As a strategic consultant with clients in the renewable energy industry, I am well aware that this sector is in the beginning of a nice multi-year (or multi-decade) bull run. Covanta is a hidden jewel in the space because Wall Street has been sun bathing in solar, blowing in the momentum of wind, and obsessing over ethanol. Although waste-to-energy is not as sexy as a Toyota Prius, Covanta's financials have more juice: the company reported Q1 earnings of $0.08 per share (excluding non-recurring items), $0.07 better than the Reuters Estimates consensus of $0.01, and revenues rose 8.1% year-over-year to $330.2M versus the $310.9 M consensus.
One of the main drivers for this stock's appreciation is growth. Covanta recently took a 40% interest in a new waste-to-energy partner in China, and they are exploring opportunities in the UK and Italy (two countries as hot on renewable energy as Wall Street). A keen investor knows that executing growth requires free cash flow, and Covanta has the green to make good on their plans. In the latest quarter, levered free cash flow (i.e., free cash flow minus payments of interest on debt and any dividends to preferred shareholders) was 14.2% of sales.
The main risks to Covanta's success are capital expenditures and lead times. The cost of processing waste and generating energy is high. However, excellent free cash flow and long term contracts (e.g., waste processing and purchase power agreements) mitigate this risk. On another note, the time between proposing a new plant and generating revenue can take a few years. Thus, investors must be patient for new plants in China to begin hitting the bottom line.
Covanta's PE and PEG are a bit rich here, but I think both growth and future earnings predictions are on the light side. Couple that with some exciting announcements about new domestic and international projects, and I think the stock has some nice room to continue powering ahead.
Disclosure: SmartGuyStocks is long CVA
CVA 1-yr chart