Covanta Holding Corporation
Q4 2020 Earnings Call Transcript

Published: 19 Feb 2021

[Operator:]

Good morning, everyone, and welcome to the Covanta Holding Corporation Fourth Quarter and Full Year 2020 Financial Results Conference Call and Webcast. An archived webcast will be available two hours after the end of the conference call and can be accessed through the Investor Relations section of the Covanta website at www.covanta.com. The transcript will also be archived on the company's website. At this time, for opening remarks and introductions, I'd like to turn the call over to Dan Mannes, Covanta’s Vice President of Investor Relations. Please go ahead.

[Dan Mannes:]

Thank you, Lisa, and good morning, everyone. Welcome to Covanta's fourth quarter and full year 2020 earnings conference call. Joining me on the call today will be Mike Ranger, our President and CEO; Derek Veenhof, our COO; and Brad Helgeson, our CFO. On today's call, Mike will provide an update on the strategic review, Derek will discuss our operating performance and Brad will provide a more detailed financial update. Afterwards, we will take your questions. During their prepared remarks, Mike, Derek and Brad will be referencing certain slides we prepared to supplement the audio portion of this call. Those slides can be accessed now or after the call on the Investor Relations section of our website, www.covanta.com. These prepared remarks should be listened to in conjunction with these slides. Now on to the Safe Harbor and other preliminary notes. The following discussion may contain forward-looking statements and our actual results may differ materially from these expectations. Information regarding factors that could cause such differences can be found in the company's reports and registration statements filed with the SEC. The content of this conference call contains time sensitive information that is only accurate as of the date of this live broadcast, February 19, 2021. We do not assume any obligation to update our forward-looking information, unless required by law. Any redistribution, retransmission or rebroadcast of this call in any form without the expressed written consent of Covanta is prohibited. The information presented includes non-GAAP financial measures. Because these measures are not calculated in accordance with U.S. GAAP, they should not be considered in isolation from our financial statements, which have been prepared in accordance with GAAP. For more information regarding definitions of our non-GAAP measures and how we use them, as well as limitations to their usefulness for comparative purposes, please see our press release, which was issued last night and was furnished to the SEC on Form 8-K. With that, I'd like now to turn the call over to our President and CEO, Mike Ranger. Mike?

[Mike Ranger:]

Thanks, Dan. Good morning, everyone. When I stepped into this role about 3.5 months ago to lead the company and the strategic review process, I brought a good perspective on the issues and opportunities given my experience with the company and similar situations. However, we did not bring a fully formed plan at that point, and we committed to let our analysis and the data direct our decisions and actions.

[Derek Veenhof:]

Thanks, Mike, and good morning, everyone. I'll be referring to the investor presentation and will begin my comments on Slide 4. 2020 was obviously a unique year that tested our people, assets and plans in ways we never could have anticipated. And overall, I think we passed the test handily. For that, I'd like to take a moment and thank all of our employees and our customer base for meeting the challenges of the pandemic and for the personal sacrifices people made along the way. It really will be a year we will never forget in this regard. From a waste market perspective, we witnessed a significant contraction in commercial waste volumes beginning late in the first quarter, due to the impact of the pandemic. In response, our waste marketing team leaned heavily on our integrated portfolio of assets, including strategically located transfer stations, along with our strong client relationships to ensure a steady flow of waste into the plants. Given our preferential locations and the quality of our counterparties, we kept our tip fee plants full throughout the year. After volumes and prices bottomed during our second quarter, our weighted average tip fee prices ticked up sequentially in both the third and fourth quarter. In total, even with a greater reliance in typical on lower price spot waste, we draw 3% same-store tip fee price growth for the full year. At the same time, we opportunistically increased the total volume of contracted residential waste, which we believe provides even more stability to our mix going forward.

