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The recycling industry is a sterling example of how grassroot initiatives can spur the creation of bonafide industries. We've come a long way since the 1960s, when tiny non-profits drove around in vans collecting recyclables from prescient individuals who didn't want to throw their "waste" away.

In less than 40 years, the U.S. recycling industry has become a backbone of our economy. In 1968, the fledgling industry pulled in $4.6 billion in annual sales; today, revenues are roughly $236 billion [National Recycling Coalition]. The industry provides employment for 1.1 million people, up from just 79,000 in the late 1960s, and 56,000 public and private facilities processing recyclables. Our research partners Cannacord Adams estimate the industry accounts for about 2% of the $12.36 trillion U.S. gross domestic product as of last year.

The recycling industry generates more than twice the revenue than the $100 billion waste management industry [National Solid Wastes Management Association] even though much more garbage is thrown out than recycled. That's because recycled materials generate economic value - waste disposal doesn't.

Indeed, at the current rate of resource depletion, the world literally can no longer satisfy demand for paper and steel from virgin materials alone. Recycling has become an absolute necessity for industrial growth and stability. We couldn't print a newspaper, build a car, or ship a product in a cardboard box without recycled materials.

Although we usually think of the benefits of recycling as reducing waste and protecting forests and habitats from mining and clearcutting, it is also a key solution for climate change. Making new materials from old ones is a classic example of energy efficiency - it vastly reduces the amount of energy and emissions required to support our economy.

Quickie Background

At the turn of the 20^th century, people made paper out of waste paper and rags when wood pulp was scarce or too expensive, and during World War II, Americans worked together to recycle scrap metal and other materials.  

In the early 1990s, non-profits began urging municipalities to set up recycling programs, but industry and government balked. The U.S. was in an economic slump and demand was low for either virgin or recycled materials.

Even as they coaxed municipalities into raise tipping fees at landfills to make recycling economical, it continued to be much cheaper to dump waste into landfills. It cost $400-$1000 per ton just to collect recyclables, compared to $70 a ton to dump them in landfills. There was little money to be made selling the materials - a ton of recycled materials was valued between $15-$60.

In the mid-90s, the economy grew as did prices for recyclables. Although the economics of recycling continued to be a mosaic of collection and landfill costs, market demand, and recycling infrastructure and technology, industry invested in high tech machinery to sort, process, manufacture and ship recycled materials.

Today we see how investing in the recycling infrastructure over the years paid off. Leaching landfills closed, and stringent environmental regulations made landfills expensive to operate. Industry pushed for incineration as the solution, but citizens embraced recycling. Now the industry is not only economically viable, but profitable, thanks to significant gains in recycling technologies that made the process of recycling substantially more efficient and cost-effective.

Industrial recycling has gone far beyond municipal recycling and is where the real action is. Over the past decade and the advent of "corporate environmental responsibility," businesses have come to rely on recycling to lower energy costs, use fewer raw materials, minimize waste streams, and reduce pollution. Now, with a global market, very high costs for virgin materials and overwhelming demand, recycling helps companies achieve competitive advantage and profitability.

Just about every kind of product is recycled - paper, all metals, car parts, and carpet. Decks are commonly made completely of recycled materials. The newest category is electronics.

Advantages of Recycling

Energy savings from using recycled vs. virgin materials:

Iron and Steel: requires 74% less energy. 2/3rds of steel produced in U.S. is from recycled materials.
Non-Ferrous Metals (all other metals): requires 96% less energy for aluminum. 60% of metals are now made from scrap.
Paper: requires 36% less energy and far fewer chemicals. 51% of paper recycled in 2005.
Plastic: requires 80% less energy and reduces petroleum use. Only 17% is currently recovered for recycling.

Recycling is successful because it benefits both the environment and the economy.

Environmental Advantages:

• Less pollution: reduces or eliminates the need to extract and process virgin materials - very energy and fossil fuel-intensive processes. Less mining also eliminates the use of toxic chemicals.
• Reduced greenhouse gas emissions from incinerators and landfills; reduces the need to burn fossil fuels manufacture materials.
• Conserves natural resources and habitat by reducing the need for wood, water, and minerals.

Making products from recovered materials reduces 10 major categories of air pollutants and eight categories of water pollutants. With a national recycling rate of 30.6%, we save about 256 billion barrels of crude oil, the equivalent of taking about 22 million cars off the road each year [US EPA]. 

Economic Advantages:

• Dramatic energy savings
• Job creation: 1.1 million U.S. jobs with an annual payroll of $37 billion.

• Supports vital industries: paper and steel mills, iron foundries, plastics converters, computer demanufacturers, composters, and plastic lumber manufacturers.
• Saves money: in addition to selling recycled materials, towns reduce the use less fossil fuels, even after factoring in the energy required to collect and transport materials.

