Waste Management’s Hidden Value Driver Doesn’t Stink

One thing has plagued mankind from the very first man caves tens of thousands of years ago to the streets of modern day cities: waste. Where do you dispose of it? What do you do once it gets there? Do groggy drivers trying to get to work really have to be pitted against massive, stinky garbage trucks for street supremacy again next Wednesday morning?

Of course, the unsightly smell of a Wednesday morning garbage truck blocking traffic on your one-way street (can you tell I've been there?) hardly goes unnoticed. And as investors we simply cannot discount a gem like Waste Management (NYSE: WM  ) . Nonetheless, the company gets relatively little respect given the logistical masterpiece it has constructed of the messy problems caused by waste. Why? As American astrophysicist Neil Tyson once said: "The act of doing something perfectly is the measure of it going unnoticed. It's like shaving. No once comes up to you and says, 'Hey, you shaved really well today!'"

Investors would be justified in investing on that premise alone, but chances are most of us are overlooking a key driver in the company's growth. Why? Because once again, the company executes its agenda flawlessly.

Light bulbs, and gas tanks, and homes, oh my!
Waste Management has quietly become a leader in waste to energy (WtE) and landfill gas to energy (LGTE) technologies. Heck, when you go through the trouble of collecting people's trash you might as well use it to your advantage. The company, using various sources of waste as feedstock, generates up to 550 MW of renewable energy each year – enough to power almost 1.2 million homes. Internal goals call for increasing that figure to 915 MW (2 million homes) by the end of the decade.

The ambitious goal aims to green the planet and your pockets. In fact, it already has. Despite the company's renewable energy business accounting for only 7.6% of total revenue in 2011 it served up 22% of total net income. That translated to nearly 18% of the company's total dividend and share buyback program.

Wherever waste gets converted to energy, high yields follow. Republic Services (NYSE: RSG  ) operates 69 energy projects in the United States and pays investors with a yield over 3%. Covanta (NYSE: CVA  ) is the nation's leading waste to renewable energy operator and supports investors with a yield over 3%, too. Waste Management, which resides in the top 10% of S&P 500 dividends, throws cash at shareholders to the tune of over 4% per share. Waste Connections (NYSE: WCN  ) , which serves over 2 million customers throughout the U.S., but is void of major renewable energy projects, sports a dividend yield of only 1.16%.

In other words, investors should be focused on the industry's development of renewable energy. Let's dive deeper.

Waste to energy
Waste Management's waste to energy services ignite solid and municipal waste to produce syngas, which is burned to spin turbines and, alas, create renewable electricity. Wheelabrator, the company's subsidiary, operates 17 WtE facilities in the United States that can convert over 8 million tons of waste into 333 MW each year. That is second only to Covanta, which owns 44 facilities that convert over 20 million tons of waste into 9 million MWh of electricity each year – equivalent to 8% of all renewable energy in the United States.

It goes without saying that the two are competitors. And although the latter is nearly 6.5 times larger, Covanta has been creating energy since 1983. Don't look for a buyout anytime soon though. Covanta generated just $217 million in operating income in 2011, compared to $168 million for the much smaller Wheelabrator (more on that below). Waste Management can create more value by organically growing its operations for now.

One such investment is in the form of a 40% stake in Shanghai Environment Group, which will soon have seven WtE facilities in operation. The facilities will have a total generation capacity of 220 MW and pave the way for more widespread adoption throughout China.  

Landfill gas to energy
Perhaps the most important growth project under Waste Management's belt is landfill gas to energy (LGTE) technologies. Wheelabrator may have enjoyed an impressive operating profit margin of 19% in 2011, but LGTE notched an astronomical 35%. A side-by-side comparison of 2011 suggests most of the growth lies ahead:

 

Wheelabrator

LGTE

Operating revenues

$877 million

$140

Total expenses

$709 million

$91 million

Operating income

$168 million

$49 million

Power generation

333 MW

217 MW

The company's dedication to a little-known project with the EPA could have enormous windfalls for investors – and everyone with an electric bill. The Bioreactor Landfill Project (link opens PDF) is looking for better ways to manage, regenerate, and capture biogas from landfills via three microbial biomes. Here's the scary part: the Department of Energy estimates that 1% of total U.S. electricity supply could be met by upgrading just half of the country's landfills. That's equal to one-third of the entire wind industry's generation waiting to be tapped for the cost of a few simple improvements. Not to mention, bioreactor landfills also reduce operating costs and landfill volume by 15%-35%.

The project's impact to the bottom line is twofold. Not only will it become an undeniable profit machine, but it will also cut away at the company's soaring fuel costs. In 2011, direct fuel expenses totaled $628 million, or 7.35% of total operating expenses. The company estimates that fuel costs explained 23% of total year over year expense increases when accounting for the impact of subcontractor fees. Yikes!

How will LGTE make a difference? The company has developed a system that turns biogas into usable compressed natural gas fuel. Last year was the first full year of operation for Waste Management's fleet of over 1,400 natural gas trucks, which are expected to reduce the company's fuel consumption by 11 million gallons per year. A small step, but one in the right direction.

Foolish bottom line
It may not seem obvious that one of the country's largest and most accessible sources of renewable energy is our own waste, but if you're an investor in Waste Management you should definitely be aware of this strategic, low-cost growth driver. I believe renewable energy initiatives can carry the company to new heights in the next decade.

If you're wondering whether this dividend dynamo is a buy today, you should read our premium analyst report on the company today. Just click here now for access.

 

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