“Energy’s $40 Billion Killer App”

Checking out Zachary Scheidt's dividend tease that "Creates new natural gas fields"

“Far from the muddy shale gas fields of the Bakken, a radical new drill-less technology could render fracking nearly obsolete.

“Here’s how this breakthrough has quietly created a virtual monopoly for one unlikely company that could… make you a small fortune….

“This company has the PERFECT business model.

“When I first uncovered the secret technology this company is using, I was dumbfounded. It’s genius.

“And recently, people have started to take notice. The company’s share price shot up as much as 35% in 2013.

“Recently, it’s pulled back a bit. But that’s good news for you because…

“The dip is a buying opportunity.”

That’s a good lead-in, right? The words are from Zachary Scheidt, who these days edits the Income & Dividend Report for Contrarian Profits (that publisher and newsletter have changed names and editors several times in the years I’ve been writing Stock Gumshoe — you might remember them as Taipan or “Insiders Strategy Group.”)

And the pitch is for an almost ideal company — they create gas… without the drilling or fracking that makes everyone mad. They have a monopoly (investors love a nice yummy monopoly).

So what is this secret company? Here’s a bit more from the ad…

“Technology Creates New Natural Gas Fields

“If you’ve spent any time online recently, you’ve no doubt read about America’s resurgence in oil and natural gas production. If you were savvy enough to get in on this rush 10 years ago, you’d probably be sitting on a mountain of cash right now.

“But if you didn’t… and you think you’ve missed out on getting in on the natural gas revolution… the next few minutes could change your financial future for decades to come. Because…

“I’ve discovered a company that’s exploiting a hidden natural gas reserve without the use of conventional drilling or dangerous fracking.

“Instead, it uses a special killer app gas extraction method that I call the Ten Hills Technique.”

Oh, man. Does that sound familiar? The “Ten Hills Technique?” Yep, this one is a rehash of an old teaser pitch for Unconventional Wealth, a different newsletter from the same publisher. It might ring a bell for those of you who’ve been sailing the good ship Gumshoe for a few years.

But for the rest of you, we won’t spoil the surprise just yet… let me snip out a few more clues for you and then we’ll get to the details.

“It all started around 1975 in a small community just down the road from Los Angeles.

“It’s no secret that California is an early adopter for environmentally friendly activities. And this time they got it right.

“Because this little community was the first in the United States to use the special drill-less natural gas extraction technique to power its entire town….

“… it can be used everywhere. And that flexibility has opened doors for the company I’ve found to use the Ten Hills Technique all over the country.

“The best news is it doesn’t matter even if natural gas prices hit historic highs or historic lows. This company stands to make money either way.

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“What it’s doing is so ingenious and creates such an unfair advantage that it seems criminal.

“But I assure you it’s 100% legal.

“In fact, some local governments across the country have gone out of their way to eliminate this company’s competition.”

So who is it? One more snippet of clues, then I promise we’ll reveal all:

“Amazingly enough, the service this company provides has nothing to do with the traditional natural gas industry.

“Yet it has quietly become a major player in the resource market by using the Ten Hills Technique.

“I’ll show you how to get all the details in my Special Investment Report ‘The Ten Hills Technique: Securing Your Retirement Through the Secret Natural Gas Market.'”

So what is the service this company provides?

Hauling trash.

And what’s the “Ten Hills Technique?” Extracting methane from their landfills and using it (or selling it) as natural gas.

And the stock? Waste Management (WM)

Which you’ve probably heard of. Heck, there’s a good chance they drive down your street once a week — they’re the biggest trash company in the country (market cap around $20 billion — second place is Republic Services (RSG) at about $12 billion), and they do indeed own a bunch of landfills that produce gas from the decomposition of the nasty stuff they’ve buried, gas which can be used for electricity generation or powering their natural gas-powered fleet of garbage trucks.

The stock has also been a favorite of dividend investors in recent years, they’ve now put together a string of ten years in a row of dividend hikes and they pay out a decent yield in the 3.5% neighborhood. Really, in many ways it’s probably best to think of WM as a utility — they have a pretty capital intensive business, running landfills and operating huge fleets of trucks, but they also often have a monopoly or an otherwise very strong market share in local areas thanks to deals with governments or entrenched customer relationships. Trash is still a pretty fragmented industry, with lots of local governments still providing the service on their own and with lots of small local haulers in the business, and that’s the fuel for growth for them — in order for WM to keep growing in any significant way, they need to keep acquiring companies and expanding revenues. Individuals continue to generally create less trash and more recycling (recycling is generally less lucrative for companies like WM), and business trash is generally pretty cyclical depending on the pace of economic growth, so the trend is not for big compounding of the business and growth unless they grow their footprint. Again, kind of like a utility — they expand into other communities if they’re looking for meaningful growth.

I wrote about these guys last year, when the teaser pitch was resurrected by Scheidt for the first time (the stock was around $41 then, so it has gone up a bit more than 5% — a little worse than the S&P 500 during that time period), and my opinion on them hasn’t really changed.

I don’t expect their methane production to have an impact on their earnings in any meaningful way, but it’s possible — investing in plants to generate electricity at their landfills, and operating them, also costs money even if the feedstock is something they’re paid to collect. The big boost in the stock price over the last two years has come as much from multiple expansion (meaning, investors are willing to pay a higher PE multiple — perhaps in part because of the dividend) as from actual revenue or earnings growth, WM has not had a PE this high in ten years. The stock has done well coming out of its 2012 doldrums, but the climb during that time really just mirrored the climb in the overall market.

