GFL Environmental Inc
TSX:GFL
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GFL Environmental Inc
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Good morning, ladies and gentlemen, and welcome to the GFL Environmental 2023 Q2 Earnings Call. [Operator Instructions]. Also note that the call is being recorded. And now I would like to turn the conference over to Patrick Dovigi. Please go ahead, sir.
Thank you, and good morning, everyone. Sorry for the slight delay as our conference operator is experiencing technical difficulties at the current time. So you may hear from others that they may have not been able to log in, but anyone that logged in prior to sort of 8:15 a.m has the ability to log in. But it is -- the conference call is available sort of on the webcast and was logged in before 8:15 can certainly ask questions. So I'd like to welcome everyone to today's call, and thank you for joinin us.
This morning, we will be reviewing our results for the second quarter and updating our guidance for this year. I'm joined this morning by Luke Pelosi, our CFO, who will take us through our forward-looking disclaimer before we get into details.
Thank you, Patrick. Good morning, everyone, and thank you for joining. We have filed our earnings press release, which includes important information. The press release is available on our website. We have prepared a presentation to accompany this call that is also available on our website. During this call, we'll be making some forward-looking statements within the meaning of applicable Canadian and U.S. Securities Laws, including statements regarding events or developments that we believe or anticipate may occur in the future.
These forward-looking statements are subject to a number of risks and uncertainties, including those set out in our filings with the Canadian and U.S. Securities Regulators. Any forward-looking statement is not a guarantee of future performance, and actual results may differ materially from those expressed or implied in the forward-looking statements. These forward-looking statements speak only as of today's date, and we do not assume any obligation to update these statements, whether as a result of new information, future events and developments or otherwise. This call will include a discussion of certain non-IFRS measures. A reconciliation of these non-IFRS measures can be found in our filings with the Canadian and U.S. securities regulators. I will now turn the call back over to Patrick.
Thank you, Luke. In the second quarter, we continued to build on our strong start to the year with another quarter of double-digit core pricing and over 300 basis point expansion of underlying solid waste margins. Based on our strong performance in the first half, Together with our optimistic outlook for the remainder of the year, we are increasing our already industry-leading guidance for 2023. Both Q2 top line growth and margin expansion were beyond our internal expectations. And continue to demonstrate the strength of our best-in-class asset base and the ability of GFL's exceptional team to execute on our proven value creation strategies. With each passing quarter, I continue to be more humbled by the capacity of our 20,000-plus employees to drive our results, and I'm grateful to each and every one of them for their contribution to our success. The second quarter also saw the successful completion of our portfolio rationalization initiative that we committed to earlier in the year.
From these non-core divestitures, we realized gross proceeds of approximately $1.65 billion which is $150 million more than our original guidance. We also completed all three divestitures 1 quarter earlier than we had originally anticipated. Our ability to complete an initiative of this size and complexity over a short 6-month period is another testament to the capabilities of our team to successfully execute on our strategies.
The rationalization initiative was part of a broader, more comprehensive portfolio review that we undertook in 2022. As a result of that review, we recognized that while all the divested assets were of high quality, their forecasted return profiles were far less attractive relative to other outside accretive growth opportunities that we had identified in other areas of our business. We expect that the resulting geographic concentration of our portfolio after these divestitures will further support our ability to compound earnings and free cash flow industry-leading growth rates.
The divestiture had the added benefit of accelerating our balance sheet deleveraging with the net proceeds from the sales applied to paying down our highest coupon floating rate debt. As a result of the pay down, we ended Q2 with our lowest net leverage in company history. The resulting enhanced strength of our balance sheet alongside our margin expansion and accelerated free cash flow generation sets us on a clear path to ending the year with net leverage at less than 4x. and the opportunity to de-lever into the mid-3s by the end of 2024. As we have demonstrated, we remain committed to our stated deleveraging goals and are optimistic about the positive impact of the credit rating upgrades that we expect will occur along the way as our net leverage decreases with an eventual path to investment-grade ratings.
On our Q2 operating performance, we achieved revenue growth of nearly 14%, including the impact of asset divestitures, driven by Solid Waste core pricing of 10.4%. The combination of open market pricing activity, the roll forward of our surcharge initiatives from last year and the continued elevated price increases on our CPI-linked revenue drove our core prices to close to 200 basis points higher than expectations. We expect that the strength of the pricing that we have experienced in the first half will position us to achieve a full year core price of over 9% compared to 8% that was the basis for our initial 2023 guide. Lower Solid Waste volumes in the quarter were in part driven by the pull forward of volumes in the first quarter, but also our exit from non-core service offerings, mostly in our Canadian business.
As part of our strategic portfolio review that I described earlier, we also decided to intentionally shed high-volume, low-quality revenue, primarily in our U.S. residential service line and to deploy our resources into other attractive opportunities. We believe that this quality of revenue focus is yet another example of our discipline around capital allocation and our returns on invested capital. The margin expansion that we are seeing in the first half of 2023 continues to demonstrate the impact of our diligent focus on optimizing price and our cost base to drive higher underlying profitability.
Consolidated margins in the quarter expanded 130 basis points over the prior year. As the spread between price and cost inflation continues to widen, adjusted EBITDA margin expansion in our underlying solid waste business accelerated to 315 basis points in the quarter. In addition, our Solid Waste adjusted EBITDA margins were 60 basis points ahead of 2021, meaning we now have more than recovered our pre-cost inflation margin profile. The effectiveness of our fuel cost strategy initiatives can be seen in the quarter-over-quarter decrease in the margin impact of diesel prices.
