A Waste-to-Energy Stock for Investors
If Hollywood has taught us anything, it’s that in the future you can use garbage to power your time-traveling DeLorean sports car. But we’re still stuck with the realities of today’s technologies when it comes to dealing with waste. In the United States alone, each person generates nearly 4.5 pounds of Municipal Solid Waste (MSW) per day, which works out to about 262.4 million tons, according to the Environmental Protection Agency (EPA). At best, only about 24% of MSW is recycled, and those rates may worsen as China refuses to be our plastic trash dump any longer. We recently wrote about the plight of small, low-lying island nations and their mountains of trash, asking whether waste-to-energy could be a viable solution. So what if we told you about a waste-to-energy (WTE) company that is publicly traded with a $2.2 billion market cap and yield approaching 6%?
That company is Covanta out of New Jersey. Yes, a garbage company in a state infamous for being the inspiration for the street names in the game Monopoly and for enjoying a brisk criminal enterprise in the MSW game. As recently as 2011, the mafia was still a player in the state’s waste business, which has been going on since the 1960s. Of course, we’re not at all suggesting that Covanta has anything to do with organized crime (especially on the advice of our overworked attorney). It’s just a fun fact.
History of Covanta
Another fun fact is that Covanta itself has been around for much longer, with a pretty colorful history that has nothing to do with the mob (as far as we know): It started life in 1939 as a public utility holding company called Ogden Corporation. In 1948, it registered with the Securities and Exchange Commission (SEC) as an investment company. It also got into manufacturing. One particularly pivotal moment came in 1955 when Ogden acquired a scrap processor, Luria Brothers. That brought aboard a fellow named Ralph E. Ablon who would eventually become CEO and transform Ogden into a wide-ranging conglomerate focused on service industries ranging from entertainment to aviation.
Another offshoot of the Ogden empire, Ogden Projects, got involved in the emerging waste-to-energy market in the 1970s, during a time of rising energy costs and decreasing landfill space. Various divestments and deals followed through the decades until Ogden became Covanta Energy Corporation in 2001, only to file for bankruptcy the following year. In 2004, Danielson Holding Corp. acquired Covanta in a $30 million acquisition. Today, Covanta Holding Corp. (CVA) is a global waste management and energy company that trades on the NYSE.
What is Waste-to-Energy Disposal?
At its most basic, waste-to-energy in the MSW industry refers to incinerating trash to produce energy. As waste is burned, the heat converts water in steel pipes into steam that rises through boiler tubes where it is superheated. The steam turns a turbine-driven generator to produce electricity, or may sometimes be used directly for heating or industrial processes. This is not unlike how geothermal energy is captured to produce electricity. You can learn more about the Covanta process below:
Each ton of waste can generate 550 to 700 kilowatt hours of electricity. Steam from the process is condensed back into water and returned to the boiler tubes, making it an efficient closed-loop system. After combustion, the volume of waste is reduced by about 90%, leaving just an inert ash and metal.
Advantages of Waste-to-Energy
Covanta operates 41 waste-to-energy (or energy-from-waste) facilities that annually process about 21 million tons of garbage into power for more than one million homes. So, that’s a lot of trash that’s being diverted from landfills. In addition, the EPA has said that MSW burners reduce the amount of greenhouse gas emissions in the atmosphere compared to landfills, largely due to the high methane emissions from the latter. The EPA estimates that one ton of combusted MSW saves one ton of greenhouse gas. And waste-to-energy is twice as clean as coal-burning power plants, according to EPA estimates:
Another byproduct of the Covanta waste-to-energy process is that it recycles about 600,000 tons of metal, enough to build nearly six Golden Gate Bridges and manufacture three billion aluminum beverage cans every year.
Disadvantages of Waste-to-Energy
Of course, if waste-to-energy was all that and a bag of incinerated chips, then we probably would have a trash dumpster fire on every corner, just like they had in the Bronx back in the 1970s. The No. 1 problem from an environmental standpoint is that while the technology reduces greenhouse gas emissions versus landfilling, it does release harmful pollutants such as mercury, formaldehyde, and nitrogen oxides. There is also an ongoing argument on whether or not waste-to-energy technology qualifies as renewable energy, which would help companies qualify for lucrative subsidies to compete against established players in solar and wind. Such a debate is happening right now in Baltimore where legislators have proposed revoking WTE’s green card.
