Waste Management Inc Q4 FY2022 Earnings Call

Good day and thank you for standing by. Welcome to the WM Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to our speaker today, Ed Egl, Senior Director of Investor Relations.

Thank you, Josh. Good morning, everyone, and thank you for joining us for our fourth quarter 2022 earnings conference call. With me this morning are Jim Fish, President and Chief Executive Officer; John Morris, Executive Vice President and Chief Operating Officer; Devina Rankin, Executive Vice President and Chief Financial Officer; and Tara Hemmer, Senior Vice President and Chief Sustainability Officer. During their prepared comments, Jim will cover high-level financials and provide a strategic update, John will cover an operating overview, and Devina will cover the details of the financials. Following comments, Jim, John, Devina and Tara will be available to answer questions. Before we get started, please note that we have filed a Form 8-K this morning that includes the earnings press release and is available on our website at www.wm.com. In addition, we have published a supplemental presentation with additional information about our multi-year plan for investments in our renewable energy and recycling businesses, and it is also available on our Form 8-K and our website at investors.wm.com. The Form 8-K, the press release, the supplemental presentation and the schedules of the press release include important information. During the call, you will hear forward-looking statements, which are based on current expectations, projections or opinions about future periods. All forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially. Some of these risks and uncertainties are discussed in today's press release and in our filings with the SEC, including our most recent Form 10-K. John will discuss our results in the areas of yield and volume, which, unless otherwise stated, are more specifically references to Internal Revenue Growth, or IRG, from yield or volume. During the call, Jim, John and Devina will discuss operating EBITDA, which is income from operations before depreciation and amortization. Any comparisons, unless otherwise stated, will be with the fourth quarter of 2021. Net income, EPS, operating EBITDA and margin and SG&A expense results have been adjusted to enhance comparability by excluding certain items that management believes do not reflect our fundamental business performance or results of operation. These adjusted measures, in addition to free cash flow, are non-GAAP measures. Please refer to the earnings press release and tables, which can be found on the company's website at www.wm.com for reconciliations to the most comparable GAAP measures and additional information about our use of non-GAAP measures and non-GAAP projections. This call is being recorded and will be available 24 hours a day beginning approximately 1:00 PM Eastern Time today. To hear a replay of the call access the WM website at investors.wm.com. Time-sensitive information provided during today's call, which is occurring on February 1, 2023, may no longer be accurate at the time of a replay. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of WM is prohibited. Now, I'll turn the call over to WM's President and CEO, Jim Fish.

Thanks, Ed, and thank you all for joining us. 2022 was another very successful year at WM. Coming into an uncertain 2022, I wouldn't have predicted that we would grow adjusted operating EBITDA by more than 9.5% for the year, and 8.8% for the fourth quarter, all while recycling was down $59 million for the year on a sharp drop in commodity prices. That's exactly what happened. Strong operational execution and an unwavering commitment to our strategic priorities led to our full year adjusted operating EBITDA growth of $480 million. We achieved this tremendous growth in the face of elevated inflation, a tight labor market, and a downturn in the recycled commodity price market. So, we're very proud of our results. Our robust operating EBITDA translated into record cash from operations of more than $4.5 billion, which allowed us to return more than $2.5 billion to our shareholders through dividends and share repurchases. As 2023 kicks off, we're confident that our long-term focus is on sustainable growth; transforming our business through technology and automation are setting us up to meet the changing needs of our customers, our people, and our business environment, while leveraging our competitive advantages. Turning to our high-level outlook for 2023. We expect to deliver adjusted operating EBITDA of between $5.825 billion and $5.975 billion in the year ahead, representing growth of just over 7% at the midpoint, which continues the trend of robust operating EBITDA growth that we've delivered since 2019. Since then, we've grown operating EBITDA almost 26%. And at a time when the economic outlook is increasingly uncertain, we're pleased to be anticipating another strong year of earnings growth in 2023. The essential nature of our service, our diverse customer base, and recurring revenue streams provide stability in times of economic uncertainty. Much of the growth in our 2023 outlook comes from deliberate steps that we've already taken to grow revenue and efficiently manage costs. Overall, we're anticipating between 40 and 80 basis points of adjusted operating EBITDA margin expansion in the year ahead, driven by our collection and disposal business. Moving now to our sustainability growth investment. Let me give you an abbreviated overview of the supplemental deck that was posted to our investors website. The investment in our renewable energy business is a unique opportunity that we simply couldn't afford to miss. You're all aware that since the passage of Subtitle V and associated air quality regulations in the 1980s and 1990s, landfills have been required to install gas collection systems. Historically, we've been collecting our landfill gas, converting much of it into electricity, which provides an earnings stream for us. Fast forward to present day, with landfill gas designated as a renewable resource, we are increasing the value of the gas that's an inevitable byproduct of most landfills. These RNG plants are simply taking gas that's naturally produced from the landfill and converting it into a cash-generating machine with a three-year projected payback and a far better environmental outcome than the status quo. And our returns far surpass those of our competition by virtue of our CNG fleet, which today represents 74% of our routed vehicles. As a result, we're better positioned to close the loop and capture extremely valuable regulatory RIN credits. At the same time, the recently enacted Inflation Reduction Act will provide tax credits and benefits that serve to amplify the value creation of WM's renewable energy business. The supplemental presentation to the earnings press release provides details on the investments and our projections for cash flow and operating EBITDA growth. But suffice it to say, we view this as a very strong positive for shareholders. We have a number of attractive options for our renewable energy portfolio. Internally, we said there are three possible outcomes from this opportunity: good, really good or great. And we're heading down the great path by owning the landfill gas and renewable energy facilities, generating RINs through our CNG fleet and maximizing the value of new tax benefits to increase the resulting earnings and cash flows. We're also advancing our planned recycling investments and have provided more details in the supplemental presentation on our website. Our portfolio of projects to automate existing and build new material recovery facilities have three key financial benefits: reduced labor costs, improved product quality that commands a price premium and capacity growth. In the fourth quarter, labor costs per ton at our single-stream automated MRFs improved by 35%. The automation of these plants enabled us to reduce 137 positions through attrition in 2022. And in 2023, we expect to reduce labor dependence by another 200 positions. By the end of 2023, we're anticipating about a 15% increase in processing capacity from our automated facilities and new markets. We will host a virtual information session for investors on April 5th to provide even more insight into our recycling and renewable energy growth plans. Devina will discuss our 2023 capital allocation plans in more detail, but I want to emphasize our confidence in our ability to continue to allocate capital to all of our priorities, including investing in these high-return sustainability growth projects, returning cash to shareholders through dividends and share repurchases and acquiring accretive businesses. In closing, I want to thank the entire WM team for another fantastic year. We look forward to 2023 as we continue to execute on our operating plans and progress our investments in renewable energy, recycling and automation to drive growth. I'll now turn the call over to John to discuss our operational results.

