Covanta Holding Corporation (CVA) Q4 2022 Earnings Call Transcript

Covanta Holding Corporation (NYSE:CVA) Q4 2022 Earnings Conference Call April 26, 2023 12:00 PM ET

Company Participants

Jim Reilly - VP & Treasurer

Gregg Kam - EVP & CFO

Conference Call Participants

Craig Robinson - Credit Suisse

Kareem Mansur - Whitebox Advisors

Peter Bray - NYLIFE

Eric Goto - PineBridge

Operator

Good morning, and welcome to the Covanta Holding Corporation Fourth Quarter Conference Call. This call is being recorded and an archived recording will be available after the end of the conference call and can be accessed to the debt investor information section in the Covanta Investor Relations website.

At this time, I'd like to turn the call over to Jim Reilly, Covanta's Treasurer. Please go ahead.

Jim Reilly

Thank you, M.J., and thank you everyone for joining. With me on the call today is Gregg Kam, our CFO. Today, we'll be discussing our fourth quarter results, which were posted to our debt investor site yesterday after market close. After our prepared comments, we'll take your questions.

During the prepared remarks, we will be referencing certain slides that we prepared to supplement the call. Those slides can be accessed now or after call on the Investor Relations section of our website, www.covanta.com. These prepared remarks should be listened to in conjunction with these slides. Call participants should also see the earnings release for a discussion of our usage of forward-looking statements and non-GAAP financial measures.

With that, I'd now like to turn the call over to Gregg Kam.

Gregg Kam

Thanks, Jim, and good morning, everyone, and thank you for joining our fourth quarter 2022 conference call. 2022 was a great year for Covanta and we made significant progress across several of our strategic initiatives in the first year under EQT ownership. For the first time in company history, we generated over $2.2 billion of revenue and $560 million of adjusted EBITDA, as our business model displayed its resilience in a challenging inflationary environment.

We also took significant steps in our transformation to a leading North American sustainable material management company, with the successful closing of several strategic acquisitions that meaningfully advance our capabilities as a single source partner for businesses seeking sustainable waste solutions.

Before I discuss our fourth quarter results, I'd like to provide you update on a handful of key events. First, I'd like to provide an update on the fire at Miami-Dade facility. And second, I'd like to discuss our recently announced acquisition of CIRCON.

First, with respect to the Miami-Dade facility, for those who you may not be aware, we have a longstanding service contract to operate the Waste-to-Energy facility located in Doral. That is owned by our partner Miami-Dade County. A fire broke out at the facility on February 12, 2023 that quickly spread and ultimately caused significant damage to several structures at the site.

The cause of the fire remains under investigation. Thankfully no one was injured and a significant Covanta team remains on-site continue to assist our client. While no municipal solid waste is currently being processed at the site as the county has been bypassing tons to other disposal options in Florida. We've begun processing tires for beneficial reuse at the site. At this time, our client continues to explore options including possibility of constructing a new facility in the county, but no decisions have been made concerning resumption of the historical level activity at the site.

Our current base assumption is that a loss of revenue related to cessation of processing at the facility due to the fire will be covered by business interruption insurance, so that the overall impact of Covanta's results will not be material and will keep you updated during future earnings calls.

Turning to a second topic. I'm very excited to update you on our recently announced acquisition of CIRCON Environmental. The transaction was announced on April 3 and is expected to close on May 1, this Monday. CIRCON based in La Porte, Texas is an industry leader dedicated to the engineering and processing of hazardous and non-hazardous waste streams to create fuel replacement to traditional gas and coal. The business has significant national scale and a broad suite of ESG focus end-to-end environmental solutions that complement our growth strategy.

Although details of the transaction were not disclosed publicly, we could share to this audience that will pay total purchase price of $655 million, which represents an acquisition multiple of roughly 11.5 times based on anticipated 2023 pro forma adjusted EBITDA, including expected synergies. EQT have committed the entire purchase price and equity given a volatile backdrop at the sign of closing.

Looking ahead, we will continue to consider cost effective ways to right-size the capital structure in amount of consistent with our conservative financial policies. Our integration teams are already at work on the transition and integration, and we look forward to updating you in the future on our progress.

Now moving onto the quarter. I'll review certain key performance indicators on Slide 3. As I stated at the opening, 2022 was a great year for Covanta and our teams executed well against many of our strategic initiatives, which resulted in our delivering record North American revenues of over $2.2 billion and North American adjusted EBITDA of $547 million.