We are pleased with the progress we have made on the respect of fuel surcharges and see incremental opportunity as we continue to optimize the program across our platform. While commodity prices continue to be a margin headwind compared to the prior year, we believe an eventual price recovery will occur and the future benefit of margins as we go forward. As we anticipated, cost inflation, excluding fuel prices, continues to moderate, although we continue to see repair and maintenance cost pressures persist. We now expect to end the year 50 basis points above the original plan on the R&M expense line but with the overall cost trending in the right direction.
Labor costs continue to sequentially improve, and we are optimistic about further moderation in the back half of the year. Performance in our Environmental Services segment was equally impressive with a revenue growth of nearly 20% and adjusted EBITDA margin expansion of 100 basis points. We continue to believe our strategic focus on our revenue quality and asset utilization will yield meaningful incremental operating leverage in this segment over the coming years with a line of sight to segment EBITDA margins. Adjusted free cash flow was ahead of plan, inclusive of incremental interest expense as a result of the earlier debt payment, which was not previously factored into our guide. CapEx spend was slightly behind expectations, attributed to the timing differences. The CapEx for the quarter included spend on new projects incremental to the original plan.
With the success of the divestiture transactions, we intend to allocate $200 million to $300 million of the proceeds to a number of incremental sustainability-related capital projects, primarily related to opportunities arising from extended producer responsibility legislation and renewable natural gas. In keeping with our strategy to maximize our returns on invested capital, we believe that these projects represent some of the highest quality near-term investment opportunities and are excited about the positive contribution that these investments will have across many facets of our strategy going forward.
On RNG, we had the ribbon cutting at our RNG facility in June, marking the completion of its construction. The Arbor Hills RNG plant is the first and largest GFL renewables project that we have with Opel fuels and is expected to produce more than 2.5 million MMBtus of RNG when it comes online later this quarter. We had said earlier in the year that we expected to have two projects in addition to the Arbor Hills online leader as part of this review. We now expect that we only have one of the additional projects to meet that time line with the third project now expected to follow by the second half of 2024.
The recent run-up that we have seen in the RIN prices is very positive for our investments in these project. But even without those larger, higher prices, we remain very excited about the contributions of EBITDA from our landfill gas energy project that we will begin to see this year and ramp into 2024 and 2025. We believe that our existing network of best-in-class assets and market selections positions us for high-quality organic profitable growth.
In the first half of this year, we have been very focused on completing the 3 non-core divestitures and harvesting the self-help opportunities in our existing platform. Our results demonstrate our success in implementing these initiatives. We continue to have a robust M&A pipeline. And given the enhanced strength of our balance sheet and free cash flow profile, we will again focus on our M&A strategy of densifying our existing footprint in North America. On the ESG front, we made progress in several areas. GFL was named Corporate Knights as one of the Canada's 50 Best Corporate Citizens and was awarded the SEAL Business Sustainability Award for the second time in 3 years. For the RNG initiatives that we are implementing in our landfills.
These RNG projects are key pillars of our sustainability action plan and support our goals of reducing our own emissions by increasing capture of landfill gas and displacing the use of virgin fuels in our fleet. We are also continuing to increase our ESG disclosure with the filing of our first CDP report this month, and we are on the path to completing our first comprehensive stand-alone report in line with the recommendation of the task force on climate-related financial disclosures by the end of the year. I'll now pass the call over to Luke, who will walk through the quarter in more detail, then I'll share some closing comments before we open it up for Q&A.
Thanks, Patrick. For the following discussion, I will refer to our accompanying investor presentation, which provides supplemental analysis to summarize our performance in the quarter. Page 3 summarizes the bridge between realized revenue and our guidance. Updated to reflect the impact of the divestitures consistent with our June press release. Excluding the impact of the steady appreciation of the Canadian dollar since the beginning of May when we provided this Q2 guide, revenue was $1.955 billion as compared to our pro forma guide of $1.95 billion.
When unpacking the out-performance, it is really a function of incremental solid waste pricing, which was about 175 basis points ahead of plan, offset by just under 200 basis points of incremental negative Solid Waste volume. Recycled commodity prices and higher revenue from our environmental services line contributed to the out-performance, but the amounts were relatively immaterial. Solid Waste core pricing continues to be strong in both our geographies.
Recall the normal and expected cadence of quarterly pricing is a peak in the first quarter and then a sequential step down thereafter. The 200 basis point deceleration in pricing from Q1 was less than expected as open market pricing remained constructive and our CPI-linked revenue continued to reset at elevated levels. Providing support to the relatively lower percentage price increases historically realized in the residential collection and post-collection lines of business. Q2 Solid Waste volumes was negative 3.5% and which included a certain amount of volume pulled forward into Q1, as we had suggested on the first quarter call as well as intentional shedding of low-margin work. Looking at the first half as a whole, which is more reflective of the underlying performance of the business, Solid Waste volume was negative 160 basis points.
The components of this negative 160 breaks out as follows. Approximately 60 basis points relates to the exiting of non-core other revenues in our Canadian business. These are lower-margin ancillary services inherited through acquisitions that we have decided to no longer provide as a result of our ongoing strategic portfolio reviews that Patrick spoke to. Another 20 basis points relates to special waste volumes, which tend to vary in timing from 1 year to the next. And the other 100 basis points relates to non-regrettable losses, substantially all of which is in the collection line of business.
Our underlying volume growth for the first half was approximately 20 basis points. The vast majority of our customers are willing to pay for our high-quality services, and we continue to retain existing customers and win net new customers at appropriate prices every day. But as Patrick mentioned, we're electing to not renew contracts that do not meet our return thresholds, given our increased focus on quality of revenue. In the current operating environment, we believe that it's better use of our resources to focus on the many other accretive opportunities we see before us. The positive impact of our pricing and deliberate volume strategies can be seen in the underlying adjusted EBITDA margin expansion.