Thanks, Jim, and good morning, everyone. Jim described our fantastic results in 2022 and that all begins with our collection and disposal business. In the face of some of the highest inflationary cost pressures, our collection and disposal business delivered double-digit adjusted EBITDA growth for the full year. During the fourth quarter, collection and disposal results were even more impressive as adjusted operating EBITDA grew more than 11% and margin expanded 40 basis points. This momentum sets the stage for continued growth in 2023 and strengthens our conviction that the investments we're making in our people, in automation and in differentiating our service offerings are the right decisions. The growth in our collection and disposal business starts at the top of the income statement with robust organic revenue growth. Full year core price was 7.8% with collection and disposal yield of 6.7% and volume of 1.8%. As we work to keep pace with decades-high inflation, our revenue management teams delivered record core price in 2022 in every one of our lines of business, led by 10.5% in our commercial line of business. We talk often about our focus on generating appropriate returns in our residential and post-collection lines of business. And in 2022, we delivered core price of 6.5% in the residential line of business, 6.4% at our landfills and 5.9% at our transfer stations. Our revenue metrics demonstrate that our customers' receptivity to our pricing remained favorable through the fourth quarter. Our rollback percentage was almost 400 basis points better for the full year, while new business pricing increased more than 6% in our commercial line of business. The results clearly demonstrate our ability to manage cost pressures through continued pricing discipline and momentum, while maintaining our focus on customer lifetime value. As we move into 2023, our disciplined pricing programs combined with the strong momentum from 2022 are expected to deliver core price of between 6.5% and 7% with yield approaching 5.5%. Our expectation is for strong rollover of 2022 price performance. Given the acute inflationary environment in 2022, we increased certain fees that we don't expect to step up again at the same level. We remain committed to securing pricing that outpaces our cost inflation, which is demonstrated by the operating EBITDA margin expansion that we're anticipating in 2023. Shifting to volumes. In the fourth quarter, event-driven volumes remained strong with special waste and C&D volumes growing double digits. Our commercial and industrial volumes were positive for the full year. However, we saw some softening in the fourth quarter. Given these recent trends, we are tempering our volume expectations in the year ahead. Our guidance includes 2023 collection and disposal volumes that are relatively flat with 2022. We continue to see the rate of labor increases easing in our business, and we remain focused on managing our operating expenses and flexing down costs with the changing volumes. In our collection and disposal business, we are seeing improvements in our labor costs as inflationary wage pressures are easing. Turnover trends are improving and the investments that we are making in automation are showing benefits. These improvements were on display in our fourth quarter results as we saw operating expense margin improved by 30 basis points despite still stubbornly higher maintenance and repair costs. For the full year of 2022, operating expenses increased 50 basis points as a percentage of revenue, but that was largely driven by negative impacts from higher fuel costs and recycling commodity prices that together impacted the measure by 80 basis points. This increase was partially offset by lower labor and related benefits costs in our collection and disposal business and improved risk management costs. Putting it all together, when you combine our pricing efforts with our progress on cost containment, we expect 2023 operating expense as a percentage of revenue to improve between 30 and 50 basis points for the full year, with those improvements beginning in the second quarter of 2023. In the fourth quarter, our recycling operating EBITDA remained solidly positive even with the sharp decline in commodity prices to about $47 per ton. Over the last several years, we have intentionally taken steps to shift the business to a fee-for-service model that has reduced our sensitivity to commodity market changes. When we started this journey in 2017, commodity prices were 60% higher than what we are anticipating in our 2023 outlook, yet 2023 operating EBITDA is expected to be about 13% higher than in 2017. This clearly demonstrates that our business model is profitable and generates solid returns in any economic environment. As we look to the future of recycling, we remain focused on advancing automation across our MRF network, which we have proven can lower the cost of processing material, achieve better quality while enhancing recycling profitability. Our employees delivered strong results in 2022, and I want to thank the entire WM team for their commitment to providing the best customer service while focusing on improving our operations. The team has done an exceptional job, and I know that this will continue in the year ahead. I'll now turn the call over to Devina to discuss our 2022 financial results and 2023 financial outlook in further detail.

