sort of August 1-ish. That's the timeline we have laid out. I mean obviously, certain parts of it like accounting, HR, that's moving over quicker, but fully integrated sort of by August 1. And then you have 15 deals that were smaller than $10 million of enterprise value, right? So very small, just little regional tuck-ins, generally hauling only, that tuck into our existing facilities to leverage our fixed cost base of transportation, recycling facilities, landfills. And then you have five between $10 million and $30 million. But that group of 20 acquisitions will be fully integrated over the next 30 to 60 days. It will be fully on our platform, and it will just run in the normal course. But nothing out of the ordinary, very simple spread through nine provinces in Canada and 26 states in the U.S. So not a lot for the team to take on.

Michael Hoffman, Analyst

And regarding the $300 million, how much of it is from the U.S. compared to Canada?

Patrick Dovigi, CEO

So yes, I mean of the total $300 million? About $240 million of it is in the U.S.

Michael Hoffman, Analyst

So that keeps the mix from shifting at all, right?

Patrick Dovigi, CEO

No.

Michael Hoffman, Analyst

And then lastly, on the RNG, there are so many developers now playing in this game. What are the chances since you've, I think, wisely are partnering? What are the chances you can negotiate where you put less capital up but get equal or better economics?

Patrick Dovigi, CEO

So that is certainly something that's available to us. I mean, as the developers are sitting on a lot of capital on their balance sheet, they're looking at finding ways to differentiate themselves. One way to differentiate themselves is by putting up capital. Obviously, we have the asset, which is the gas. So they have to find a way other than just saying, 'Hey, we know how to develop a site to be able to move forward with that.' So I think you'll see some of that as we share more details over the next couple of quarters, reaffirming that $115 million to $125 million of gas in the base case. Obviously, the incremental sites come on; that number is going to go up. We think internally the opportunity is there to probably grow that to somewhere between $150 million and $200 million. But we know what we're communicating today is sort of $115 million to $125 million, which we feel we have in hand. That's using fairly conservative numbers on the actual sale of the gas. And so all of that is well on track. It's coming online, and it's coming online in 2023 and 2024. We feel very comfortable with what we previously communicated. There's been no changes. So all that will progress nicely over the course of the next sort of 12 to 18 months.

Michael Hoffman, Analyst

And last one for me. Given the data you shared on your script, it feels like there's about $8 million of real cost impact from fuel. Will the fuel surcharge cover everything from this point forward, and then the rest of the year, you'll work at making up the $8 million?

Luke Pelosi, CFO

Yes, so Mike, that's right for Q1. I think you do have a timing lag when you look at the spike in diesel; March was the majority of it, and then the pace at which you can sort of recover. But when you peel it all back, I mean, we're viewing fuel as a meaningful opportunity for GFL. I think when you look at the industry, the mechanisms that are in place and tried, tested and true for recovering increased fuel cost, they exist. And we just have opportunity within our book to implement an incremental quantum of that among our total customer base. Today, we're probably recovering 40% to 50%. If you look at what best-in-class looks like, it's a much higher number than that. In addition, the actual fuel cost itself in managing the consumption. If you look at our fuel cost, I think in the P&L was sort of a mid-5% to 6% number. I think we have some of our peers in the industry with that number is sub 3%. Now that's a function of CNG and other measures. But again, are opportunities available to us. So we foresee the fuel in totality while there may be some noise from quarter to quarter this year is ultimately to be a great tailwind for GFL as we look toward what the profitability of this business can become. So yes, this year, there's a bit of a go get that we're chasing after. If prices stay where they are today, you probably have a $25 million to $35 million hole that you would have to get through incremental open market pricing or incremental surcharges that aren't there. Now we're confident in our ability to go out and execute that. When we give our updated guide in Q2, we'll have incremental perspective on what we think any hole would be. But I think on the dollars per side, you're covered; and then the question is how much of that margin impact can you overcome? And we're feeling quite bullish about what our opportunities that looks like.