The recycling industry is benefiting from a confluence of trends:

• High energy prices favor increased recycling. With energy costs reaching permanently high levels, recycling is the avenue of choice. It takes much less energy to make a product from recycled than virgin materials. Example: energy accounts for 20-30% of the cost to make metals such as aluminum and zinc.
• Metal prices are rising sharply from strong demand - partly from growth in India and China - creating strong economic incentives to recycle all kinds of metals. Although metal prices fluctuate, strong continued demand is likely to keep prices high, benefiting recycling.
• Recycling benefits from the attention to climate change for its ability to reduce the energy intensity of manufacturing and methane generated by landfill waste.
• Growing recognition that natural resources are scarce, finite, and increasingly expensive to mine. Example: virgin copper and zinc supplies could be completely exhausted within decades.
• Rising concerns about pollution from discarded electronics

Recycling Industry Segments   

Re-manufacturers, which recycle old materials into new products, are the largest segment of the recycling industry. This $180 billion industry - consisting of steel mills, plastics converters, glass producers, iron and steel foundries, and rubber product manufacturers - represents 75% of the industry's revenue.

The second largest segment consists of paper stock dealers and scrap metal re-processors that process recyclables, sorting and compacting materials. This segment generates $41 billion in sales or 18% of the industry.

Companies involved in reuse - motor vehicle part re-manufacturers, tire re-treaders, and computer de-manufacturers that refurbish existing products -  generate $16 billion in sales or 6% of the industry.

The collection side of the industry - those that pick up curbside consumer recyclables, materials recovery facilities and material wholesalers - is the smallest segment, generating 1% of revenue, about $2 billion annually.

Non-ferrous metals and plastics have the highest economic value per ton of material; glass and yard waste have the lowest sales value. Iron, steel, paper/paperboard and tires have the highest recycling rates.

Recycling Giants: Iron and Steel

Iron and steel, known as ferrous metals, are the giants in recycling. Steel is the most recycled material worldwide, achieving a recycling rate of 75.7% in the U.S. for 2005 [Steel Recycling Institute]. About two thirds of all steel is now made from scrap, which can be recycled over and over again.

The extraordinary increase in the price of ferrous scrap over the past five years - from $100 a ton in 2001 to well over $250 ton this year is a very significant driver.

What's the most recycled consumer product? Vehicles! 100% of the steel used in cars is now recycled. Steel cans lag far behind with a 63% recycling rate, largely because people can't toss their cars in the garbage as they can with cans.

Mini-mill steel producers - which make steel from scrap - now comprise 56% of U.S. steel production, up from 38% in 1992. The technology used to make steel from scrap not only lowers feedstock costs (scrap costs less), but enables faster production.  

Along with rapidly escalating energy prices, another major trend in the industry is consolidation.  There are some 1200 scrap recyclers in the U.S.; even the largest has no more than a 15% market share. As the smaller players get rolled up, the industry benefits from greater pricing power, the elimination of excess capacity and greater control of output when the economy softens, raising the floor for ferrous prices.

The steel industry recycles some 76 million tons of steel and iron annually, generating $62 billion in sales and saving enough energy to power about 18 million homes. Recovering one metric ton of steel from scrap saves 2,500 pounds of iron ore, 1,400 pounds of coal, and 120 pounds of limestone [American Iron & Steel Institute]. The Institute estimates the industry has reduced greenhouse gases emitted per ton of steel shipped by 45%.

Non-Ferrous Metals

Any metal other than iron and steel is considered non-ferrous: aluminum, copper, lead, zinc, nickel, titanium, cobalt, chromium, and precious metals (ie., silver and gold). This group generates about $28 billion in sales [National Recycling Institute].

The global aluminum industry is the first industry to commit to achieving greenhouse gas neutrality. The target date is 2017.

Aluminum is by far the most valuable material households recycle. For many communities, it often subsidizes the cost of recycling less valuable materials. Using recycled aluminum eliminates almost 96% of the energy and emissions that would be produced if it were made from pure bauxite ore. Indeed, virgin aluminum is a primary source of perfluorocarbons (PFCs), greenhouse gases that are thousands of times more potent than carbon dioxide, according to the EPA.

The aluminum industry recycled 52% of the 51 billion aluminum cans produced last year, and almost 90% of that used in vehicles [Aluminum Association]. Since 1888, about 75% of the aluminum produced is still in use, says leading manufacturer Alcoa. Insatiable demand from China and the trend toward using aluminum to make lighter, more fuel efficient cars, is significantly increasingly the market for aluminum.

Paper/ Paperboard

With about $50.5 billion in annual sales, recycling paper and paperboard is the second largest recycling sector. 37% of the raw material used to make all paper products now comes from recycled paper.

Plastic

Plastic is the third largest sector with $28 billion in sales [National Recycling Institute]. Despite demand from plastic recyclers, plastics have a mere 20% recycling rate, down from 40% in 1994. The huge growth in bottled water, which is rarely recycled, have pulled recycled rates down because most of it is consumed away from home where it's difficult to recycle. And few container deposit laws cover plastic water bottles.

The impact on the environment is substantial: it takes 1.5 million barrels of oil to satisfy U.S. demand for bottled water [Earth Policy Institute]. The number of plastic bottles used has more than tripled since 1996 - to 200 bottles per person per year! 

Source: Container Recycling Institute.

Electronics Recycling 

Extremely short product lifecycles and the proliferation of gadgets like cell phones, iPods and Blackberrys, has made electronics the fastest growing waste stream worldwide. When the U.S. shifts to digital-only television in 2009, as many as 100 million TVs could be obsolete.