Thanks, John, and good morning. Once again, our solid waste business was at the center of WM's strong quarterly results, capping off a great 2022. Our team delivered strong organic revenue growth with a diligent focus on leveraging core price to offset cost inflation, while prioritizing customer service and customer lifetime value to minimize customer churn, all resulting in record high yield. When combined with strong cost control, these efforts delivered an 80 basis point expansion of operating EBITDA margin in the fourth quarter. Importantly, we achieved these excellent results while investing in technology and sustainability growth that will benefit WM for years to come. Full year adjusted SG&A was 9.6% of revenue, a 40 basis point improvement over 2021 as we achieved back-office operational efficiencies through standardization and process improvement that enabled us to reduce more than 600 positions through attrition. You can clearly see our strong performance and the record cash flow from operations that we achieved in 2022, which grew 4.6% to $4.536 billion. The increase in cash allowed us to accelerate investments at year-end, which brought full year capital spending to the high end of our expectations. 2022 capital expenditures totaled $2.587 billion with $2.26 billion of that related to normal course capital to support the business and the remaining $561 million related to the strategic growth of our recycling and renewable energy businesses. Putting these pieces together, 2022 free cash flow was $1.976 billion despite an increase in cash taxes of $370 million. During 2022, we returned a record $2.58 billion to shareholders, paying $1.08 billion in dividends and repurchasing $1.5 billion of our stock. In addition, we spent $377 million on traditional solid waste and recycling acquisitions to grow our business. We accomplished all of this while accelerating our sustainability and growth investments and achieving our targeted leverage ratio of about 2.75 times. Our balance sheet is well-positioned for growth through capital investments in our business or strategic acquisitions. Moving to our 2023 financial outlook. As John mentioned, we anticipate organic growth approaching 5.5% from yield. Given an expectation for a little more than 1% revenue growth from acquisitions, and a decrease in revenue contributions from recycled commodity sales and fuel surcharges, we anticipate total revenue growth of between 4% and 5.5%. When combining our plan to deliver strong organic revenue growth with a focus on optimization and cost control to drive 40 to 80 basis points of operating leverage, we expect to generate adjusted operating EBITDA of $5.825 billion to $5.975 billion in 2023. We expect to allocate $1.1 billion to capital investments in recycling and renewable natural gas growth projects in the coming year and 2023 is expected to be the peak investment year for each business. While these investments are reported as a component of our capital expenditures, and therefore reduce our traditional measure of free cash flow, we view these investments as better than an acquisition dollar as they will produce even higher return growth as a strong complement to our existing business. Our normal course capital to support our business is expected to be between $2 billion and $2.1 billion in 2023. And free cash flow is projected to be between $1.5 billion and $1.6 billion, including the impact of sustainability growth investments. Our outlook anticipates an increase in cash interest and taxes of $175 million to $215 million and about an $80 million headwind from working capital due in large part to the timing and amount of incentive compensation payments. As Jim discussed, even as we step up our investment in high-return recycling and renewable energy growth projects, we remain well positioned to allocate our cash among all of our capital allocation priorities, including returning cash to our shareholders. Given the Board of Directors' intended 7.7% increase in the 2023 dividend rate, we expect dividend payments to total about $1.1 billion in the year ahead. We also expect to continue our share repurchase program in 2023, as the Board recently provided authorization to repurchase up to $1.5 billion of our stock. While our guidance does not specifically include acquisition growth, we will continue to be opportunistic in pursuing the right deals at the right price. In closing, we are proud of what we achieved in 2022, and we're excited about the opportunities that lay ahead for 2023 and future years. I want to thank our hard-working team members for all of their contributions to our success. With that, Josh, let's open the line for questions.

Thank you. Our first question comes from Jerry Revich with Goldman Sachs. You may proceed.

Yes, hi. Good morning, everyone.

Good morning.

I'm wondering if you could just talk about the puts and takes around the guidance. If recycled commodity prices remain tough over the year, that should be about a $50 million drag to EBITDA, give or take. And in that scenario, I'm wondering if we should be thinking about yield that's above the 5.5% target that we're laying out here this morning as we think about the potential for the yield number to move higher over the year as we've seen over the past couple of years?

Jerry, let me tackle the first question first on recycling, and then I'll touch on yield overall. Recycling, obviously, fell off the table there at the end of the year. I think a lot of it had to do with China itself. Even though China isn't a big customer of ours anymore, they still affect the overall market, particularly when we think about OCC. Their zero-COVID policy certainly destabilized the market. I think as they've reopened, we've started to see some stabilization there. So that should help, and that's part of why we are a bit more optimistic in 2023 with pricing starting to climb back up. It did climb up a bit in December, and we think it will continue to climb, albeit not back up to where it was for the year in 2022. To your question about yield in general and 5.5%, yield is doing exactly what we thought it would do. It's doing exactly what we said it would do last year. I kind of felt like yield and cost were in a fistfight for the last 18 months with really no winter. And what we said was that we hope that when inflation moderated, which it is, that we would start to be able to use yield to not only cover costs, but also put a few points on the board in terms of margin. And that's exactly what's happening. So, we think that 5.5% yield number is absolutely the right direction. We're sensitive to customers. I mean, some of our yield numbers last year were double digits. And when inflation comes back down to 4% to 4.5%, I don't expect to take commercial increases at the 11.5% range. So I think we're pleased with the projection, and we're pleased actually with the fact that costs are starting to moderate and we can actually apply a little bit of our yield to the margin line.

Super. And Jim, maybe just to expand on that last point, given the margin cadence over the course of the year to get the margin expansion that you're targeting for 2023, it looks like you're going to be exiting the year with margins up maybe closer to 100 basis points year-over-year in the fourth quarter, just given the seasonality and cadence. Can you just comment on that and whether that momentum could continue into early 2024?