Operator, Operator

Our next question is from Walter Spracklin of RBC Capital.

Walter Spracklin, Analyst

I wanted to touch on volume, looking ahead. In the U.S., we've moved past the reopening phase. Patrick, as you pointed out, it's well behind us in Canada, and in the U.S., volume has actually picked up. I spoke with one of your competitors who mentioned that even though the general perception is that industry volume is flat, larger companies have a chance to capture market share by investing in technology and providing better service. Do you agree with that perspective? Can we expect consistently higher volume in the future due to size and service compared to smaller competitors?

Patrick Dovigi, CEO

I think it's possible. I mean, I think we're seeing some uptake, particularly on the municipal side. As new tenders come out, municipalities have had some interesting experiences with some of the smaller players that probably haven't performed and have those labor challenges and equipment challenges. So we're seeing some opportunities certainly on that side. Obviously, on the C&I side, there's still recoveries to come in both Canada and the U.S. I mean, I don't think we're fully recovered. So yes, I think there's some certainly some opportunity; what that level is, I don't think it really moves much in the models, whether that's 50 basis points or 100 basis points; I don't think it's a material needle mover. But yes, I think there's opportunity certainly for the short term here that we're going to see some elevated numbers on the volume side.

Walter Spracklin, Analyst

And regarding the Green Infrastructure Partners, it presents a significant opportunity for you. Your shareholders are quite interested in that venture. How will we be able to track the progress of that roll-up strategy? Will you provide updates? Have they already started, or is this something that will ramp up more towards the end of the year? What is the anticipated pace of that roll-up strategy's progress, and how do you plan to inform us about its success?

Patrick Dovigi, CEO

Yes, we will provide annual updates on the business. I will address it every quarter, but expect a brief update every six months. Annually, we will give a comprehensive update. There are significant opportunities within that business, similar to when we previously owned it. We chose to invest in other areas within Environmental Services and Solid Waste, where you can see the funds we are allocating. I believe this will lead to a positive outcome for our shareholders. We are already active, engaging in discussions on six opportunities in that line of business. Many of the previous opportunities were set aside due to our focus on other prospects and considerations regarding leverage. However, in the private setting, we will put those funds to use. As a private company, we have access to various financing options that will reduce our equity requirements. Our plan is to eventually take this business public again. We have already begun preparations to drive progress in this area, which will unfold as usual.

Luke Pelosi, CFO

Walter, to clarify a point that Patrick made, while the company remains private, we will be using equity method accounting for our reporting. This means that on a quarterly basis, there will be certain disclosures; however, given its materiality to GFL as a whole, these may not provide the insights that people are hoping to see. As Patrick mentioned, we plan to offer a more comprehensive update on a semiannual basis in one of our investor presentations, allowing individuals to access information that goes beyond the financial statement disclosures, as the disclosures in isolation may not fully address the insights individuals are seeking.

Walter Spracklin, Analyst

And just a final question for me. Luke, you updated the guidance to reflect the mark-to-market of the M&A activity to date, but you didn't update the net debt guide for year-end; does that hold even with the updated M&A guidance? In other words, the fact that you didn't change it does consider and contemplate the M&A pace you've done? Or is that net debt also to be updated in the next quarter or when you do your more formal update later on?

Luke Pelosi, CFO

Yes, the net debt figure and leverage will need to be adjusted to account for the M&A activity. The guidance indicated a reduction in leverage from 4.75 to 4.25 based on no additional M&A. If there is more M&A, it may slow down the deleveraging process, but we can still achieve it due to strong free cash flow. Given the significant M&A we've accomplished early this year, it appears we will have another strong year in that area. Therefore, the ending leverage will differ from the guidance that assumed no M&A, although we remain committed to our overall deleveraging goals. By the time we reach Q2 and discuss updates, we will have a clearer picture of how the year unfolds, allowing us to refresh our expectations for year-end leverage.