[Brad Helgeson:]

Thanks, Derek. And I'll begin my review of the financial results on Slide 6. Total revenue for 2020 was $1.9 billion up $34 million from 2019, driven by higher tip fee prices which added $16 million and new electricity load serving revenue which added $31 million. These were partially offset by lower environmental services revenue related to the pandemic slowdown over the spring and summer, and lower project refurbishment activity at client-owned facilities for which we earn revenue. Commodity market prices had a $6 million negative impact on revenue in 2020, split roughly evenly between energy and ferrous metal. Transactions overall reduced revenue by $10 million with asset divestitures and closures partially offset by a full-year of operation at the Manhattan Marine Transfer Station. Completing the year-over-year bridge long-term contract transitions added $6 million. Now moving on to Slide 7, adjusted EBITDA was $424 million in 2020 a $4 million decline compared to 2019. Positive drivers were 3% tip fee growth, the new wholesale load serving contracts, higher EBITDA from Covanta Environmental Solutions and lower overhead costs reflecting the cost savings program that we instituted in response to the pandemic. These items were essentially offset by higher cost of operating during the pandemic and higher planned maintenance expense. Commodity prices represented a $5 million headwind to adjusted EBITDA, while transactions in long-term contract transitions added $3 million in total. Now turning to Slide 8, free cash flow was $95 million for the year compared to $140 million in 2019. The adjusted EBITDA relatively flat, the primary year-over-year driver was higher planned maintenance CapEx consistent with our guidance at the beginning of the year. This was partially offset by increased cash flow from working capital which reflected a $20 million upside of our accounts receivable securitization program during the fourth quarter. I will now review our outlook for 2021, please turn to Slide 9. We are initiating 2021 adjusted EBITDA guidance of $435 million to $465 million. The year-over-year increase is driven primarily by our forecast for higher recycled metals prices as Derek discussed. Before commodities, we're expecting results to be generally similar year-over-year. However, there are a number of variances under the surface both positive and negative as the pandemic leads to some noise in the comparisons. We expect tip fee growth of 3% to 5% as waste markets have largely returned to normal and we resumed trend growth. This remains the key driver for our results. On the expense side, we expect to see some difficult comparisons. Our pandemic cost reduction program saved nearly $25 million in 2020 and while we remain highly focused on controlling costs in 2021. Most of those savings were one-time in nature, most notably the temporary salary reductions and furloughs and will not recur in 2021. In addition like many companies, we experienced a reduction in medical benefit experience in 2020. Our guidance range assumes a return to normal or towards normalized levels, so we'll see how that plays out. Lastly, with macro pressures in the insurance market, specifically the adverse claims experienced and low interest rates, we're seeing an increase in property and casualty insurance costs of approximately $10 million in this year. I will note that our guidance discussed today does not reflect any potential actions taken as part of the strategic review. When we announce specific steps, we'll update guidance at that time, if and as appropriate. Now turning to Slide 10, we expect to generate free cash flow in the range of $100 million to $140 million in 2021. The main drivers are the year-over-year improvement in adjusted EBITDA as discussed and significantly lower maintenance CapEx. Lastly we expect working capital to represent the $10 million to $30 million headwind on a year-over-year basis, essentially implying relatively flat working capital in 2021 compared to the positive cash inflow in 2020. Now please turn to Slide 11, where I will discuss capital allocation. We're expanding our usual presentation here to look at the overall utilization of free cash flow. From a discretionary growth perspective, we're planning approximately $20 million of investment this year, primarily funding construction in the UK. During 2019 and 2020, we garnered premiums and development cost recovery as our partners bought into the Rookery, Protos and Newhurst project at financial close. This help to defray our investments in these projects. Our dividend policy change announced in April resulted in a $44 million reduction in dividend payments in 2020 with an annualized reduction of approximately $90 million at the new rate reflected in 2021. We can now confidently point to a path of reducing our leverage before taking into account the actions resulting from the strategic review. And our baseline expectation is to have $40 million to $80 million available for debt reduction in 2021 or else being equal. Now please turn to Slide 12, where I will provide an update on the balance sheet. At December 31, net debt was $2.5 billion a $16 million increase from the year end of 2019. Our consolidated leverage ratio was 6.2 times, which has remained largely flat during 2020. And our senior credit facility covenant ratio was two times. Available liquidity under our revolving credit facility was $443 million at year end. I'll conclude my remarks with an update on our growing business in the UK and Ireland, please turn to Slide 13. We now have four projects under construction in the UK, which are expected to move into operations in the following order; Rookery in the first half of 2022, Newhurst and Earls Gate in 2023, and Protos in 2024. The schedule on the top right of the slide presents Covanta’s required equity investment into the UK projects. Sale proceeds and premiums received at the net of two. We estimate an additional $140 million of net investment through 2024 to complete construction of the four projects with the majority to come in 2022. We have more than ample cash flow and liquidity to fund these amounts. As you can see the initial sale of a 50% interest in the Dublin project in 2018, where we formed our partnership with GIG along with premiums received in the UK to-date will in effect fund the entirety of our investments in the four new projects. When all projects are operational, we estimate that our business in Ireland and the UK will generate a $100 million to $110 million of adjusted EBITDA proportional for our ownership and $50 million to $60 million of free cash flow, reflecting project equity distributions and our O&M fees. Given these estimates, along with our proportional share of the unconsolidated project debt of approximately $650 million on a fully-funded basis, you have the necessary data to estimate the emerging value of this business. As I mentioned, Rookery is expected to reach commercial operation in the first half of 2022. For modeling purposes, as this date approaches Rookery will generate approximately $30 million of adjusted EBITDA to Covanta on an annual basis. As Mike discussed, we're pursuing additional projects and look forward to providing details as these developments mature. Given the continued need for landfill alternatives in the UK, attractive economics and a supportive regulatory framework we see more opportunities for growth here and due to the financial estimates that we're providing today is our starting point. With that operator, we would like to move on to the Q&A portion of the call.

[Operator:]

Our first question today comes from Noah Kaye with Oppenheimer. Please go ahead.

[Noah Kaye:]

Good morning. Thanks for taking the questions. I hope everyone is well. Mike, can I start with a question for you? Appreciate all the color on the priorities for the strategic review. I guess I would just ask, after 100 days or so I'm getting started with this review. What can you share with us about what you've learned or what you kind of have come to incrementally appreciate about the business and about the opportunities you see?

[Mike Ranger:]

A couple of things. First of all, the one conclusion that we came to quickly was the business is largely organized in a homogenized fashion. So it's very consolidated without, I think enough scrutiny for capital allocation directed at the most profitable assets. And we still need to, and we're in the process of rationalizing what the expense structure should look like, once again, to warrant expenses directed at the most profitable operations. So that would be the first. The other is, is that some of that consolidated character is helpful when it comes to things like our environmental services business, where we bring the breadth of services that having Waste-to-Energy facilities have, plus our dedicated environmental services facilities, and together can supply an alternative for our commercial customers that is a zero landfill opportunity at premium pricing. So that's one we're together. That's a pretty strong customer facing business that I think is somewhat unique. And then clearly, the UK is completely different than Ireland because those are now the newest technology, newest plants in a waste environment that is looking for non-landfill solution. So that's very different than a client service business in North America, obviously, where you've got much more dated assets and you've got contractual, both obligations and contractually constrained pricing. So being in a more merchant market for our own plants in North America and in the UK is obviously very preferential.

[Noah Kaye:]

That makes sense. And then it looks, I mean, there's a lot of detail here as I think Brad said about the UK portfolio with which we can make our own valuation judgments. But it does look like you may have nudged expectations for kind of the profitability portfolio slightly higher. I'm just wondering, what has improved in your view about the sort of run rate profitability of the portfolio? Can you give us any color on what you're in the UK and Ireland waste markets or anything you've seen improving in the economics? Thanks.

[Brad Helgeson:]

Yes. Good morning, it's Brad. There were a few things that led us to nudging it up. In the UK, first off, as we always said when we provided preliminary ranges, those will be finalized based on our final equity ownership positions in the project. We ended up increasing our ownership percentage in the Protos project relative to what had been assumed in that range, number one. Number two is currency. Obviously, the pound has strengthened pretty significantly here recently. So we've updated – we noted this on the slide. We've updated for current forward currency rates. And then also the range contemplates certain asset management improvement opportunities. We see at the Dublin project now that we've been operating it for a few years. And so that shouldn't be viewed necessarily as a static level of contribution.

[Noah Kaye:]

Okay. That's very helpful. Thank you.

[Brad Helgeson:]

Sure.

