A Compelling Way to Profit From Trash

It may not seem remotely conceivable that the burning of garbage would be a viable or even appealing option for creating energy, but it is. There is an entire industry devoted to it, known as waste-to-energy, or WtE for short. The process involves the incineration of waste to create either electricity or heat energy — and it could be big business.

Incinerating waste is not a new industry, but recent technological advancements mean new facilities can literally be state-of-the art. Given the increased efficiencies, WtE has become a viable alternative energy option that is arguably as “green” as other sources of energy that are considered truly green, such as wind or solar energy.

For starters, WtE reduces the need for landfills that pollute the environment and are not a long-term solution for disposing of waste. Technologically, WtE facilities already meet strict emission standards, and firms in the space are constantly working to make them safer to the environment. Finally, as with any alternative energy, WtE reduces the dependency on foreign oil and dirtier options to create energy, such as coal.

The appeal of a WtE facility is that it is effectively a never-ending landfill and frees up land for more appealing uses. It is also widely embraced in certain foreign countries, including those in Northern Europe and even China. In fact, China is one of the most proactive builders of WtE facilities.

Covanta (NYSE: CVA) is a publicly-traded pure play on the industry, providing WtE services in North America, Europe and Asia. The company is worth investigating to get a solid understanding of the industry and the process by which it builds WtE facilities and obtains the waste to feed its facilities. As of the end of last year, it owned or operated 64 facilities, 40 of which are in the United States.

However, there is a more interesting potential play on growth in this industry. Waste Management (NYSE: WM) is the largest solid-waste management firm in North America. It holds an estimated 24% market share in the $55 billion solid waste market. For all practical purposes, it has the rights to an endless supply of waste to turn into energy.

It should be no surprise that the WtE industry is on Waste Management’s radar screen. In a recent company presentation at an investment conference, the company illuminated how turning waste into energy is a natural fit with its existing businesses. Given the supply and focus on alternative energy sources, it is also a bona fide growth opportunity for the firm.

Waste Management detailed that WtE can be a high margin business. Its existing WtE business consists of a couple of plants in the United States, and it also recently acquired a 40% interest in Shanghai Environment Group, which has two facilities in operation and six more in the works. The company is also bidding on business in European markets.

Waste Management estimates +11% returns for new WtE projects. It is also acquiring business: in April of this year it bought a WtE plant in Virginia for $150 million. The China interest was acquired for $142 million. The China angle is important, as it represents a large field of opportunity. Currently, the country only has about 50 WtE facilities, but it is set on increasing capacity going forward. In other words, the growth and profit potential is potentially huge for Waste Management.

Action to Take —> Investors interested in pure-play exposure to WtE should look more closely at Covanta. Another potential option is that Waste Management’s and Covanta’s futures could become intertwined, given Waste Management’s supply of solid waste and Covanta’s global network of WtE facilities. Interestingly enough, Covanta is in the process of renegotiating a contract that secures a large percentage of its waste volume and could conceivably turn to Waste Management, as the relationship is certainly a logical fit.

As it stands currently, Waste Management predicts it can grow sales between +3% and +5%, and earnings between +8% and +12% over the long haul. WtE currently only represents 6% of the company’s sales, based on the last full year of results — but it has the potential breathe life back into sales and earnings growth

Right now, the stock is appealing as an income play, given the 3.4% dividend yield. Free cash flow also exceeded $1 billion last year. Adding growth into an already appealing investment could position shareholders for above-average gains for many years to come.