VEOEY - Veolia Environnement: 4% Yielding Non-Cyclical Remains A Bargain

2023-05-11 15:10:56 ET

Summary

• Veolia has had a nice run in the past 8 months since we initiated on it.
• EBITDA grew 8% in the March quarter compared to guidance of 5-7% this year.
• EPS is expected to grow mid-teens this year but likely in the 5-10% range long term.
• With 85% of the business non-cyclical, we continue to like the stock at 14.2x forward earnings. We purchased it around 12x.
• The long-term average multiple is 16.6x, which implies as much as 30% upside should it continue to re-rate higher.

Earnings Summary

Veolia (VEOEF) has been a nice 40% gainer in the past year since we initiated on it last September . We continue to like the long term story as organic revenue grew 6.3% in constant currency terms in the first quarter of 2023. That is excluding the increase in energy prices. Including energy, revenue was up 19.9%.

Most importantly, EBITDA beat expectations by 1% and grew 8% year over year in euro terms.

Note that the European shares (VIE FP) today trade around €27.50 and the ADRs (VEOEY) are around $15. There are 0.5 ADRs per share, so just divide the VIE shares by 2 and multiply times the exchange rate (currently around 1.10) to convert Euro per share figures to ADR per share figures.

Bears might argue that 100% of the EBITDA growth came from efficiencies and synergies from the Suez deal, which may or may not be long term sustainable. Inflation also negatively impacted EBITDA by €43 million in the quarter (down from €55 million last year however).

In 2023, the company aims to cut costs/generate synergies of €480 million on a base of €6.2 billion in EBITDA last year. Given the size of the company there do seem to be a couple of years of cost saves that the new CEO has been pretty good at realizing.

Below was guidance provided in January 2023 for the year. The company reiterated guidance with Q1 earnings.

Slides

In 2022, EBITDA guidance was 4-6% growth and the company hit 7% growth (organic). With the Suez deal, Veolia has guided to 40% accretion in EPS by 2024 (compared to 2021 figures of €1.48). That works out to €2.07 next year in EPS ($1.14 per ADR).

This year the Street expects EPS of €1.87 and we have modeled €1.92.

Analysts are forecasting 5.5% EBITDA growth in 2023, so the bar looks relatively low to beat expectations this year based on Q1. But the company does have some cyclical revenue in the mix. Roughly 15% of the company's industrial revenue is tied to the cycle . Recyclate prices (paper, cardboard, plastics, aluminum) also fluctuate quite a bit and can create some earnings volatility.

On the inflation front, 70% of the company's revenue has CPI indexation factors in their contracts to protect margins. The other 30% the company suggests that they are able to negotiate price increases. So far, inflation seems not be a factor on margins. Indeed, EBITDA margins continue to gain ground with cost saves/synergies. Mentioned on the call specifically were 6% price index increases on the company's French businesses this year. That is up from 4% last year as there is a lag in passing costs through.

As for the segments, there are a lot of moving parts, so here are a few relevant slides.

Here is the Water Segment with volumes continuing to be solid at 5.1%.

Here is the Waste Segment which showed flat volumes and headwinds on recycled material prices. Inflation pass throughs however were 4.1%.

And lastly, Energy where there is some movements in revenue based on energy prices which generally are pass throughs.

Geographically speaking, 20% of consolidated revenue is from France, 47% from the rest of Europe and the balance in various global locations (Middle East to Asia to Australia and North America).

Finally, in the past year, Veolia has reduced debt by €2.6 billion, or about half a turn. Debt/EBITDA stands at 3.0x with the company solidly rated investment grade.

Valuation

We modeled pretty close to company targets at €2.09 in EPS in 2024. At 15x, which seems fair we think the stock has 19% upside in a year potentially.

Longer term, should the company settle back to 4-5% EBITDA growth, then we can see 10-11% IRR's with EPS able to grow 6-7% plus the dividend yield of 4.1% . Fortunately all of the company's businesses are environmentally important with long term secular growth set to continue for years. We consider Waste the crown jewel.

In the US, comparable company Waste Management ( WM ) trades at 28x earnings and 14x 2023 EBITDA. WM is growing overall EPS by roughly 10%+ each year and is considered stable, non-cyclical and once waste management companies pick up municipal contracts, they are quite sticky.

So, with 30% of EBITDA in Waste at Veolia, there is an argument that this segment alone covers all the debt and adds value of €10 per share on the stock. That implies investors are only paying 2.5x EBITDA for the other two businesses (which are probably worth 4x in energy and 6-8x+ in Water).

On an EV/EBITDA basis, Veolia's average multiple has been 6.6x since 2015. At that valuation, VEOEY could offer us 27% gains in 1-2 years.

Our downside case is a recession, which hits the cyclical side of the business by 50%. We get €1.78-€1.93 in EPS. At 12x, VIE would trade at €21-€23, down 20% in our worst case scenario.

For VEOEY ADR holders with the stock at $15 today, this suggests downside to $11-$12 and upside to $21.50 in 2025 with two years of dividends. That is 20% downside and 40% upside with patience in a couple of years.

This does assume a Euro/Dollar exchange rate of 1.10 for the record so the percentage returns here for the ADRs equal those of the European listed shares (VIE FP). But dollar based investors could see a wider range of outcomes depending on how the dollar performs.

Below $13.50 on the ADRs looks like an attractive entry point from here.

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