Don't Waste This Opportunity

Treasure from trash? The environmental services group is riding high in this week's Relative Strength rankings

By Sam Stovall

Listed below are the sub-industries within the S&P Super 1500 (the aggregate of the S&P 500, S&P MidCap 400 and S&P SmallCap 600 indexes) that posted six-month price performances that were in the top 10% of all of the 115 sub-industries. (Each sub-industry carries the highest S&P Relative Strength Ranking of "5".)

One observation of interest is how these top performers were spread among seven of the 10 sectors. Only Consumer Staples, Information Technology and Telecommunications Services had no representatives, while Materials had the greatest number of sub-industries in the top 10 with three.

Yet one sub-industry stands out from the rest on momentum -- Environmental Services. This group is ranked "5" on three-month, six-month and 12-month relative strength. And Stewart Scharf, S&P's Environmental Services analyst, is positive on the group.

Why? Despite modest volume growth reflecting soft economic conditions, Scharf expects selective price hikes to offset weak commodity recycling prices. Given the satisfactory recent results, coupled with still low valuations (35% discount to market), S&P's investment outlook remains positive.

Scharf points out that while growth by acquisition was the main trend in the late '90s, companies now are seeking niche acquisitions and asset swaps, while focusing more on internal growth, and developing synergies from the integration of businesses. Waste companies are passing higher fuel costs on to customers with some price increases in regions with low risk of market share loss. Scharf says that overall, solid waste companies are attempting to improve operating margins by increasing internalization rates (the percentage of trash disposed of in company-owned landfills) and route density (the amount of waste collected along a localized hauling route).

One other trend to watch, according to Scharf: President Bush's energy group is recommending expanded tax credits for new landfill methane and waste-to-energy projects.

Although Waste Management, which controls the bulk of this index's market value, is not expected to reap the full benefits of its new strategic plan until 2002, it will roll out a new billing and information system this year. Waste Management is focusing on growing its core North American operations. The company expects to use $2.6 billion in proceeds from asset sales to reduce its debt-to-capital level by year end to below 60% from 66%.

Meanwhile, Allied Waste expects to use $1.6 billion in divestiture proceeds to cut its heavy debt burden to $9.2 billion by the end of 2001, down 5% from 2000.

Both companies were plagued by the difficult task of integrating their businesses with large acquisitions: Waste Management with USA Waste and Allied Waste with Browning Ferris. The integration problems contributed to a drastic drop in their stock values since July 1999, says Scharf.

Growth in the $3 billion hazardous waste industry has slowed tremendously, notes Scharf, with total shipments to commercial landfills and combustion facilities unchanged at four million tons per year since 1995 when new landfill disposal regulations took effect. In addition, more hazardous waste is being classified as non-hazardous and dumped in regular landfills.

Sub-Industry Company S&P STARS Rank
Environmental Svcs. Waste Management (WMI)
Environmental Svcs.
Health Care Facilities HEALTHSOUTH(HRC)
Health Care Facilities
Homebuilding Lennar Corp. (LEN)
Leisure Products SCP Pool (POOL)
Leisure Products
Metal & Glass Containers Pactiv Corp.(PTV)
Metal & Glass Containers
Oil & Gas Refining/Mktg Sunoco Inc.(SUN)
Oil & Gas Refining/Mktg
Reinsurance Everest Re (RE) Not Ranked
Steel Nucor Corp. (NUE)
Trading Cos. & Distributors Fastenal Co. (FAST)
Trading Cos. & Distributors
Water Utilities American Water Works (AWK)
Water Utilities

Got a question you'd like Sam Stovall to answer? He will be the guest on the July 16 Ask the Analyst video on BWOL. Click here to e-mail your question.

Stovall is senior sector strategist for Standard & Poor's

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