Unbelievably, about 70% of the heavy metals and 40% of the lead in U.S. landfills seep out of dumped electronics, according to the EPA. And 80% of e-waste is shipped to Asia and Africa, where it is simply dumped after the metals are salvaged.

High prices for metal scrap, and pressure for recycling from government regulation and NGOs, will benefit the burgeoning e-cycling industry going forward.

The European Union passed two major laws - Restriction of Hazardous Substances (RoHS) and the Waste Electrical and Electronic Equipment Directive (WEEE)) - which require e-cycling as well as green product design to minimize hazardous chemicals and waste.

In effect since July 2006, RoHS restricts the use of six hazardous chemicals in electronic equipment manufacture - lead, mercury, cadmium, chromium VI, and two flame retardants. WEEE encourages green design by mandating that electronic products contain certain percentages of recyclable materials.

In the U.S., manufacturers have taken on product take-back. 35 states have banned electronics from landfills, setting the stage for the emerging e-cycling industry.

Several large recyclers and about 400 small recyclers in the U.S. generate $700 million in annual sales from processing 1.5 billion pounds of electronics [International Association of Electronics Recyclers (IAER)]. They recover about 900 million pounds of materials - an impressive 60% recycling rate.

IAER predicts the industry will process three billion pounds a year by 2010, making the development of an efficient infrastructure the key issue for the industry.

Waste Management Raises Bar  

Underscoring the importance of resource optimization and sustainability, Waste Management (NYSE: WMI), the largest waste management firm in North America, recently announced it would significantly increase recycling volumes and waste-to-energy production over the next 12 years.

WMI says it will more than double recycling by 2020 - from the current eight million tons a year to 20 million tons - through single stream recycling and e-cycling, and it plans to double waste-to-energy production by 2020, with an emphasis on landfill gas.

The move is further evidence of a paradigm shift in the waste management business where "trash" is viewed as a valuable resource to be mined, rather than as a nuisance to be landfilled.

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The recycling industry is one of the few areas where investors can find protection during a recession, according to our research partner, Canaccord Adams. 

For 2007, the Canaccord Adams Recycling Index (CARI) rose 7.3%, easily beating the 3.7% gain in the S&P 500 Index, although it trailed Nasdaq. The top five stocks in the index averaged a 148% return in 2007; the bottom five stocks had a 71% loss [see CARI in the Tables section of this Report].

As we noted in the previous article, high energy prices, rising costs for virgin materials, advances and efficiency gains in recycling technology, and sharp increases in metals prices have created a profitable environment for recycling.

"This confluence of trends in the world today is creating what we call a ‘perfect storm' scenario for the recycling industry. For the first time, all of these important dynamics have come together simultaneously, thus providing a unique and powerful growth catalyst for the industry, in our view," says Eric Prouty, Senior Technology Analyst, Canaccord Adams.

While high energy prices hurt all manufacturers, they particularly hit metals producers for whom energy comprises as much as a third of operational costs. Energy costs are much smaller piece of the pie for metals recyclers and are easily outweighed by the higher scrap prices they receive.

The process of making steel from scrap is simple: melt the old steel, remove impurities and then cast it into its new shape. Compare that to the energy needed to mine the ore, melt it down to coke to create iron and then refine that iron into steel in a furnace.

Therefore, high energy prices directly lead to greater use of scrap metals. It's not surprising then that spot prices for various metals have risen substantially over the past several years due to steep demand - China alone has been buying 30% of the world's steel, up from 18% in 2000. Aluminum prices are up almost 80%, nickel 169%, and copper a whopping 350%. As prices for virgin metals rise, so do scrap metal prices - making the situation quite positive for recyclers.

Metals recyclers offer excellent investment prospects as do value-added recyclers - companies that use recycled materials to create new products.

Waste electronics compose 5% of the U.S. municipal waste stream and are projected to grow five times faster than all other wastes, making e-cycling the leading edge of growth for the recycling industry.  Worldwide, e-waste is forecast to grow 9% a year through 2009 - an $11 billion market, up from $7.2 billion in 2004. Australia-based Sims Group, the world's largest e-cycler, is the only publicly traded company in the space today. Over the next few years, venture-backed e-cyclers such as Electronic Recyclers International will likely enter the public markets.

Another boost to e-cycling will be the U.S. transition from analog to digital television in February 2009. No one knows how many people will throw out their old TVs, but the recycling industry is bracing for 25 million to 100 million.

Panasonic, Sharp and Toshiba recently launched a joint venture e-waste recycling company - Electronic Manufacturers Recycling Management Company (MRM) - to manage collection and recycling of used electronics in the U.S. MRM says it plans to work with stakeholders to establish a long-term national solution to the e-waste problem.

The World's Top Recycling Stocks:

Befesa (BMA.MC; BFMDF.PK): metals recycler in Europe

Casella Waste Systems (Nasdaq: CWST): regional solid waste company with a strong focus on recycling.

Metalico (AMEX: MEA): small cap metals recycler.

Mayr-Melnhof (218214.VI; MNHFY.PK): leading European paper packaging recycler - manufactures corrugated cardboard.