Operator, Operator

Our next question is from Kevin Chiang of CIBC.

Kevin Chiang, Analyst

I just have a question on pricing. And most specifically, when you acquire, you made 21 acquisitions here to date. But when you acquire these businesses, what's the delta between the pricing we're getting in the market versus maybe what you find acceptable? Like are you finding that they're pricing similar to what you would be doing? Is there a negative delta there? And if it is the latter, just how quickly can you replace that book so that margins or the return on invested capital is where you want it to be on an acceptable level?

Patrick Dovigi, CEO

Sure. Yes. I mean, typically they are small, which is to put the larger ones. I think it's obviously bifurcated by customer base and what the contract structure is of the contracts that they have. But what history tells us is that we got most of the smaller ones. Particularly these, call it, 20 acquisitions that we did between $1 million and $30 million of enterprise value, typically don't have fuel escalators that work properly, typically aren't doing proper environmental surcharges. So there's definitely a good pricing opportunity within those books of business. And with our model, obviously, of integrating these within 30 days to close and putting them on our platform, that pricing will effectively take place within the first 60 days of the acquisition. So I mean, obviously, it's subject to the contract, but generally, that's what we're seeing today, that there is a very large pricing opportunity within those books just based on bringing surcharge levels to where they should be.

Kevin Chiang, Analyst

That was my follow-up question. Luke, you've mentioned the opportunity to implement some of these surcharge programs. Where do you think the gap is? Is it mainly from the recent deals you've made? To what degree do you believe the smaller players not actively applying these surcharges presents an opportunity? Or do you think there are also areas within your existing portfolio that you could improve given the current inflationary conditions?

Luke Pelosi, CFO

Kevin, it's across both those buckets. I mean, we were talking pre-COVID about the latent pricing opportunity in the legacy book, and a big component of that was tied to the surcharge program. And then as Patrick just alluded to, some of the recent M&A, while the books may be priced well, many don't have the surcharges at the levels to which is more customary in the industry. So when you look at what the art of the possible is here, I think there are some peers that are well established in this that cover dollar for dollar or maybe even more in certain respects. And we're probably at a position today where we're covering $0.45 to $0.50 on the dollar. With the timing lag, I think there's a real opportunity as we move forward to not reinvent the wheel but simply just to get to the place where a lot of our peers already are. I think that's an important consideration when you think about where the path for us looks as we go forward versus those that perhaps have already optimized their profitability in this regard.

Kevin Chiang, Analyst

Can you remind us again when you expect your base outlook for 2022? You're tracking it out on pricing. What did you assume regarding the underlying recovery? This may be more relevant for Canada, considering the challenges earlier this year. Are we past those challenges? What would your base level of recovery assumption be at this point? Can you provide an idea of how things might look post-Omicron, so we have a sense of potential offsets when you update the base business?

Luke Pelosi, CFO

Yes. So Kevin, I think certainly Q1 played out better than anticipated from a volume perspective in Canada. That was most prevalent in the Environmental Services segment, and we're delighted to see that recovery starting to materialize. I think it was Michael who often made the comment, 'Well, Canada, and now it's May; is it summer, should we therefore continue to sort of drag our feet until September?' And that's the sort of one unknown that we have because as much as we had this momentum; last night at the hockey game, people are out and enjoying the freedom once again, is there going to be continued to be just a delayed draw because we're finally entering into summer? So I think going back to my comment about our desire to reserve our update timing to when we speak in late July. The next couple of months will tell. We do think it is something better than what the guide was based on what we've seen thus far and what the next couple of months look like. How much that upside may be remains to be seen. What I'd say for Q2, specifically, and I alluded to this earlier, originally because of the strength of Q2 2021, we thought of this Q2 as sort of flattish. Where now, I think there's a path for Q2 to be sort of plus 100, 125 basis points, right, on volume. So that's the near-term look, but how it plays out for the year as a whole, I think we're asking to wait until we come back in July, and we'll have better visibility at that time.

