Finding Gold In Garbage

By Aaron Levitt | August 19, 2010 AAA

With the markets continuing their return to volatility, investors are starting to revisit the idea of safety for their portfolios. With the specter of another potential recession and deflation looming on the horizon, dividends and the sectors that produce them are once again becoming en vogue. The Utilities Select Sector SPDR (NYSE:XLU) and its 4.3% distribution yield, has seen a resurgence of interest and is performing quite well over the last few months. Performing essential services necessary for modern living, the utility sector can be seen as a great hedge against uncertainty. However, investors shouldn't just stick to the electricity generators and water utilities. Another, "dirtier" sub-sector might just be what investors need to turn trash into treasure.

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It's a Dirty Job, But Someone Has to Do It
The waste collection industry might just be what investors are looking for in a safe sector. The United States generates more than 800,000 tons worth of garbage each and every day at a cost of around $40 a ton. According to the research firm Hoovers, there are currently 20,000 different companies associated with sanitation producing nearly $75 billion in revenue. Waste collection is big business.

The industry's steady recession resistant cash flows stem from two factors. By and large, homeowners aren't given the choice of what waste collection company to use. Citizens are "forced" to use the company that is under contract with their municipality or haul their trash to the dump themselves. Secondly, the waste management firms charge a set period fee regardless of the amount trash hauled. Most customers, especially individual households, pay the disposal companies the same amount whether or not their trash can is full every week. Unlike electricity or water usage, individuals are locked in on their garbage disposal prices, despite reducing their trash levels.

Sanitation as a Portfolio Play
While there are thousands of individual garbage companies, only a handful that are publicly traded. The Market Vectors Environmental Services ETF (NYSE:EVX) can be used as an overall play on the sanitation theme. The ETF follows 22 of the most prominent waste collection companies including Stericycle (Nasdaq:SRCL) and Darling International (NYSE:DAR). The ETF is very thinly traded and investors may be better suited in individual equities within the sector.

Any discussion about environmental services must include the two dominate players in the industry. Both Waste Management (NYSE:WM) and Republic Services (NYSE:RSG) represent the industry. While Warren Buffett prefers Republic, investors may want to stick with Waste Management. The company offers a higher dividend (3.7%), lower P/E (17) and has a higher dividend growth rate of around 9.5% over the past five years than its competitor.

Getting Larger
IESI-BFC's
(NYSE:BIN) recent acquisition of Waste Services follows the general trend of the industry; consolidation. Smaller firms such as Heritage-Crystal Clean (Nasdaq:HCCI) and WCA Waste Corporation (Nasdaq:WCAA) could be seen as targets as the big boys move into different markets and hazardous waste areas.

Finally, the waste industry is experience a renaissance by "drilling the pile" and becoming energy producers. The growth of waste to energy facilities is expected increase by 173% over the next five years as the industry adds another 9,699 MW worth of capacity. The average kitchen sized bag of trash contains enough energy to power a 100 watt light bulb for 24 hours. Waste Management is a leader in landfill gas facilities having pioneered the technology in the 1970s. Covanta (NYSE:CVA) and Casella (Nasdaq:CWST) are more pure plays on waste to energy, with Covanta heavily expanding in China and India.

Bottom Line
While it is a dirty job, the waste management industry could be exactly what a portfolio needs in this time uncertainty. Steady cash flows and dividends are hallmarks of the sector with new landfill gas and recycling providing growth elements. Either adding individual stocks or the Environmental ETF to a portfolio can do wonders as recession hedge. (To learn more, see Less Trash For More Cash.)

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