Yes, Jerry, I think that overview that you provided is spot on in terms of how it is that we're looking at margin for the year ahead. Sixty basis points of margin expansion at the midpoint indicates our confidence that the momentum that we saw in the back half of 2022 should continue into 2023. We expect some of the margin pressure from the recycling part of the business to continue in the first half. So we are seeing strong fundamentals in the solid waste part of our business that should help to offset that as they did in Q4. That being said, some of the cost execution, we really are laser-focused as a management team on what we're doing on the cost side of the business. And that's not just looking at inflation and responding to it but being proactive in terms of what we can do to manage it appropriately. Truck delivery trends are favorable now relative to where we started 2022, and that should give us some relief both in repair and maintenance and in truck rental costs. Our frontline retention efforts are showing really strong benefits, and we expect that to continue in 2023. We're managing down professional fees, particularly in our SG&A. And then on the SG&A front, we're also leveraging technology to automate our processes, which is improving the customer experience and reducing our cost to serve. So all of that gives us confidence that it's our strong execution on the cost side of the equation that will complement the yield that Jim just spoke to in terms of delivering that margin expansion and exiting 2023 with 100 basis points above this current run rate feels like the right target for us.

Super, Devina. Thank you. And can I just sneak one more in. I really appreciate the landfill gas disclosures. I'm wondering, Tara and team, can you just give us an update on off-take agreements? A quarter ago, you were at one-third of your off-take agreements done. Can you just give us an update on where that stands today and whether the pricing point on off-takes in the market is still in the $20s or if that's come in, given the pullback in Henry Hub gas. Thank you.

Yes. So Jerry, in 2022, we were at 30%, and we're projecting in 2023 to be at 40% of our off-take in fixed. And I think what's important to note here is we really took a look at this back in early 2022, looking at the volume ramp of our RNG, and we were pretty intentional about thinking through how to tap into those voluntary markets. So those markets today, we're seeing them be quite robust if you think about large public utilities and industrial end users. This is a great way for them to tap into a low-carbon fuel and we're not seeing any price back at the moment. We'll give a bit more detail in April on what it looks like longer term as well.

Super. Thank you.

Our next question comes from Toni Kaplan with Morgan Stanley. You may proceed.

Thanks so much. I wanted to start out on renewable energy. Thanks for all the details in the supplemental presentation. I know you had previously talked about 2023 as an elevated year for investment, but it seems like you decided to accelerate it and expand even more. So I guess, why is this the right time, and what is the expected cadence of the investment during the year? And does this mean that M&A will be lower this year versus last year? Thanks.

We didn't really give guidance on M&A. Historically, we've said $100 million to $200 million, so it's likely going to be kind of in that range. But the reason, to your point, that we've decided to accelerate some of this is just simply the opportunity itself. I mentioned it in my prepared remarks, but it really is part of our solid waste business. This is gas as a result of Subtitle V and air quality regulations that's coming to us anyway. About half of that gas has been monetized over the last 20 years, but we still have half left and we're certainly not monetizing the full amount when you look at that deck. What we are monetizing we're effectively paying kind of a three times multiple instead of what you might pay for an acquisition, which would be kind of eight to 12 times. So that's why we're feeling so good about it. And we've modeled these at very conservative numbers. Right now, we're well above those. So, I think the opportunity just started to present itself through the designation of this gas as being renewable, the markets themselves opening up and now with an opportunity, which Tara can go into about electricity. In those cases, we don't even have to add capital if we already have electricity generating facilities out there.

The only other thing I would just add to what Jim said regarding the acceleration of the investment is the investment tax credit and the fact that that is a really strong pathway for us to get some tax credits on our investments and there's a timeline associated with that. And we feel really positive about where we are in our ability to capture those tax credits. We've modeled about $300 million, which you see in the deck. Regarding our broader portfolio, this is one of the reasons why we talk about this opportunity being so great because we preserved so many options for WM because we own the gas. We own our projects. We announced 20 projects. There's a whole pipeline that can come after that. And then with the e-RINs pathway, if you look at our legacy landfill gas to electricity projects, we can create an earnings stream with no incremental capital, and that's not in our numbers today. So, that's upside long-term. So, we're really optimistic about what we have in front of us here.

And one last point here that I did mention also, but I'll mention it again. That differentiates us from our competition, and that is that CNG fleet. I mean 74% of our fleet is CNG and the way RINs works is you have to burn the fuel before you can monetize the RIN and having a fleet that is three quarters natural gas gives us a potential earnings stream that our competition who might be at 15% to 30% CNG simply don't have to the same extent.

Super. And I wanted to ask about volume. You mentioned the softening in commercial and industrial in the fourth quarter. Maybe just a little bit more color there, the magnitude, how quickly it happened—was it early in the quarter or throughout the whole quarter, et cetera? And are you expecting any softer volumes in the remainder of the year implied in the guide? Thanks.

There were a few moving parts in the volume that was down slightly for Q4. Some of it was by design, residential specifically. Some of it was a couple of lost contracts in the commercial line of business and that was typically going to be in our national accounts group. And then, some of it is maybe softness showing up in the roll-off line of business. If there's any good news there, and it is that when we just looked at our January numbers this morning, they were actually better than Q4 on the volume front, particularly C&D, although some of that C&D might be coming from the hurricane cleanup in Florida. But MSW was a positive sign for January. So even with that, we felt that a negative 0.5% to a positive 0.5%—so a flat volume with last year, as John mentioned, was appropriate. As we look at the broader economy, there are a few factors that are concerning out there; the housing slowdown, for sure. I mean, that's been widely discussed and that housing slowdown will affect C&D volumes. Special waste continues to be a strong point for us and the pipeline is good there. But I think as you think about whether it's the housing slowdown or the consumer savings being drawn down because inflation has eaten up that savings, that's going to affect the consumer. The good news for us is that our strategy is really not built around the volume aspect. It's built around cost controls, it's built around building out this sustainability strategy, and it's built around pricing. And so, we're pleased with being able to come in at the top end of the range on EBITDA at 7% for 2023.