Schnitzer Steel (Nasdaq: SCHN): vertically integrated scrap metal recycler and steel manufacturer.

LKQ Corp (Nasdaq: LKQX ):  the largest vehicle recycler, dominates the automotive replacement parts market in the U.S.

Interface (Nasdaq: IFSIA):  leading carpet tile manufacturer uses a high percentage of recycled material.

Sims Group (SGM.AX): the world's largest metals and electronics recycler just merged with the one of the largest full service U.S. metals recyclers, Metals Management (NYSE: MM), to form Sims Metal Management.

Transpacific (TPI.NZ): leading waste management firm in Australia and New Zealand - half its revenue comes from oil recycling.

Sampling of other recycling companies:

Astec Industries (Nasdaq: ASTE): makes equipment to recycle asphalt and grind up trees and other green waste.
BioteQ Environmental (TSX: BQE): treats water from the mining industry, recovering metals for resale. 
Caraustar Industries (Nasdaq: CSAR): paper recycler
Centillion Environment and Recycling (SGX: C49): Singapore-based e-cycler expanding in the US and Asia.
Horsehead Holding (Nasdaq: ZINC): recycles zinc from steel mill byproducts.
GreenMan Technologies (OTCBB.GMTI) recycles tires. 
Kadant (NYSE: KAI) manufactures paper recycling equipment.
Stillwater Mining (NSYE: SWC): mining company with over 50% of revenue from recycling catalytic converters.
Tomra Systems (TOM.OL) makes reverse vending machines and equipment for single stream recycling.

The Private Side

The majority of privately held recycling firms are mature, often family-owned recyclers that are extremely profitable, generating as much as billions of dollars in revenue a year. The following are a sample of venture-backed firms, some of which could go public in the next few years.

Lehigh Technologies (Naples, FL) is commercializing a proprietary technology that freezes scrap tire material with liquid nitrogen, making rubber brittle enough to be pulverized into a fine powder. The powder retains some of the characteristics of rubber such as elasticity and impact resistance, making it a value-added ingredient in paints, coatings and sealants, chemicals and auto parts.

Lehigh says its new 83,000 square foot plant has a zero carbon footprint and can produce 100 million pounds of rubber power annually from six million scrap tires. www.lehightechnologies.com

MaSeR Corp. (Marblehead, MA) has developed next-generation material separation processes that maximize the economic value of materials such as electronics and plastics. Its turnkey recovery services separate metals from metals and metals from plastics. www.masercorp.com/

Paradigm Environmental Technologies (Vancouver, BC) treats wastewater by converting waste-activated sludge into methane at wastewater treatment plants, and turns it into natural gas to heat the plants. Its proprietary technology is said to reduce volatile solids production up to 90% in sludge while lowering costs to produce significantly more methane.  www.microsludge.com

Electronic Recyclers International (Fresno, CA) is California's leading e-cycler. It can process up to 10 million pounds of e-waste per month. Its cathode ray tube crushers give it the ability to process over 1,500 units per hour, and the company has an exclusive partnership with Dlubak, the nation's largest glass recycling company. www.electronicrecyclers.com

Sterecycle (London, UK) recovers up to 80% of recyclables and then uses an autoclaving technology that converts it into fuel while minimizes the volume and weight of waste. The process only uses steam - no emissions and no incineration. www.sterecycle.com

Other key players in e-cycling include Intechra, Amandi Services, Earth Protection Services, Inc., Global Electric Electronic Processing Inc. and eCycle Solutions (Canada).

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The following stocks have BUY Ratings.

Casella Waste Systems (Nasdaq: CWST)
Rutland, Vermont, USA

Market Cap: $267M                   
52 Week Range: $8.86-$16.20
www.casella.com

Casella is considered the most progressive waste management company in the U.S. Primarily a regional player in the Northeast U.S., it has been at the forefront of recycling since it began 33 years ago. Recycling is its second largest division after municipal landfill operations. It collects, processes and sells its own and others' recyclables, and is one of the largest municipal waste recyclers in the U.S.

Recycling constitutes 33% of revenue - almost triple that of its closest competitor Waste Management (NYSE: WMI) - and has 18-20% margins, making it one of the most profitable recycling operators in the country.  It is benefiting from high commodity prices, especially in plastics, which are directly related to the price of oil.

Its first landfill gas project is about to begin operations, with more projects planned for 2009. Casella has a 24% stake in privately held RecycleBank, whose innovative incentive-based business model is leading to extremely high recycling rates, often in communities which previously didn't recycle. Households receive discount coupons at retailers like Starbucks and Whole Foods based on the amount they recycle. The company is rapidly expanding from 35 communities serving 125,000 homes in 2007, to an estimated 500,000 homes by year end. Casella has a long-term exclusive processing agreement with RecycleBank.

US GreenFiber - a 50/50 joint venture between Casella and Louisiana-Pacific - produces insulation, fire and soundproofing products from recycled paper. The Cocoon brand is sold through major retailers and contractors across the U.S. and Canada, and has been growing quickly along with demand for non-fiberglass insulation and value-added sound proofing. Greenfiber is underperforming due to the housing crisis, but Casella expects improving results by late this year.

