Earnings Call Transcript
Waste Connections, Inc. (WCN)
Earnings Call Transcript - WCN Q4 2022
Operator, Operator
Good morning, and welcome to the Waste Connections Fourth Quarter Earnings Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. Now I'd like to turn the call over to Mr. Worthing Jackman. Please go ahead.
Worthing Jackman, CEO
Thank you, operator, and good morning, everyone. I'd like to welcome everyone to this conference call to discuss fourth quarter results and our outlook for both the first quarter and full year 2023. I'm joined this morning by Mary Anne Whitney, our CFO and several other members of senior management. As noted in our earnings release, Q4 topped off an extraordinary year for Waste Connections, highlighted by continuing outperformance during the period and providing a higher entry point and enhanced visibility for 2023. Strong operational execution and over 10% solid waste pricing along with acquisitions closed during the period, once again, provided for better than expected results. We more than offset inflationary pressures and commodity-related headwinds to expand adjusted EBITDA margin by 30 basis points, excluding the margin dilutive impact of acquisitions completed since the year ago period. Looking at the full year, double-digit percentage growth in both revenue and adjusted EBITDA along with adjusted EBITDA margin expansion, excluding the impact of acquisitions, continued to differentiate our results. We overcame elevated wage, fuel and inflationary pressures and a 70% drop in recycled commodity values in the second half of the year, with an acceleration in pricing during the year, providing momentum for higher core pricing in 2023. Acquisition activity during the year also outpaced expectations for a total of approximately $640 million in acquired annualized revenues, which along with activity year-to-date, already provides acquisition contribution of 5% in 2023 with additional dialogue ongoing. In short, tremendous operational execution in 2022 has provided outside visibility for double-digit top line growth along with adjusted EBITDA margin expansion in 2023, with upside from any improvement in recovery commodity values or inflationary pressures, as well as incremental acquisition activity during the year. Before we get into much more detail, let me turn the call over to Mary Anne for our forward-booking disclaimer and other housekeeping items.
Mary Anne Whitney, CFO
Thank you, Worthing, and good morning. The discussion during today's call includes forward-looking statements made pursuant to the safe harbor provisions of the US Private Securities Litigation Reform Act of 1995, including forward-looking information within the meaning of applicable Canadian Securities Laws. Actual results could differ materially from those made in such forward-looking statements, due to various risks and uncertainties. Factors that could cause actual results to differ are discussed both in the cautionary statement included in our February 15th earnings release and in greater detail in Waste Connections' filing with the US Securities and Exchange Commission and the securities commissions or similar regulatory authorities in Canada. You should not place undue reliance on forward-looking statements as there may be additional risks of which we are not presently aware or that we currently believe are immaterial, which could have an adverse impact on our business. We make no commitment to revise or update any forward-looking statements in order to reflect events or circumstances that may change after today's date. On the call, we'll discuss non-GAAP measures such as adjusted EBITDA, adjusted net income attributable to Waste Connections on both a dollar basis and per diluted share and adjusted free cash flow. Please refer to our earnings releases for a reconciliation of such non-GAAP measures to the most comparable GAAP measures. Management uses certain non-GAAP measures to evaluate and monitor the ongoing financial performance of our operations. Other companies may calculate these non-GAAP measures differently. I will now turn the call back over to Worthing.
Worthing Jackman, CEO
Thank you, Mary Anne. First off, I'd like to recognize and applaud the efforts of our local teams, whose execution most notably over the past few years in the face of arguably the most challenging operating environment has continued to drive differentiated results. In 2022, our 25th anniversary year, we once again demonstrated two hallmarks of Waste Connections; sustainability and sustaining ability. There should be no trade-off between the two. As noted earlier, we're extremely pleased with our strong operating and financial performance in Q4 and throughout '22 as we overcame elevated wage, fuel and inflationary pressures and a 70% drop in recycled commodity values to drive adjusted EBITDA margin expansion, excluding acquisitions in the year. In 2022, we also delivered pricing of 9.2%, more than 200 basis points above our initial outlook and about 85% of which wasn't core price. Moreover, given the acceleration of pricing during the year, the lagging benefit of higher CPI resets and a strong start to the New Year were already set up for pricing to increase sequentially by about 100 basis points from the fourth quarter to 11.5% in Q1 and to average about 9.5% in 2023, essentially all in core price. We delivered adjusted free cash flow of $1.165 billion in 2022, up over 15% year-over-year on CapEx of $913 million up 23% year-over-year, reflecting a purposeful step up in CapEx during the year for opportunistic real estate purchases. Net of asset sales, CapEx was about $30 million above our outlook in spite of ongoing supply chain constraints for fleet and equipment. As noted in our press release, we've been navigating the uncertainties in manufacturer delivery timing, and now expect to take delivery of an additional $50 million in fleet in 2023 that was originally expected in 2022. Our 2022 CapEx also included about $75 million for sustainability related projects, which was about $25 million less than we originally had expected, primarily for the two R&D facilities and two recycling facilities we've previously discussed that will total about $150 million once completed. Our 2023 sustainability CapEx is expected to be up from 2022 due to the timing of some of the expected 2022 outlays that drifted into this year, as well as the expected initiation of development of an additional large R&D project at a recently completed acquisition. As we have described previously, these R&D facilities are strategic investments with attractive paybacks at range of values for recovered resources. With the additional project noted, our aggregate