Fantastic. Thank you.

Our next question comes from Tyler Brown with Raymond James. You may proceed.

Hey, good morning, guys.

Good morning.

Hey, Jim. Thank you for the supplemental deck. But I do kind of want to get to the heart of it. So is the idea here that the contribution in 2026 between RNG and recycling, maybe it's now expected to be $740 million, I think, if my math is right, and that was upsized, is that right?

That's correct.

Okay. But you're also in the midst of a labor automation effort. And I just want to make sure that I'm not double counting, because some of that is probably in recycling. But how much additional EBITDA are you expecting by 2026 from that effort as well?

So there is a bit of the automation impact in the recycling piece in the deck. There was $70 million called out, and that is included in the recycling number. But there are other areas where we're automating positions and processes that are not captured in that deck at all, and those really have nothing to do with RNG or recycling.

Yes. That's my point. Can you quantify that piece?

Tyler, I would tell you that it's too early for us to predict the impact of that to 2026 and beyond. What we're really emphasizing in our 2023 outlook is that we're starting to see some of the benefits. Yes, recycling is a piece of that. But beyond the recycling line of business, we're seeing back-office improvements; 600 headcount attrition that I mentioned in customer experience is a strong example of that. And the leverage we've gotten in SG&A margin is in large part due to some of that success. So the 40 to 80 basis points of margin expansion really is all solid waste. That strong performance in 2023 is an indicator of future value that we think will come as we start to see optimization efforts in the collection line of business take hold. Some of that is delayed because of truck deliveries as well as some of our efforts to take that across additional lines of business. We started in the industrial line of business intentionally, and we're seeing strong success in some of those pilots. We're happy with where we are, but it's too early for us to predict how much efficiency gain we can get across all lines of business in 2026 and beyond. But taking the 40 to 80 basis points accomplished or predicted for 2023 is a strong indicator of the strength of those initiatives.

Tyler, let me expand quickly on what she just said about the 600 positions, because that will become close to 1,000 positions just in customer experience. We've talked a lot over the last couple of years about automation, but we haven't really given you the numbers and where it's benefiting the bottom line. This is a good example. We used a turnover number that was close to 50% in customer experience, took advantage of that attrition, and at the same time automated the customer experience, which every other industry has done over the last 20 years, and we hadn't. It was still kind of a person-to-person experience. We haven't eliminated the person-to-person experience, but we've made a self-service option available to our customers. As a result, our call volume is down close to 25%. That's a huge drop in call volume and hence our ability to take advantage of attrition to the tune of 600 positions in 2022 and another close to 400 positions in 2023.

Okay. Yes, that's extremely helpful. A lot to come there. Okay, Devina, coming back to 2023 margins and I don't want to be super pedantic, but can you just talk about first half and second half margins? So are margins going to be a little flatter in the first half and then up quite a bit in the second half? Could margins actually be down in Q1 year-over-year?

Margins could be down in the first quarter of the year. The pressure from the recycling line of business is the most acute, and while a drop in commodity prices is typically something that we see benefit our margin in that part of the business because of the pass-through elements of some of it, we have seen some pressure. So we are predicting some flatness in the first quarter, with expanding margin in the second quarter, particularly on the cost side of the business and starting to see the pricing parts of the business really contribute as they did in the second half of 2022 as we anniversary some of those impacts from recycling. So first half, second half, you'll see more muted margin expansion in the first half and stronger margin expansion in the back half. That being said, I wouldn't expect the minus-100 / plus-100 volatility that we saw in 2022 because we've overcome many of the operating cost headwinds that we were experiencing and are really starting to see strong momentum there.

Okay. Perfect. That's extremely helpful. And my last one, you kind of went through quite a bit on the free cash flow puts and takes. But can you go back over what the expectation is year-over-year for cash taxes, cash interest and then maybe working capital? Just trying to help build that bridge.

Sure. So EBITDA growth at the midpoint is $390 million, and so that will be the driver of free cash flow growth and cash flow from operations growth next year. Unfortunately, with this interest rate environment, we're going to have to give some of that back because our cost of debt is going up. As you can see, when you look at our fourth quarter results, our weighted average borrowing rate in the fourth quarter actually went up 80 basis points. That was an increase of $26 million in the quarter. We were virtually flat all year long in advance of Q4. When we take that Q4 impact and extrapolate it to 2023, that's what's going to be driving our interest costs higher. So that in and of itself is a little over $100 million of impact. And then we do expect our debt balances to increase in the year ahead. Our debt balances are going to increase because we are seeing such strong growth, and we are going to be investing in all elements of capital allocation with that strong balance sheet. We are not pulling back on our allocation of cash to share buyback in the year ahead; that is our current plan. We may moderate it some, but we'll give you more color on that over the course of the year. So with the higher debt balances and the higher interest cost that really is all of the $175 million to $215 million that I mentioned in interest and taxes. Taxes are actually going to be essentially flat. While we would have expected some moderation in that because of the one-time payment that I mentioned of $100 million, we're really seeing that offset by two things: one, higher pretax income; and the other being the expiration of a piece of bonus depreciation and the asset mix that we're putting in place. Those are the interest and tax pieces. The $80 million headwind I mentioned on working capital— we had an $88 million contribution to working capital in 2022. So we're essentially saying that we think we might give some of that back. Some of that is a moderation in DSO, just because of the economic environment that we're predicting. But a large contributor is timing and amount of incentive compensation payments.