Casella is also a leader in the trend toward single-stream recycling, which tends to double recycling rates by allowing people to commingle materials in one bin. Single stream tends to produce higher volume, higher quality recyclables, which enables Casella to benefit from higher commodity prices.

The downside to Casella is that it's a relatively small player in a very competitive industry and has a lot of debt, which could impede its ability to grow. The stock trades at a lower multiple than competitors because the recycling side of the business has yet to be factored in.

Cannacord Adams believes Casella is "among the best-positioned companies to capitalize on changing industry dynamics, such as sustained high energy prices, commodity price inflation and scarcity, and global environmental concerns."  

Price Target: $20

Industrial Services of America (Nasdaq: IDSA)
Louisville, Kentucky, USA

Market Cap: $30.79M
52-week Range: $5.75-$18.19
www.isa-inc.com

IDSA has been providing metals scrap recycling services since 1953. It collects and recycles ferrous and non-ferrous scrap from large, multi-location commercial and industrial companies in primarily the Midwest U.S. IDSA recycles metal scrap and also sells and services waste handling equipment. The company's IPO was in 1996.

A new initiative will help smaller scrap yards by aggregating and marketing their scraps. IDSA's guidance for 2008 is 30-40% year over year growth.  

Price Target: $18

Interface, Inc. (Nasdaq: IFSIA)
Atlanta, Georgia, USA

Market Cap: $979M
52-week Range: $13.11-$20.55
www.interfaceinc.com

The sustainability advantage that Interface has been working so long and hard on is working. Bolstered by the strong trend toward green buildings, Interface is outperforming peers in revenue, margins, market share and brand recognition. Interface continues to expand its green carpet product lines, cementing its position as the leader in the rapidly growing green building market.
 
The growing adoption of modular carpet tiles - Interface's specialty - in commercial real estate is also significantly benefiting the company. Modular carpet sales grew 18% in 2007, exceeding analyst forecasts and showed continued growth, albeit lower, during the first six weeks of 2008. Interface has expanded into a variety of institutional markets and solid growth in the world's emerging markets is offsetting weakness in the U.S.  About half of Interface's business is now outside the U.S.

While the construction industry suffers during this historic downturn, Interface should weather the storm because of its unique positioning.

Price Target: $22

LKQ Corporation (Nasdaq: LKQX)
Chicago, Illinois, USA

Market Cap: $2.95B
52-week Range: $10.16-$23.66
www.lkqcorp.com

Founded in 1997, LKQ is the leading automotive parts recycler in the U.S. and the first company to achieve a national presence in the field. It has acquired 50 companies in its short history - including one of the largest - Keystone Automotive - and went public in 2003. It has 122 locations and 3500 employees.

LKQ buys totaled vehicles at auction and then refurbishes and sells the usable parts, such as engines, doors, and headlights. Insurance companies are a key driver for the business as they increasingly turn to lower cost recycled parts to reduce repair costs.

Another driver for LKQ's business is the unfortunate increase in traffic congestion which inevitably leads to collisions and the need for repairs. Collision repair is a growth market, rising almost 6% a year for the past five years.

LKQ expects to see double-digit revenue growth and 20% EPS growth for the next few years as it continues to gain market share. Continued opportunities for acquisition in the very fragmented auto parts market should contribute to growth.

Although LKQ's debt rose with the Keystone acquisition, improved logistics and warehouse consolidation  increased productivity substantially.  This was born out in the latest quarterly results which beat analyst expectations. The company is expected to grow revenue 10% in 2008 and 23% in 2009.

LKQ is a top stock during this economic downtown because of its non-cyclical business and consistent operating performance.

Price Target: $25

Metalico, Inc. (AMEX: MEA)
Cranford, New Jersey, USA

Market Cap: $310M
52-week Range: $4.14-$13.25
www.metalico.com

Metalico is a regional metal recycler - the largest in western New York State - and is the leading fabricator of lead products (except vehicle batteries) in the U.S. It processes and sells a wide range of ferrous and non-ferrous metals to mostly domestic customers such as steel mini-mills, foundries and aluminum recyclers. MEA went public in 2005.

MEA is growing through acquisitions, leveraging its existing infrastructure through strategic ‘tuck-ins' of local firms. It recently expanded its aluminum deox facility, which removes oxygen from molten steel - a significant growth opportunity. Precious metals prices are also strongly higher, which could account for a third of Metalico's revenue this year.

The primary risk for Metalico and other scrap processors this year is the extremely tight supply of metal scrap in the U.S., the result of reduced automobile production and the ongoing exodus of manufacturing overseas. While scrap scarcity pushes prices higher, it negatively impacts volumes. 

MEA is a small player with relatively limited daily trading volume. It is exposed to environmental regulations - lead is an increasingly regulated substance which is beginning to be banned in some applications. After a strong run-up, lead prices dropped 30% in Q407, for example, negatively impacting MEA's revenue for the quarter.

MEA trades at a premium to its peers because of its high profitability and growth potential. Analysts estimate 48% EPS growth for 2008.

Price Target: $15.

