Covanta Holding Corporation (NYSE:CVA) uses waste that would otherwise be sent to landfills to produce electricity (the company has about 1 million residential customers in North America) as well as to extract some metals for re-use. At a market capitalization of $2.3 billion, the company trades at 32 times earnings, which is a bit high but could be appropriate for a “next generation” type of company.
However, so far the company seems to have trouble living up to the market’s implied growth trajectory. In its most recent quarter its operating revenues were flat compared to a year ago, with little change in any aspect of Covanta’s business (waste, electricity, and other revenues). Expenses, and therefore net income, were roughly flat as well. Because the company reduced its share count, earnings per share edged up from 13 cents to 14. The first half of the year told a similar story, with revenue flat and income only down because the company recorded income from discontinued operations in the first quarter of 2011. The company has doubled its dividend since last year and its dividend yield is now 3.4%, putting it in the same ballpark as other electric utilities.
Covanta’s similarity to other utilities in the yield department underscores that it is considerably higher priced than its peers in relation to its earnings. We’ve mentioned the trailing P/E of 32. Despite not achieving growth over the past year, Wall Street analysts believe that earnings per share are on the way up at the company (and it has shown small growth in EPS by buying back shares): they expect that 2013’s earnings per share will be 16% above this year’s. In addition, the Street expects the rest of this year to substantially outperform the second quarter. Even with these assumptions, Covanta carries a forward P/E of 26.
Three electric utilities which have market caps between $2 billion and $2.5 billion, and therefore serve as good peers, are Portland General Electric Company (NYSE:POR), IDACORP Inc (NYSE:IDA), and Cleco Corporation (NYSE:CNL). Dividend yields at these utilities are between 3% and 4%, so as we’ve mentioned Covanta is well in line there. However, their trailing earnings multiples are well lower: the highest of them is 16, half of Covanta’s. IDACORP even trades at 12 times trailing earnings. The Street’s optimism on the waste-to-energy company brings it a little closer in terms of forward multiples, but these three comparable companies place in the teens by that metric. We do see varying growth rates in their last quarters over the same periods a year ago, but overall we think Covanta is not as attractive as these less interesting companies. On the waste management side, we would compare Covanta to, well, Waste Management, Inc. (NYSE:WM), the $16 billion market cap leader in disposal services (it does operate waste-to-energy plants itself). Waste Management trades at 17 times trailing earnings and 14 times forward earnings estimates, both well below the multiples we saw for Covanta. Waste Management’s dividend yield of 4.2% is higher as well.
According to our database of 13F filings, Marty Whitman’s Third Avenue Management was the largest hedge fund holder of Covanta at the end of June. The fund reported a position of 8.5 million shares, down slightly from its stake at the beginning of the quarter. This also made Covanta one of Third Avenue’s top five holdings (see more large positions owned by Third Avenue Management). Iridian Asset Management, run by David Cohen and Harold Levy, had 3.1 million shares of Covanta in its portfolio at the end of the second quarter (learn about other stocks Iridian owns). D.E. Shaw, owned by the billionaire of the same name, owned 1.6 million shares of the company (find more stock picks from D.E. Shaw), though this was also a decrease in its position. We would say that Covanta is a sell at these levels, and might make for the short side of a pair trade with a utility or with Waste Management.