Very detailed as always. Thank you so much.

You're welcome.

Our next question comes from Noah Kaye with Oppenheimer. You may proceed.

Good morning. Thanks. D&A stepped up in 4Q. Can you first provide a little color on that and then give us what should be D&A for 2023?

Sure. So the color there is really inflation in our landfill costs. It's both from normal inflationary cost pressures, as well as the regulatory environment that's driving some of our costs for closure and post-closure higher. The charge that we took in the fourth quarter relates predominantly to our closed site part of the portfolio, though some of it is also representative of changes we're seeing in management of the active landfills, too. In terms of next year's DD&A, we're not predicting another step change from this current level, but we are expecting DD&A levels to reflect better delivery of trucks in the year ahead. So you'll see some increased depreciation in the first half of the year rather than waiting to see all of that impact in Q4.

Okay. But we could again be above that $2 billion number for 2023. So net-net D&A would step up year-over-year?

Net-net DD&A is going to be moderately higher just with the capital expenditure deliveries, but it's not going to be another step change from this level.

Yeah. Okay. And then just on pricing, Jim, listening to your comments around some of the softening in the commercial sector. How do we think about the cadence of price growth expectations? It seems hard to sustain double digits in C&I as we go through the balance of the year. There is some math on that, of course. But how do we think about pricing? And what elements of the business may see the greatest sequential price declines on a cadence basis?

We think about pricing because there are a two-fold exercise here. One is combating cost increases or inflation, which was why the last 18 months have been so challenging, because we really felt like almost all of the pricing was about combating inflation. The second piece is adding a few margin points for us. As we look at pricing, particularly for commercial since that's where your question was, we think that pricing will moderate a bit because inflation is moderating significantly. That's a good thing for us. If you look at collection and disposal yield for last year versus our guidance for this year, last year was 6.7% and our guidance for this year is 5.5%. So there is some moderation in yield there. But significantly, we're projecting a different cost picture. So we think price will start to contribute to margin again, whereas it hasn't for the last three years.

I would add that the residential line of business, specifically, if you look at our volume loss there, clearly we continue to make deliberate decisions. We mentioned some of the franchises that we've parted ways with. Even with the negative volume, our revenue was still up over $50 million for the quarter in residential. We're going to continue down that path until we get acceptable returns and margins for that line of business. We don't like intentionally shedding business but under these conditions, like Jim said, inflation is what we're combating and it's been most acute in residential, partly due to the labor intensity there.

One place where pricing might not moderate as much is on the landfill side. We have a differentiated product there. MSW yield was 6.2% last year. I think that's probably the highest annual yield for MSW in our history and I don't expect that to come down a lot.

Very helpful. Thank you.

Our next question comes from Bryan Burgmeier with Citi. You may proceed.

Good morning and thanks for taking the question. I understand free cash flow will be pressured near-term. But do you think WM can emerge from this investment period with structurally higher free cash flow conversion from EBITDA than you had in 2021 and before? It seems like these investments will be highly cash generative once ramped and can potentially exceed where you were before the investment period.

Yes, Bryan, you're spot on there. Our ability to convert revenue and EBITDA dollars to free cash flow with the sustainability investments will be heightened as we come through the investment period. Fundamentally, that's because there's a different capital outlay model for this part of our business than there is for the collection and disposal business, where you're having to spend capital dollars effectively each day that you service the customer. With maintenance capital levels meaningfully lower in both recycling and renewable energy, we're optimistic that cash flow conversion will be stronger after this investment period.

Got it. Thanks for that. And last question for me. The press release called out investment in plastic recycling infrastructure. Maybe just from a high level, is it possible to say what makes that such an enticing market for WM longer term, do you have any thoughts on how the margins or returns could compare to your existing business?

Sure. The investment we made in Natura PCR is really about taking film and film plastic and mechanically recycling it. Film has very low recycling rates today. On top of that, all of the brands out there—CPG companies—have very strong commitments to use more recycled content products. So it's a market where there is a very strong need and we have a strong fit. Also, if you think about the plastics that we collect on the brokerage side of the house, it felt like a natural fit for us. What you're seeing in the press release are some capital dollars to invest in building out that plant portfolio in Houston and also in the Midwest, and we'll be providing a bit more information on that in April.

Okay. Great. Thanks a lot. I'll turn it over.

Our next question comes from Kevin Chiang with CIBC. You may proceed.

Hi. Thanks for taking my question and thanks for the supplemental information. If I look at your pro forma earnings contribution from these sustainability investments and do a quick back-of-the-envelope math, it seems like you'd get to something like 15% maybe even upwards of 20% of your earnings coming from recycling and RNG. The payback looks phenomenal and ROIC is obviously very high. But how do you think about the underlying earnings volatility of the business now that it becomes more commodity exposed once these investments are completed?

I can speak to the commodity volatility on both sides of the business. On the RNG side, we've talked a lot and I mentioned it today that we have 40% of our volume that's tied into fixed price markets. And then we also have the ability on the transportation side to leverage WM and tie it into RINs. We're being thoughtful about how our ramp looks long term and how to tap into fixed versus transportation markets. We'll give more information in April. Suffice it to say, it's something we're tracking closely, and we have a whole host of options to ensure that we can navigate that. There are strong fundamentals: the EPA announcement on the renewable volume obligation and setting a three-year pathway shores up the long-term outlook for RNG. On the recycling side, if you look at the $240 million in EBITDA, 60% of that is really independent of commodity prices, and that speaks to the fact that a big piece of it is coming from labor improvements—35% reduction in labor cost per ton at our automated facilities—and improved product quality that can command price premiums. So a lot of what we're doing helps us insulate from commodity volatility.