Patrick Dovigi, CEO

We're feeling pretty bullish about what the rest of 2022 looks like from all perspectives. So I think it will be a favorable outcome given the trends we're seeing today.

Kevin Chiang, Analyst

Obviously, you are off on a strong note there. Congrats on a very good Q1.

Operator, Operator

Our next question is from Tyler Brown of Raymond James.

Tyler Brown, Analyst

I want to clarify that only 40% of your book currently has a surcharge mechanism. Patrick mentioned the scenario where new customers come on board without a surcharge at all. In those cases, we will introduce a surcharge, starting at a fixed, low amount for recovery, but it doesn’t have the flexible mechanism yet. Throughout 2021, we reported prices and surcharges together because many of those initial base level surcharges functioned similarly to a base price increase. Now, I credit Greg Yorston and his team for transitioning those to the appropriate flexible multiples that adjust as prices change. The initial step is to get something in place, and then we build from there. At present, we're recovering about $0.45 on the dollar within the Solid Waste business alone, while our Environmental Services sector has a natural sort of hedge. The opportunity lies in adjusting those existing surcharges to better align with market pricing.

Patrick Dovigi, CEO

Yes, I think you've wildly oversimplified it, but yes, that's why when I'm talking about the opportunity here, it's not like we need to go out and do something. As you said, this is a common practice. It just takes some coordination to get that all sort of in place. And so that is what the effort. But I think the pace at which we'll be able to pivot and recover incremental dollars will be impressive to folks. And that's why let's see how we can execute over the next couple of months and then hopefully come back with some good news when we speak in the next couple of months.

Tyler Brown, Analyst

And then on GIP, I just want to make sure that I have it all here. So number one, that transaction has fully closed. That happened in April. You got CAD 225 million for your contribution, and you retained about a 45% stake in the new entity. Is all that correct?

Patrick Dovigi, CEO

Correct.

Tyler Brown, Analyst

So now that GIP is fully funded and that COCO deal is closed, what is the pro forma EBITDA? And more importantly, what is the pro forma leverage so that we can kind of ascribe value back based on whatever multiple we think is appropriate, etc.

Patrick Dovigi, CEO

I would estimate the pro forma EBITDA for 2022 to be $190 million, with the pro forma leverage for the business typically around the mid-4s.

Tyler Brown, Analyst

It still is of EBITDA.

Patrick Dovigi, CEO

The average.

Tyler Brown, Analyst

Yes.

Patrick Dovigi, CEO

We're currently around $850 million to $900 million of debt.

Tyler Brown, Analyst

And then Luke, can you just kind of give the high-level pieces due to Solid Waste margin walk through m 31 to 29.9, just thinking about things like fuel, M&A, commodities, etc.?

Luke Pelosi, CFO

Yes. So Tyler, the walk this quarter is a little unique just based on what I'd call the anomalous margin profile of the prior period, right? And for the reasons I articulated in the prepared notes, the 31 was arguably 100, 150 basis points higher than it ought to be when you think about the normal seasonality cadence. That was a whole confluence of factors benefitting the margin profile of the Q1 2021. So if you think about it in the context that there's this sort of roughly 150 basis points of this anomaly component, you then walk through, and you have a 100 to 105 basis point drag from fuel pricing, offsetting that by commodities to the tune of roughly 85 basis points. And you have sort of a 30 basis point drag from acquisitions. So if you just look at those three pieces, you then are left with the delta of what I'd call the normal course underlying margin expansion from the overall operating leverage and pricing strategies of the business.

Tyler Brown, Analyst

Yes. That's kind of my line. So at a core level, margins were slightly up?

Luke Pelosi, CFO

Yes. I think in this inflationary environment to be able to do that's a real testament. It’s again like I know everyone’s reporting, and there might be some slight sort of pressure. But overall, I think it's a testament to the industry and the pricing available to it can more than cover the cost of inflation and drive margin. There may be a temporary timing difference in a quarter when fuel runs up in the last 30 days to sky-high levels from balance, actually, but when you peel it all back, the operating model and the operating leverage is there, driving underlying margin expansion by the strength and quality of pricing that's available.