[Operator:]

The next question comes from Michael Hoffman with Stifel. Please go ahead.

[Michael Hoffman:]

Hi. Thank you very much. Back to the strategic review, have you actually concluded certain assets should be marketed and advisors have been hired? And if such, if you're asking us to apply evaluation to, say, UK, could you give us what you're thinking about selling what that EBITDA looks like so we can incorporate that also in the analysis?

[Mike Ranger:]

We’re at the point now where we're organized to seek third-party value from the market in terms of some specific assets. So once we have a sense of what the market would be interested in and what those value differentials could be relative to our publicly trading – traded multiples, we'll have a much better sense of that. But clearly, until we get market feedback, we would be guessing at what was our greatest interest to the market. But as we said from the beginning that everything really is on the table to try to maximize the value of the company. So that interaction with the market is what we're going to be engaged in here in a pretty short period of time.

[Michael Hoffman:]

Okay. So I'm a pretty simple fellow. Very specifically, you are shopping certain assets. And if you get appropriate values and you're prepared to sell them, and if you're not, you wouldn't, is that what I'm hearing?

[Mike Ranger:]

Yes, that's fairly accurate. Right.

[Michael Hoffman:]

Okay. On the capital side, Mike, you made a comment in the beginning about allocation across the portfolio versus cash flow. If I look at total maintenance spend between what goes through the P&L, what goes to the cash flow statement, how would I proportion what sort of the service fee side versus the company-owned side?

[Mike Ranger:]

That's a good question. Some of it would be volumetric in terms of the biggest plants with the most volumes would warrant more continued investment. So, and clearly the skewing across 39 plants in North America would be the merchant plants garner greater capital allocation than the client service plants do.

[Michael Hoffman:]

Okay.

[Mike Ranger:]

You had to do is split, you would say maybe two-thirds, one-third might be about right. One-third being the client-owned plants and two-thirds being the merchant plants that Covanta owns.

[Michael Hoffman:]

Okay. All right. That's very helpful. And then from a standpoint, Brad, the guidance around this transparency on Slide 13, Dublin's about $30 million now. You're suggesting Rookery’s about $30 million, that's the EBITDA sort of coming into the EBITDA contribution of the $100 million to $110 million. If I apply sort of a proportion of tons versus ownership, I can kind of map out the rest. I'm assuming that's not a bad way to look at how to map out the rest to get to the range of $100 million to $110 million.

[Brad Helgeson:]

No, it's not. I suspect you'd come pretty close using that methodology.

[Michael Hoffman:]

Okay. And then using a 50% of the EBITDA as the cash generation is sort of a reasonable, multiple to just sort of drop the cash down from each one?

[Brad Helgeson:]

Yes, more or less.

[Michael Hoffman:]

Okay. All right. And then layout the same kind of pathway about, it's a first year, middle, half contribution, and then kind of roll it forward that's – so if I get to 2025, 2026, that's when I'm at that $100 million to $110 million full contribution.

[Brad Helgeson:]

Yes. I mean, of course, we haven't been specific yet as to first half, second half on Protos’ Newhurst and Earls Gate. But if you want to assume mid-year in absence of any more specific guidance, which we'll give as we get closer, but that's not inappropriate.

[Michael Hoffman:]

Okay. And then given the evolution of the metals markets in your own comment, and I agree, I cover some companies that do electric arc furnace dust recycling. Is there a growing opportunity to be able to hedge some of this volatility? I mean, I get historically haven't been able to, but can we start to head some of the volatility so we take that out of a business model?

[Brad Helgeson:]

Yes, we can. And I would say for us, it's an emerging opportunity. As we have increased our improved recovery and sorting of non-ferrous materials, I think there'll be opportunities for us to, for example, specifically hedge copper as opposed to a mixed product, which really was not hedgeable historically. We haven't yet hedged on the non-ferrous material, but we see that as an opportunity going forward. On the ferrous side, the challenge we face is that the index we sell against with our off-takers is not one that's currently hedgeable effectively with a traded contract. There is a traded contract that we would hope to transition to over time that's essentially equivalent, that has a corresponding traded financial contract. We've done that at one plant so far and actually have begun as a result hedging ferrous prices, again, for the output at just one plant. So baby steps so far. But absolutely our objective would be to hedge this revenue increasingly going forward.

