Tuesday, October 26, 2010

ToeMahToe, ToeMayToe

Covanta Holding Corp. (CVA: NYSE) is in the business of converting the cast-off and tossed out into energy. Based in New Jersey, the company has assembled an impressive portfolio of investments around the world, applying the company’s expertise in processes that can recapture the energy in garbage. Covanta operates fifty-six energy generation facilities in the U.S. and eight in Europe and Asia. The plants use a variety of fuels, including municipal solid waste, wood waste, and landfill gas. The company also operates more conventional power plants using hydroelectric, natural gas, coal, and heavy fuel-oil. Covanta has equity interests in two plants in China.

Locating close to the waste source is vital to make a waste-to-energy business model economical. Covanta has fortifyied its portfolio with interests in waste source collection points, including a transfer station acquired in 2009 along with six waste-to-energy plants from Veolia Environmental Services (VE: NYSE). The Veolia deal follows a string of acquisitions and green-starts over the past three years.

Most of the Covanta’s operations are conducted in agreement with municipalities. The company is able to charge a service fee for operations and a tipping fee for waste collection and sorting. Revenue in the twelve months ending September 2010 was $1.7 billion providing $0.43 per share in earnings. The company experienced a dip in revenue in 2009, but the pace of business has picked up with the U.S. economic recovery in since the beginning of the current year.

Analysts following Covanta are expecting modest increases in revenue in the next year, but substantially improved margins on operating leverage. Accordingly, the CVA forward price-earnings ratio is 22.0 times the current 2010 EPS estimate of $0.62 and 22 times the 2011 estimate of $0.72. The Price/Earnings-to-Growth ratio is well over the 1.0 hurdle.

That said, Covanta is among the first waste-to-energy companies - or energy-from-waste as Covanta likes to call their business - to post sustained profits with a fairly reliable growth trajectory ahead. We expect the demand to increase for the company’s turn-key waste-to-energy facilities. In our view, Covanta’s expertise in successful plant operations sets it apart from some of the newest renewable energy developers, making the premium valuation a bit more palatable.

We also note that CVA has a significant short interest of 8.2 million shares or 6.8% of the float and the equivalent of eight times the daily trading volume in the stock. Positive fundamental developments could put the quintessential squeeze on short positions, driving the stock upward on a wave of short-covering.

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 the Crystal Equity Research Beach Boys Index in the Waste-to-Energy list.


No comments: