By Ken McEntee
(The Paper Stock Report) While
recovered paper prices continue to fall, Waste Management said it has
renegotiated customer contracts to ensure that it can recover its
material processing costs.
Speaking on a conference call to
announce the company’s full year and fourth quarter 2014 financial
report, David P. Steiner, president and CEO, said falling recyclable
commodity prices have created margins that are too small to recover
processing costs. In response, Waste Management has renegotiated
contracts to ensure that processing costs will always be recovered, even
if the company has to charge customers to accept recyclables.
“We're
going to use the opportunity to make sure that we restructure our
business such that we can make it profitable come hell or high water,”
Steiner said, adding that it isn’t only Waste Management that has been
impacted by weak recyclable markets.
“We need to take some steps
to really fix the recycling business. because if you look at not just at
Waste Management, but across the entire recycling industry, you're
seeing a stark divestment in recycling assets,” he said. “You're seeing a
lot of the smaller players starting to close up shop. That gives us a
great opportunity to restructure the recycling business, to restructure
it to where we can make a guaranteed return every year, which means we
can invest in recycling assets. We cannot invest in recycling assets in a
situation where nobody has any idea where commodity prices are going.
So, for the benefit not just of Waste Management, but I think for the
viability of recycling in the United States, we have to have some core
fundamental changes to make the business long-term viable.”
Steiner
said Waste Management’s recycling operations performed well in the face
of declining commodity prices. For the full year, the company’s
recycling line of business increased about $0.03 per share when compared
to 2013.
“This improvement was driven by better operating cost
performance, offsetting a more than 5 percent decline in OCC (old
corrugated container) prices,” Steiner said. “Our managers did a great
job managing their rebates and costs, as commodity prices declined
throughout the year. Until recently, we had expected our recycling
operations to remain flat in 2015. However, the recent slowdown in
Western U.S. ports has had a dramatic effect on the movement of
commodities overseas.”
He said lower Chinese demand for recyclables has also affected commodity prices.
“In
the last few weeks, we've seen another drop in commodity prices such
that we now expect recycling to have a negative effect on 2015 earnings
of between $0.03 and $0.05 per share,” he said. “That assumes that we do
not see another drop in commodity prices, and given current uncertainty
in the market, that's certainly possible. In the face of weaker
commodity prices, we must continue to take actions to ensure the
viability of recycling over the long-term.”
Specifically, that refers to the renegotiation of processing contracts.
“We
need to take a stronger stance to ensure that we recover our full
processing costs,” said James C. Fish – CFO and executive vice
president. “Processing costs increased due to circumstances beyond our
control like the Chinese Green Fence. We need to recover those costs. So
as we've said in the past, our strategy in pricing our recycle business
is to recover our processing costs before we split the commodity value.
Our contracts will also contain force majeure language to cover
increases in processing costs beyond our control, and if our processing
costs are higher than the commodity values, our customers will have to
pay for the difference.”
The viability of recycling, Steiner said, is based on a simple equation.
“In
the past, what the industry has done is said we'll sell the commodity
for a certain price and then whatever our processing cost is we'll be
able to pocket the difference,” he said. “The reality is as commodity
prices have come down, you have instances where our processing cost is
higher than what we are selling the commodity for. And so you can't have
the business model where it says we'll sell the commodity, split the
proceeds and hopefully cover our operating costs. The way we're changing
the contracts is to say, look, we are going to recover our operating
costs, whatever those might be and however those might be affected by
things that we can't control like the Chinese Green Fence. So we're
going to recover our processing costs. And if we're able to sell the
commodity for more than our processing costs, then we'll split the
proceeds with the customer. If our processing costs are higher than what
we can sell the commodities for, we're going to have to charge our
customers in order to recycle. And that's the only way that we can make
recycling viable for the long-term.”
Fish, however, suggested
that all of the contract changes have not been implemented and noted
that January’s overall recyclable commodity prices fell $10 per ton,
following by further declines in February, Fish said
“We
finished the year 2014 at $98 (per ton) and we saw a January drop about
$10, so to $89, and that impacts us on the 6 million tons that we
actually pick up and take to our MRFs, about $60 million in revenue,
which equates to somewhere in that $0.03 to $0.05 range on the EPS
line,” he said “We think in January, the cost control that we put into
place fully compensated for that which is why we were prepared to come
on a call and say we thought it'd be flat. And then with the February
decline, we just have not been able to put the more stringent contract
changes and cost controls in place yet. So can we do that? That is our
plan.”