On Page 4, we show the bridge of the 220 basis point year-over-year Solid Waste adjusted EBITDA margin expansion. Commodities continue to be a year-over-year headwind in a 110 basis point impact compared to the prior year. Due to our scale and the quality of the commodities we sell, we typically realize a selling price at a spread above market indices. However, periods of significant price volatility can temporarily cause spread compression such that the net price we realize can decrease even when the headline market indices increase, and that's what we saw in Q2. Although fiber prices have increased recently, the coincident rapid and significant decline in non-fiber prices yielded this type of spread compression during the end of Q2.
As a result, the average net commodity price we realized for the quarter was only very modestly above our initial guidance. Divestiture of the , which had a blended basket of goods price higher than our company average, also impacted our average commodity price. The continued decline in non-fiber prices since quarter end results in a current basket price approximately equal to our original guide. The anticipated stabilization and subsequent recovery in commodity prices towards the end of the year should result in a reversal of this trend.
The incremental effectiveness of our fuel cost recovery strategies is clearly evident on the bridge on Page 4 of the presentation with an 85 basis point sequential improvement to the net margin impact over Q1. With the substantial completion of the first phase of our surcharge initiative, we do not anticipate material negative margin impacts from future rapid increases in diesel costs and we see additional upside from continued enhancements that we are implementing, including on the indirect fuel side. Also shown on the bridge is the impact of M&A and of receiving approximately $5 million of business interruption insurance from the fires that we had in Canada last year. After excluding those items, base business solid waste margins expanded 315 basis points a 125 basis point acceleration over Q1 and demonstrative of the widening spread between price and cost inflation that we forecast in the 2022 guide. The accretive margin impact of the non-regrettable revenue losses that Patrick and I just described also contributed to the margin expansion out-performance. Adjusted free cash flow for the quarter was $9 million, better than our plan despite incurring $10 million incremental cash interest expense as a result of repaying our floating rate debt earlier than originally anticipated.
Adjusted cash flows from operating activities increased 18% despite a 32% increase in cash interest expense versus the prior year. On Page 5, we have summarized the impact of the now completed divestitures, due to timing differences between in-year impact of divested adjusted EBITDA and the associated savings and interest cost and CapEx, the divestitures are modestly dilutive to 2023 results, but are still anticipated to be accretive within the first 12 months. Cash taxes and transaction costs resulting from the asset sales will total just under $400 million and the approximately $1.3 billion of proceeds were used to repay outstanding borrowings under our revolving credit facility and just under half of our term loan B.
As Patrick mentioned, with the transactions yielding $150 million more than the original plan and closing the quarter early, we are reallocating a portion of the proceeds towards attractive capital opportunities that we have been evaluating. Which I will flesh out in more detail when we walk through the guidance update. As a result of the net debt repayment and the strong first half operating performance, we ended Q2 with net leverage of . On Page 6, we have summarized our new debt profile, where it shows that now almost 80% of our debt is fixed rate, and the overall complex blends to a borrowing rate of approximately 5.2% and nearly 50 basis points better than before the debt pay down.
In terms of our updated guidance for the year, Page 8 provides the bridge from our original guidance by approximately $70 million on a like-for-like basis. The new guide assumes an FX rate of for the balance of the year. So the last step on the bridge shows the impact of that change in FX rates. Underlying this new guide are the following assumptions: Solid Waste pricing goes to just under 9.5% from 8%. Surcharges go to negative 1% from flat, reflecting lower diesel prices, Solid Waste volumes go to negative 2% from flat with underlying volume growth of positive 20 basis points, offset by approximately 110 basis points of intentional shedding and approximately 90 basis points from exiting non-core ancillary services mostly in our Canadian business.
Commodity prices are expected to impact consolidated revenue by negative 60 basis points, while FX is expected to contribute positive 160 basis points. The new guide also assumes that Environmental Services organic growth improved 200 basis points to around 7% and the net impact of M&A decreases to 1.7%, reflecting the out-performance in the first quarter in new M&A during the year, offset by the impact of divestitures. The new guide assumes today's commodity price environment, as previously discussed, the net impact of which is broadly in line with our original guidance.
The expected recovery of commodity prices should provide upside to the guide throughout the back half of the year. Page 9 completes the guidance update and shows the pieces to walk from revenue to free cash flow. Adjusted EBITDA increases $55 million using the same FX rate as our original guidance or $50 million at the new FX rate. And adjusted EBITDA margin expands an incremental 50 basis points over the original pro forma guide as the widening spread of price over cost, improved asset utilization and the accretive impact of shedding low-margin volume all drive incremental margin. Cash interest expense reduces to $490 million as the in-year savings from the debt repayment are partially offset by the increased interest costs from floating interest rates and borrowing levels higher than originally anticipated.
In 2024, the full year impact of the debt repayment will be realized and cash interest expense will be closer to $400 million. On CapEx, as we said, we see highly compelling opportunities to redeploy a portion of the proceeds from the divestitures and into incremental organic growth initiatives, which we anticipate will provide accretive returns on invested capital long into the future and further improve our ability to generate high-quality, sustainable free cash flow growth. Some of these projects were already in our queue and the incremental expenditure reflects the acceleration of investment that would have otherwise been made beyond 2023.
