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Smells Like Money: High Income from Waste Treatment

By John Persinos on October 3, 2017

The images are upsetting and downright nauseating: toxic mixtures of sewage, chemicals, poisons, garbage, building detritus, smashed vehicles, and human corpses accumulating in city streets and suburban neighborhoods, from Houston to Key West to San Juan. The costs in recent weeks of removing and treating trash from hurricanes Harvey, Irma and Maria already are staggering.

However, these unfortunate events spell growth opportunities for the stocks of waste management and environmental remediation companies. With income investors foremost in mind, I’ve pinpointed two high-quality “green” plays that also pay out strong dividends: Covanta Holding (NYSE: CVA) and Waste Management (NYSE: WM). I examine each stock in detail below.

Particularly riveting in recent days has been the sight of San Juan Mayor Carmen Yulín Cruz, standing waist-deep in swirling rivers of raw sewage and wielding a bull horn, while she directs relief and emergency rescue operations in her ravaged city.

Hurricane Maria was the strongest hurricane to hit Puerto Rico in nearly 100 years. Estimates of the storm’s damage to the island’s already ailing economy range from $45 billion to $95 billion.

At the same time, the Environmental Protection Agency (EPA) and Federal Emergency Management Agency (FEMA) are getting their budgets slashed, staff decimated, and morale undermined. Critics say federal government responses to the environmental crises spawn by the storms have been late and inadequate.

Garbage removal and treatment may not be sexy, but the demand is steady. With the trifecta of hurricanes Harvey, Irma and Maria, the costs of trash pick-up and environmental remediation will run into the hundreds of billions of dollars. That translates into enormous, long-term need for the services of our two dividend plays.

Tailwinds for both Covanta and Waste Management include the ever-growing mounds of refuse that the world is struggling to dispose and recycle. American households, stores, restaurants and other businesses generate about 251 million tons of solid waste every year, according to the most recent statistics available from the 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 U.S. population has increased only about 90%. The U.S. disposes enough trash every day to fill 50,000 garbage trucks with 18,000 pounds of trash in each.

Nationwide, the number of active landfills has shrunk from nearly 8,000 in 1988 to fewer than 1,900 today. The U.S. 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 U.S. The problem perplexes global leaders as well. The United Nations estimates that almost 27 billion tons of waste will be generated around the world by 2050 as a consequence of population growth and rapid urbanization.

Cleaning up on garbage…

First, let’s look at high-dividend payer Covanta Holding. Chances are you’ve never heard of Covanta, but it’s hidden gems like these that provide the best investment opportunities.

While income investors flock to the usual suspects — utilities, real estate investment trusts, and master limited partnerships — this under-the-radar waste management firm is currently paying out a hefty dividend yield of 6.73%.

With a market cap of $1.9 billion, Covanta provides waste and energy services to municipalities in the U.S. and Canada. You’ll never hear the preening peacocks on CNBC discuss Covanta, because it’s a small cap operating in a supposedly boring, non-glamorous industry.

Based in New Jersey (no jokes, please), Covanta owns and operates infrastructure for the conversion of waste to energy; it also transports and disposes of waste. Covanta customizes recycling and energy recovery solutions for clients, as an alternative to landfills.

Covanta’s waste-to-energy plants annually burn about 20 million tons of waste from municipalities and businesses, while also generating electricity to power one million homes. Covanta recycles about 500,000 tons of metal each year. The company operates a nationwide network of treatment and recycling facilities, as well as landfills.

Admittedly, second-quarter fiscal 2017 earnings were a bit rocky for Covanta, with adjusted earnings per share coming in at a loss of 22 cents, compared to the same per-share loss in the same quarter a year ago. Investments in expansion projects weighed on earnings. However, adjusted earnings before interest, tax, depreciation and amortization (EBITDA) in the second quarter was $93 million, an $11 million year-over-year improvement.

With new projects about to go online, the company should renew its growth trajectory. The average analyst expectation is that CVA’s year-over-year earnings growth will reach 187.5% next quarter and 52.8% over the next five years on an annualized basis.

CVA’s price-to-sales ratio (P/S) is 1.1, which is a reassuringly low valuation compared to the average of 2.1 for its industry and the S&P 500. The price-to-cash flow ratio (P/CF) is 7.8, also low compared to 11.9 for its industry and 13.5 for the S&P 500.

Bags of cash…

For a safer income play on waste management, consider global industry leader Waste Management. With a market cap of $34.5 billion, Waste Management is the world’s largest solid waste collection and disposal company.

Houston-based Waste Management also treats and disposes of hazardous and medical waste, as well as operating waste-to-energy and landfill gas-to-energy facilities.

The trash clean-up bill in Waste Management’s home of Houston because of damage from Hurricane Harvey is projected to exceed $200 million, and that’s just one city. Meanwhile, new regulations from global organizations designed to boost environmentally friendly technologies are a boon for transnational players such as Waste Management.

As the largest residential recycler in North America, Waste Management expects to recycle more than 20 million tons in the region every year by 2020, up from the 12 million tons the company handled in 2012.

Waste Management’s services generate a steady cash flow that the company mostly devotes to acquisitions, dividends and share buybacks. The company has consistently paid healthy dividends since 1998.

The average analyst expectation is that Waste Management’s year-over-year earnings growth will come in at 9.2% next quarter and 10.4% over the next five years on an annualized basis. WM sports a current dividend yield of 2.17%. WM’s P/S is 2.5 and its P/CF is 11.6.

Both Covanta and Waste Management are enjoying the highest core prices ever in their commercial, industrial, and landfill businesses. When combined with cost-control initiatives, these price increases are helping to fuel margin expansion.

Trash to cash: it’s an investment alchemy that will continue to work magic for income investors.

 


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