Operator, Operator

Our next question is from Joe Revich of Goldman Sachs.

Joe Revich, Analyst

I'm wondering if you could just expand on your comments, Luke, on the landfill gas investments being ahead of plan. That's nice to hear. I think you spoke about one plant starting up in the first quarter of '23, another one in the second quarter. What's the updated timeline? And how quickly do we get to the full earnings run rate in those operations once they do commence?

Luke Pelosi, CFO

Yes, so Jerry, I think the original guide, you completed that we said that the capital deployment would be mostly in 2023. It looks like the pace at which these guys are moving, there'll be more opportunity to deploy that capital earlier in 2022. If there was originally going to be $20 million to $25 million, that number could be upwards of $75 million to $100 million within this year. Now that incremental CapEx with the incremental $90 million proceeds of disposal, we're still covered from a net CapEx number for this year. So no change there, but would just be sort of accelerating that path. Your comment about the first projects coming online in the first half of 2023, that remains accurate where we sit today. Now I suggested that everyone just think about that as coming online late 2023, just so we build in a little bit of buffer. But I think where we sit, it is a path for that to be earlier in the year, and we'll, therefore, enjoy the benefit of that free cash flow within 2023 instead of it just being a 2024 number.

Patrick Dovigi, CEO

Yes, we mentioned that we are targeting the largest CFM site to go live first. The goal is to have it operational by April. They have a three-month commissioning period that will fully optimize their models by mid to late June.

Joe Revich, Analyst

Can you share your thoughts on the differences between spot market and contract rates? It was encouraging to hear about some European offtake agreements in the mid-30s. I'm curious about how you see the offtake market developing, especially since there has been a positive trend in the spot market for both RINs and Henry Hub gas prices, which influenced your initial investment decisions. What are your plans regarding hedging versus term agreements?

Patrick Dovigi, CEO

Yes, I mean, again, we're not an energy company. So we're still of the mindset that we are going to enter into some long-term offtake agreements. We're being a little bit patient at the moment, just given the material moves in the voluntary market. And what I mean by the voluntary market is really just sort of large corporations that are focused on ESG type initiatives that are looking to significantly reduce their carbon footprints. So we're in negotiations and in talks with a lot of the voluntary market. We will float a certain amount. So we'll have some volatility with the rigs. But our model still internally is to fix 60% to 70% of the revenue stream coming out of those facilities. So we don't get the quarter-to-quarter volatility and have to explain to investors about why our cash flow estimates, etc., changed based on sort of where the wins are. I mean, it's a material amount of money. Like I said, we said with the initial ones, there's $115 million to $125 million of incremental sort of free cash flow. The reality is when you look at all the sites combined, that number can grow to easily $150 million to $200 million, and that's a material amount of money. From our perspective, you buy this for the stability of the industry, not to be energy traders. We plan on locking in a significant amount of that cash in terms of long-term contracts.

Joe Revich, Analyst

And Patrick, is that market developing? I think it's in the early stages of ramping, at least people's willingness to take long-term deals. Can you comment on how that market is developing?

Patrick Dovigi, CEO

Yes, the market has changed significantly in the last eight to nine months since we began discussing it. From our perspective, rates have increased, as they should have with the rise in RINs. Looking ahead, RINs are projected to decrease slightly next year, but that doesn't have much of an impact. It's really about protecting against potential losses while benefiting from some gains. The new long-term agreements will include a floor price, and we'll share in any upside beyond a specific threshold, which is currently under negotiation.

Joe Revich, Analyst

And then just to shift gears, Luke, I know with your accounting systems, you have really good visibility on inflation in real-time basis. I'm wondering if you can comment on what was the inflation cadence year-to-date and any differences between U.S. and Canada? And any signs of potential moderation based on what you're hearing from your purchases outside of diesel, of course.

