Could You Turn Trash Into Treasure With These Stocks?

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

Garbage is big business. It might seem silly, but it’s true. The industry might seem more appropriate for a segment on Dirty Jobs, but there’s serious money to be made from trash. In fact, one of the major industry players, Waste Management (NYSE: WM), is a favorite among income investors for its market-beating yield.

After considerable rallies, Waste Management and close peer Republic Services (NYSE: RSG) now trade at multi-year highs.

In that light, is there still time for investors to strike gold from garbage? Or are you better off tossing these stocks into the dumpster?

Disturbing Debt

Waste Management and Republic Services are both industrials, meaning they have lots of long-lived assets on the balance sheet. As is usually the case, lots of long-term assets are usually accompanied by a lot of long-term debt used to finance those assets.

At the same time, it’s not a great time to have a lot of debt on the balance sheet, particularly if that debt needs to be refinanced over time. Interest rates are on the rise, and I’m nervous about investing in companies with a lot of debt on their books.

To that end, at the end of the first quarter Waste Management had $9 billion in long-term debt on its balance sheet and just $6.7 billion in total shareholder’s equity. That means its long-term debt to equity ratio stands at a nauseating 134%.

Republic Service’s long-term debt to equity ratio, meanwhile, sits at a better (but still uncomfortable) 91%.

Is growth a source of optimism?

Of course, high debt levels aren’t a huge cause for concern if the companies can grow at rates that make their interest expenses acceptable. Last year, Waste Management saw its revenues inch up 2% and its diluted earnings per share drop 14% from the year prior.

At the same time, Republic Services reported a 1% drop in sales and flat diluted earnings per share in 2012, year over year.

Unfortunately, these growth figures aren’t exactly inspiring, and when you consider that each stock trades for more than 20 times trailing EPS, it’s looking more and more like these stocks are fully valued.

An international candidate to consider

An interesting alternative in the waste management industry is Veolia Environnement S.A. (NYSE: VE). France-based Veolia does have exposure to the United States, a plus for investors reluctant to allocate capital to the shaky European economy.

Another huge plus for potential investors is the company’s gigantic dividend yield. Veolia pays an annual dividend, and according to Yahoo! Finance, 2013’s payout of $0.91 per share amounts to a greater-than 7.5% yield at recent prices.

It’s worth noting that because the company is domiciled in France, investors will lose a percentage of the payout to foreign withholding taxes. Even so, Veolia’s yield is double the yield of either Waste Management or Republic Services, and several hundred basis points higher than the yield on the 10-year Treasury Bond.

Bottom line: pass on trash

With Waste Management at $40 per share and Republic Services at $33 per share, my position is that their soaring stock prices have become disconnected from their fundamentals. The waste management industry is a slow-growing one, and the underlying revenue and earnings growth of each of these two companies bear this out.

Waste Management and Republic Services operate highly profitable businesses, but there simply isn’t enough growth potential to justify paying 21 or 22 times trailing earnings for either of these stocks.

At these prices, I’d reason that Waste Management and Republic Services investors can look forward to their 3.7% and 2.8% respective yields, along with dividend growth in the mid-single digits going forward. At the same time, it doesn’t appear that either of these stocks currently provides compelling capital gain potential.

If high yield is the focus of your investing, you’d be better off with Veolia, which provides a huge yield that compares favorably to its two industry peers.

All told, the mixture of high debt and low growth can be a toxic combination. As a result, I’m content to wait on the sidelines for Waste Management and Republic Services to get their financial houses in order, and I’d recommend investors do the same.

Waste Management has been a longtime favorite for dividend seekers everywhere, but the share price performance over the last few years has left many investors wanting. If you're wondering whether this dividend dynamo is a buy today, you should read The Motley Fool's premium analyst report on the company today. Just click here now for access.

Robert Ciura has no position in any stocks mentioned. The Motley Fool recommends Republic Services, Veolia Environnement (ADR), 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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