BIG-Time Recycling: One Man's Trash Is Another Man's Treasure

by: Joseph L. Shaefer

What follows is an idea not for this week, maybe not for this month, but at the right price I expect this to be a burgeoning industry and today to represent the ground floor.

Recycling is not an area that has caught on much among investors. Part of the reason may be because they have been burned so many times by pie-in-the-sky promises, particularly in the green alternative energy area, that may have seen the occasional meteoric rise but just as often saw no rise at all or a rise followed by an equally spectacular crash landing.

Solar companies whose stocks rose spectacularly in 2007 faced the reality in 2008 that they could only be profitable in the presence of both strong bureaucratic proponency and those same bureaucrats so freely spending your money and mine (via subsidies). Many investors paid the price for not realizing this.

The story was similar among the much-touted wind energy companies, most of which have since come a-cropper. And the best example of all may be the ethanol craze, some beneficiaries of which actually make a profit -– regrettably at the cost of sending food corn prices through the roof and at the expense of the American taxpayer.

So investors can be forgiven for thinking, “Oh boy, here it comes again! Another green idea that looks good as long as you don’t look too deep.” I disagree. First of all, I’m not referring to the bulk recycling of consumer commodity items like waste paper, glass and plastic. I’m referring to the base metals that are discarded every day by industry and the public in the form of appliances, old cars, tools, and so on. I also am thinking, increasingly, of the gold, silver, platinum, palladium, rare earth elements, lithium and other precious metals that are tossed by consumers getting rid of these elements in their cell phones, laptops, desktops, TVs, and scores of other consumer electronics that, individually, are not worth one’s while to recycle for themselves -- but in the aggregate, in this throwaway society, mean billions of dollars in potential profits to the right firms.

Second, what sets this “green” idea apart from so many that went before is that there is no hype surrounding companies in the recycling industry. “Scrap metal recyclers, huh? BOR-ing!” is the usual response. So prices of these firms’ stocks remain eminently fair.

Third and last, I believe each has other businesses that are also growing as well as demographic trends that favor their growth with or without cranking up their recycling capabilities.

My comments do not apply only to base and precious metals, by the way. There are so many better uses for that yucky, nasty stuff we toss into our garbage cans and watch as it is dutifully hauled away every week. Why in heaven’s name are we taking food crops like corn (and in the most energy- and water-intensive manner possible), and eking out a fractional increase over and above the energy needed to fuel the process, move the water, transport the corn, etc. etc.? (If you answered, “To provide taxpayers’ dollars to big farming conglomerates so they can make big political contributions to Congressmen from farm states,” I believe you win the Common-Sense Prize.)

Instead, rather than corn, an equally effective biofuel might be the non-recyclable paper and cardboard, sheet plastic other non-recyclable plastics, clothing, fabrics, broken toys, wood waste, and packaging material that we all – millions of us, every day – throw away as if they are of no value to us. It isn’t now, of course. At least not at the micro level that we see. But imagine if, instead of merely filling more Mount Moretrash landfills with ripped clothing, broken toys, wooden tool handles, and such detritus of daily living, we instead burned or biologically transformed 5 or 10 million such items per day into our ethanol or methane, what a difference it would make.

This kind of recycling -- trash-to-energy and methane-to-energy, for instance -- can be profitable only to the biggest of the big. It takes a certain size organization with a steady supply of product to generate the economies of scale that justify investing capital in the plants, incinerators, generators and other machinery to make this a net energy gain rather than a net energy drain, or, worse, a net energy pain like corn-based ethanol.

Waste Management (NYSE:WM) is one such company. Already, out West, the volume of waste being placed in landfills has been steadily dropping thanks to more aggressive and more technologically advanced recycling. In fact, more than 50% of the “useless” waste products that used to go to landfills in California, have been diverted to recycling. Even then, methane gas generated from landfills is being used to power some Waste Management trucks, and they are building a methane-to-energy plant in a small town here in Northern Nevada, that will effectively provide power for the entire town.

(If you’d like to see more about how this works, visit the website for Fulcrum BioEnergy. Fulcrum is a privately held company down the hill from my home in Lake Tahoe. In Reno, officials are quietly seeking industry to replace gambling revenues and this is an example of the kind of firm it is attracting. Trashed by some for allowing gambling, it seems Nevada is now gambling on trash…)

Founded in 1894, WM is the biggest waste management company on the continent. It collects some 115-120 million tons of waste per year. The company owns 270 landfills and is the USA's largest provider of recycling services, generating more than 20% of its revenue from that sector. WM has a steady record of earnings growth and has raised its dividend in each of the past four years. It currently yields 3.65% and sells at a PE of 19.