Schnitzer Steel Industries (Nasdaq: SCHN)
Portland, Oregon, USA

Market Cap: $1.63B
52-week Range: $36.31 - $77.88
www.schnitzersteel.com

Schnitzer is a vertically integrated metals recycler and steel manufacturer. It recycles ferrous and nonferrous metals and sells them to its steel manufacturing division, which uses mini-mill technology to produce finished steel products. The steel manufacturing division obtains its entire feedstock from the recycling division, which guarantees a steady market for its recycled steel.

SCHN is primarily an exporter, shipping roughly 70% of its products to foreign countries. The company celebrated its 100th year of operations in 2006. It has 28 facilities across the U.S. and exports from both coasts. It is also a leading auto parts recycler with a chain of 35 self-service Pick-N'Pull stores and 17 full-service retail stores.

Schnitzer is benefiting from robust global demand and high prices for steel scrap and steel. Ferrous scrap prices are up 25-30% since the start of 2008; exports are up 30% since 2006. Deep sea freight rates have dropped from recent record highs, easing pressure on margins.

Price Target: $80

Sims Group (SGM.AX)
Sydney, Australia

Market Cap: $4.12B
52-week Range: $22.62-$34.67
www.sims-group.com

Based in Australia, Sims is the world's largest scrap metals and electronics recycler. This massive global company - with 122 recycling plants on four continents - also recycles plastics, appliances and other end-of-life products.

Sims sources scrap metal from crushed vehicles, demolished buildings, old appliances, and old construction equipment. It shreds and breaks the metal down to smaller pieces and then re-sells them.

Sims just completed a $1.6 billion all-stock merger with Metal Management (NYSE: MM), one of the largest metal recyclers in the U.S. On March 17, the combined company started trading on the NY Stock Exchange as Sims Group Limited (NYSE: SMS), giving U.S. investors easy access to the stock. That alone could push share prices higher.

In late 2005, Sims acquired NYC-based Hugo Neu, creating the world's largest metal recycling company.  Hugo Neu recycled much of the recovered metal after the 9/11 World Trade Center attack, and has recycling contract for New York City.

Although metal recycling is by far the largest division of Sims' business, electronics recycling is a very important driver for growth. E-cycling - which has triple the profit margin of steel - currently comprises about 10% of revenues (up from 7% a year ago), and 21% of profits (compared to 12% a year ago). As part of e-cycling, Sims recycles televisions, which could become a major waste stream in 2009 when the U.S. shifts to digital-only television.

46% of revenues come from North America, 33% from Australia and Asia, and 21% from Europe.  Sims recently expanded its recycling clout with acquisitions in Canada and the UK, and has entered the e-cycling markets in India and China.

Sims benefits from higher energy costs and steel prices. Because analysts haven't factored in the e-cycling side of the business, Sims trades at a fairly low multiple on par with other metal recyclers.  It has a dividend yield of about 6%.

Price Target: $31

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We interviewed three financial analysts that cover the recycling sector to learn the ins and outs of investing in the industry.

Eric Prouty, Senior Analyst, Cannacord Adams, equities research firm
Matt Patksy, Managing Director, Winslow Asset Management, manages two green mutual funds and portfolios for high net worth individuals and institutions.
Jon Forster, Investment Manager, Impax, based in the UK, manages green funds and portfolios

The following discussion will give you insights into their views on the top companies in the sector, many of which are in buying position now. We also talk about other interesting companies to give you an overview of the industry as a whole.

Stocks with Top Buy Ratings:

Casella Waste (Nasdaq: CWST): waste recovery, recycling, landfill gas, landfills
Industrial Services of America (Nasdaq: IDSA): metals recycler
Interface (Nasdaq: IFSIA): carpet tile manufacturer with high recycled content
LKQ (Nasdaq: LKQX): auto part recycler leader
Metalico (AMEX: MEA): U.S. metals recycler
Schnitzer Steel (Nasdaq: SCHN): vertically integrated metals recycler and steel manufacturer
Sims Group (SGM.AX): world's largest recycler

Other top stocks:

Befesa (BMA.MC; BFMDF.PK): European metals recycler
Interseroh (ITS.DE): European metals recycler
Mayr-Melnhof (218214.VI; MNHFY.PK): European leader in paper recycling
Shanks (SKS.L): sorts, recycles, composts municipal and commercial waste
Transpacific (TPI.NZ): oil recycler in Australia, New Zealand

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PI: Given the severe economic downturn, have you changed your positive outlook for the recycling industry?

Eric Prouty, Cannacord Adams:

Not at all. Recycling is a great, long term secular trend. Beyond the ups and downs of the economy, natural resources are becoming increasingly scarce and energy prices are very high - the economics of recycling are easily justified as the way to save money. China, India, Russia and the Middle East have rapidly expanding infrastructures and increasing domestic consumption, sucking up the world's natural resources. That level of demand can't be met by virgin supply. We depend more and more on recycled materials to feed that hunger.

Matt Pasky, Winslow:

Yes, because of increased global demand and high commodity prices, it's just become more economical to use recycled materials. It's finally become advantageous for companies like Interface to recycle its old carpet to make new carpeting. The recycling trend is definitely is worth investing in.

We believe global growth will continue regardless of a U.S. recession. If anything, demand will continue tightening supplies, making recycling increasingly necessary and pushing commodity prices higher. We haven't seen even a hint of reduced demand because of economic conditions. We own all the major recycling companies in our funds.

