How to turn a garbage dump into a gold mine

Rubbish tips have suddenly become much more attractive. That's because trash is a rich source of renewable energy - no bad thing in these carbon-conscious times. We pick a firm at the forefront of the landfill gas-to-energy business.

Waste disposal is something that we in developed countries tend to take for granted at least until the system breaks down. Just ask the poor citizens of Naples, where a dispute between the mafia and local officials has left garbage piled six-foot high in the streets and reduced the locals to nightly rosary vigils around massive bonfires of rubbish.

It's no surprise gangsters are drawn to the waste business, as Michelle Tsai points out on Slate.com. It's always been a dependable business, but changes over the last ten years have added some exciting growth areas to the industry. It's no longer just about piling up waste at the local landfill. Trash is now a commodity. India is crying out for scrap aluminium, China wants our discarded steel to build its skyscrapers, and a whole industry has sprung up recycling laptops and phones. A tonne of scrap from discarded PCs contains more gold than can be produced from 17 tonnes of gold ore.

Better still in these carbon-conscious times is the news that trash is a rich source of renewable energy. When garbage at the local landfill degrades, it gives off methane gas. Once trapped, the gas is a powerful fuel and can be used to generate electricity. The US Environmental Protection Agency estimates that landfills are the source of about 12% of global methane emissions and there are already some 1,000 projects underway worldwide selling gas gleaned from degrading rubbish to industrial outfits. German carmaker BMW is already running a factory in Carolina on power derived from incinerated rubbish.

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It's a welcome boost for a business that's traditionally been high volume, low margin. But even without the renewable energy rush to the dump, waste disposal remains a steady business during tough times. Landfill tipping fees have been increasing in the US since the mid-1980s, rising from $9 to $30 a ton today. As Tsai says, people always need to get rid of their rubbish, so even in hard times demand doesn't fall off and there's a lot of money to be made if you're a big enough player.

This need for scale has ensured that, not unlike the mobsters, a small number of big waste firms have taken a grip on the industry over the last decade, elbowing out the smaller players. "The consolidation has produced a healthy, functioning industry," Morningstar waste analyst Brian Nelson told the International Herald Tribune.

When the US garbage business was more of a public venture in the 1980s, the industry was still using age-old dumps such as New York's Staten Island landfill. They were badly managed, leading to a trash crisis as landfills overflowed. Privatisation drastically improved the management of the dumps trash was moved from major cities to huge landfills in the Midwest and the amount recycled jumped from 10% to 30%. And the availability of cheap landfill real estate in "flyover country" will ensure there's plenty of cheap capacity for some time to come, says Daniel Duffy in the Journal of Municipal Solid Waste Management.

With large reserves of working capital to draw on, US waste companies are well placed to make the move into the lucrative business of renewable energy. And with a wealth of methane and metals in their landfills, they are sitting on a goldmine. We have a look at one garbage outfit set to make a fortune from landfill mining in the box below.

Allied Waste Industries: a jewel in the garbage can

One company that is knee deep in the business of turning waste into energy is Allied Waste Industries (NYSE:AW). Allied has 52 landfill-gas-to-energy projects underway in America, including 41 electricity generating plants. Another 17 are under construction.

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Allied also owns the second-largest network of landfill operations in the country. And given the massive barriers to entry into the business, this leaves the company in a very privileged position in the garbage industry. As landfill space dwindles in some parts of the country and tipping fees escalate, the value of Allied's disposal capacity will drive increasing returns over the long term, says Morningstar analyst Brian Nelson.

And yet the group is valued on an attractive-looking forward p/e of 10.7. Alex Morozov of Morningstar reckons that the stock has been written down on concerns about its debt load and softening housing construction. But housing waste only makes up 5%-7% of revenues, says Morozov and the market is overlooking the fact that Allied is a "cash-generating machine". After recent refinancing efforts, the burden of debt is less of a concern "the financial turnaround is complete". Morningstar analysts expect the stock to achieve a three-year annual return of 33.6%.

Eoin came to MoneyWeek in 2006 having graduated with a MLitt in economics from Trinity College, Dublin. He taught economic history for two years at Trinity, while researching a thesis on how herd behaviour destroys financial markets.