Others are net new opportunities that arose this year. As Patrick said, we expect that we'll be able to deploy an incremental $200 million to $300 million of CapEx before the year is done and have updated our guidance for this gross CapEx accordingly. The breakdown of the incremental investment is approximately $150 million to $200 million into 5 , 4 of which are in Canada and one in the U.S. $25 million to $50 million into RNG project development and another $25 million to $50 million for land and building infrastructure to support these initiatives. The payback on the RNG investments are well known. At today's VIN prices, the returns are even more attractive at sub 3-year paybacks. So we're obviously motivated to accelerate these projects as quickly as possible.
And in certain instances, the incremental R&D capital as a result of a changing partnership economics, which we expect to be positive. On the spend, these projects are largely in response to existing EPR legislation and strategic positioning in markets where we expect EPR to arrive or where we have sufficient internal volumes. These new EPR contracts can be 10-year fee for processing based models with accretive margin profiles and sub 5-year paybacks.
We view these investments as a reallocation of proceeds received from the divestitures. We think that offsetting this excess investment by a corresponding and equal allocation of divestiture proceeds yields an adjusted free cash flow metric that is more reflective of the current cash-generating capabilities of the business. The impact of working capital and other operating cash flow items are expected to be close to 0, excluding the impact of the cash taxes associated with the divestitures, which we intend to exclude in our adjusted free cash flow reconciliation. The resulting balance sheet from the revised operational guide is net leverage of less than 4x exiting 2023, and a level that should organically reduce another 50 to 70 basis points by the end of 2024, as shown on Page 11 of the presentation, putting us on a solid path toward an investment-grade rating in the medium term.
In relation to our specific expectations for the third quarter, we expect consolidated revenue of approximately $1.865 billion, just under 80% of which will be in Solid Waste. Keep in mind, the recent divestitures impact Q3 revenues by $115 million compared to the original guide, which is the driver of the atypical step-down in quarter -- the recast FX rate also impacted sequential quarterly comparison by approximately $20 million. Solid Waste adjusted EBITDA margins are expected to be in line with the second quarter, reflecting underlying sequential expansion, offset by the 35 basis point benefit of insurance recoveries that we recognized in Q2.
Environmental Services margins are expected to be between 30% and 31% through operating leverage realized on the peak third quarter revenues. Corporate cost margins are expected to be 10 basis points higher than Q2 on continued investment in IT development and the impact of the divested revenue. This results in adjusted EBITDA of approximately $525 million at consolidated margins of approximately 28%, representing over 200 basis points of expansion compared to the prior year. From that adjusted EBITDA, the components to get to adjusted free cash flow or cash interest costs of $115 million, a benefit from working capital net of other items of about $25 million and gross CapEx of $275 million to $300 million or approximately $160 million when incorporating the allocation that the divestiture proceeds previously discussed. That results in adjusted free cash flow for the third quarter of approximately $275 million. That's the summary of the guidance update. I will now pass the call back to Patrick, who will provide some closing comments before Q&A.
Thanks, Luke. This quarter shows the results of our focus on taking the exceptional platform we have built and continuing to enhance it to produce industry-leading results. We continue to use all of the self-help levers that we have at our disposal to improve asset utilization and cost efficiency and the impact of that is demonstrated in the quarter-over-quarter underlying margin expansion. We are taking action across our network of assets to maximize the returns from our customer base. From each market area and from strategic capital investments, all confirming the relentless commitment of GFL's employees to long-term value creation for our shareholders.
As I said earlier, I'm extremely grateful to all of GFL's employees for their commitment to the success of Team Green. I will now turn the call over to the operator to open the line for Q&A.
[Operator Instructions]. And your first question will be from Michael E Hoffman at Stifel.
Patrick, let me start with price. So the whole industry has been enjoying this benefit. From your perspective, is it better retention of what you've been doing? Or did you come back through and look for more? And then I'd like to talk about cadence because inflation is starting to [indiscernible]. So we do need to manage the thought about cadence?
Yes. So I think -- I mean, we had the benefit of, again, some of the surcharge programs and rationalizing the existing book that we had. We had -- a lot of that will be recognized in base -- the initial recognition that comes into base price. So that remains at elevated levels. But the -- we still have a good opportunity with the existing book of business with some underpriced customer bases, particularly on the commercial side and on the residential side, to continue moving those up coupled together with the CPI lags in the residential books of business.
So all those put together, allowed us to sort of move up the guide, particularly on price, particularly with seeing where some of those CPI adjustments have been coming earlier in the year and where we think the balance of those re-rate. So we're in a good position. Obviously, with CPI come down as that moderates, we've built that into our forecast. But I think from where we sort of sit today, we feel very comfortable with the guidance that we put out.
And how should we think about cadence through the second half and then into '24? Because CPI is coming down. And that doesn't mean you won't maintain this really strong spread, just the rate of change will narrow?
Yes, Michael, it's Luke speaking. I think that's right. For the balance of '23, we expect that we'll call it kind of the normal cadence that sees Q3 stepping down, like another 200 basis points similar to Q1 and then the step down sort of moderates in Q4, and you're looking at sort of more like 100 basis point step down then. And then we're not in a position where we want to talk about 2024 in earnest. But as we've said historically, we think there is a constructive backdrop with the delays in CPI as well as the constructiveness of the open market dynamic to continue it, but the elevated levels of pricing. I don't think you're going to see it at 2023 levels.
But to your point, we're going to be facing a cost inflation number that is well inside of what 2023 saw. So we think, as we've been saying for the last couple of quarters that there's an opportunity to continue to maintain is an outsized spread as compared to historical amounts.
Okay. And you have socialized in the past the idea by 2025 an adjusted cash number of $1 billion, but it would appear now that without adjustments that $1 billion is achievable by 2025. Are we looking at that correctly?
I would be disappointed if it wasn't there, for sure. I mean -- if you sort of look at what the math, I mean, we said we think when you sort of layer in RNG and you layer in all the other aspects and now with the accelerated de-levering, I think we're certainly going to -- my expectation is we are definitely going to exceed the $1 billion in 2025.
Okay. And then the RNG projects that you're adding in the accelerated spend, do they qualify for investment tax credits. So I'm going to get that capital -- some of that anyway?
Yes.
And can you max it out at 50%? Or should we think about it as 30%?
I mean we'll push to maximize that 50%, but for conservatism perspective, we're using 30%.
All right. And then what gives you confidence you can spend all this money in '23, given the delays that happen in other stuff?
We're not certain. I think from our perspective, it was prudent to sort of bring it up. I think when you think about these incremental capital spend, as you know, we've been sort of a leader, particularly on the PR front. And a lot of those contracts have come together over the last couple of months, and they are a combination of and hauling businesses to support those. Not only in Ontario but supporting them in other parts of the country. And the way I would think about, hey, if this was an acquisition, you're basically getting call it, somewhere between $40 million and $50 million of EBITDA at very sort of high EBITDA margins for a spend of a couple of hundred million so you're paying sort of 4 to 5x.
So I think from our perspective, we think we have the ability to deploy those dollars. Some of this has been in planning with the expectation that this would happen. Because these negotiations started last fall, but have really come together over the last couple of months.
And Michael, the uncertainty about the ability is also the basis for the wider range but on that basis. You also have to remember, as Patrick said, a lot of this is an EPR and . And while machine and the likes may not be able to deliver all the equipment in certain instances, there's land building retrofitting existing properties, construction. So there's other costs that can be to be done in preparation for it. But you're absolutely right. It's a bit of uncertainty on that [indiscernible] and hence, the wider range.
Next question will be from Kevin Chiang at CIBC.
Maybe just on how to think about CapEx moving past 2023 gross CapEx, and I appreciate you have offsets here given the successful asset divestitures. But if I think of what the gross CapEx intensive the business is in '24 and onwards? Should we be holding at these levels kind of 14%, 15% of revenue, just given the pipeline of opportunities?
Or you kind of step back down to let's say, 10%, 11%, 12%, like you were assuming in the original forecast earlier this year?
Yes, Kevin, it's Luke speaking. I think characterizing this year as an outlier is the appropriate approach, and it's really by function of these divestitures, proceeds being reallocated. The other component to this is R&D. And if you look at our total spend over all of the projects in totality might end up being at a sort of gross level in a sort of $500 million level. But when you think about 30% ITCs, you think about 40% to 50% project level financing your actual equity check at the end of the day is going to be materially less than that. But sometimes, there's timing differences as part of this year's spend is the ITCs are going to come next year, but we want to invest the capital this year.
And so we are going to have a bit of this gross versus netting as we deploy into RNG -- I think when you look at our underlying business, you think about the relatively lower landfill concentration that we have because of the Canadian dynamic and the Environmental Services business that both run at lower capital intensity than industry averages. We see a clear path to live at that sort of 11% level, which is inclusive of the normal course growth. To the extent attractive, compelling opportunity to deploy capital arise, we'll talk about it like times like this. But I think the relative dollars at play as we go forward will become less impactful to the overall and that in and around 11% is the right intensity to think about.
Excellent. That's great color. And then you laid out a, I'll say, a target to mid-3x leverage exiting 2024. I guess when I think back to your Investor Day, you kind of laid out a number of acquisition scenarios. Just if you're able to share with us, which of those three should we be thinking about to the mid-3s? Are you kind of back to an elevated M&A scenario in your mid-3s? Or are you kind of in the middle of the pack? Does it assume no M&A? Any color there would be helpful?
Yes. Listen, I think from where we sit today, we have some wonderful acquisition opportunities that will be very compelling for us to execute on in the back half of this year. So we put out this guide. We've taken a conservative view on the guide. Obviously, every quarter since we've been public, our philosophy has been sort of under promise and over deliver. So I think that theme will continue. The backdrop is we've committed to this year, keeping leverage sort of around 4 terms. And we will do that with the model we have as well as executing on the M&A. So where we sort of sit from the company's first time in history, given the free cash flow profile of the business now and what that looks like for next year, we've thrown out a number next year for almost $875 million of free cash flow.
When you look at that, coupled together with the free cash flow in the back half of the year, we're going to be able to do both. The business is going to grow organically, it's going to naturally de-lever. M&A, taking a bunch of the free cash flow and reinvesting that into our M&A program. Again, we'll all be de-levering events. So we think we're going to get there irregardless of our normal sort of M&A spend.
And Kevin, the math today, I mean, it's pretty straightforward. If you think about organically, the business could de-lever low 3s how much M&A will temper that otherwise de-levering. It's roughly 4 basis points of leverage for every $25 million of EBITDA you buy. And so if you put that together, if you to $100 million of EBITDA that has an impact of somewhere to the sort of 10 to 20 basis points of incremental leverage.
Okay. That's great color. I guess last one for me. environmental services, long-term target of getting to 30% EBITDA margin. You kind of hit that in certain quarters, at least very high-20s. Just when you think of getting there, I guess, on an annualized basis, Is it trying to reduce the seasonality of the margins, which are a little bit lower in the shoulder quarters? Does everything have to come up by basis points?
Or do you just have to kind of hit it out of the park even more so in the Q2 to Q3 quarter? Just wondering how you think about getting to that 30% overall, just given the seasonality in that profitability?