To add, you could say it adds some volatility, but this gas is coming to us regardless. We're taking gas produced by these sites and turning it into value. We're also able to fix a portion of that pricing. Fundamentally, we're monetizing an existing byproduct in a way that generates very attractive returns and paybacks.

That's great color, Jim. Maybe just on the automation on the customer service side, it sounds like obvious wins there. Just wondering what you're seeing from customer metrics as you roll that technology out—Net Promoter Score or churn improvements? Any benefits beyond the labor cost savings?

Good question. We've digitized a lot of the customer-facing transactions so customers can transact with us when and how they want. We're seeing that translate to NPS scores. We had some dips in NPS earlier in the year as we were challenged on some labor and asset fronts, but that started to improve in the second half of the year which has helped service quality. We're also seeing benefits from labor arbitrage—these are not jobs we're moving offshore; these are positions we're not replacing because of high turnover. The ASL system and other automation are delivering clear benefits.

Excellent. That's it from me. Thank you very much.

Our next question comes from Walter Spracklin with RBC Capital Markets. You may proceed.

Yes, thanks very much Jim. Just following up on Kevin's question regarding volatility and your pricing — investors are accustomed to price never going down. But with renewable energy fluctuations and recycled commodity prices, as you build these out more, is this something you would consider spinning off while retaining a stake to separate the two so investors can choose exposure to volatility or steadiness? Is that something you've thought about?

A couple of points. First, price isn't going down; it's just going up by slightly less than it did last year. Regarding spinning off the RNG business, we keep options open, but part of the value for us is that we own the gas and the facilities. For the time being, we're going to develop these ourselves and retain the value. We like being in a position where we manage the well fields that produce the gas. Not to say we wouldn't consider options down the road, but for now we're going to own and develop on our own.

On the recycling side, if you went back five or six years ago and looked at commodity price sensitivity versus earnings stream, it's much different now. At around $47 a ton, we're still seeing strong earnings and returns in our MRFs, and automated plants deliver even higher margins. We've removed a lot of volatility from the recycling business, which supports our conviction in further investments.

Thanks very much.

Our next question comes from Sean Eastman with KeyBanc Capital Markets. You may proceed.

Hi, team. First one, I wanted to reconcile the 35% labor cost per ton reduction on the recycling footprint mentioned and the headcount reduction of 137. Just trying to reconcile those two data points.

John mentioned in his remarks the 35% reduction in labor cost per ton at our automated plants that we saw in Q4. The 137 number is related to the headcount attrition related to automation in 2022, and we're expecting 200 in 2023.

Okay. Helpful. And then the inputs on the guidance for this year—$70 per ton commodity basket and $2.30 RIN price—could you tell me where those numbers are today and how to think about sensitivity if we don't climb to those numbers?

Just to clarify, it's $70 per ton in our commodity basket for 2023 exiting December of this year, with the current level just north of $50 per ton. We're seeing some signs on the plastic side where pricing is increasing a bit as CPG companies try to meet sustainability commitments. We expect that ramp through Q1, Q2 and Q3. On the renewable energy side, the $2.30 RIN price is what we have in our guidance. Exiting 2022 RIN prices were higher and we've seen a bit of a dip to start 2023. Remember, 40% of our off-take is fixed, so 60% is exposed.

The midpoint of our guidance anticipated the commodity values Tara went through. The downside has contemplated some of the risk should those values be less than what we're predicting.

Understood. Thank you very much.

Our next question comes from Michael Hoffman with Stifel. You may proceed.

Good morning. I just want to make sure this is very clear. You are not seeing unit prices come down, the rate of change in price is narrowing, correct?

No, sir. We are not seeing unit prices come down.

Okay. And you are in a position today where you have a real spread against the internal cost of inflation?

Yes. That gives us the spread. We had essentially no spread for the last 18 months.

I'm trying to get at how much power is in the solid waste business. Are you about 80% to 85% of your EBITDA from solid waste and 15% to 20% from sustainability and recycling? Is that roughly right?

If you look at our outlook for the year ahead, we're implying growth from the solid waste business of about $475 million, and that rivals the highest levels of growth we've ever seen. We focus on growing that business over the long term through pricing execution and operating cost efficiency and those are driving that $475 million target.

Devina and I both focus intently on OpEx. The efforts we undertook last year and what happened in the last two quarters make us feel really good about what's happening on the solid waste side. The guidance on OpEx and the EBITDA improvement give us confidence about entering 2023.

I think the solid waste business could grow 9% to 10% in EBITDA in 2023 and expand by maybe 90 basis points in margin while giving a little back in other areas, right?

We are predicting that strong solid waste growth coupled with SG&A margin expansion. Those are the two levers for next year's overall EBITDA growth.

Would you consider segmenting your disclosures to show recurring core solid waste versus alternatives so we can track it better?

We always focus on making sure you have the best information available and we'll continue to try to meet that goal. We'll step back and look at our disclosures and ensure they're appropriately robust. We think they are today, but we know we can always get better.

Baseline capital spending at $2.0 to $2.1 billion comes out at about 9.9% of revenue, which is below your long-term average. Why is that baseline settling this way given vendor-side inflation?

