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Covanta 4Q19 results and natural gas outlook +3

09:42 21-Feb-20

The Covanta conference call has just concluded.  As expected, commodity pressure is negatively impacting results.  HMS averages $233/ton for 2019, and is estimated at $200-250 this year, which represents a headwind.  TAPS has begun early commissioning, with equipment being delivered and tested.  Early discussions with a community about the next TAPS are scheduled for Monday.

Of course, energy prices are the bigger problem, and they've withdrawn again this morning, with natural gas below $1.90.  On the bright side, Covanta has almost 20% less at-market-energy exposure than it did over the past two years.  However, it estimates that will sell at $16-28/MWh vs $26.31 last year and $37.21 in 2018.  As per the outlook given below, you can expect this to continue through at least next year, and that's going to lead to persistent worries about the dividend.

Management's response is that it has good visibility to increased cash flow from the main business.  It hopes to announce more UK developments this year, however current FX rates makes both expenses and FCF contribution lower.  America is also looking much more promising, with Regulated Medical Waste being a significant organic growth driver.  There was also discussion of converting existing contracts to a more reasonable index than the government's 2% official figures, but barring that, new conversion don't come until 2024.  Thus, the SEMASS facility is being converted to a baghouse and there is one more potential conversion.  Increased maintenance spend for next year and beyond embodies similar investment, with 3% CAGR over the long term.  It is to be hoped that good performance will help facilitate a reset of the American market.  Keep your eye on the elections, though.

All this makes for ugly numbers over the next year or two, and management foresees >6x leverage continuing for 2020.  It remains committed to dividend, and may expand accounts receivable securitization to support it.  The realization of $250M in free cash flow by mid-decade that was projected two years ago will almost certainly be delayed, while we wait for the commodities environment to recover.  However, I Covanta has much better financing, partners, and growth options than it did then.  Any immediate upside would have to come from a new partnership, but the value and performance in this environment are extraordinary.

Covanta has published its fourth quarter results:

• 9 cents of EPS beats by 2 cents
  
• from $485M of revenue, which beats by $5M
• guides FY20 FCF to $120+/-20M (down 14% YoY) and EBITDA to $430+/-15M (up half a percent)
  

I think it's remarkable that Covanta was able to achieve these results in the current macro environment.  Energy revenue was down 5% sequentially, which is no surprise, while metal revenue was up 8%.  I suspect that virus troubles affecting Chinese iron production may have actually helped the scrap market.  Shares are up about 1% after hours and the guidance may yet hold them back.

The conference call is at 8:30 tomorrow morning, which leaves time to discuss the natural gas outlook.  Shell gave its annual update on the situation this morning, and the executive summary is in line with what I've been saying for quite some time: that the next year or two should continue to be challenging, but demand will keep growing.  However, it also sees weakened Chinese demand extending into March.  On the positive side, the demand outlook is reinforced by a new pipeline and long-term gas agreements.  Those can't come soon enough, as Texas makes excuses for third world style pollution via flaring.  The resultant export and shipping discussions should also be of interest to Golar.  For Covanta, though, the current macro environment looks like the darkest hour before dawn.  More tomorrow.

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