[Michael Hoffman:]

All right. Thank you very much.

[Brad Helgeson:]

Thank you.

[Operator:]

The next question is from Tyler Brown with Raymond James. Please go ahead.

[Tyler Brown:]

Hey, good morning, guys.

[Mike Ranger:]

Good morning, Tyler.

[Tyler Brown:]

Hey. Hey, Derek, nice job on the tip fee pricing, I think all things considered this year. I know in the deck you talked about CPI being muted in 2021. But if we do see some higher CPI prints through this year, should we expect those to kind of flow through into 2022? And then can you just remind us maybe how much of the book is directly tied to CPI?

[Derek Veenhof:]

Well, first of all, thanks Tyler for the compliment on the tip fees. I appreciate that. A lot of work went into that. So on the inflation escalation on the waste side, I would expect a lot of our indices move either at the mid-year or towards the end of the year. So yes, your question is, would you see a benefit if CPI is less muted, would we see it in 2022, the answer to that would be yes. And then when you look at the overall revenue base between the service fee plants and the waste revenue we have roughly about $1 billion of revenue tied to some form of escalation, some of it being fixed within the contract, some of it being exposed to whatever indices that contract is governed by.

[Tyler Brown:]

Right. So the movements. Yes they'll move in sympathy with CPI, I would think.

[Mike Ranger:]

Yes.

[Tyler Brown:]

Okay. And then you mentioned – yes, that's perfect. You mentioned 3% to 5% tip fee growth here in 2021. So how much of that is simply mix versus, say call it core pricing and do you have any bigger call it chunkier volumes set to rebid over the next couple of years in the Northeast?

[Mike Ranger:]

So it's always going to be mix, because we keep the plants full, generally speaking absent a major snowstorm or two. So it's always going to be on the mix side. So right now, Tyler we're – over the last few years, we've been pretty heavily contracted, committed. We actually have increased our committed alignment. Again, I think we're on the merchant side roughly 83% committed for this fiscal year. So there's not a lot of wiggle room left on what's exposed currently. But I do feel pretty strongly that as contracts roll-off we're repricing into and you're seeing it in our results. We're repricing into much stronger markets and stronger opportunities. And we can be a lot more disciplined, I think then, if you go several years back, we had a lot of exposure at a lot of these plants and the reality is, because of our contracted nature now, we've got a lot more flexibility to be choosy about what we chase.

[Tyler Brown:]

Okay, very helpful. And then Brad just appreciate the simple EBITDA bridge. But I was hoping for a little more color in that core business piece. So I think you gave a little bit of color on some of the – I'm going to call it costs comebacks, but specifically how much of the headwind are all of those costs coming back, which includes healthcare and insurance, and everything. Basically, I'm trying to figure out how strong the core business is that's basically offsetting that.

[Brad Helgeson:]

Yes, it does. Yes. I mean the three that we can point to relatively discretely are insurance, which I mentioned in my prepared remarks is about $10 million year-over-year. That's mostly driven by a pretty substantial increase in our premiums for property and casualty coverage which is a market phenomenon. It's not a Covanta specific phenomenon. Medical benefits for employees, the experience there, our forecast and what's assumed in our guidance has that higher by close to $10 million as well, that's based on actuarial estimates and so we'll see what happens there, it's just an estimate at this point. And then the other that cited, that I would describe as relatively discrete was the specified cost reduction program that we’ve put in place last year. We benefited from that, we calculated $24 million in total cost savings specific to that program. We will retain some of those cost reductions. Certainly travel for example has not gone back to where it was, given the macro environment and other reasons we've maintained a pretty tight grip on new hiring as another example in the corporate office. So we'll retain some of it, but most of it was by definition temporary that was by design. So, I don't have a specific number for you, but I would say majority – the vast majority of that $24 million should come back.

[Tyler Brown:]

Okay. But there could be some lingering comebacks, I guess in 2022. And there's probably some structural saves as well?

[Brad Helgeson:]

Absolutely. Well. And as Mike said at the beginning, one of the things we're looking at with the strategic review of course is, as our business evolves, what's the right cost structure for this business and so nothing we've talked about today regarding guidance reflects of course any of those thoughts.

[Derek Veenhof:]

And just to follow up on that. I mean, if you just think about it from a perspective of having a North American portfolio of 39 plants plus an Environmental Services business, if you make some moves to streamline the business, by definition you're going to have a step function change in cost structure. So that's one of the things that we're spending an enormous amount of time on. If you want to come out of this in a very advantageous position and when you think about cost structures that's all what we're working on. We're trying not to do it from the top-down but from the bottom-up and figure out what we need, what's essential, what will allow us to continue to operate with the integrity that we've had in the most cost-effective way. So that's why it's taking a little more time, but it's better than trying to enforce from the top, just across the board kind of reductions without that kind of thought behind it.

[Tyler Brown:]

Okay. That's helpful. And then my last one, if I can squeeze this one in, so Mike, I'm just not much of a utility guy, but basically what is load serving, that line keeps creeping up. You've talked about it quite a few times in the call, but basically just what is that, what drives it and how do we think about that into the future?

[Mike Ranger:]

It's really a stabilizing force. It's the advance – I mean, Derek used the term, so I'll use it as well. It's a renewable, sustainable base load facility, which is unusual in that regard. And so it's able to be on-call to support the system. So if a utility, like for example in New Jersey, where we've got more wind, I mean more solar power now because of the public policy support work, so that intermittent power needs to be levelized against when it can't operate, right and so having the load stabilizing facilities like we have basically levelized as some of the ups and downs that you would get in the system now. So the system is just more volatile. I mean, not to get into all of this, but you could see the perfect storm in Texas was too many things that were – that all correlated to each other. So when you've got something like we have that can operate this way, it's very different because it's not correlated to natural gas prices. It's not going to have constraints or pipelines. So it's going to operate in a way that is somewhat counter to those things that are most sensitive on an electric system.

[Tyler Brown:]

Okay. That's very helpful. I didn't want to go down a rabbit hole. Thank you. Appreciate it.

[Operator:]

Next question is from Mario Cortellacci with Jefferies. Please go ahead.

[Mario Cortellacci:]

Hi good morning. Just on the strategic review. I think you'd be touched on, obviously you're shopping some of the assets, but I guess just could you give us a sense for whether if this could be a plant or two or three and maybe separate sales or is this something where you're even considering bundling a few plants, if the offer is right from a particular buyer?

[Mike Ranger:]

All the above and that's the whole idea of value discovery in the market, is to figure out what is the most attractive configuration to the market and what kind of valuation could differentials can we get for it. So everything you just described is what is in the process of being pursued.

[Mario Cortellacci:]

Got it. And then obviously you're still in the process. Just thinking about potential buyers, would you expect something to be more from a PE perspective or are you selling to municipalities? And obviously, like I said, this is more or less like a speculation, but if you had to guess one way or the other like I guess, who do you think would be the best strategic buyer for something like that?

[Mike Ranger:]

Well, our assets fit a lot of categories, so it depends upon where the value would come in. And clearly the nature of our business fits pretty well with private equity infrastructure focused pools of capital. So, I mean that's clearly one alternative and there are strategics in every line of our business. So we wouldn't want to discount that either. But clearly there's a cost of capital advantage that some pools of capital would bring to the profile of our various business segments.

[Mario Cortellacci:]

Got it. Okay. And then just last one from me. On profiled waste, do you think you guys were up 3% on the year, does that imply you are negative in Q4 and is that just driven more from the resurgence of the virus and I guess more and more restrictions or lockdowns? And then what you guys are thinking for profiled waste in 2021 in terms of volume and price that you can get there?

[Brad Helgeson:]

Yes. Hey Mario, it's Brad. I'm not sure what numbers you're looking at to imply down Q4, we were up Q4. So maybe we can take that offline to help reconcile that. But looking ahead to next year, we're looking at 5% to 10% growth in profiled waste. Again which has been the rate of growth we've had in that business far back as I can remember.

[Mario Cortellacci:]

Got it. Thank you.

[Operator:]

This concludes our question-and-answer session. The conference has now also concluded. Thank you for attending today's presentation. You may now disconnect.