Over the past eighteen months, a number of stocks have benefited handsomely from environmentally-oriented proposals and/or new legislation issued by the EPA. Last year, shares of ADA-ES Inc. (ADES) doubled ahead of the EPA's new coal-fired power plant regulations that went into effect early this year. In the fracking industry, shares of Flotek (FTK) rocketed higher in 2011, as big oil companies embraced the company's environmentally friendly fluids ahead of EPA inquiries into the cleanliness of produced water. After the EPA proposed to decrease annual HCFC-22 consumption by 11%-44% over the next three years, shares of micro-cap Hudson Technologies (HDSN) quickly doubled in the first quarter of this year.
To those investors well-versed on these respective regulations ahead of time, identifying companies who would benefit the most from them proved to be a well-thought out investment plan. This leads us to the following question: which sector of the economy will be next to see increased regulatory initiatives from the EPA, and which companies should investors invest in to take advantage of these impending regulatory changes? We have an answer: the stormwater industry.
The Stormwater Industry: A vertical on the cusp of sweeping environmental regulations
Stormwater regulation is a newly regulated area governed by the EPA that has strict requirements and imposes significant fines that are increasing in scope. Originally introduced with The Clean Water Act of 1972, stormwater regulation has been slowly implemented in stages over the past decade. This is set to change in a dramatic way late this year, with the EPA poised to enact the most significant expansion in stormwater regulations, establishing stormwater requirements across entire metro areas and suburbs and also across existing infrastructure as well as new developments.
For those not familiar with stormwater, here is an easy way to understand the issue. As a storm gathers force, run-off water gets carried away into nearby rivers, lakes and oceans, allowing a variety of pollutants to enter into these respective waterways. As these toxic chemicals and bacteria mix in with the stormwater, water quality is affected, often resulting in beach closures each summer. Because this is such a prevalent problem, and one that is growing progressively worse, the EPA has begun to issue heavy fines to those cities and municipalities in violation. With the new regulations poised to take effect late this year, municipalities and cities will have essentially one choice: retrofit and upgrade their storm sewer systems.
At a recent environmental law symposium commemorating the 40th anniversary of the Clean Water Act, the U.S. Attorney for the Eastern District of California, Sylvia Quast, stated, "the next area of enforcement will be municipal separate sewer systems." As a corollary to this, the Justice Department is going to re-direct its focus toward enforcing stormwater regulations for municipal separate storm sewer systems. Up until now, their main focus has been on violations which lead to overflow at systems that carry combined wastewater and sewage.
Taken together, the stage has been set for the EPA to issue a dramatic set of new regulations within the stormwater industry in the second half of the year. Not surprisingly, California has taken the initiative and chosen to get ahead of these new regulations. Let's examine recent developments there.
L.A. County and California already leading the charge
In what will eventually be looked upon as a breakthrough moment for the stormwater industry, on March 28th L.A. County and the EPA agreed to strict new pollution reduction plans for 175 waterways in the L.A. area. The agreement calls for reductions in the amount of bacteria, nitrogen, phosphorus, mercury and other toxic chemicals found in these waterways. In time, these plans will lead to an eventual improvement in water quality, restore ecosystems, and eliminate beach closures.
We view the March 26th agreement between the EPA and L.A. County as significant for a number of reasons. First, it provides a model for other counties, cities, and states to follow. Long considered to be at the forefront on environmental issues, we expect the rest of California to now follow L.A. County's lead and implement similar pollution reduction plans for their stormwater discharges. More importantly, the EPA's agreement with L.A. County should serve as a template for the impending set of regulations that should be put into place for the rest of the country later this year. Having secured this landmark agreement with L.A. County, it will be more difficult for any municipality to resist the upcoming EPA mandates.
Waste Management and Abtech, an unlikely duo poised for success
How can investors get ahead of these pending regulations and potentially profit from them? We spent the past two months trying to ascertain the best answer to this question. Here is what our research has unearthed.
With water 36% of its overall business, French conglomerate, Veolia (VE), immediately came to mind.However, we quickly ruled this company out, due to its lack of exposure to the North American stormwater market. At first glance, Mueller Water Products (MWA) also seemed to be an obvious choice. Upon further inspection, MWA seems to be more of a play on the housing sector than the stormwater sector. We therefore ruled Mueller out, especially after it recently sold its pipe business.
A friend of ours then recommended that we research Abtech (ABHD.OB), which is an environmental company dedicated to providing innovative and proprietary solutions to remove pollution and contamination from water. With its 17 patents and an EPA-approved product for the stormwater market called the SmartSponge, our interest in Abtech grew after we also learned that the company had already secured a 5-year agreement with Waste Management (WM), a Fortune 500 company who would serve as the exclusive distributor for the company's SmartSponge product.
Hoping to learn more about Waste Management's involvement with Abtech, we then turned to Google. Upon googling "stormwater roll-out" we stumbled upon the following headline: AbTech, Waste Management begin stormwater solutions roll-out in North America. Sure enough, this news release seemed to confirm that the purest ways to play the stormwater vertical would be through simply buying into both Waste Management and Abtech.
We immediately questioned why Waste Management would partner with a virtual start-up such as Abtech. After all, why would WM, with over $13 billion in revenues in 2011, get involved with a company like Abtech unless there was a huge market opportunity that was just about to reveal itself? This is when our research began to get fun.
For the past number of years, Waste Management has been struggling to attain revenue growth. Hoping to jumpstart its growth, WM has begun to focus on "green" initiatives, ones that could be easily plugged into its extensive existing client base of municipalities around the country. With a keen insight into where municipalities would have to spend billions to upgrade infrastructure projects, Waste Management chose to partner with Abtech for one main reason: it needed Abtech's technology in order to penetrate the stormwater industry.
Having spent the past 15 years developing its SmartSponge technology and getting it certified by the EPA as a "best-practices" solution, Abtech was an easy choice for Waste Management to partner with. Because its products can be retrofitted into any infrastructure, a highly preferable choice to building new water treatment plants and rerouting stormwater and sewer overflows to such new plants, Abtech immediately filled a big void within Waste Management's "green" portfolio of next-generation products. This is why WM has partnered with Abtech.
Although the partnership is still in its early stages, it is easy to envision how Waste Management and Abtech will both win big in the stormwater market. With its vast and extensive client base of municipalities across the country, Waste Management can now tap into what is essentially a new, multi-billion vertical for the company. With no R&D required and no new sales people required to cross-sell this new product line, this should eventually be a very profitable venture for WM, one which could move the needle on the overall profitability of the company.
As for Abtech, the partnership with Waste Management seems poised to be a game-changer for the company. Because it has partnered with a Fortune 500 company with a client base that will be the envy of all others within the stormwater space, it is easy to see how Abtech can essentially scale from being a start-up company to one with $100 million in revenues within the next 24 months. Considering its current market cap of only $60 million, it would seem that Abtech's stock could double or even triple from current levels by next year as new investors look to gain exposure to this new market vertical.
In summary, this should be a groundbreaking year for the stormwater industry. Unknown to most investors now, this seems to be the best time to invest in the space. While Waste Management is the more conservative play, Abtech is the purest play that we have discovered in the space, and therefore, our favored way to buy into the expected uptake this year. It is a risky investment, however, and one that should only be considered by those investors with a high tolerance for risk.
Disclosure: I am long WM.
Additional disclosure: I am also long Abtech (ABHD.OB).