But they are a large, dominant national player, and they do have the advantage of massive scale — they’re continuing to growth through acquisitions, particularly in recycling but also in new landfills and new haulers, and … well, I guess this is as close as you get to a “blue chip” in the garbage business, so it’s a familiar kind of company these days — large, pretty stable, wringing profits out by restructuring, and having trouble generating top-line sales growth without a kick in the pants from the economy (more housing and construction would be good for them, too, adding customers and construction waste).

I wouldn’t count on ‘Ten Hills’ or their ‘Killer App’ adding meaningfully to their earnings over the next few years, but it might help improve margins and they’ll probably try very hard to keep increasing the dividend even though their payout ratio is already very high. They have a large debt position and little cash, so it’s a balancing act — presumably their debt is cheap, and they do have lots of very valuable assets, so I’m not that worried about the debt, but this isn’t a cash-rich company — they need debt to grow, and future health for them os all about ongoing cash flow since they pay out almost 75% of their projected earnings as dividends.

And frankly, it seems like WM is trading even more like a utility this year than it was last year — they had a rough fourth quarter, missing earnings and guiding down for this year, which drove the stock back down to $41… and then beat on earnings by a bit in the first quarter and upgraded their free cash flow guidance, so they’re again back near $44. They said positive enough stuff in the last quarterly report that analysts pretty much unanimously raised their earnings numbers for this year and next… but not by very much. The company now expects to generate free cash flow of between $1.4-1.5 billion in 2014, but they haven’t yet changed their earnings guidance of $2.30-2.35 for the year (analysts aren’t much higher than that, at $2.37 currently).

Really, what we have here is a company that, like many huge companies, grows through acquisitions and is having trouble generating revenue growth — their typical revenue growth in recent years has been 1-3%. They are still turning that into slightly better earnings growth most of the time, with a jump up last quarter thanks to cost controls, and generating good cash flow that they put into that growing dividend payment, but there’s not a huge amount of room for disappointment with analysts forecasting earnings growth between 5-10% into the future and the stock now trading at more than 18X expected 2014 earnings.

Where does the $40 billion number come from in the teaser pitch? The company has slow-growing revenue of about $14 billion a year, but this is how Scheidt explains the much larger number:

“I realize to truly appreciate what this company does, you need a little more detail about its patented technique. So here goes…

“In its simplest form, it is the process of taking a resource that virtually everyone places zero value on, burying it in a specially designed container and then applying a complex extraction technique to mine the natural gas it produces.

“As I said… it’s not terribly exciting. But here’s something that is… in fact, it’s a game changer.
The company estimated that the raw material it buries could produce $40 billion in energy.

“That’s not a typo. $40 BILLION per year in energy.

“Remember, this company is not a mining company. It doesn’t sell the gas it produces.

“So creating $40 billion of energy is like throwing billions of dollars right to the bottom line. Billions of dollars it can use to slam the door on the competition even further.

“Just as importantly, billions of dollars it could pay out as dividends.

“But unlike drillers that operate under the reality that their supplies will eventually run out… this company’s feedstock will never go away.

“And the kicker is… it gets PAID nearly $14 billion per year to take the feedstock it uses in its Ten Hills Technique….

“Right now, the company has 135 sites that can convert the gas to electricity. And that number is planned to grow to 160 projects.

“The company creates enough electricity by burning the gas it produces to power more than 1.2 million households. And it plans to up that number to 2 million homes by 2020.

“But that’s just the tip of the iceberg. This company also uses the drill-less gas it producers to power more than 2,000 trucks in its fleet and is in the process of switching over 18,000 more of its vehicles.”

I suppose that is the “tip of the iceberg” when it comes to what might be possible for their energy initiatives, including their incineration plants and their landfill gas electricity generation… but that doesn’t necessarily mean that these energy initiatives are going to drive financial performance in the near term. The old “trash is cash” phrase still applies — the revenue from their electricity-related businesses, including the Wheelabrator incinerators (burning trash to generate steam, instead of the “Ten Hills” technique of extracting methane from decomposing trash in landfills), is well under a billion dollars as of 2013 and has not been a consistent generator of profit or free cash flow, the cash s till comes from the ownership of valuable landfills and the fees they earn for hauling trash to those landfills.

Which doesn’t mean it’s a bad investment, or that this couldn’t change substantially in the decade to come — lots of folks are predicting more energy extraction from garbage, including Sam Zell with his continuing investment in Covanta (CVA), more of a pure play on energy production through waste incineration, but it’s not a fast-moving business and the economics of trash collection and disposal have tended to dwarf the ecomomics of the “alternative energy” side of the business, so housing booms that generate lots of trash are good, economic slowdowns and higher recycling rates are bad (more recycling brings lower margins).

WM is a blue chip in trash, and pays a growing dividend, but the price you pay matters and I find it hard to imagine anyone paying 20X earnings for this stock next year and driving it up to even $50 (which would be a 15% rise from here), so it’s probably best to look at this one for the dividend alone if you’re interested, and keep your hopes muted from this price point. Think differently? Excited about WM or anyone else in the trash space? Let us know with a comment below.


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