The technology is also expensive, especially as environmental regulations limit that noxious cocktail of pollutants that such facilities are allowed to belch. Covanta says its waste-to-energy plants cost upwards of $600 million to build, as opposed to digging a big hole in the ground. That might explain that while the first U.S. incinerator was built back in 1885, there are only about 80 or so WTE facilities operating in the whole country, which account for about 13% of all MSW disposal. The first new waste-to-energy plant built in the United States in 20 years was in West Palm Beach, Fla. in 2015.
Covanta is the U.S. Market Leader in Waste-to-Energy
That makes Covanta the U.S. leader in waste-to-energy, as the company claims a 75% market share. Its biggest competitor is a privately held company called Wheelabrator Technologies, with about 16 plants in the United States. Still, energy is only a secondary revenue stream for Covanta, as about 70% of the company’s revenues come from waste management fees. As one Covanta executive observed during an interview, “All of our revenue matters, but waste matters a lot more.”
So, let’s talk a bit more about revenue then. Covanta is by no means some fly-by-night operation. Total revenue through the first six months of the year was nearly $1 billion at $920 million. However, the company ended the first half of 2019 in the red to the tune of $16 million. The second quarter was a bit rough, with metals revenues down $5 million due to low ferrous prices and energy revenues sinking about $4 million because of high natural gas production and lower overall demand. Since the company emerged from bancruptcy after restructuring in March of 2004, the stock has returned +82% which hasn’t quite managed to beat the broader NYSE benchmark return of +95% over the same time frame:
But what’s really concerning here is the company’s long-term debt of around $2.4 billion. The reason they went into bankruptcy in the first place was that they defaulted on a $4.6 million interest payment in March 2002. The company paid $72 million in interest in the first half of 2019 which is about the same amount they distributed in dividends over the same time frame. Investors who buy this stock for the above-average yield of nearly 6% need to consider just how dependable that dividend is when the company starts operating in the red. Sure, a company can operate for decades in the red and still pay a dividend through clever financial engineering, but that’s not sustainable.
We often talk about our own Dividend Growth Investing (DGI) strategy which is a portfolio of 30 stocks that have not only paid but increased yearly dividends for 36 years on average. Sure, none of those stocks except AT&T sport a dividend anywhere close to 6%, but they’re dependable. These companies know how to weather economic storms. We might argue that AT&T sports a dividend of nearly 6% today because the sustainability of that dividend is questionable in the face of their $167 billion pile of debt and the likelihood that dividend grows beyond inflation is low. So, when looking at Covanta’s yield of nearly 6%, consider just how predictable that income is and the likelihood that it grows over time to offset inflation.
It’s tempting to give Covanta the thumbs down and move on. However, the company is shedding unprofitable WTE plants in the United States, while at the same time it is pursuing construction on at least four WTE plants in the UK in partnership with an investment firm called Green Investment Group. Covanta expects to spend upwards of $200 million on the projects but reap an annual cash flow of $40 million to $50 million. The UK is lagging behind the rest of Europe in diverting waste away from landfills and exports more than three million metric tons per year to the mainland. The largest outlet for exported waste, the Netherlands, is considering a tax on imported waste for waste-to-energy processing, making Covanta’s WTE facilities potentially more attractive and lucrative to the Brits.
And let’s not forget about the country that does everything big: China. In 2020, China expects to open the world’s largest waste-energy-plant in Shenzhen, a city of about 20 million people near Hong Kong that produces 15,000 tons of waste per day. The new facility, which will also be covered in solar cells, will be able to handle and convert about a third of the city’s waste into electricity. Covanta is currently a big fish swimming in small ponds, but if it could break into the densely populated Asian market, the company could see some real growth in the future. Until then, it’s just treading water.