How You Can Make Money From Garbage

Madhukar is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In the past decade, municipal solid waste in the US has increased by approximately 20%. This trend is expected to continue in the coming years, given factors such as the population growth and increased consumer spending. Keeping this in mind, let's look more closely at three waste management stocks that might benefit from these trends: Stericycle (NASDAQ: SRCL), Covanta (NYSE: CVA), and Waste Management (NYSE: WM).

Stericycle: StrongPak is the future 

Stericycle's results for the fourth-quarter of 2012 exceeded consensus expectations, as revenue increased by 12.8% year over year. The domestic market saw decent organic growth; both in large-quantity as well as small-quantity business. The key driver to the organic growth is its “cross-selling service” to existing customers. Stericycle’s 541,000 medical waste consumer base, provides an excellent platform for other services like: compliance training, sharps management, and patient communications. 

Moving forward in 2013, I believe StrongPak should drive the future growth of revenue for Stericycle. This waste management program for retailers is dedicated to hazardous materials, including bleach, pesticides, aerosols, solvents, cleaning supplies, and batteries. It is a route-based service that helps retailers to manage and properly dispose of smaller quantities of hazardous waste. This, in return, avoids the potential financial penalties under federal regulations.

The recent California v. Walgreen case, in which Walgreen was charged with $16.6 million penalty for improper disposal of hazardous waste, has raised some serious concerns. The proceeding was followed by a queue of other cases against national retailers like Target, Wal-Mart, and Costco. These cases enhance the opportunity for the hazardous waste management services like Stericycle's StrongPak.

StrongPak has already completed its pilot phase, and will be offered to 750,000 retail locations. This service could turn out to be a $1 billion opportunity for the company. With additional benefits from cross-selling, it may make the service even bigger by increasing its reach. 

I feel that Stericycle's future is strong, considering its StrongPak service and its huge customer base. However, I do see some headwinds in the form of potential penalties from pending lawsuits that allege that Stericycle overcharged various U.S. municipal governments for its services. 

Covanta: The Power of Generation

Covanta’s two-thirds of revenue come from the waste and energy segments, which are either contracted or hedged. I see some headwinds in 2014, as some of the transition contracts may expire without being renewed, due to above-market prices. However, the growth in the metal recovery segment and an expected increase in natural gas price should offset the risks of exposed contracts. 

Covanta has entered a $2.5 billion deal to generate 750,000 MWh of energy per year for the next 12 years, at flat pricing. This is in line with the company's idea to increase its energy-from-waste exposure to around 7 million MWh in the next four years, with a 15% increase in 2013 itself.

However, in the future, the company's number of hedged contracts will decrease, exposing 4 million MWh of Covanta's production to more volatile market pricing. But if natural gas prices rise, Covanta's energy-from-waste process may grow more cost-effective, improving the company's performance. Every increase of $1 per thousand cubic feet in the price of natural gas will add around $7 million to Covanta's profit. 

Covanta may face some headwinds as its existing power contracts expire. But the company's focus on increasing its energy segment, aided by a potential rise in natural gas prices, should provide the stock an upside in the future. 

Waste Management: A New Green Star

This trash hauler's results for the fourth quarter of 2012 came in below the market's expectations. It posted adjusted EPS of $0.57, compared to analysts' consensus estimate of $0.60. Additionally, its 2012 EPS guidance was not very promising, either. I am not very optimistic about the stock's future, due to the weakness in the sale prices of its recycled products. 

On a more positive note, Waste Management is making small purchases to achieve a larger goal. It recently completed the acquisition of Greenstar, a private recycler. Annually, Greenstar is capable of recycling around 1.5 million tons of material. Although the acquisition is not a revolutionary step for the company, it brings Waste Management's total annual recycling capacity close to 15 million tons, a step closer to its 20-million-ton target.

Additionally, there are few small factors that should assist the company's performance in the future. These include the new share buyback plan of $500 million, an intention to increase the annual dividend to $1.46, and the restructuring initiatives that may lead to a cost saving of $130 million in 2013. 

The company's huge capacity to recycle materials should help improve its overall profitability. But I'll remain neutral on the stock until the volatility in the sale prices of recycled products stabilizes. 

The bottom line 

I prefer Stericycle and Covanta over Waste Management. Both StrongPak and cross-sale opportunities should boost Stericycle's stock performance in the future. Covanta should also benefit from more power production, especially if natural gas price rises. On the other hand, low prices for recycled goods could hurt Waste Management, at least in the short run.

madhudube has no position in any stocks mentioned. The Motley Fool recommends Stericycle and Waste Management. The Motley Fool owns shares of Waste Management. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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