Looking more closely, we generate these record results despite having higher unscheduled downtime during the year at certain of our waste energy plants, resulting in processing volumes for the year that were below expectations and slightly below prior year by about 400,000 tons. Waste pricing on the other hand was a bright spot as waste energy tip fees grew 6.1% year-over-year in the quarter, reflecting a combination of inflation linked escalations under long term contracts, improved pricing on new contracts and a favorable waste mix including higher levels of profiled waste.

Higher power pricing also contributed a net benefit with average realized price for the quarter up 5% year-over-year. From a risk management standpoint, we continue to pro-matically (ph) increase our hedging profile and layered an additional fixed swaps through calendar year 2025 to reduce future volatility in our energy market exposure. At quarter end, we had roughly 80% of our production either hedged or under contract through calendar year 2024 and roughly two-thirds of calendar 2025 is hedged or contracted.

Turning to recycled metals, ferrous pricing after posting strong year-over-year gains, early in the year declined sharply during the fourth quarter down 43% year-over-year to $142 per ton. Ferrous tons recovered and sold were both up slightly compared to prior year. Non-ferrous pricing also declined in the fourth quarter, though to a smaller extent than ferrous down 27% versus prior year.

Non-ferrous price seeing nonetheless remains on a high end of historical range. Non-ferrous tons sold were down 14% versus prior year in the quarter, reflecting a decline in metal yield as well as a discontinuation of certain processing activities in 2022 that are included in 2020 or including our pricing line at Fairless Hills. We made significant strides in the quarter advancing our efforts to reduce volatility in our recycled metals revenue through a combination of financial floating to fixed swaps as well as amending certain of our commercial offtake contracts.

At the end of March, approximately 50% of our 2023 ferrous volumes and over 50% of our non-ferrous volumes are either hedged or contracted at a fixed price. We intend to continue to reduce volatility in recycled metals pricing through hedging and/or conversion of commercial offtake to fix price with a target of roughly half of our volumes by the end of 2023.

We manage our overall commodity risk management priorities with a prudent focus on potential impact on liquidity. We made significant progress over the past reducing our potential exposure to collateral recall at a level well within our revolving capacity. The mark-to-market liability on our energy hedge book at year end was approximately $240 million with approximately 90% of this liability under lean-based collateral arrangements.

As of this Monday, April 24, the mark-to-market liability has decreased by $100 million to $137 million. As of December 31, we had posted $106 million in cash and led us a credit posted as margin against our hedge positions. As of Monday, we had -- April 24, we had $37 million, over 90% of our current power hedge book faces lean based counterparties.

The successful transition to lean-based support coupled with the more recent decline in power pricing reduced our exposure to potential collateral calls at [indiscernible] to less than $45 million as of Monday. Although, collateral requirements will likely remain fact of our business for the foreseeable future, we remain confident that we have ample liquidity to maintain a highly hedged or contracted profile going forward.

Turning to Q4 results. I'll now discuss year-over-year drivers of revenue more specifically. Please refer to Slide 4. North American revenue was $565 million in the fourth quarter, up 5.2% from $537 million in the prior year. Our disciplined pricing programs helped drive organic price growth that contributed over $10 million. In addition, improved waste flows from service fee contracts and contractual escalators led to a $12 million increase in service fee revenue.

Our material processing facility also had another strong quarter and contributed an additional $20 million of growth, roughly half of our -- roughly half of which stem from our recent acquisitions. Overall, continued MPF growth and higher waste pricing helped offset a decline in commodity pricing as well as lower processing volume, which comprised a majority of the $17 million decline in other.

Moving to adjusted EBITDA for the quarter, I'll refer to Slide 5. Consolidated North American adjusted EBITDA was $142 million in the fourth quarter, up slightly from $139 million in the prior year. Solid MPF growth in our pricing programs and a favorable variance in maintenance spending versus prior year help offset net commodity pricing and the impact of inflation we experienced in fuel, chemicals and reagents and contract labor.

Turning to free cash flow. I'll refer to Slide 6. Fourth quarter North American free cash flow was negative $15 million in Q4 2021, a $32 million improvement from the prior year. The $63 million improvement other column predominantly flex to roll off as a significant merger related one-time cost paid out in Q4 2021. This cash flow benefit was offset in part with increased capital spending as well as higher cash interest costs.

Now turning to full year 2022 results. I'll begin with the revenue on Slide 7. We generated $2.2 billion of North American revenue in the year ended December 31, 2022, up 8% or $170 million from prior year, despite a $36 million aggregate headwind from increased unscheduled downtime as well as lower construction revenue. As previously noted, higher tip fees contributed $42 million in revenue terms and improved waste flows from service fee clients and contractual escalators added another $29 million increase in service fee revenue.