capital outlays for owned R&D projects are now approaching $200 million between 2022 and 2025. These projects, along with over a dozen others we've partnered on, are conservatively estimated to generate an incremental $200 million of EBITDA in 2026 or about $1 of EBITDA per dollar of CapEx. Provisions in the recently promulgated Inflation Recovery Act would further enhance expected returns and could provide tax-related benefits as soon as 2023 as one of the new plants is scheduled to be online and start contributing in the second half of this year. As we have consistently emphasized in our approach to ESG, these projects are integral to our business, consistent with our focus on value creation and additive to our growth strategy, not something in lieu of acquisitions. Looking next to acquisitions, in 2022, we closed approximately $640 million in annualized revenue. We completed 24 acquisitions all in solid waste and spread across the US and Canada, in both franchise and new competitive markets, including integrated markets, new market entries, and a number of tuck-ins to existing operations. This robust activity in 2022 capped six consecutive outsized years RAC acquired annualized revenue, totaling over $2.1 billion since 2017, and we've had another strong start to the year in 2023. As always, we maintain a disciplined approach to market selection, the risk profiles we accept and evaluations we determine to be appropriate. Since year end, we've closed another integrated West Coast franchise with over $35 million in annualized revenue, which along with the rollover contribution from deals completed in 2022 already provides for 2023 acquisition contribution of over 5%. Continued dialogue sets up the potential for another outsized year of activity for which we remain well positioned, having entered 2023 with leverage below three times, in spite of acquisition outlays of over $2.3 billion during 2022. Our balance sheet strength and free cash flow profile provide flexibility for continued elevated levels of investments in our organic solid waste growth strategy, along with renewable energy projects and solid waste acquisitions, while also increasing our return of capital to shareholders. In 2022, we returned $668 million to shareholders through dividends and opportunistic share repurchases, up nearly 20% from the prior year, and we invested over $3.2 billion in CapEx and acquisitions for future growth. Now I'd like to pass the call to Mary Anne to review more in depth the financial highlights of the fourth quarter and provide a detailed outlook for Q1 and full year 2023, all then wrap up before heading into the Q&A.
Mary Anne Whitney, CFO
Thank you, Worthing. In the fourth quarter revenue of $1.869 billion was $24 million above our outlook and up $245 million or 15.1% year-over-year. Acquisitions completed since the year ago period contributed about $153 million of revenue in the quarter or about $150 million net of divestitures. Total Q4 price of 10.6% included 9% in core price, which stepped up sequentially by 70 basis points from Q3. Reflecting our highest levels in 2022, Q4 total price ranged from about 6% in our mostly exclusive market Western region to between about 11% and over 13% in our competitive markets. The pricing acceleration in competitive regions during 2022 along with the lagging benefit from higher CPI linked market increases in '23 positioned us for about 9.5% total price in 2023, essentially all core, with over 75% of that pricing already largely in place at this time for now. Solid waste volumes in Q4 were down 1.7%, excluding 80 basis points from the final quarterly impact from the purposeful non-renew renewal of two municipal contracts noted throughout 2022. Volumes were in line with our expectations in spite of the severe winter weather in late December. Looking at year-over-year results in the fourth quarter on a same-store basis, commercial collection revenue was up 14%, mostly due to price, roll-off polls per day were about flat with revenue up 9% and landfill rates per ton were up about 7.5% on daily tons, down about 2% with MSW and special waste each down 3% to 4%, partially offset by higher C&D waste up 7%. And finally, E&P waste revenue of $53 million was in line with the prior quarter and up more than 50% year-over-year. Looking at Q4 revenues from recycled commodities, excluding acquisitions, recycled commodity revenues were down about 70% year-over-year, about as expected due to the precipitous decline in values since July, which has continued through November. Prices for OCC or old corrugated containers declined about 60% sequentially from Q3 to average about $56 per ton in Q4. OCC pricing has been relatively stable since November in the range of $55 to $60 per ton with some recent indications of improvement. Finally, looking at year-over-year landfill gas sales and renewable energy credits for RINs, landfill gas revenues were up nominally in Q4 with lower RIN values offset by higher values. RIN values averaged about $2.65 in Q4 and have since declined to levels around $2. Adjusted EBITDA for Q4 is reconciled in our earnings release was $564 million up 13.8% year-over-year and about $11 million above our outlook, driving adjusted EBITDA margin of 30.2%, a 20 basis point beat to our outlook. Margin in the quarter was up 30 basis points year-over-year, excluding the impact of acquisitions, as we more than overcame the toughest quarterly comparisons, including almost 150 basis points in headwinds from lower recycled commodity values. Moving to full year adjusted free cash flow; we converted over 52% of adjusted EBITDA to adjusted free cash flow above our outlook at $1.165 billion or 16.2% of revenue. We over-delivered in spite of an incremental $30 million in CapEx as we opportunistically made certain real estate purchases during the year. As Worthing noted, our 2022 CapEx is also noteworthy for what it doesn't include, that is about $50 million in fleet due to manufacturer delivery delays, as well as about $25 million in sustainability-related outlays, all of which were expected in 2022 and are now included in our outlook for 2023 CapEx. I will now review our outlook for the first quarter and full year 2023. 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 state harbor statement and filings we've made with the SEC and the Securities Commissions or similar regulatory authorities in Canada. We encourage investors to review these factors carefully. Our outlook has assumed no change in the current economic environment. It also excludes any impact from additional acquisitions that may close during the remainder of the year and expense of transaction-related items during the period.