Yes, there's always going to be a large element of seasonality in that business just because for the simple fact that it's levered to Canada. So we are going to have that normal cadence each and every year. That being said, there's going to be a high focus on quality of revenue and surcharges that we believe we should be getting in that line of business. So I think when you look at it, I think there's the ability to just really take up margins. The Q1 margins will obviously always be the lowest. Q4 will be the next roll up in Q2 and Q3 will be the highest we have to push Q2 and Q3 exceedingly above sort of where they are today, and we have to get those surcharges implemented to offset the sort of Q1 and Q4 dynamics. So it's going to be a bit of a mixed bag, but I think we have a clear path to sort of getting there. And I think you're seeing that come through quarter-over-quarter, year-over-year.
And Kevin, you got to remember the foundation of that business is largely [indiscernible] on, these post-collection facilities we have across Canada that are very high fixed cost base in nature. And as you think about the revenue growth, we're now putting in the utilization improvement of those assets, you get a lot of operating leverage coming in that. You're seeing that this year. And as we roll that forward, what was used to be $500 million, $600 million of revenue in that segment. We're now going to be approaching $1.5 billion and you're going to get meaningful operating leverage at a much more fixed cost base.
Next question will be from Jerry Revich at Goldman Sachs.
This is Adam Bubes on for Jerry Revich. Can you talk to the incremental, I think it was $25 million to $50 million RNG&D investments. Does that include any new projects? And should that change how we're thinking about the cadence of projects beyond 2023?
So Adam, it's Luke speaking. Nothing is new in that number. There is one project that was previously going to be a partnership that we're now going to go alone in that it was a partnership with not one of our core partners, but a tertiary partner. We've now bought them out are going to go alone and accelerating some of the spend on that. So we're still looking at the same number of projects in totality -- the reality is, as I was speaking before, with a combination of timing of receipt of ITCs as well as project level financing, there's just a bit of a change in the cadence of our equity checks.
And so I think when you get to the end of the next couple of years, the actual net investment will remain the same, but just there will be some lumpiness from quarter-to-quarter.
Understood. And then with RIN fee prices now in $3 range -- can you just update us on how you're thinking about your offtake strategy in RNG? Do you have a targeted percent that you intend to sell into transportation markets versus long-term arrangements?
Yes. So again, currently in process, I think our longer-term strategy may differ from the shorter-term strategy. But in the longer term, like we said, we want to get to a point where we basically have 60% to 65% of our take [indiscernible] off and sort of long-term agreements. Obviously, we want the right price for that. Obviously, with a $3 RIN, that helps the longer-term strategy for those longer offtake agreements, but we want to get to a point where we're going to be at sort of a longer-term offtake agreements in the sort of 60% to 65% range. .
Got it. That's helpful. And then lastly, really strong margin performance in the quarter with margins well ahead of normal seasonality. Just looking at the back half guidance, it looks to be implying sequential margins basically in line with normal seasonality. And it also looks like your underlying inflation is decelerating much faster than price. So just any puts and takes around the sequential margin cadence from here relative to normal seasonal trends?
Yes. So I think last year sort of defied the normal seasonality by virtue of the inflationary ramp that was really more focused in the second half of this year. And so as that's unwinding causing some impact the current year sort of seasonality cadence. But look, for the Q3 guide that we've put out, effectively saying Solid Waste continues to expand from where it is today. Just normalized for the insurance recoveries that we received in Q2, which created about a 30, 40 basis point benefit to Q2. So if you're stripping that out, continued sequential improvement in solid waste and that's really a function of that continuing widening spread. Yes, cost inflation is anticipated to moderate even further in Q3, and you're going to be in a mid-single-digit number.
And as pricing sort of comes down accordingly, I think you'll get a little bit more spread above those too. Environmental Services is similar to the comment we were saying before, really firing on all cylinders, but with the Q3 peak revenue, so you're going to get the sort of optimized operating leverage. And that's why we see now a path that margins in that segment for Q3 could touch 31%. And then Q4, obviously, as the seasonal cadence, you have a bit of a step down from there as you move into the winter season.
Next question will be from Tyler Brown at Raymond James.
Luke, I think you touched on it, but volumes were a bit weak in the quarter, it sounded a bit by design. You gave some color, but second half volumes are maybe down 2% on my math. Is that about right? And will there be any difference between 3 and 4?
Yes. So I'd say your math is right. about what the second half is looking at. And it's really just a continuation of what we are articulating in the first. So as I said, I think the pull forward from Q2 into Q1. So I think looking at first half in totality makes more sense, negative 160 basis points of volume. If you break that down, you had about 60 basis points, which was $15 million of what I'm calling this non-core ancillary services. This is work stuff like wood shipping or gravel hauling and other ancillary type services, primarily in secondary markets, we've been doing for a while, but we really don't make any money there, and we're exiting that. That's one component of it, and that will sort of basically maintain each quarter throughout the year until that work is gone. For the first half, we have about 20 basis points of the event-driven special waste volumes.
If you look last Q2, special waste volumes or landfill volume in the U.S. was plus 12%. I think we benefited from cleanup from some tornadoes and other events. That's always going to have a trend that are concerning there, but rather just the normal sort of change. So I'm anticipating by the end of the year, that sort of neutralized more back to sort of flat sort of level. And then what you're left with for the first half is this sort of 80 basis points or call it $20 million of the net of this intentional shedding offset by real underlying volume growth. And the intentional shedding, look, it's primarily in residential collection, although some is in IC&I and this is a function of our strategy of price over volume. And I think, by and large, it's working and you can see it in the numbers and in the margin. But certain select handful of residential large accounts that are unwilling to pay for our service.