Our material processing facilities revenue had another year of strong growth of $61 million year-over-year revenue terms, approximately $50 million of which was contributed by recent acquisitions. With the line of sight to continue growth at our MPS as demand for our growing suite of sustainable solution continues to increase with commercial and industrial customers are increasingly looking for zero to waste landfill options for their waste streams.

Higher energy prices even with much of our output already hedged as well as higher sales prices for renewable energy certificates contributed $74 million to revenue growth offsetting a $7 million decline in metals pricing.

Moving to adjust EBITDA for the 12 months, I’ll refer to slide -- I refer to Slide 8. North American consolidated adjusted EBITDA was $547 million in 2022, up $41 million or 8% from 506 in 2021. The primary driver, the year-over-year growth was the contribution from higher power pricing, which offset decline in metals pricing and all other negative variances.

Unpacking the $20 million negative and other, I'd like to highlight that production challenges we faced at a handful of plants in 2022, which reduced production volumes and negatively impacted adjusted EBITDA by $28 million year-over-year. Although strong waste pricing growth and MPF growth combined to more than offset the significant inflation pressures we experienced in 2022 across all of our major spending categories. This growth was not sufficient to fully offset reduced production volumes.

Now please turn Slide 9, while I walk through the free cash flow on a year-over-year basis. 2022 North American free cash flow was $101 million, up slightly from the prior year. Free cash flow for the year benefit from higher adjusted EBITDA and overall favorable working capital management, which is partially offset by increased capital spending as well as higher cash interest costs, resulting from the new capital structure and rising interest rates.

With respect to interest rate risk, please note that we entered into incremental interest rate swaps in the quarter on another $500 million of our secured credit facility. Increasing the fixed to floating mix across the capital structure to above 80%. The new swaps were executed at a fixed rate 3.48% and the weighted average fixed rate on a combined $1 billion notional swaps is 2.244% -- 2.44%. Our core strength of our business model is resiliency and consistency of our cash generation throughout the business cycle.

As a management team, we are focused on how best to deploy that capital to many consistencies of cash flow generation and improve our growth and credit profile over time. With new management now in place, we continue to perform detailed reviews of our infrastructure and have identified opportunities to optimize our boiler (ph) performance, improve our preventive maintenance practices and further enhance our HSE performance.

We intend to continue to follow our long term maintenance planning and accelerate project as necessary in support of our operational excellence sustainable initiatives. We've also made the strategic decision to revitalize certain infrastructure that prior management had marked for decommissioning, as we see significant potential for select facilities like our facility in Tulsa, Oklahoma.

Capital spending in 2022 is elevated compared to 2021 as we accelerated select long term maintenance projects. Looking ahead, we foresee continued elevated capital investments as we complete critical HSE initiatives, operational excellence projects, as well as continue to grow the business. These initiatives will require incremental capital investments over coming months and we are confident that the expected reliability and availability improvements will improve profitability and generate returns over time that improve our credit profile, enhance the long term value of our business.

Turning to the balance sheet on Page 10. We ended 2022 with $3,460 million of gross debt. On a pro forma basis, our total consolidated debt ratio is defined in the indenture to the 2029 notes and consistent with the corresponding measure in our credit agreement was 5.39 times, on December 31, 2022, down from 5.69 times at the end of 2021.

Our liquidity position remains strong with $320 million available revolver capacity at year end despite incremental revolver borrowings to fund our four announced 2022 acquisitions for an aggregate purchase price of $167 million. At the end of March, we maintained strong liquidity in excess of $310 million.

Before concluding comments on capitalization debt structure, I note that we successfully transitioned our secured credit facility as well as related interest rate swaps from LIBOR to so far in December and we appreciate the support of our lender group in achieving that milestone.

In conclusion, as we look ahead to 2023, the fundamental strengths of our business model and credit remain intact. We own and operate unique and irreplaceable infrastructure that provides essential service to our client communities and commercial customers. We offer differentiated negative carbon sustainable waste solution. Our revenues remain highly contracted and predictable with roughly two-thirds of our waste revenues on the contract and over 80% of our energy revenue either hedged or contracted through 2024.

Waste revenues represent roughly 70% of our consolidated revenues and continue to benefit from declining waste disposal in key markets that has resulted in supply demand imbalances that we expect will continue to provide supportive secular tailwinds.

Lastly, our recent acquisitions set the stage for continued growth as we transition toward providing a broader suite of sustainable solutions. Overall, we remain confident in our value creation plans as our ability to improve credit over time.

With that, we'll move to Q&A. Operator, please open the line for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Today's first question comes from Craig Robinson with Credit Suisse. Please go ahead.