Luke Pelosi, CFO

Yes. I mean, obviously, the diesel component has really skewed everyone in sort of Q1. But if you take that out of the mix, I mean, at the end of the day, labor is really what's driving. As we've said throughout last year, it remains true today. We've seen it less in Canada versus U.S., as much as the secondary market versus the primary market. In the dense urban areas, we've seen greater wage inflation than we have in our sort of secondary markets. I think that's tempered the impacts on our business versus what it otherwise may have been. As expected, Q1 was a high number; I think all in, it was low 6s in terms of the wage inflation. But that is based on the comp of Q1 2021. I think more telling is the rate of acceleration sequentially from the prior quarter, which was sub-50 basis points, right? If you look through our 2021 quarter-over-quarter, you had 200 to 300 basis point increases as we felt the pinch. Now we're starting to lap all of that. I think Q1 was the peak; Q2 will still be elevated. But as you get into Q3 and beyond, I think at the current pace, you're going to see those sequential decreases significantly reduce and therefore be in a path where we could end the year where probably a little bit higher if the original guide for the year was sort of 4, low 4s. You're probably a little bit higher than that, but you're going to see the pricing respond to, again, more than cover....

Operator, Operator

Our next question is from Hamzah Mazari of Jefferies.

Unidentified Analyst, Analyst

This is Tom Hoffen filling in for Hamzah. Could you comment on how much of your business is indexed to CPI and how those contracts are structured? Additionally, what is the performance of the CPI book compared to the open market?

Luke Pelosi, CFO

Yes. So about $1.1 billion, $1.2 billion of the book of business in terms of revenue is tied to CPI linked. That's spread across just 800, 900 contracts, most of which are in residential collection. We also have other post-collection ones linked to that. The resets of that book of business have been roughly 40%, 45% in Q1, 25%, 30% in Q3 and then the balance is sort of spread between Q2 and Q4. The reset mechanisms can be based at the point in time. Many of them are based on a reading sometime before the contract reset. So in January 1 pricing may actually be based on what the levels were at June 30 of the prior year, for example, and that's often set up that way, so municipalities have visibility into what their sort of upcoming budgets look like. If you think about that book normally running at a sort of blended 2% number, you're seeing that book today more at a sort of 4% to 5% number. Certain contracts are now resetting that are tied to meaningful components on diesel at much higher rates than that. A lot of it is still lagging the current inflationary environment. So I think in reality, the real benefit on that book of business will only be realized in earnest by 2023. So we're happy with where it's going; there's still a lag but we just view that as opportunity and upside as we go forward from there.

Unidentified Analyst, Analyst

And then could you just comment a bit on labor turnover, like sort of what you're seeing there? I guess, the assumption on labor inflation for the year?

Luke Pelosi, CFO

Yes. So labor turnover in Q1, you've got to remember there's a meaningful seasonality component of what we're seeing. Versus the comps of last year, there have been meaningful improvements for sure. Q2 and Q3 is really where the story will be told. I think the material friction that was being experienced in the peak of last year has definitely subsided. We're going into the busiest season with a much better turnover rate and complemented drivers that we think positions us far better for success than what we experienced in the second half of last year. As we've said, it's really sort of May through July that will really sort of tell the tale. We're feeling good. Because when we come back and speak to you at the end of Q2, we'll have better perspective on exactly how it's playing out. On the labor inflation rate, I think I just provided that color in the previous question.

Operator, Operator

We have no further questions. So I'll hand back to our hosts for their closing remarks.

Patrick Dovigi, CEO

Thank you, everyone, for joining the call, and looking forward to seeing everybody at Investor Day in New York. And for those not attending, we look forward to speaking to you after our second quarter. Thanks very much for joining.

Operator, Operator

That concludes today's call. Thank you for joining. You may now disconnect.