Worthing Jackman, CEO
Looking first at the full year 2023, revenue in 2023 is estimated at $8.05 billion. For solid waste, we expect pricing of about 9.5%, essentially all core and volumes in the range of flat to down 1%, plus about $360 million of estimated revenue in 2023 from acquisitions already completed and E&P waste activity and values for recovered commodities assumed in line with recent levels. Adjusted EBITDA 2023, as reconciled in our earnings release, is expected to be approximately $2.5 billion for about 31.1% of revenue, up 30 basis points year-over-year in the face of approximately 100 basis points in headwinds from recycled commodity and RIN values. Said another way, adjusted EBITDA margin guidance is up 130 basis points year over year, excluding those two commodity drags. Any moderation in inflationary trends, increases in the values for such recovered commodities or E&P waste activity or additional acquisitions closed during the year, would provide upside to our 2023 outlook. To be clear, our outlook does not assume any improvement in recycled commodity values from earlier this year, which for instance, would add $10 million in annual revenue for every 10% move in price levels, or in RIN values, which would add approximately $5 million in annual revenue for every 10% move in price levels, both of which have very high flow through. We're encouraged by the improvement we're hearing about in February for recycled commodities with prices in some markets reported to already be up more than 10% from recent lows. That said, we have not factored any such pickup into our outlook. Interest expense is estimated at approximately $255 million, and our effective tax rate for 2023 is expected to be approximately 22% with some quarter-to-quarter variability. Adjusted free cash flow in 2023, as reconciled in our earnings release, is expected at $1.225 billion on CapEx of $925 million, including $50 million in delayed fleet delivery in the prior year as noted earlier. We also expect about $30 million in asset sale proceeds primarily associated with excess facilities we've either replaced or exited. Given the expected timing of CapEx and other outflows this year, adjusted free cash flow is expected to start the year relatively lower in Q1 and ramp higher in the subsequent quarters.
Mary Anne Whitney, CFO
Turning now to our outlook for Q1 2023, revenue in Q1 is estimated at approximately $1.895 billion. We expect price plus volume growth for solid waste of 10.5% on pricing of about 11.5% and E&P waste revenue of approximately $45 million, reflecting typical seasonality. Recovered commodity values are expected to remain in line with recent levels. Adjusted EBITDA in Q1 is estimated at approximately 30% of revenue, or $568 million in what sets up as the toughest quarterly comparison in 2023 for recycled commodities and RINs. Depreciation and amortization expense for the first quarter is estimated to be about 13.2% of revenue, including amortization of intangibles of about $38.5 million or $0.11 per diluted share net of taxes. Interest expense, net of interest income is estimated at approximately $67 million, and the tax rate is estimated at about 22%. And now let me turn the call back over to Worthing for some final remarks before Q&A.
Worthing Jackman, CEO
Thank you, Mary Anne. Our results in 2022 and positioning into 2023 are testament to the culture of accountability that has been the cornerstone of Waste Connections' 25-year history of outperformance and value creation. We are proud of our accomplishments in 2022 and grateful for the commitment of our over 22,000 employees whose tireless efforts positioned us not only to overcome the challenges of 40-year high inflation, compounded by dramatic drop-off in recycled commodity values during the year, but also to emerge a more cohesive and resilient team. Moreover, their efforts have positioned us for double-digit revenue growth, along with the adjusted EBITDA margin expansion in 2023 with industry-leading free cash flow conversion. And to be clear, that's all without any assumed improvement from multi-year low recycled commodity and RIN values, causing an expected 100 basis point margin headwind. We're encouraged by indications that we may already be off those lows and look forward to realizing upside from sustained improvement in these recovered commodities, as well as any moderation in inflationary pressure or additional M&A activity, again, sustainability and sustaining ability. We appreciate your time today. I'll now turn this call over to the operator to open up the lines for your questions.
Operator, Operator
Thank you. We'll now begin the question-and-answer session. First question will be from Jerry Revich, Goldman Sachs. Please go ahead.
Jerry Revich, Analyst
Good morning. I wonder if you folks can just expand on the margin cadence implied by guidance. So just looks like, with the first quarter outlook you're setting up to be exiting the year with margins up, call it 80 basis points year over year in the fourth quarter and seasonally adjusted margin rate that's closer to 31.5%. And I'm wondering, as we think about what '24 might look like, it looks like you've got some natural momentum even before thinking about what commodity prices do to drive a year of outsized margin improvement in '24. I'm wondering if that cadence is consistent with how you're thinking about the flows.
Worthing Jackman, CEO
Well, I'll start with the '24 observation and hand it off to Mary Anne for the quarterly progression in the year. But I think you're right with regards to '24, as much as we said this year is an outsized margin expansion year, excluding the headwinds from recovery commodities, obviously they have a 100 basis point headwind and guide up 30 basis points, it means the underlying is up 130 and we typically talk about being up to a targeted 20 basis points to 40 basis points, not 130 basis points. If you move into next year, again, you've got the franchise markets printing, pricing for next year, office CPIs we're seeing during the year this year by mid-year and so obviously the pricing within the franchise markets should stay in that 6% plus or minus range. We're printing seven this year as inflation moderates into next year, if inflation does average like the pundits think three to 4%, what you're seeing next year in the franchise markets is really more of the recapture of what we couldn't get in '22. So that becomes an outsized year. And again, as you know, within our overall pricing structure, we typically exceed CPI by about 150 basis points or more. And so, next year should stay that combined with, again, improving recycling values if it steps up during the year, should provide for another above-average margin expansion for the full year above the typical 20 basis points to 40 basis points, now with regards to the flow during the year.
