Covanta: A Safe Name in Cleantech

Dec.10.08 | About: Covanta Holding (CVA)

Jefferies & Co. analyst Paul Clegg this morning initiates coverage on Covanta (NYSE:CVA), which operates energy-from-waste (EfW) facilities that burn garbage as fuel to generate electric power.

The gist:

We believe investors should view Covanta (CVA) as a "safety name" in the clean tech space due to its recession-resistant business model, secure, highly contracted cash flows, high FCF yield, significant barriers to entry, and very valuable, difficult to replace physical assets.

Defensive names in the cleantech sector aren't easy to come by, but the thesis here is that unlike lots of other upstart green companies, Covanta won't be subject to the worst of the problems stemming from the slow economy and the credit crisis. That's because its customers are municipalities, where times may be tight but long-term contracts are still being paid. More:

We believe that in the current market environment, investors seeking shelter from potential credit-driven demand destruction in other clean technology plays should view CVA as a “safety name” in clean tech due to its secure, highly contracted cash flows, high FCF yield, significant barriers to entry, and very valuable, difficult-to-replace physical assets. EfW has historically been a recession-resistant, non-cyclical industry with steady growth rates (~3% longterm). Short-term revenue growth rates are limited by the highly contracted nature of its business and the small incremental impact and long-time frame involved with expansion projects. Yet we see upside to current equity values being driven by progress on longer-term growth opportunities in non-US markets (e.g., China, U.K., Ireland) and a favorable impact of de-levering on the value of equity stakes in CVA. Management has stated in the past that if it cannot find projects with favorable returns that it will look for opportunities to return cash to investors (e.g., share repurchases, dividends).

Clegg gives the company a $28 price target based on a 10x multiple on his 2009 EBITDA estimate of $583 million, and notes the company often trades at higher multiples than its peers thanks to better margins and a stronger balance sheet. Plus, he notes current estimates only reflect a modest increase in EBITDA growth (about 2 percent in '09). Convanta shares are up about 3.3 percent in early trade at $21.33.