So where is the catalyst I see that will goose growth even more? WM is already #1 in “eCycling,” the recycling of electronic devices. Inside these devices are small amounts of precious metals and rare earth elements whose physical qualities make them the best choice for certain applications; even though they are expensive to buy, only small amounts are needed for each device. In the aggregate, however, there are literally billions of dollars worth of these materials being thrown away every year. Of its 100 or so recycling plants, WM devotes 3 to eCycling electronics exclusively. The massive size of these facilities allows them to separate these materials profitably. At a time of rapidly increasing metals prices and supply falling short of demand for mined REEs, recycling seems to be a particularly profitable way to go. And WM is becoming increasingly sophisticated in this area. In addition to extracting the metals, it actually separates those pieces of equipment that can be refurbished and re-sold. In the case of a large corporation, it can cart away computers (for which they collect a fee), certify the complete destruction of data (for which they collect a fee), and extract the valuable materials within (on which they make a third profit!)

The other factor I see putting wind in WM’s sails is that many municipalities have so mis-managed their finances for so long that they will be looking to outsource big expenses like municipal waste handling to for-profit organizations that can do the job cheaper and better.

Two other firms in the US could benefit from all the above trends. #2 waste handler Republic Services (NYSE:RSG) handles non-hazardous solid waste in 40 states and Puerto Rico. It owns or operates 192 solid-waste landfills, 74 landfill renewable-energy projects, and 78 recycling facilities. It sells at a PE of 23 and yields 2.7%.

U.S. Ecology (NASDAQ:ECOL) is a horse of a different color, specializing in providing industrial waste-management services to government and commercial clients like chemical plants, manufacturers, electric utilities, steel mills, hospitals, and such, and assists with the disposal of radioactive and hazardous and non-hazardous industrial waste. It sells at a PE of 28 and yields 4.4%.

Finally, a backdoor way to play eCycling might be perennial under-performer Alcoa (NYSE:AA) which, since 1980, has been beaten by the S&P 500 (NYSEARCA:SPY) 3-to-1. In the most recent decade, with the S&P essentially flat, AA shares are actually still down 50%. But if you like to pick up used cigars, AA may well fit the bill. It just this week announced that it has taken a minority interest in and placed one of its executives on the board of Electronic Recyclers International, which is the biggest electronic waste shredding and recycling firm in the country. (Yep, even bigger than WM currently.) The private company also leads the U.S. in data destruction.

Outside the U.S., Australia’s Sims Metal Management Limited (SMS) is a huge metals recycling company. Its core businesses include iron recycling, non-ferrous recycling, and recycling solutions, which means solutions for the disposal of “post-consumer” electronic products, as well as secondary processing, which comprises a process involving the melting, refining and ingoting of certain non-ferrous metals, reclamation and reprocessing of plastics, and gas-to-energy. It operates in the U.S. and Canada, Australasia (in which category they include India), South Africa, and Europe. With operations across five continents, SMS is the world's largest metals recycler.

Two other U.S.-based metals recyclers you might consider (though I think the integrated waste handlers will do better) are Schnitzer Steel Industries (NASDAQ:SCHN), which deals with BIG metal -- appliances, cars, trucks, rail cars, industrial machinery, and demolition from bridges, buildings and other obsolete structures. And small-cap Metalico (NYSEMKT:MEA) operates 24 metal recycling plants across the United States.

I mentioned REEs earlier. This is an area that is heating up for recycling, as well, and Japan is leading the charge, both to recycle these rare earth elements as well as to find alternatives to their use. The country needs to wean itself, at least partially, from dependence upon overseas suppliers of REEs. Japanese firms consume about 30,000 tones a year of REEs to power their commanding presence in building smart phones, electric car motors, high-tech electronics and batteries. It is Japan’s goal to cut rare earth consumption by a third within the decade and reduce its reliance, especially on China, by providing subsidies to companies that recycle the REEs.

Japan now has more than 160 projects on the books, from leading technology firms like Hitachi Metals Ltd, Intermetallics, Mitsui Mining, and Asahi Glass (OTCPK:ASGLY). These companies have contracted to invest more than $1.3 billion) by this time next year, accepting government subsidies totaling about a quarter of that as seed money.

As the director of the nonferrous metals division of Japan’s Ministry of Trade noted recently, "We've been supporting research and development in areas like reducing the amount of rare earth in abrasives by allocating money from our annual budget, as well." Japan is taking the squeeze on rare earth elements very seriously, as well they should. Japan's, and our, production of TVs, computers, cell phones, video games, and a whole host of hi-tech defense applications, are dependent upon the continued flow of these minerals. Whether they come from mining or recycling doesn’t matter, as long as they are available!

We are cautious on the short-term market outlook but bullish on this “boring” industry going forward. We look forward to purchasing many of these companies at somewhat lower price/sales, price/book and price/earnings ratios.

Disclosure: We, and/or those clients for whom it is appropriate, are long only AA and SMS. We bought AA below 10 so our cushion there is pretty good. We look forward to having the opportunity to add to these positions on any decline.

The Fine Print: As Registered Investment Advisors, we see it as our responsibility to advise the following: we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as personalized investment advice.

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