Mary Anne Whitney, CFO
Sure. Thanks Worthing. So Jerry, when you think about the flow during the year, I think that the most instructive way to come about it is to look at what the headwinds do. And if you look at that 100 basis point headwind over the course of the year from recycled commodities and RINs, it's heavily weighted to the first two quarters. So if you have about 150 basis points headwind of each of the first two quarters, that gets about cut in half in Q3 and essentially goes away by Q4. If you just played that through, you can see how, to your point, you'd have the toughest comparison earliest in the year, and we've already guided to Q1, which by the way, pretty similar to the way we guided Q4. And then you'd see the improvement, you'd see the ramp over the course of Q1 to Q4 of course with the overlay of seasonality and your highest reported quarter still being Q3 would be the likelihood could be, the cadence there is Q3, Q2, Q4, Q1 in terms of seasonality. But the most important thing, I think about '23 is the headwinds diminishing over the course of the year, even before we see any improvement.
Jerry Revich, Analyst
Super. Thank you. And can I just shift gears a little bit, talk about R&D, since your last public comments, the EPAs rollout of RINs and overall framework really essentially blesses R&D as an effective biofuel and with that context, I'm wondering if we could talk about what number of sites that you folks have that don't currently monetize gas in the plan could ultimately over time if you get permitting, etc. monetize gas at economically viable levels. And, separately, obviously lots of details to be worked out on RINs, but I'm wondering if you'd be willing to share how much energy your gas to electric facilities are generating adjusted for your ownership position?
Worthing Jackman, CEO
I think you almost answered your own question when you asked it, as there are still many details to work out. Our current stance on eRINs is to wait until the final rules are established this year before making any hypothetical comments. Anything we might say now would just be speculation. Clearly, eRINs offer options for the projects we have in progress as we compare one RNG approach to another, but it is still unclear who will actually own the eRINs in relation to the OEMs and generators. Therefore, we believe it is best to wait for the final rules to be announced before we comment further.
Jerry Revich, Analyst
Fair enough. Worthing, I'm wondering, you just comment on the number of facilities part of the question. So what's not monetized yet within your footprint in terms of number of facilities that could get monetized?
Worthing Jackman, CEO
Well, we currently have electric generation facilities at 17 of our sites.
Operator, Operator
Thank you. Next question will be from Toni Kaplan, Morgan Stanley. Please go ahead.
Toni Kaplan, Analyst
Thanks so much. Wanted to ask about volume, you have the expiring contracts running through in '22. So that was an impact there, but it did seem that volume is getting progressively softer. You did have some tough comps but wanted to talk about sort of, is it price discipline or is it the special waste that you called out last quarter or something else? It seems like you are implying a little bit of benefit or improvement I should say in '23. So, just wanted to ask about it and really just the normalized level, I know the expiring contracts are sort of rolling off, so that'll help.
Worthing Jackman, CEO
Yeah, we think about this industry as more of a kind of a plus one minus one type volume industry. Obviously, it's a big more of a fixed price service based business. Episodically, whether it be through special waste or new contract wins that could push volume above the 1% episodically within gravitational pull kind of brings it back within that range. Obviously last year we talked about the purposeful shedding of two contracts that pushed reported volumes below the negative 1%, but we said, hey, adjusted for that, it's, it was still staying nicely between net zero and negative one. And we look at this year as likely, another year of zero to negative one. Episodically, there may be a couple things that do drive us above zero into the positive on any one quarter, but we'll wait to see how the year plays out on that. The important thing obviously in this environment is price. The important thing is core price. And that's why we're pleased that the 9.5% and core price are regarding to for the year.
Mary Anne Whitney, CFO
And the only thing I'd add to that, Toni, would be that, we'd say there's really been no change, no discernible change in any of the trends we've seen. If you think about it, roll off polls have been in that flat to kind of up a point or two landfill volumes have been flattish to down a little bit all year long. I look at January numbers, they're not materially different. Maybe January's a little better than December was. There's always a little noise in the winter, but the key is that, that we haven't seen any market change really for the last year or so.
Toni Kaplan, Analyst
Great. And I was hoping you could talk about your sustaining ability within sustainability. My question really is, do you see sustainability as being a bigger part of your strategy in the future? I know you gave the EBITDA benefit and the CapEx, but just broadly, I guess maybe just talk about your differentiators versus peers in the sustainability area?
Worthing Jackman, CEO
We've always emphasized that our sustainability efforts have been integral to our identity for the past 25 years. Recently, we've begun to communicate more about these initiatives and share our story. I believe we're improving our transparency regarding our activities over the years. Our perspective on investment in sustainability balances projects we own with those we partner on, and we've discussed the dollar-for-dollar return of EBITDA for capital expenditures deployed overall, which remains consistent with our values. Our conversation around sustainability serves to remind everyone that sometimes priorities shift from execution to long-term sustainability promises and their potential benefits. We're proud to highlight our continuous efforts in both current operations and how our team has faced some of the toughest operating environments in recent years. We are pleased to reflect on these achievements. And so I think we've over 25 years, if you want to define standing ability, I think it's that performance you've seen over 25 years, and hopefully that pendulum that swings from execution to sustainability and really swung hard to the sustainability side from just a conversation on the market. Hopefully that's drifting back more to a more balanced view of both execution and sustainability. If people can hear us we're calling the operator to check in on what's happened to the call, but can't hear anyone. That's interesting. Well, I could ask myself questions and we could. I could interview myself. Yeah, we're trying to correct this. They can hear us. Evidently, we can't hear them.
