Cash from Trash

The world’s garbage glut is a worsening headache for government officials, but it’s a big opportunity for investors to achieve healthy capital growth. Buying top-quality waste industry stocks can help you unleash the secrets of a new alchemy—the conversion of trash into cash.

American households, stores, restaurants and other businesses generated about 250 million tons of solid waste in 2010, according to the most recent statistics available from the US Environmental Protection Agency (EPA).

Every year since 1960, Americans have generated more solid waste than the year before. The amount of trash the country produces has tripled since 1960, while the US population has increased only about 90 percent.

Nationwide, the number of active landfills has shrunk from nearly 8,000 in 1988 to 1,908 in 2010. The US disposes enough trash every day to fill 50,000 garbage trucks with 18,000 pounds of trash in each.

The search for new methods of disposal is becoming more frantic among federal, state and municipal leaders in the US. There’s enormous variation in waste capacity among the states. For example, Arkansas reports sufficient capacity to operate more than 600 years without launching another facility, while New York State only has 25 years of capacity left.

The problem perplexes global leaders as well. The United Nations estimates worldwide annual waste production at more than 1.3 billion tons, a figure that’s growing every year in the high double digits. In particular, developing countries such as China and India face massive waste handling problems, as their middle classes rapidly expand.

Below are the two leading companies in the handling, treatment and disposal of solid waste. These stocks enjoy strong fundamentals and excellent prospects for outsized price appreciation. On average, they also sport lower valuations and higher per-share earnings growth than the typical S&P 500 stock.

These stocks have recently lagged the market because of municipal budgetary crises and cutbacks, but their bargain prices won’t last long. It’s hard to go wrong with these stocks because garbage will continue to be generated, whether it’s disposed of or not. The first is more oriented toward global growth; the second on conditions in the US.

At the Top of the Heap

Waste Management (NYSE: WM) remains the leader of the pack. This giant is the world’s largest solid waste collection and disposal company. Waste Management also treats and disposes of hazardous and medical waste, as well as operating waste-to-energy and landfill gas-to-energy facilities.

Waste Management’s services generate a robust cash flow that it largely devotes to acquisitions, dividends and share buybacks. The company has consistently paid dividends since 1998. The dividend was raised from $0.34 per share to $0.355 per share in March. At the stock’s current price of about 34, that represents a healthy 4 percent dividend.

Waste Management reported that revenue in the second quarter of 2012 reached $3.46 billion, an increase of 3.3 percent from revenue of $3.35 billion for the same period in 2011. Earnings were $208 million, or $0.45 in earnings per share (EPS), compared with $237 million, or $0.50 in EPS for the second quarter of 2011.

Growing revenue from acquired entities around the world, higher capital expenditures and increasing operational efficiencies should enable the company’s earnings to more than double within the next five years.

Meanwhile, new regulations from global organizations designed to boost environmentally friendly technologies are a boon for transnational players such as Waste Management. Notably, the World Trade Organization this month significantly reduced tariffs on activities and products related to recycling, waste management and wastewater treatment.

The stock’s price-to-earnings (P/E) ratio is 14.4, roughly in line with its sector. Waste Management is a buy up to 41.

Republic Services (NYSE: RSG) is the second-largest company in the waste-disposal sector, behind Waste Management. Republic provides waste collection and recycling services in 40 US states and in Puerto Rico. The company also operates 73 landfills and handles more than 4 million tons of recycled materials per year.

The company’s residential collection operations include curbside collection of refuse from small containers into trucks for transport to landfills. The company also supplies waste containers and rents compactors to large waste generators.

Republic reported second-quarter 2012 earnings of $149.2 million, or $0.40 in EPS, compared to $46.5 million, or $0.12 in EPS, for the comparable period last year. Second-quarter revenue was $2 billion, a modest 1.2 percent decline from the same period a year ago. That performance demonstrates resilience, in light of weak economic growth.

Republic’s P/E is only about 14. The company’s historical 15-year earnings growth rate is 10.3 percent; consensus estimates call for the company’s earnings to grow at about 8.4 percent for the full year.

Not only is the stock a bargain now, but it also pays a healthy annual dividend of 3.44 percent, or $0.88 per share. Republic Services is a buy up to 37.

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