Thursday, February 19, 2015

Waste Management recycling will be profitable ‘come hell or high water’

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.”

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