A Canadian Cash Flow Winner

05/28/2013 9:00 am EST

Focus: STOCKS

Ari Charney

Analyst and Associate Editor, Canadian Edge and Personal Finance

Although it missed estimates, this company tripled profits and remains an analysts' favorite, says Ari Charney of Personal Finance.

Industrial waste-management firm Newalta (Toronto: NAL) reported a 3% increase in revenue for the first quarter, to C$171.3 million, while profits nearly tripled to C$14.2 million.

Nevertheless, the company missed analyst estimates by a sizable margin for both sales and earnings per share. But Newalta's shares still rose 2.6% in the trading session that followed its earnings release.

And Bay Street's sentiment remains largely unchanged, with nine "buys" and one "sell," though several analysts lowered their 12-month price targets. The consensus price target now stands at C$16.93, which is 21.3% higher than the current share price.

Similar to last quarter, Newalta's results were dampened by falling commodity prices and a decline in drilling activity in Western Canada. A majority of the firm's revenue is now derived from offering waste management and recovery solutions to the energy sector. Those sales accounted for 76.1% of profits in 2012 and 85.2% of profits in first-quarter 2013.

As of the beginning of the year, Newalta reorganized into three divisions, and now reports results for each of these segments, in addition to the firm's overall performance.

Although the company's fast-growing New Markets division, which specializes in cleanup and recycling at unconventional energy plays among US shale formations and Canada's oil sands, is still dwarfed by its Industrial division in terms of revenue, it now delivers the bulk of the firm's gross profits.

For full-year 2012, the New Markets division accounted for 26% of total revenue and nearly 40% of profits. But during the first quarter, profits at this division fell 8.5% year over year, to $13 million, accounting for just 34.4% of net income.

Over the long term, the company hopes to achieve 30% annual growth from this segment by aggressively expanding its network, as well as generating stable cash flows via long-term contracts from its onsite facilities.

By contrast, the Oilfield division, which handles waste-processing for conventional and unconventional energy plays, accounted for 50.8% of first-quarter profits, even though segment profits fell 1.5% to $19.2 million.

As part of the operations at these two divisions, Newalta recovers significant quantities of crude oil, which it's then able to sell.

In the first quarter, for example, the company's New Markets and Oilfields divisions recovered 141,800 barrels of oil. That was an increase of 13.8% over the prior year's quarter, but the higher volume was more than offset by the drop in Canadian crude prices resulting from a lack of pipeline capacity. Revenue from crude oil sales fell 6%, to $9.4 million.

The slower-growing Industrial division, which offers waste-management and recovery solutions to a wide array of Canadian industries, had a modest 2.5% bump in revenue, but saw gross profits tumble 39.1%, to $5.6 million.

Funds from operations (FFO), the relevant metric when it comes to the firm's ability to fund its dividend payout, fell 29%, to $23.7 million. But the firm's payout ratio for the quarter was still a conservative 23.1% of FFO. Meanwhile, Newalta's board approved a 10% boost to the company's quarterly dividend, to 11 cents per share for its next payout.

Management expects to see its bottom line improve as a result of its investments in organic growth, such as its expansion into US markets, as well as a rebound in commodity prices. For the second quarter, it forecasts adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) to jump 20% from a year ago, thanks to growth in its New Markets division.

Newalta's fortunes are closely aligned with the energy sector, so investors should be prepared to endure the volatility inherent in its exposure to this space. Newalta's shares currently yield 2.9%.

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