Craig Robinson

Hey. Thanks for holding the call and taking the question here. I just have a couple. One, I noticed that you back out the Europe and Asia adjusted EBITDA in your pro forma LTM calculation. Are you also adding the EBITDA that you acquired in December and throughout 2022?

Gregg Kam

Craig, are you looking at -- are you looking at -- in the bridges, it's just -- it's the actual, right? So to the extent they contributed in 2022, they were mostly acquired late in the year, right? So there wasn't a material amount. But when you pivot to our -- the 6.15 in pro forma adjusted on the GAAP table, that's a fully loaded number.

Craig Robinson

Okay. So that – okay, that's what my question was. I wasn't clear if you were adding acquired EBITDA as well as backing out debt asset. And then also I think I might have missed it, but can you just go over again the volume declines and waste volumes in the quarter? I guess, [indiscernible] was driving that.

Gregg Kam

Yeah. So we had a slight waste declined due to some unscheduled downtime we had in the plants. And that's why we talked about a little bit about accelerating some capital investments to improve be on schedule downtime in 2023 and 2024.

Craig Robinson

Okay. I mean, how is that looking so far in ‘23, have you seen an improvement back to historical levels? Are you still kind of running below what you think the true run rate should be?

Gregg Kam

Yeah. So what we're having right now, so in the first half of the year, we have a lot of our scheduled maintenance downtime in the plant. So we will see improved -- our plans are to see significant improved unscheduled downtime in the second half of the year and in much greater higher levels of EBITDA in the second half. Not only that we have the plants down and not producing, the unscheduled downtime in the second half should be significantly lower than historical levels.

Craig Robinson

Okay. Got it.

Gregg Kam

With the exception of course Miami-Dade, which we had to fire. So that's going to skew some of the volumes.

Craig Robinson

Okay. Yeah. It makes sense. Do you know how much volume that was just contributing to the total or give us a rough idea?

Gregg Kam

Yes. The total lot -- Jim, keep me honest here was about 800,000 to 900,000 tons in a full year basis. Miami-Dade?

Jim Reilly

Yeah, indeed.

Gregg Kam

It's about 800,000 to 900,000 tons per year.

Craig Robinson

Okay. Got it. Thank you. Appreciate it.

Operator

The next question comes from Kareem Mansur with Whitebox Advisors. Please go ahead.

Kareem Mansur

Hi. Thanks for taking my question. Can you go over again how much of your actual debt has hedged at what rate in also the actual tenor itself. You threw out a couple of numbers. Just want to make sure that I capture those.

Gregg Kam

Yeah. So in aggregate, we have $1 billion of floating to fixed swaps, right, basically designated against the term loan. And that's against one-month term SOFR (ph). The weighted average fixed rate across all of the combined $1 billion was restated in the remarks, I think 2.44%. So the floating rate portion of the capital structure now is essentially that unhedged portion of the term loan, plus whatever direct revolver borrowings would be outstanding.

Kareem Mansur

And then what's the length of those hedges?

Gregg Kam

They are through calendar 2026.

Kareem Mansur

Okay. Thank you. That's it for me. Appreciate it.

Operator

The next question comes from Peter Bray with NYLIFE. Please go ahead.

Peter Bray

Hi. Just a question on the Miami-Dade facility. What's the expected annual, I guess B&I contribution, do you expect?

Gregg Kam

B&I?

Peter Bray

Sorry, the business interruption proceeds.

Gregg Kam

Yeah. So the Miami-Dade facility EBITDA contribution to the company was quite immaterial like certainly sub 5% of the total. We expect to fully recover the impact of the business interruption impact on the company by the end of the year to keep 2023's P&L neutral to what our budget was.

Peter Bray

Okay. And then is there any sort of potential like I guess environmental remediation on your regs part or is it just on the county?

Gregg Kam

That's on the county. So the county owns the facility. So we don't see any issues with environmental remediation with the site. The fire is out and the investigation continues under way. So the question will be is and we're working with the county is, how do they want to rebuild the site they want repair it in kind or bring up an actually new state of the art facility and the timing of that. We should have better visibility of that by the end of June.

Peter Bray

Okay. Thank you.

Operator

The next question comes from Eric Goto with PineBridge. Please go ahead.

Eric Goto

Hi. We'll circle on the part of the restricted group at a guarantor?

Jim Reilly

Eric, yes. This is Jim. Yeah. It will be a restricted subsidiary as I understand it correct.

Eric Goto

Okay. And you mentioned in your opening comments about rightsizing the capital structure in the future, I suppose since you're funding circle with equity. So do you have a [indiscernible] target in mind?