Even if the U.S. enters a period of stagflation akin to the 1970s, it will be different due to the huge demand from developing countries. If our industries are serving that demand, we think they will fare well.

Jon Forster, Impax:

Legislation is also increasing recycling, especially in Europe. The EU Landfill Directive is driving waste away from landfills and low value treatment processes into higher value processes. In the UK, for example, landfill taxes are escalating every year, which helps innovative technologies be commercially viable.

Germany has been leading in deposit schemes - you pay a small deposit that you get back when you return a bottle. Initially, legislation was necessary to force industries to adopt deposits, but now they're doing it on their own because the economics stack up. They want the value in these materials.

PI: Which companies are best positioned now?

Eric Prouty, Cannacord Adams:

The largest part of the recycling economy by far are massive flows of scrap metals from industry, not municipalities. Recycling rates for industry are very high, driven purely by economics.

With commodity prices rising so rapidly that's the exciting place to be. Australia-based Sims Group (SGM.AX), the world's largest recycler, just completed the acquisition of one of the largest U.S. metals recyclers, Metals Management. Sims is a great company and pays a dividend. It's also the play for electronics recycling.

The combined company now trades on the NY Stock Exchange as Sims Group Limited (NYSE: SMS), making it easy for US investors to buy stock in Sims for the first time. That move alone could push up the share price.

In the U.S., we have Buy ratings on Metalico (AMEX: MEA), Schnitzer Steel (Nasdaq: SCHN), LKQ (Nasdaq: LKQX), Industrial Services of Amercia (Nasdaq: ISDA) and Casella Waste (Nasdaq: CWST).

Even though U.S. demand for steel is down a bit from our slowing economy, the weak U.S. dollar actually insulates many domestic steel makers. We're importing less steel so metal recyclers like Metalico and IDSA, which sell domestically, are going gang busters. [Disclosure: Canaccord Adams received compensation in the past year for investment banking services for Metalico].

Matt Pasky, Winslow:

Metalico is also benefiting from the boom in precious metals like platinum and palladium. Schnitzer is in our top 10 holdings and Sims is our 12^th largest holding. The fundamentals of the industry - prices, volumes, demand have never been better for these companies. And their stocks are at very reasonable multiples.

LKQ, which has risen sharply recently, is another great stock. They strip down vehicles and use almost all the scrap, selling the rest to companies like Schnitzer. They've gone national by acquiring mom and pop junkyard chains. There are still many Sanford & Son-style scrap yards - who would've thought it would become such a great business?! LKQ acquires them and automates them - just about every last thing is stripped off junked vehicles.

Eric Prouty, Cannacord Adams:

If you're looking for a business that's fairly immune to economic downturn, LKQ is a great holding. The number of car accidents doesn't drop in a bad economy, but you'll probably fix your car with a cheaper, used part.

Interseroh (ITS.DE) is a small cap that's one of Germany's top steel scrap recyclers and has been acquiring companies in the U.S. Metals are also a big play in Europe.

Jon Forster, Impax:

Interseroh and Befesa (BMA.MC; BFMDF.PK) - which Abengoa has a big stake in - are good investments in European metals recyclers.

LKQ is great. The Keystone acquisition gives them the full range of auto parts. It's not a cheap stock, but management is very strong, they are well positioned and have an impressive track record. 

For paper recycling, we like Mayr-Melnhof (218214.VI; MNHFY.PK), which makes corrugated cardboard packaging. It's important for recyclers to have a strong regional market share - Mayr has done in Europe what Metalico and others have done in the U.S. - a very good job of consolidating the industry, integrating acquisitions and increasing capacity utilization of the plants they buy.

Another company we like is Transpacific (TPI.NZ), based in Australia. The company is split between waste management and oil recycling, and has leading market share in Australia and New Zealand. Waste oil used to be sold as a fairly low value product, but now that they have reached scale, they are creating a network of refineries, which increases the profitability of the business. They have been very good at acquiring businesses, integrating them, bringing them up to standard.

Transpacific's stock has been sold off hard, but business is very good. We're very optimistic about the stock this year. 

PI: What about on the municipal side?

Eric Prouty, Cannacord Adams:

Recycling rates will rise for municipalities when it's easy and cost effective. Although metals became profitable about five years ago, paper recycling wasn't economical until 2-3 years ago, and only 1-2 years for plastics.

One community I know of posts its recycling rates at the town's recycling center. It says: if we recycle X amount more the town will receive X hundreds of thousands of dollars in income. We need measures like this to get people involved, along with monetary incentives.

That's where Casella Waste comes in. They were the first waste company to embrace recycling as an integral part of the business model and as a profit driver. Waste Management - the largest waste company - just announced a big recycling initiative, but so far recycling doesn't even account for 10% of revenue, compared to 33% for Casella. Casella really views trash as a resource rather than waste to be stuck in the ground, which we believe is the direction the industry is gravitating towards.

Casella may have been a little ahead of its time, but we think it's well positioned because of its early investments. They're really pushing single stream recycling, which takes the burden off households to separate recyclables by putting them all in one bin.  Its investment in RecycleBank should really pay off. Incentive-based recycling is the way to go - it's going to be widely successful.