Operator, Operator
Pardon me, this is the operator. Are you ready for your next question?
Worthing Jackman, CEO
Yes, Nick, thank you. If you could let the next question come through.
Kevin Chiang, Analyst
Thanks and good morning. I’d like to discuss the M&A pipeline. I've noticed that the average size of deals has steadily increased over the past few years, particularly seeing a significant jump in 2022. I wonder if we should anticipate another large year in 2023. Has the composition of the pipeline changed at all? Are there larger companies available for sale? Is the pipeline expanding in terms of what you would consider a tuck-in acquisition? This would be interesting to examine given the trends we've observed regarding average deal size in recent years.
Worthing Jackman, CEO
Sure, and you're right, Kevin, there been some, what I would call more outsized transactions, companies with $50 million, $60 million, $80 million or $100 million type revenue profile. But you look, an average year for us is 15 transactions to 18 transactions that might be two to four new market entries between, $20 million and $40 million of revenue. And it might be 10 tuck-in or 12 tuck-in or kind of market expansion acquisitions that could be as low as $1 million or $2 million or as high as, $5 million or $8 million. It's just that the combination of those 15 transactions to 20 transactions typically has gotten us to an average of about $150 million right? It's just when a, when we do have a year of 24 acquisitions with a good handful of them being, $50 plus million in revenue, that's what really drives the number to $640 million. If you look at the pipeline right now, I mean, it's still what I would call middle of the fairway. You know, we're $20 million to $40 million it's considered a large transaction. And there's a lot of fives and tens in there as well. There's nothing that's, you know, what I would call outsized, but we never say average. It's early in the year, right? But no, the average profile of what we're targeting is no different. It's just sellers of great businesses pick the time to sell and it's just, you've seen more people come to market or are finally after 20 years or 30 years of dialogue decide to say, Hey, it's time to sell the transaction. Earlier this year, again, $35 million fully integrated franchise in the west coast again, right in the sweet spot of that $20 million to $40 million.
Kevin Chiang, Analyst
Perfect. That's super helpful. And maybe just a second one for me, just a clarification, you talked about the potential upside with the IRA just confirming it doesn't sound like you're assuming any of that in your, I guess in 2023 numbers or even your longer-term kind of return profile on these investments in R&D. It sounds like that would be upside to the numbers you provided in your prepared remarks.
Worthing Jackman, CEO
That's correct. We have an investment tax credit that we can utilize for the plant we are bringing online in the latter half of this year. Mary Anne mentioned it could lead to approximately $10 million in cash tax savings this year, and it might even be more, but we will need to see how everything unfolds. This will likely be our first experience with the investment tax credit, and we are observing how the process develops. However, this figure is not included in our estimates. Clearly, it would enhance our free cash flow and lower the net invested basis for that plant. Additionally, regarding eRINs, we have not factored in any expectations in our projections as we await the finalization of that rule.
Kevin Chiang, Analyst
Perfect. Congrats on a very strong 2022 there.
Walter Spracklin, Analyst
Thank you for your understanding regarding OCC. It poses a significant challenge for analysts who must account for varying levels of conservatism in management teams' estimates. Is it accurate to say that the 10%, which corresponds to a $10 million revenue, also applies to EBITDA? Presumably, that would flow directly to the bottom line, correct?
Mary Anne Whitney, CFO
Yes, it's fair to say that, as we said in the prepared remarks, very high flow through on both OCC and RINs. Yes.
Walter Spracklin, Analyst
Okay. So that's great. And then on acquisitions, when you're buying a lot of companies, it was indicated by one of your peers that sometimes they come with some assets that are in areas that you may not necessarily want to be in or is more difficult to operate in and it's leading to some asset sales by one of your peers. Is that something that you're finding as well? Would you consider kind of pruning or swapping? Would you be buying assets that competitors are selling in markets where perhaps they're smaller and your larger and vice versa? Is that something that you see a possibility as doing? Or are most of your acquisitions in areas you want to be and kind of build up in that area?
Worthing Jackman, CEO
Yes. When we think about the types of companies we are acquiring, they usually operate within a single market. This means we are not dealing with multi-state operations where we favor two states but not the third, for example. Therefore, with the companies we are considering, there is typically nothing that needs to be divested. Occasionally, they might come with a problematic municipal contract that we would need to evaluate, and we would remain neutral about keeping or letting it go. However, this does not involve a broad geographic exit.
Operator, Operator
Thank you. Next question will be from Noah Kaye, Oppenheimer.
Noah Kaye, Analyst
Maybe give us a picture on the labor front. When we start to lap these high single-digit rates of labor pressure flowing through the P&L, how would that play into the margin outlook that you've outlined for the back half and some of the expectations that you outlined for 2024?
Worthing Jackman, CEO
Sure. I would say that wage rates are currently in the mid to high single digits in terms of overall pressure. Wage pressures in the service sector are likely to be more persistent compared to those affecting software engineers and others who have been laid off, as seen in recent headlines. We consistently price above these wage pressures. The positive news about labor is that as we progress through Q4, employee turnover has improved month-to-month. This year, Q4 was one of our strongest periods for new hires. The pressure on wages over the past two years, which was primarily due to hiring difficulties, is now easing as the scale of new hires aligns better with the existing wage structure. Consequently, we're seeing more typical and normalized wages. Most of the wage adjustments we planned for the year are already in place, and we'll maintain them for now. However, if inflation decreases as we move into 2024 and turnover and retention continue to improve, I anticipate that wage pressure will reduce to the mid to low single digits as we enter 2024.