We're going to walk away from, and we're happy to do so in this environment. So for the back half of the year where you end up with the roughly 200 basis points or $100 million of negative volume for the year as a whole, you roughly have half of that as a result of the exiting the non-core ancillary services. Another so to call it $60 million from the non-regrettable losses or intentional shedding. And then you have an underlying $10 million, $20 million of positive growth from our normal course service level and increases in new customers.
Okay. Very detailed, very helpful. I appreciate that. Patrick, I want to talk about repairs and maintenance because it sounds like the OEs are starting to deliver. It seems like pulp prices are dis-inflating, and I think rentals might be down next year. But does feel like it could be a uniquely good story in '24?
Yes. I mean we're -- we're still basically 100 -- almost 100 basis points more than where we've been historically. So yes, I think we're going to -- this year it's going to be 50 basis points ahead of our -- what our original plan was at the beginning of the year, but things are certainly coming down. We're certainly getting more truck deliveries and the timeliness of those truck deliveries is coming on board. Now from an OEM perspective, it's obviously moderating prices on supply of parts as well. So all of those coupled together are coming down. I mean, if you look at from us, from a rental truck perspective, we are -- or we are renting a quarter amount of the truck that we were renting a year ago, right? So that's all in the R&M line. So yes, you're right. And I think as that moves into '24 and '25, that is certainly going to moderate and be a good news story as we move over those next 2 years.
Okay. We'll keep an eye on that. And then, Luke, on the $1.65 billion gross proceeds, I think you said $400 million maybe in taxes and transactions that's going to be out the door. Has any of that been paid? If not, when will that be paid? And where will that show up on the cash flow statement?
Yes. So maybe a modest amount of transaction costs have been paid roughly, I think of it, $360 million of taxes, $40 million of transaction costs, round numbers to get you to that $400 million a modest amount of transaction costs would have been paid in Q2. The rest was accrued, and you can see that in the large transaction cost adjustment we have in the P&L. The balance of those transaction costs will be paid in Q3 and will show up in our normal transaction cost bucket. The cash taxes will be paid sort of roughly, call it, half in Q3 and half in Q4, maybe actually more like 60-40 towards Q3. And will show up in our cash tax section and the cash flow. We may have some incremental disclosure to break it out, so you can see the impact of what we're calling the sort of onetime versus ongoing.
Okay. That's helpful. And then my last one, kind of another question along maybe a similar line. But a couple of your RNG plants are kind of in that initial start-up phase. But how much EBITDA contribution are you baking in on those facilities? And how is the accounting going to work?
Are you guys seen at consolidated. So will you just have some sort of an add-back in the EBITDA reconciliation? Or how is that going to work just practically?
So for 2023, the guide anticipated an inclusion of an immaterial number, I think it was about $10 million in total -- with the delays, I mean, that might be a little light, but the RIN pricing probably offset. So the 2020 number is sort of as per the original guide.
The 2023 number.
As you get into 2024 and that starts ramping up, Yes, Tyler, I think that's right. These are joint ventures that are unconsolidated. And our perspective is the GAAP-based accounting answer doesn't accurately reflect what our investors are looking for. So you will have an adjustment to remove the GAAP-based net income that you're picking up and replace it with your proportionate share of the EBITDA.
So we'll preview that as part of our 2024 guide to make sure everyone understands very clearly what we're showing there. But we anticipate something to that effect.
Next question will be from Walter Spracklin at RBC Capital Markets.
Good morning, everyone. So on the intentional shedding of business, we're hearing that from your peers as well. Just a basic question. Where is that being shed to? Are you seeing smaller players now picking up some of this? Is it going to some of the majors that are seeing a better opportunity through combining with their own operator? Just curious as to what your experience is where a couple of year -- or at least one of your peers is talking about some pretty significant also intentional shedding of business as to where it's ending up?
Yes. I mean, for the most part, I mean, it's in very selective market. It's been a mixture of both. It's been some strategics that have some strategic opportunities there, whether that's internalization of streams into their landfills, et cetera. And in a couple of the markets, it's been municipality taking a chance on a smaller type collector in a market that's sort of a recent start-up. History tells us with those we always generally end up with the work coming back to us over the course of the next sort of year to 1.5 years. And from our perspective, particularly in this OEM environment of getting new trucks, and the cost of capital, we want to be rewarded appropriately for it. So in some of these residential contracts came with acquisitions, et cetera, I tell everybody in the organization, we're a for-profit organization. We don't need to practice. So there's no sense in practicing on some of these residential contracts, particularly in this environment.
If we can take those good dollars and deploy them into things that are actually we're going to make money from. So a bit of mixture of both.
And there's no worry here that this is representative of a lack of discipline among smaller players or anything to that?
No. No.
Okay. On the margin, Luke, you mentioned margin spread expansion in 2023, and that comes after you saw some cost inflation really ramp in 2022. And your mechanisms kicking in nicely now in '23 to be able to allow for an expanding spread, whereas perhaps it was contracting last year or was pressured last year. How do you look at it for next year? Are you expecting more of a normalized? In other words, is there less benefit from an expanding spread? Or could we see that spread last longer into 2024? Based on how your mechanisms work.
Yes. Walter. So I think as we've been saying consistently, we anticipate '24 being another outsized year. And it's a combination of not just the natural spread expansion that you're going to have. But there's also -- I mean Patrick just signed R&M. That is not going to get fully sorted this year and will represent an incremental tailwind. You can talk about commodities. I mean we are very optimistic commodities will start rebounding this year, but I think that's going to be a real tailwind going into next year. I'm not saying ample of what should be a tailwind.