Matt Pasky, Winslow:

We're one of the largest institutional holders of Casella's stock right now. We hold it in both our mutual funds. Now is a good time to build a position in Casella. It's down because of concern that the economic slowdown could negatively affect its landfill business - people make less waste during a recession.

We don't see it that way. There aren't enough landfills and we can't imagine why tipping rates [the price to dump garbage] would come down. Casella's doing a great job with single stream recovery, which is the direction municipal recycling is going. If there's a downside, it's that they are still family-controlled and need more outsiders and diversity on the Board.

Jon Forster, Impax:

Another interesting company along these lines is Shanks (SKS.L). It's an innovative company that sorts, recycles and composts a wide variety of municipal and commercial waste, and uses mechanical biological treatment to minimize waste. Shanks completed its first big project in the UK, which we see gaining further traction in the next few years.

With a slightly longer time frame, we also like Tomra (TOM.OL), based in Norway. Tomra is known for manufacturing reverse vending machines - which you use to return your deposit bottles/ cans - operating largely in Germany. Now they are working with Tesco [largest supermarket chain in the UK] and Waste Management in the U.S. in markets that don't have deposit schemes.  

Tomra is installing high tech Total Recycling Centers, which accept a wide range of recyclables, in Tesco parking lots. When people drop off recyclables they get points which go toward purchases in the supermarket. The idea is to make recycling attractive, while increasing traffic in Tesco stores.  

It's been a long haul for Tomra to break open these markets, but we see it moving ahead now. Once they do, it will start a new era for them. It could happen this year or into next year.

Matt Pasky, Winslow:

Many municipalities in the UK still don't have curbside recycling, which is why Tomra's Total Recycling Center makes sense. They have developed very sophisticated single stream recycling machinery - you dump all your recyclables in it and it sorts them out. So far, it's much more expensive than they expected, which is hurting margins. Until people learn what they can and can't recycle, the machines have to be repaired each time people dump things like frozen turkeys, golf clubs and bowling bowls in there!  We're not investing in Tomra until these issues are resolved.

PI: Will the trend toward turning municipal waste into energy or biofuels hurt recycling?

Eric Prouty, Cannacord Adams:

Casella is also involved with landfill gas. There's always a debate about whether it makes more sense to compost food and other green waste - why separate it out when you can throw it in a landfill and produce landfill gas? It's much better to keep it out of the landfill and compost it - you get a higher value add that way, and that's true for all recyclables. Materials that can't be recycled or have very low value will end up being gasified or liquefied.

New England Organics, which is a Casella subsidiary, is one of the larger composting companies in the U.S. Synagro is the other large one, which was taken private. Recycling green waste is one of the last materials to really take off  -  compost doesn't compare in revenue to catalytic converters which contain platinum, for example.

PI: Are there other stocks you like now?  

Eric Prouty, Cannacord Adams:  

We also have a Buy rating on Interface (Nasdaq: IFSIA) - a green building related company that  uses a high percentage of recycled content in its carpet tiles. 

Companies like Trex (NYSE: TWP) and Advanced Environmental Recycling (Nasdaq: AERT) are suffering from the housing crisis. They make composite decking from recycled materials, which is mostly used for houses. Trex is the largest paper bag recycler in the US. We have a speculative buy rating on AERT because of its proprietary technology which recycles the dirtiest of plastics - a waste stream most others can't touch. If and when the residential market turns, they will be in a great competitive position with $100/ barrel oil.

The composite lumber industry added a lot of capacity during the glory years of the housing market - now we see many of them dropping out. The survivors will have very nice market share when the market turns around.

Matt Pasky, Winslow:

We hold Interface across all accounts. They are a major beneficiary of the trend toward green buildings, and they're benefiting along with the recycling industry. As the price of petrochemicals rises with oil, they have a competitive advantage using high percentages of recycled materials.

Darling International (AMEX: DAR), which recycles fat byproducts from animal slaughterhouses, is another good stock. The fat is turned into low value products like soap or cat food or other products you don't want to know about - at least everything is being used. Fat can also be used as feedstock for fuels, which they're looking into.

Jon Forster, Impax:

Steico (ST5.DE) is another company that will benefit when construction rebounds. Based in Germany, it makes insulation from recycled waste wood with very good thermal properties. Energy efficiency is a big theme in EU markets.

PI: Everyone is justifiable nervous about the stock market now. What's your approach to investing during this period?

Matt Pasky, Winslow:

We are sticking to our knitting - small cap growth stocks - investing in the leaders with the highest growth prospects, and staying on top of them. If the overall market goes down, everyone goes down - hopefully, we won't go down as much.

The recycling industry truly offers us an important hedge against this tough market, especially the metals recyclers.

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CARI Index

The Canaccord Adams Recycling Index (CARI) is a market cap-weighted index of 38 global companies that operate in the recycling sector. The Index has tracked the industry since 2006, benchmarking its performance against the S&P 500 and the NASDAQ Composite Index. CARI significantly outperformed both indexes over the past 20 months (through 2007), gaining 34% vs. 20% for the S&P 500 and 18% for the NASDAQ Composite.

Publicly Traded Recycling Companies

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