Noah Kaye, Analyst
That's great color. And I'm sure others will ask about some specific guidance items, but I just want to ask, what is the actual sustainability CapEx budget for 2023 since you mentioned some shift in the timing?
Mary Anne Whitney, CFO
As we indicated, a portion did shift from 2022 to 2023. Initially, we planned for $150 million to be allocated as $122 million and $50 million in 2023, but that has adjusted to approximately $75 million to $85 million for 2023 due to the new project.
Noah Kaye, Analyst
Okay, please go ahead, Worthing.
Worthing Jackman, CEO
As you can see with the total we discussed for RNG and the two recycling facility plants, as the capital expenditures decrease through '25, the capital expenditures as a percentage of revenue will also decline. At that point, the conversion of free cash flow to revenue will start to approach 16.5% again. Furthermore, if you consider the contribution from the renewable fuel plants by '26, that will structurally increase free cash flow generation to about 17.5% of revenue by '26, contributing an additional $200 million or so.
Operator, Operator
Next question will be from Tyler Brown, Raymond James.
Tyler Brown, Analyst
Mary Anne, did I hear you right, but at this point, 75% of your pricing is already set for '23. And if that is right, doesn't that feel a bit more visible at this point in the year, would that be fair?
Mary Anne Whitney, CFO
That is. It's a great point, Tyler. So typically coming into the year, by the time we report Q1, we're in the position to make a statement like that, that 75% plus is either in place or is known because it's linked to a CPI adjustment, which has a look-back period. And this year, we're that much further ahead because of the nature of the price increases in '22. So if you think about it, there are a few different buckets that contribute to the 75% that's known or in place. One is the rollover contribution from PIs done last year, which, of course, accelerated over the course of the year. The next piece is the CPI-linked contracts, which as we've talked about, step up from 5% to 7% in 2023. So that piece is known. And then the final piece is what we've already put in place with our typical early approach to pricing, which was no different this year. We hit it hard doing the vast majority of our price increases in January this year. And so the combination of those 3 buckets really is what gets you to about 75%, as we described it already known or in place.
Tyler Brown, Analyst
Yes. Perfect. Okay. That's very helpful. And then can we quickly re-walk the Q4 margin? I think margins were down 30 basis points. I think you said 150 basis point headwind in commodities. But how much specifically from M&A and maybe some fuel impacted margins? Can you just go through those really quick?
Mary Anne Whitney, CFO
Sure. So the pieces are that there was a 60 basis point drag, 6-0, from acquisitions, which is why we made the point that it was up 30 basis points year-over-year ex acquisitions. And that was in the face of fuel was about a 60 basis point headwind and recycled commodities were about 150 on their own.
Tyler Brown, Analyst
Do you have a hedge position in your fuel? How does that affect next year? I'm assuming that's included in the guidance. When we look at the margin walk for 2023, you mentioned a 100 basis points impact from commodities, but what about fuel? Also, what impact did M&A have? It seems like you acquired some well-integrated companies in 2022, so is that not as significant of a concern?
Mary Anne Whitney, CFO
Yes, the situation is easier to understand this year. There were no significant negative effects from acquisitions throughout the year, mainly due to the type of assets acquired in 2022 and the focus on disposal assets. While there was a slight negative impact in the first quarter, this reduced over time, leading to an overall flat performance for the year. Fuel had a similar situation as it presented challenges in the first quarter, around 30 basis points, but by the end of the year, it won't be a concern. This improvement is due to approximately 50% of our fuel being hedged and, alongside the changes in fuel prices and strategic locks implemented late last year, we have effectively mitigated the risks. Therefore, at current levels, fuel will not affect our performance.
Tyler Brown, Analyst
Okay. Perfect. And then I had a couple of questions. So I just want to kind of go over the free cash flow guide and make sure I've got it all straight in my head. So last quarter, I think you said there was a line of sight to double-digit free cash flow growth. I'm going to say that was off of your one spot not 16 guidance, which would have put you a call it just under $1.3 billion, assuming, call it, low, low double-digit growth. But it sounds like there's about $50 million more in CapEx than was anticipated. So if I kind of take that off, that's what kind of gets me back to where the guide. Is that the right way to kind of square all that?
Mary Anne Whitney, CFO
Yes, I would agree with that. The number I would use is a 10% increase off of what we expected to deliver before we over-delivered in '22 was $127.5 million. You back off $50 million, you're at the $122.5 guide that we provided.
Tyler Brown, Analyst
Yes, perfect. And then just my last one real quick. Worthing, you talked a little bit about this, but holistically, what is kind of the unit cost inflation assumption in '23, including labor and subcontractor and everything kind of all in?
Worthing Jackman, CEO
Yes, we're assuming a range between about 6% and 7% all in.
Operator, Operator
Next question will be from Michael Hoffman of Stifel.
Michael Hoffman, Analyst
I'm interested in understanding the growth of free cash flow over the next two to three years, considering the various factors that can impact it during those periods. What insights can you share regarding the growth trajectory of free cash flow?
Worthing Jackman, CEO
Certainly. On the capital expenditures side, we’re projecting close to 1% of our revenue from sustainability initiatives this year and next year. As we look towards 2025, we expect to moderate this figure. For this year, we are guiding around 15.5% or more as a percentage of revenue, which will help us return to the 16.5% range and keep us comfortably above 50% of EBITDA. As renewable natural gas begins to contribute, we anticipate generating about $200 million in incremental EBITDA by 2026, which will also positively influence our cash flow generation to around 1.4% to 1.5% of revenue. This is why I mentioned that by 2026, we should be aiming for approximately 17.5% of revenue and close to 55% of EBITDA.
