Making Profits From Trash

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

For every action, there is a reaction, and every invention creates garbage. Ever wondered how trash is dealt with? Here are three companies engaged in waste management and recycling. Two are based out of the US. One is limited to the domestic market, Republic Services (NYSE: RSG), and another has an international profile, Covanta (NYSE: CVA). The third is based out of France and is present in the international market, Veolia Environment (NYSE: VE). The question remains, are they making or wasting profits?

Garbage collection, water treatment, and waste-to-energy

Spread over 77 countries, Veolia is the company with the widest international footprint in the industry. Business is mainly concentrated in Europe, but also present in Africa, Middle East, Asia, Oceania, North and South America. Recent news confirmed a deal with Saudi authorities, and the St. Louis project remains halted.

Short-term attention is directed to customer diversification. Management sees a long-term growing risk to the model if contracts are limited to government agencies. In line with that, future contracts will look to develop partnerships in the industrial sector as a consultant and project developer. Contracts with government agencies, however, continue, and $400 million for a desalination plant was signed recently in Saudi Arabia.

Financially, Veolia is in need of a push. Revenues and free cash flow have entered a small downtrend during the last decade. On the good side, debt has been reduced and total cash flow increased, while net income remained stable in the same period. Finally, operating income stayed on the positive but is well below the industry average.

Veolia is trading around the midpoint of its 52-week range, at $11.17, and is expected to drop another dollar. Yield stands at 6.95% on a dividend of $0.75. In all, the stock is well-priced and I recommend buying. Projects in St. Louis and Saudi Arabia will give the company a short-term push, and a business-model focus on private partnerships will provide the long-term outlook for lasting success.

Garbage collection and waste-to-energy

Covanta is the world’s largest waste management company. With operations in North America and Europe, the business turned toward the generation of clean energy – so clean in fact, the firm has been the recipient for many awards. Shareholders were also rewarded through the last decade.

The short term is occupied by temporary contracts that amount to 25% of total revenue. On the other side, 75% of future revenue is guaranteed by long-term contracts. Having mostly exhausted domestic opportunities, the company opened activities to China and Italy. Further projects in England, Scotland, and Ireland may be delayed due to economic constraints, but government regulation prefers incinerators to landfills.

Debt is high, but stable, and backed by stable cash flow and net income. Revenues continue to grow, and operating margin recovered in the last two years, regaining six out of 11 points lost. A soon-expected deal with Harrisburg city officials will improve debt and revert current cash shortcomings. Finally, Chinese authorities' preference for local businesses offer limited expansion.

Trading at 26.2 times its earnings, just over the industry average, the stock is fairly valued. Current yield is at 3.14% at a dividend of $0.16, and the price is close to its 52-week high of $21.30. This stock is a hold for a 10-year investment until prices drop to around $18.

Garbage collection

Second to Waste Management in the US market, Republic focuses on the non-hazardous solid-waste segment. The firm recently made the news after announcing a $15 billion upgrade for its Lorain County Resource Recovery Facility. After buying Allied Waste, the company improved its costs and efficiency, digging a small economic moat.

In the short term, Republic is facing decreasing waste volumes, cutting revenues short. For the long term, the firm needs to invest in technology to avoid been shorthanded by landfill alternatives, and complete asset upgrades. Additionally, the company will have to live up to its tradition for rewarding green-thinking shareholders. So, if waste volumes do not recover steadily, the needed cash volume to pay dividends, complete upgrades, and innovate may not be available.

Financially, Republic is strong. In the last decade, revenue, net income, and cash flow have been on the rise. Debt has also been on the rise,  but it remains backed by a healthy cash flow. No less important is the fact that operating margin came in at the high teens for the whole period, and today is above the industry average.

Currently trading at 22.6 times its earnings – a 13% discount to the industry – the stock is undervalued. A 2.78% yield at a $0.22 dividend makes for an interesting long-term investment. Price, however, is close to its 52-week high, and I recommended to hold. Keep looking for a price drop and upgrades to begin before making any investment.

Recycling

Republic has failed to recycle materials, and failed behind the competition. At different scales, Covanta and Veolia have turned waste management into a profitable recycling business. Veolia is better positioned to benefit from European regulation, and I recommend as a buy.

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Victor Selva 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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