Debra Fiakas, CFA
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| The Waste Hierarchy, with energy from waste highlighted |
The self-styled “energy-from-waste” company Covanta Holding (CVA: NYSE) turns municipal waste into electricity and recycled metals. The operations also turned 21.9% of its revenue into cash in 2011. We note that the conversation ratio has declined over the last three years from 28.7% in 2009 and 27.2% in 2010, but we are still impressed with any cash conversion rate over 20%.
The company operates forty-one mass-burn facilities around the U.S. that burn all manner of unsorted municipal waste to heat water into steam. The steam in turn drives electricity-producing turbines. Covanta sells the steam or the electricity through various off-take agreements. Ferrous and non-ferrous metals are also recovered in the process and resold in the commodity markets. These two revenue sources accounted for 24% and 10% of total sales, respectively.
The real money makers for Covanta are the tipping and service fees it charges municipalities to handle the solid waste and dispose of the ash that is left over at the end of Covanta’s burn process. Besides the mass-burn facilities Covanta owns and operates or just operates municipal-owned facilities – twenty-two of them – such as ash landfills, biomass projects, hydroelectric facilities and landfill gas operations. Tipping and services fees from all these facilities totaled $1.1 billion in 2011 or 66% of total revenue.
Not a bad business – turning waste into cash. Granted, Covanta is debt-heavy with $2.3 billion in debt on the balance sheet at the end of March 2012, including the short-term portion and including project debt. This means Covanta has a debt-to-equity ratio of 2.20. However, cash earnings are 6.1 times interest burden, suggesting Covanta’s operations generate enough profits and cash flow to handle even that level of debt.
Covanta has delivered some of the largesse to shareholders through dividends of $223 million and $42 million in 2010 and 2011, respectively, and the repurchase of shares valued at $230 million in 2011. Not a bad haul for shareholders – turning stock into cash.
To get in on the Covanta action requires a payment equal to 24.0 times expected earnings of $0.59 per share in 2012. This might be an acceptable price tag if Covanta was expected to deliver that much growth in the future. Alas the same analysts who came up with the expected earnings estimate think average growth is only going to be 17% in the next five years.
Covanta is included in the Waste-to-Energy Group in our Beach Boys Index. CVA shares have corrected twice in the last two years, as much in response to broader equity market trends as to Covanta’s fundamental situation. In my view, it is a stock worth watching for an entry point.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. CVA is included in Crystal Equity Research’s Beach Boys Index in the Waste-to-Energy Group.
Debra Fiakas, CFA is the Managing Director of Crystal Equity Research, an alternative research resource on small capitalization companies in selected industries.