RNG, as that comes on for us, we have a relatively immaterial amount in the current consolidated results and it's very high margin. So I think the natural price versus cost inflation spread dynamic unto itself, should provide an opportunity for outsized expansion. But when you start layering those other pieces on top, we see the setup for 2024 to be an exceptional year.
Okay. That's fantastic. And the last question here is on the CapEx spend, and it seems like a larger number to have an all at once. And just curious, is this something you were always contemplating and just mindful of dollars spent and keeping everything in check? And with the proceeds now from the acquisition, you saw an opportunity to strike on this one. Or is it the opportunity and the capability and you hit as a result of that? Just curious as to how they came up?
Yes. So I think as part of the Divestiture program, we knew that there was going to be an opportunity particularly with where we saw the EPR opportunity going at the last half of the year, meaning in 2022. A lot of that work was tendered and developed with us in the sort of first quarter of 2023 and really formalized in the second quarter of 2023. So I think from our perspective, we -- our anticipation was that as we saw the divestiture sort of unfolding that we actually ran a little bit harder at the EPR opportunity than maybe we would have and taking on the amount of work that was available under that program. But listen, from where I sit today, there is no better use of capital, putting the RNG spend aside, then these partnerships that we've developed with the producers in Canada, particularly with some of these contracts ranging from 10 to 20 years [indiscernible] to meet their sustainability goals. I mean they are -- it's a wonderful partnership. It's a win-win for both of us.
And the fact that we've moved these to fixed fee processing contract, so we don't have any commodity volatility I mean, it's just -- it's a wonderful thing where you're basically going to be at around 4-year paybacks on these with 10- to 20-year contracts, coupled together with the vertical integration of now putting the collection contract together with them. We just didn't see a better opportunity to deploy those dollars. And given the fact that we even exceeded our internal expectations, we're getting an extra $150 million of proceeds from what we anticipated when we started the process, this was just a logical place to put those dollars. And again, the setup that gives us for '24 and '25 is going to lead to a significantly above-average growth CAGR as we move out into '24 and '25.
Next question will be from Stephanie at JPMorgan.
Growth is price-driven and surcharge driven versus the processing volume side?
Yes, Stephanie, it's Luke speaking. I mean if you look at the typical sort of growth algorithm in its always business, you probably have 80% coming from price and 20% from volume. I think our Environmental Services business today is probably the inverse of that. Now it's not it's homogenous of a mix, so it's harder to do exact, but it has certainly been a volumetric growth story and is only recently pivoting to price. So certainly a larger portion in this quarter versus the prior was price, and you're going to continue to see that migration towards a price-centric growth story. But that's what gets us excited about the opportunity because as we start being more thoughtful about the quality of revenue and ensuring we're getting priced appropriately, we see the opportunity for meaningful incremental operating leverage over where we are today.
Okay. Got it. That makes sense. And can you give us a sense of how the different business lines put in Environmental Services is doing?
I mean just at a high-level bifurcation, people have historically asked about our sort of oil and oil-related exposure and obviously, that business with a decrease in energy costs, is realizing revenues at a sort of lower point than it had sort of historically. But more and more the diversification efforts that we've undertaken I mean that business is representing sub-10% of the overall as we go forward. So really, when you think about our broad-based sort of environmental services across the collection and processing, we continue to see strength that's particularly levered in Canada. I think the brand we have created and the quality of the service that we're offering very valued by our customers, and we continue to see phenomenal sort of growth as you've seen over the past sort of year or 2.
Okay. And would you consider expanding environmental services outside of Canada, more so into the U.S?
Is the right opportunity in the right markets presented themselves? For sure. I mean we have been fully expanding into the U.S. Obviously, the market selection and the right asset base is the most important part. But yes, I mean, we'll definitely look at opportunities. We're not shying away from different opportunities in the U.S. That's for sure.
[Operator Instructions]. Your next question is from Michael Doumet at Scotiabank.
The expectation for price cost spread to expand in the comer quarters, that's been well explained. I wonder despite inflation slowing, whether you think peak price cost spread will occur in 2024 rather than in the second half of 2022. This obviously includes commodity and RNG piece?
Yes, Michael, it's Luke speaking. I think we could debate whether we'll be sort of Q4 of this year or Q2 that it's actually peaked. I think our perspective is the trend line is supportive of establishing a new wider spread than what we had before. And I think you're seeing that happening. I think if you think about the way the dynamics roll into there's clear math that supports continued wider spreads. But it's difficult to call the exact sort of when it's going to peak. We're just feeling very optimistic that 2024 will seem to be constructive.
That's helpful. And then on 2024 EBITDA margins, maybe a little bit early to discuss, but if I were to exclude the full revenue and EBITDA contributions from the divestitures from the pro forma '23 EBITDA guidance, I get to a full year EBITDA margin of 27.1%. So just thinking if that's a fair starting point for 2024? And obviously, I would add, I don't know if it's 200 or 300 basis points of price/cost spread, RNG, et cetera. Just trying to get a sense from you on how to think about those numbers?
Yes, Micheal. So we're not going to talk about 2024 today. We gave the 2023 guide, ending at $2 billion, 27% margin. I think normal course, historically, we've been saying 50 to 100 basis points of margin expansion. We think 2024 is an outsized year. So I think it's in that sort of directional ZIP code, but we're going to wait until we close out this year or at least another quarter before we start talking about 2024 guide in too much depth.
Okay. Fair enough. Yes, those are my questions. Thanks very much. .
Thank you. And at this time, sir, we have no further questions registered. Please proceed with closing remarks.
Thank you, everyone, for joining today. And sorry about the conference call. We started a little bit late given the issues with the operator, but we look forward to speaking with you after our Q3 results. Thank you. .
Thank you. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Have a good day.