If you look at inflationary pressure and the revenue performance, we've been sensitive to not simply increasing capital because revenue is up. We're looking at it by line of business and volume. You're seeing discipline around capital dollars. The supply side was challenging this year due to truck-related issues, and 2023 will be more balanced.

We did pull ahead some capital into the fourth quarter. As a result, we moderated our outlook for 2023 capital slightly from our original expectations. Should we see a need to adjust as we get into the year and perform well, we might accelerate capital further. This is about strong execution on capital discipline and ensuring our price addresses both operating cost and capital inflation.

Tara, the $500 million of EBITDA in RNG in 2026—how much of it is fixed versus spot today?

Today, we have 40% of volume tied to fixed markets based on roughly 4 million MMBtu, and that is what's fixed today. We're working on fixing more of that longer term and we'll give more information in April.

Will you provide sales detail in April so we can model revenue for RNG?

We'll unpack that in April. You can estimate revenue based on the $26 per MMBtu number we provided.

Last question: In 2019 you said the solid waste business would compound at 5% to 7%. When I add in the $740 million by 2026, will that new baseline still compound at 5% to 7% or does the step-up change the aggregate compounding?

Great question. We're working to segment parts of the business clearly so we can articulate expected growth for each. The solid waste business has outperformed the 5% to 7% target and we're proud. The RNG and recycling businesses represent a new step-level change in free cash flow generation. We'll provide more detail as we further articulate plans for building the total addressable market across our landfill network.

Okay. Thanks for taking my questions.

Our next question comes from Michael Feniger with Bank of America. You may proceed.

Thanks, everyone. Tara, apologies if you touched on this, but why have RINs rolled over at the beginning of this year? Any policy actions we should monitor that help get that RIN recovery to $2.30 for the full year?

Important to remember EPA's December rule which set a three-year framework for renewable volume obligations, and that's positive because it sets the standard for the program and RIN pathway. There has been speculation in the market about whether those were the right numbers, and we expect more clarity when EPA issues their final rule in June. Long term, fundamentals remain strong for RIN prices.

Thank you. Devina, the last four to five years your EBITDA margins have been in a tight range of 28% to 28.4%. You're guiding for 40 to 80 basis points of expansion. Can you quantify how much of a headwind there is on margin for RNG and OCC in 2023 based on the guide?

It's 10 to 20 basis points of headwind.

Perfect. Okay. Thanks everyone.

Our next question comes from Stephanie Moore with Jefferies. You may proceed.

Hi. Thanks. Continuing on the renewable energy question—what are you seeing from a pricing standpoint in your renewable energy business beyond RINs? And longer term, is there any risk of supply-demand imbalance as more RNG facilities come online that could affect pricing?

On pricing we saw some decline in the three categories: slight decline on the power side after record power prices in 2022, natural gas pricing has come down—averaging around $3.60 that we're guiding to—and RIN prices are guided at $2.30. Regarding supply-demand, there are two robust markets: the transportation side where we generate D3 RINs and voluntary markets where utilities buy RNG to decarbonize. We're in a unique position with our owned fleet and flexible options for trading and offtake. We'll provide more detail in April but are positive about the options available.

Understood. Thanks so much.

Our next question comes from Stephanie Yee with JPMorgan. You may proceed.

Hi. Thank you for taking my question. I wanted to come back to the 2023 guidance overall—are you assuming a recession in the guide or maybe just a slowing economic environment? I guess the volume guidance range implies some conservatism.

We're not macroeconomists, so whether a recession happens is hard to predict. We are projecting some softness for sure: Q4 saw some softness, particularly in roll-off, with January a bit stronger. It feels like there could be a slowdown, especially as consumer savings have been drawn down by inflation. The last thing I can do is predict a recession; we're managing the business with cost control, pricing and sustainability investments to navigate potential downturns.

Okay. Great. Thank you.

Our next question comes from Devin Dodge with BMO Capital Markets. You may proceed.

Thanks. I suspect we'll get more color on April 5, but could you provide a framework for how meaningful e-RINs could be from a WM perspective?

Important to remember e-RINs are in a proposed rulestage and EPA will come out with a final framework in the summer. From our perspective, look at the 66 landfill gas-to-electricity plants we own. If e-RINs are enabled, we believe this could be a significant long-term revenue stream with no incremental CapEx on those existing facilities. We're optimistic but are waiting for more clarity from EPA on the final framework.

Good color. On the same thread, do you think e-RINs could impact the development pipeline for landfill RNG projects, or will RNG remain the most desirable landfill gas project if the site is suitable?

Great question. We're confident in the path for the 20 projects we have in the deck and will make the best economic and environmental decisions. We have many options and will evaluate what makes the most sense long term. We view current frameworks as very favorable for WM.

Okay. One more: In Q4, core price and yield in collection and disposal converged more than recent quarters. You suggest in 2023 they'll widen back out. Can you provide color on factors that impacted that spread in Q4?

Great question. We saw the best conversion of core price to yield ever in Q4, driven in large part by strong churn performance—rollback improvement and favorable customer receptivity. That conversion was exceptional, but we used long-term averages for converting core price to yield in our 2023 guidance rather than rely on Q4 as a launch pad because of macroeconomic uncertainty. We didn't want to overpredict conversion given the uncertain environment.

Okay. Thanks, guys. Makes sense.

There are no further questions at this time. I will now turn the call back over to Jim Fish for any closing remarks.

Okay. Thank you. We ran a bit long today, but we have a lot to cover. Thank you for your patience. Thanks for joining us and we will talk to you next quarter.

This concludes today's conference call. Thank you for participating. You may now disconnect.