Gregg Kam

No, we don't have electric (ph) target in mind right now, we expect any financing to central be in the range of leverage neutral for the company. When we finally go to the capital markets and determine what the right capital structure is for whole entire company. But at the moment, we're 100 percent equity financed and we're looking at the market with our bankers on what's the right timing.

Eric Goto

Okay. Got it. And do you have or what do you expect CapEx to be this year?

Gregg Kam

It should be -- it will be elevated from prior years and we expect it to be elevated for this year and, partially next year. I don't really want to give a forward-looking forecast on our capital budget.

Eric Goto

Okay. That's it for me. Thanks.

Operator

The next question comes from James King with KKR (ph). Please go ahead.

Unidentified Participant

Thank you for taking the questions. On the acquisition, could you provide more color on what the business does? What's the EBITDA before synergies and the EBITDA margin?

Gregg Kam

Yeah. So the EBITDA -- the EBITDA is in the range of acquiring us at a range of $50 million per year. The total turnover is about $250 million. With synergies and we expect it to have some significant higher contributions of EBITDA. So what the company does, they have a big wastewater treatment business with a process recycling treatment of wastewater. They have hazardous recovery business, recovering process has its petrochemical waste for reuse as secondary fuel.

They have a non-hazard energy recovery business, which processes non-hazard solids from a variety of pre-consumer and industrial manufacturing, creating alternative energy or what we call AEF and that's primary for cement kilns. You can think of providing that and that's a focus of our company. They do some containerized wastes and they do some liquid products and recycling. But I would say on the wastewater treatment side, you're looking about 40% to 50% of the business is that then the rest of the business with all the other items.

Unidentified Participant

Okay. Got it. That's helpful. What cost down schedule downtime and the fourth quarter, you can pinpoint to a couple of things. And how are you addressing that obviously that was going to be a focus for ‘23 and ‘24?

Jim Reilly

James, this is Jim. Yeah. The volumes actually in the fourth quarter production was flat with prior year, right? And we ran the plants at the availability we were targeting. The issue is that we're referencing, we’re earlier in the year at select plants. We typically don't like to call out the plants by name, right? But at a couple of plants, there were some unique issues that had happened and we've corrected those, which is why you can see in fourth quarter we were back up to the levels we expect to run at and the availability rates consistent with history of the company.

That type of variability candidly isn't unusual in this business over time, right. I mean it's flea to 39 plants. These things happen. I think as Greg noted, we anticipate that the work that we're doing now in this outage season that we're coming out of along with some of the preventative maintenance work that we are focused on is going to result in our maintaining and continuing the high levels availability that everybody knows from this company.

Gregg Kam

Yeah. Let me just give a little more emphasis on what Jim is saying. Since we brought a new management team and some new executives that have experience running very complex manufacturing facilities. We now have or in developing and continue to develop a more robust preventative maintenance program than the business hasn't been in before. So this is a little bit of the movement to little bit higher CapEx and we expect to have significant returns from these actions of the thing we do in the first half of this year, we’ll continue to do next year. And within the next 12 months to 18 months, we expect the CapEx to decline with significant improvement in both ability to process tons and higher levels of EBITDA.

Unidentified Participant

Okay. Got it. And last question for me, it is more on the Miami-Dade fire. I understand that is owned by the municipality, but if you are determined, I know it's under investigation. But if you're at fault, like, who's going to cover for the plan?

Gregg Kam

So Miami-Dade under contract had their own property insurance. That's their responsibility and the BI insurance is on our end of it. So it's our belief and I have no reason to believe not that they are 100% responsible for the property damage at the site. And then we have our own BI insurance through our own policies.

Unidentified Participant

Okay. Got it. Appreciate the color. Thank you.

Operator

[Operator Instructions] Being no further questions in the queue, this concludes our question-and-answer session. I would now like to turn the conference back over to Gregg Kam for any closing remarks.

Gregg Kam

Yeah. I appreciate you guys attending the call. While we had a rough issue with Miami-Dade, of course, we're working on it. We have teams trying to solve the problems for Miami-Dade and working very closely with them. We're really confident in this year's performance of our business. Our new management teams in place, great support from EQT.

We're really excited of the acquisitions we made and really excited about the significant acquisitions we've made in CIRCON and what it adds to our sustainable material management business, the opportunities for cross-selling, new regional -- spreading out our regions, more in the South and the West and also up in the Chicago area and moving to higher growth rates in this sort of this MPF, AEF business, getting it to the hazardous -- a little bit to the hazardous materials, non-hazardous so we're giving you more and more revenue streams to grow this business. So again, thank you for the call and look forward to going over Q1 results. It's going to be in a short while, I think in a few weeks. So thank you for that.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.