Matthew is a member of The Motley Fool Blog Network — entries represent the personal opinions of our bloggers and are not formally edited.
I try not to think too much about it, but like most married men it’s my duty to take out the garbage. I try to wait until the kitchen garbage can won’t fit anything else before braving the winter snow to dispose of our unused wares. Sometimes the smell is more than my wife will allow despite the use of Glad Odorshield bags so needless to say I have to take our garbage out quite often. It amazes me sometimes how much trash we’ll toss out each week.
If you’re like me, the only other thought that passes through your mind on garbage day is if it’s recycling week as well. But what happens to your trash once you leave it on the curb is actually something that with an investing mind should make you think twice. Especially when you consider the fascinating business model of Covanta (NYSE: CVA).
Covanta Energy is one of the largest owners and operators of Energy-from-Waste facilities. They convert 19-20 million tons of trash each year (which is 5% of total US waste) into 9-11 million megawatt-hours of clean and renewable energy which is about eight percent of the US renewable energy (excluding hydro) and enough to power almost a million homes. It’s simply amazing. Their customers pay them to take away their waste and then after recycling what they can; they use the remaining waste as fuel in their EfW facilities. Did you hear that, they are paid for their fuel!
In 2011 they generated $ 1.65 billion dollars in revenue from three main streams: Fees charged for waste disposal or operating projects, sale of electricity or steam and then the same of recycled ferrous and non-ferrous metals. This helped them to generate a healthy $ 280 million dollars in free cash flow that they’ve started to return to shareholders through a share buyback plan and growing dividend. Just recently they doubled their dividend and added another $ 100 million to their buyback plan. The buyback alone is enough to knock out another 4.5% of their shares, which they’ve been taking down at a hefty pace as they’ve now bought back 14% of the float since July 2010.
Covanta is a pure play in this field and shouldn’t be thought of in the same way as waste collectors Waste Management (NYSE: WM) or Republic Service (NYSE: RSG). While Waste Management does have an EfW division, it’s only 6% of their revenue. One interesting concideration is that either of these two could be acquirers of Covanta if they wanted to cash in on this very lucrative business. Covanta’s market cap is just over $ 2 billion whereas Waste Management has a $ 16 billion dollar market cap while Republic is just over $ 11 billion making them easily digestible…or would that be disposable?
While I love Covanta’s business and its cash-generating business model, it does have a couple of headwinds to be aware of. First, due to the glacial speed that most municipalities move, growth in facilities will be limited. They have a couple of projects in the works, but they are mostly overseas. Much of their growth in earnings will come directly from share repurchases. Secondly, while they are hedged, much of their electricity is priced to that of natural gas so as gas stays low, so does this revenue. The market’s recently been sending their shares lower with the price of gas so it’s something to keep in mind.
There is a lot to love about Covanta the business. Turning waste-to-energy is a cause that’s hard not to like. They produce tons of free cash flow and are returning a heaps of that cash to shareholders. However, for Covanta the stock, growth in the short-to-medium term will basically just come from share repurchases. If as an investor you’d like what’s good for your bottom line to also be good for the environment then Covanta is the way to go. With a yield over 3.5% and another 4.5% worth of share buybacks to go with a near 13% free cash flow yield there is plenty of downside protection in this one. Covanta another way to play clean and renewable energy that will be a lot less volatile than solar panel maker First Solar or natural gas fueling station operator Clean Energy Fuels. If you must go green, instead of just thinking green, why not pair your favorite play with Covanta and let them convert your garbage into dividend checks?