Michael Hoffman, Analyst
Okay. And that's the important point is you've been living in a 50 to 55, closer to the low end, you're moving back towards the $55 million?
Worthing Jackman, CEO
Right. The factors bringing us closer to $50 million include the increased sustainability capital expenditures, higher interest rates, and increased cash taxes. In October, we were aware of the direction of interest rates and the trajectory of cash taxes, so we are not surprised by the year-over-year changes we see today.
Michael Hoffman, Analyst
Okay. And then can you share with us as bonus depreciation unwinds, what's the total dollar amount that is going to walk back through?
Worthing Jackman, CEO
Yes. In this capital expenditure outlay, it's going to emerge on a dollar basis, though it's challenging. The reason is that there are limitations on how much bonus depreciation we can apply in any given year. This year, our cash taxes are expected to be 65% to 70% of the GAAP accrual due to the bonus depreciation carryover that we didn't utilize in previous years. Therefore, it's not a straightforward decline like other companies may have mentioned, as our situation is a bit different.
Michael Hoffman, Analyst
Okay. Sliced a different way, is your base assumption at $2 RIN and at $2.50 gas to get to that revenue number?
Worthing Jackman, CEO
Right.
Michael Hoffman, Analyst
Okay. Everybody wants to ask about volume, and I've always heard you say you'll trade volume for price all day long. But another way to talk about volume is service intervals, sort of what's the underlying trend in the small container business. How would you frame that? Because I think that's the...
Worthing Jackman, CEO
I mean, as I look at just the last six months of last year to see that net new business remained positive through the year on a month-to-month basis. And so obviously, increases in new business are more than offsetting loss in any decreases.
Michael Hoffman, Analyst
Okay. And then you always have a phrase for each year. So can you share with us what growth of gratitude is what's the message?
Worthing Jackman, CEO
Sure. Last year was intentional, and we discussed what that meant to us over time. I won't dwell on this for long, but I see growth not just as an increase in business but as the personal and professional development of our leaders. Our leaders have invested significant effort in supporting their teams during a tough period marked by a pandemic and various health and welfare challenges. It's crucial for them to remember to invest in their own personal growth as well. We dedicate considerable resources to training and development, which I don't view as discretionary. So I remind our leaders to prioritize their own well-being and personal development while they support others in their roles. Additionally, cultivating gratitude is essential for servant leaders, as it helps them recognize and appreciate their employees, leading to positive outcomes. This is a moment to reflect on our gratitude for being part of this organization and to keep that perspective as we move forward.
Operator, Operator
Next question will be from Chris Murray, ATB Capital Markets.
Chris Murray, Analyst
Maybe turning back to the CapEx question a little bit. I guess, a couple of parts to this. First, if you look at this is the CapEx as a percentage of revenue, it's going to be a little bit higher this year with, I guess, the catch-ups. I guess a couple of things to think about. One, as we move into kind of later years and out of '22 and things start to normalize, is there any reason to believe the CapEx doesn't step back to kind of historical levels kind of around 10% of revenue? And then second, just looking at the cost line. You've kind of mentioned labor and fuel a little bit, but does getting these additional vehicles or maybe some other things, is there anything that you can talk about in terms of cost reductions or cost improvement in the margin that look to maybe generate margins over and above what you can just reprise?
Worthing Jackman, CEO
I’ll address part of your question. From a business perspective, we’re not planning any drastic investments that would result in a significant workforce reduction. We do promote automation, and local communities can decide how to implement it. While discussions can be lengthy, we do have a few markets where automation will support labor needs. Recently, we celebrated deploying our 50th robot in our recycling facilities, and theoretically, each robot could effectively reduce three to four positions if working double shifts. I'm interested to see if our headcount reflects this change. Nonetheless, we've benefited from improved product quality, which has positively impacted our pricing and sales. The advantages extend beyond just labor savings. We continually explore technological advancements, particularly in AI, not to replace customer service personnel but to enhance the customer experience and lessen the pressure on our team to respond to inquiries, ultimately aiding retention. Our messaging and approach may differ, but there’s a lot more happening behind the scenes regarding this matter.
Mary Anne Whitney, CFO
And Chris, with respect to CapEx as a percentage of revenue, you're right, to your observation that we have been in this period where as we've described, whether it's sustainability-related investments, whether it's opportunistically making outlays for real estate as we look forward for future growth for various reasons. You've seen that running higher. And I think it's a reminder of why price has been so important as we remind people, there's inflation, not just in the P&L, but also on the CapEx side, you look at what the cost of construction projects has done. And really, we're glad we've had the focus on price as we had. But all that being said, we do look forward as we move through this period to getting back to a more normalized rate, and I'd encourage you to think of that as more as 10.5% to 11% is how to think about kind of the base CapEx for a low amount of volume growth in kind of a typical year.
Operator, Operator
The next question will be from Stephanie Moore of Jefferies.
Stephanie Benjamin Moore, Analyst
I wanted to consolidate a lot of the questions that have been asked, possibly rephrased. I understand you're not factoring in significant improvements in inflation expectations. However, if inflationary pressures remain high, does that suggest there could be potential for some upside on pricing? I know you mentioned having good visibility on 75%, but is there a chance for more upside if inflation continues to be elevated? Conversely, if inflation decreases, would we expect to see margin improvements? Is it possible to experience a bit of both? I'm just trying to fit all the elements together.
