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Covanta 4Q20 results +3

09:49 19-Feb-21

The Covanta conference call has just concluded, and it was a relief NOT to have Sam Zell on it.  With regard to the strategic review that he instigated, the only update is that management expects to be able to announce actions by the middle of this year.  Beyond that, I was right about the focus on cost savings, with 2020 projected as a high water mark for expenses.  However, costs will have difficult YoY comps due to the pandemic.  Reducing leverage is once again a priority as well, with the implication that the dividend will not rebound.

The waste business was up 3% across the board, and Covanta is actively trying to re-contract in an attempt to avoid low CPI price escalation.  Tip-fees are expected to increase 3-5%.  Across the pond, Rookery is moving into hot commissioning, with commercial operation still expected next year.  Covanta also increased its ownership in Protos, and may scale up Dublin to some extent.  Management also echoed my view of currency being a tailwind.  This kicked off the discussion of selling off American plants to private equity, and with two thirds of American plants being client-owned, I wonder if Covanta will even seek to cease being an operator, since I suspect it is playing a dangerous game with maintenance costs.

Management also says that energy sales are "highly" hedged for the next 12 months, but the presentation show 1.4-1.5 MWh still at the market (22.7% as opposed to less than 10% for 2020).  Consequently, Covanta is still looking to sell energy privately.  Hedges are at $32, and only 0.8MWh is hedged for 2022.  Management mentioned using plants for load serving, where they serve as backup when wind and solar aren't available, but WtE doesn't operate that way.  Thus, it seems like that would require complicated agreements, perhaps in conjunction enterprise energy customers, and possibly a complete restructuring of energy markets.

Metals were a much brighter spot, with the industry moving to electric arc furnaces that rely heavily on scrap, and this is most of the higher forecast.  The 2021 projection is for HMS at $275-350/ton and Old Cast Aluminum 55-60 cents/lb, resulting in a corporate forecast of Ferrous revenue of $65+/-5M and non-ferrous at $50+/-5M for an over 20% YoY improvement.  New management is continuing the effort to hedge ferrous, with just one plant doing so now.

Ultimately, I still think a lot depends on how much one trusts new management.  I think pivoting toward the U.K. and new international markets makes some sense, though it's hard to say since Congress has wasted the first month the new administration.  I also fear operational risk under new management, if asset sales are not conducted quickly, have doubts about common shareholders seeing much benefit if they are.  The underlying business is still a good one, but for a situation like this, I'd want at least 4% yield, rather than the current 2.4% level.  Development will help amend that over time, but for now it seems the market is starting to realize my concerns, with CVA down over 5% in early trading, despite the headline numbers.

Covanta has published its fourth quarter results:

• 9 cents of EPS beats by 7 cents
  
• from $491M of revenue, which beats by $3M
• guides FY21 to $120+/-20M of FCF and $450M of Adjusted EBITDA, which are 6% and 26% YoY improvements
  

New management says that waste flows have largely recovered to pre-pandemic levels and also notes the strength in metals that I looked for.  I also sense cost cutting ahead of a transaction, but apparently there will be no news on that in the conference call at 8:30 tomorrow morning.  More after that anyway.

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