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Covanta 2Q18 results +3

10:18 27-Jul-18

The Covanta conference call has just concluded.  There is not much to change the executive summary that I provided last night, but here is color by segment:

• Overall: Although guidance was merely reiterated, it was commented that FY EBITDA is expected to be above the midpoint.  Management plans to close a plant in Warren, NJ plant in 2019, and fix, sell or close decisions should continue over the next year or two.  They will be FCF-based, and are very subject to local politics.  Another example is a jurisdiction where a representative is campaigning on closing a plant which is operated (not owned) by Covanta.  The plant is one of the more advanced facilities and far better than landfill, but politics are often irrational.  Neither plant will have significant impact on results, and I continue to see the overall trend as house cleaning for new transactions abroad.  Should America ever get reasonable about waste processing beyond the local level, that could still be a boon for Covanta, which sets the mid-terms up as an unusually significant harbinger.
  
• Waste Processing: 
• MSW: Continued tip free strength is expected, and contractual escalators kick in mid-year.  So, we can have confidence in the base business continuing to grow for the short-term.  China closing its doors to plastics and paper, which should be recycled, is problematic but not having a major impact on Covanta so far.  I think it is an under-appreciated problem for the rest of the country, though.
  
• Environmental Services: the segment grew 14%, profiled waste was up 9%, and medical waste 34%, but the latter is still less than 10% of revenue.  I suspect the China issue is behind management's comments on accelerating this segment, and this is just one example of the trade wars creating as many opportunities as problems.
• Ash Processing and Reuse: permits are progressing for the first processing facilities in Fairless Hills, PA.  I've seen this from the beginning as an important long-tern initiative that moves the state of the art forward.
• Energy: pricing was lower due to hedges, as I expected.  Forward electricity prices are still subdued, but some facilities are getting environmental credit on their power sales, and some are selling steam rather than electricity.  Marion county signed a 15 yr PPA, which is unusual for EfW (energy from waste).  This again shows how the U.S. market is case by municipal case, and how important a rational EPA and DoE could be, under another regime.
• Metals:
• Ferrous: grew 24%, largely due to tariffs, the HMS outlook is adjusted upwards to $275 - 325 / ton.  In some cases, Covanta is selling directly to steel mills, which results in lower gross pricing, but higher margin.
• Non-Ferrous: China represented 20% of historical sales, and has completely closed its doors which will have a mild negative impact on this sub-segment.  These materials can go to Europe instead, but processing might need to separate zinc.  It seems the uncertainty is more of a problem than processing, and I think that, as has happened before with this segment, improved processing will eventually make it stronger.
• U.K. Development: a Rookery hearing is scheduled for mid-October.  Other projects (Protus & Newhurst) are moving forward, and their permits have less chance of challenges.
  

CVA shares are up 7% above the $17.50 strike in early trading.  I think the gains are mostly justified, but perhaps a little overdone, even though I continue to be very optimistic about Covanta's long-term prospects.

Covanta has released its earnings report for the second quarter:

• a loss of 1 cent per share beats estimates by 9 cents
  
• on $454M in revenue, which beats by $4M

Management also reaffirmed full year guidance for 2018.  As expected, tip fees increased strongly, and there is a note about accelerating the pace of the profiled waste initiatives.  The surprise is that metals have also continued to be strong, with increased demand from American steel mills and non-ferrous declines in China being offset by alternate markets.  2019 energy sales are the one question that remains open, along with the possibility of new partnerships.  That's still what I will be looking for on tomorrow morning's call.

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