Worthing Jackman, CEO
Sure. Good question. We have set our pricing based on the expectation that it will remain high. So we are not surprised if it stays high longer; we planned for that. If inflation starts to decrease, as we mentioned, that presents an opportunity for us since we've already established our pricing. We believe that is more advantageous than having to adjust for inflation as we have had to do over the past two years. Our team is prepared for this situation. Many economists predict inflation will fall to about 3% to 3.5% by the end of this year. However, we did not base our pricing on this anticipated decline because if they turn out to be incorrect, we could misprice our business. Therefore, we have assumed that elevated prices will continue for a longer period, and if they do decrease, we will benefit from that.
Operator, Operator
Next question will be from Kyle White, Deutsche Bank.
Kyle White, Analyst
I know a lot has been talked about M&A, but I'm just curious, just given the fact that you spent quite a bit on acquisitions this last year, do you have the appetite and internal firepower to complete another outsized year of acquisition in 2023? Or should we expect it to be relatively subdued as you work to integrate some of those deals last year?
Worthing Jackman, CEO
Good question. After our dividend, we still have almost $1 billion of free cash flow available for mergers and acquisitions. We're not restricted by our balance sheet to have another significant year. If we consider an average year being around $150 million, if we aim for $150 million to $200 million in acquired revenue this year, that would likely mean spending about $0.5 billion. This leaves us with another $0.5 billion for any additional opportunities or to allocate elsewhere. We are fortunate to have the flexibility due to the strength of our business, cash flow generation, and increasing EBITDA, which also helps reduce leverage and maintain readiness for any potential opportunities.
Mary Anne Whitney, CFO
And to that point about balance sheet flexibility, we ended the year at a little over 2.9x debt-to-EBITDA. And if we're kind of in a normalized environment, we just do an average amount of year deals, then we'd expect that leverage to just dynamically delever, come down to about 2.5x over the course of the year.
Kyle White, Analyst
Got it. That makes sense. And then on pricing, just what's been the reception, the customer reception to kind of the pricing environment more recently or compared to pre-pandemic levels? And then on that, it seems like the industry has been very disciplined on pricing front since the pandemic and over the past few years. Do you see any signs that this discipline will carry forward maybe such that you could see a step change in pricing behavior for the better over the longer term? Or do you just view this all as a byproduct of the inflationary environment we're in?
Worthing Jackman, CEO
I believe this situation is a result of the inflationary environment. It stems from companies that operate on lower margins facing increased wage pressures due to their wage structures prior to the pandemic, which supported their low pricing strategies. Clearly, capital expenditure has risen, leading to a pricing framework influenced by cost pressures, falling commodity prices, and wage challenges. If inflation decreases to 2%, 2.5%, or 3% next year, I certainly anticipate that pricing will also decline correspondingly. Just because a 10% price increase is possible doesn't mean it should occur in a 3% inflation environment. Therefore, as we consider the long-term trend of inflation decreasing, I expect we will maintain our margin while also reducing prices in line with falling inflation.
Operator, Operator
Next question will be from Stephanie Yee, JPMorgan.
Stephanie Yee, Analyst
I wanted to ask at what point would you consider share repurchases as part of your capital allocation perhaps this year?
Worthing Jackman, CEO
Sure. Last year, we spent about $425 million on share repurchases and we remain opportunistic. We have authorization to buy back up to 5% of our shares annually. Whether we enter the market again is still uncertain. However, we prioritize acquisitions as the best use of our excess capital, so that will be our primary focus.
Mary Anne Whitney, CFO
And of course, in an environment like this, Stephanie, where incremental borrowing costs are over 5.5%, then debt repayment is another avenue that we'll consider.
Stephanie Yee, Analyst
Okay. That makes sense. And can you just make a comment on your customer retention rates overall?
Worthing Jackman, CEO
Yes, retention is quite high. I mean I think the other companies have talked about it as well. The reality is when we talk about labor constraints, it's across the industry. So it's the ability for competitors to poach is as constrained by their lack of excess capacity as others. I'd say that service in this environment matters a great deal. You can't put a price on the street and not service your customers, right? And so retention has been quite high, I'd say all-time high. I'd say retention on pricing even at these levels is at its highest level as well. And so again, that just shows you the overall constraints that everyone is operating under not just one company or another.
Operator, Operator
Next question will be from Sean Eastman, KeyBanc Capital Markets.
Q, Analyst
This is Nick on for Sean today. I just wanted to come back to sustainability. A lot of your competitors are talking about sort of increasing demand for plastic circularity. Is that consistent with maybe what you're seeing in the marketplace? And if so, would that be something you'd consider exploring further down the line?
Worthing Jackman, CEO
I think our view right now is we're happy to be a supplier of recovered plastics to some of these investments or others that are chasing this.
Operator, Operator
This concludes our question-and-answer session. I'd like to turn the call back over to Mr. Worthing Jackman for closing remarks. Please go ahead.
Worthing Jackman, CEO
Terrific, Nick, and thanks for being there for us today. If there are no further questions, on behalf of our entire management team, we appreciate your listening to and interest in the call today. Mary Anne and Joe Box are available today to answer any direct questions that we did not cover that we're allowed to answer on the Reg FD, Reg G and applicable securities laws in Canada. Thank you again. We look forward to seeing you at upcoming investor conferences or on our next earnings call. Thank you.
Operator, Operator
Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.