Fish added that Waste Management is going to be more
aggressive in setting contractual limitations on contamination levels
for materials going to processing plants, and impose contractual
remedies for contamination in excess of those limitations.
“Contamination
above 10 percent leads to higher processing costs, and we need to
continue to get assurances from our customers that they will either give
us clean material or compensate us for higher processing costs,” Fish
said. “This will ensure that we only pay a rebate for the net volumes
produced and not pay our customers for residue.”
Fish noted that glass has always been a difficult commodity to recycle and an economic challenge.
“Unlike
other recycled materials, recycled glass must compete with an abundant
supply of virgin materials,’ he said. “As a result, glass recycling does
not provide the same environmental benefits to the society and it's
always been financially challenging for recyclers. In addition, glass is
difficult to handle, hard on equipment, and as of today, only one
company takes recycled glass for MRFs, so our options are significantly
limited. With most commodities, we get paid to deliver recycled
materials. Glass is the only commodity where we aren't paid for the
outbound product. We actually have to pay to send it to a processor. We
certainly recognize that our cities and communities want to divert glass
because it is the second largest recyclable by weight. But given the
many challenges associated with glass, we need to charge extra if a
customer wants to recycle.”
James E. Trevathan – COO and
executive vice president, noted that Harrisburg, Pa., has stopped taking
glass in its residential recycling collections.
“They recognize
that the value of recycling the material is just not just positive,” he
said. “There's no real market for it, and they've decided not recycle
glass. So that's a positive sign for us.”
Looking forward at recyclable commodity markets, Fish noted a weaker Chinese economy.
“There
are quality issues with outbound product,” he said.
“And there is, of course, the (West Coast port slowdown). One of the
concerns we have, honestly, about the port strike is that there's a lot
of products sitting idle at this point. When that does eventually get
resolved, all that product ends up out on the market, which could have a
dampening effect on commodity pricing.”
“At least the Canadian government has the balls to step into the fray
and get them back to work,” said a Canadian broker. “What is Obama doing
for the West Coast of the U.S.?”
By Ken McEntee
(The Paper Stock Report) Almost as quickly as it started, the Canadian rail strike ended. Canadian Pacific (CP) and the Teamsters Canada Rail Conference (TCRC) agreed on February 16 to enter into binding arbitration, putting an end to the work stoppage by CP's locomotive engineers and conductors.
Meanwhile, recovered paper traders are wondering when the U.S. federal government is going to take action to end a West Coast port slowdown that is holding up import and export activity.
“At least the Canadian government has the balls to step into the fray and get them back to work,” said a Canadian broker. “What is Obama doing for the West Coast of the U.S.?”
Meanwhile, in an appearance this week on CNBC’s Mad Money investment show, Waste Management President and CEO David Steiner called on the federal government to be more proactive.
“We have tens of thousands of materials that are ready to be shipped to China but it can’t be shipped because of the slow down at the ports,” Steiner said. “We’re joining with all the American businesses saying let’s do something to get this resolved. Let’s be a little more proactive at the federal government level to get this resolved and not hurt the economy more than it has already been.”
In Canada, an arbitrator was to be appointed by the federal government to oversee binding arbitration talks.
"This decision ensures both sides will get back to the table, and gets us back to moving Canada's economy forward," said E. Hunter Harrison, CEO of CP. “While we would have preferred a negotiated settlement, this is the right thing to do at this time."
Restructure contracts
Steiner also told Mad Money host Jim Cramer that Waste Management has restructure its contracts for recyclables.
“When the commodity prices go down so that your processing costs are actually higher than what you can sell the materials for, that’s a recipe for disinvestment into recycling,” Steiner said. “So what we told customers is we need to restructure to make sure that we can make money long term in recycling, not just so waste management can do better, but so that we can do better for the environment, because as a business, we have to make money to invest in recycling assets.”
Waste Management last week reported that recyclable commodity prices had a negative $0.03 per diluted share effect on the fourth quarter of 2014, but were more than offset by benefits from operational improvements in the recycling line of business. Overall, recycling operations positively affected earnings by $0.01 per diluted share in the fourth quarter when compared to the fourth quarter of 2013, despite an average old corrugated container price decline of 24 percent.
The company said recycling operations improvements are not expected to keep pace with recent recycling commodity price declines such that the recycling line of business is estimated to be between a negative $0.03 and $0.05 per diluted share in 2015 compared to 2014, assuming no further degradation in the prices of commodities.
