VEOEY - Veolia Environnement SA Is Worth Holding

2023-08-01 09:45:24 ET

Summary

• Veolia Environnement shares are currently selling at a high price, limiting short-term profit opportunities for retail value investors.
• The company operates in essential industries and has a strong history, but earnings and margins need improvement for long-term success.
• There are risks associated with the company's debt, low net income margin, uncertain dividend, and reliance on debt for growth.

Cleaning Up Veolia

We believe shares of Veolia Environnement SA ( VEOEF and VEOEY ) are selling at a price limiting opportunities for retail value investors to generously profit in the near term. Over the long term, we are bullish but earnings and margins must improve and the dividend ratings must become more secure.

Shares now sell near to the 52-week high at ~$32.75 per share and $16.30, respectively. We like the company's long history; the industries in which Veolia operates are essential to modern society and industrial growth; M&A drives revenue and expansion but earnings lag, management uses debt to build the company, and cash flow and net margins are wanting. A dip in share price that seems to happen regularly may be an opportunity for moderate buy consideration.

Company Profile

The company is highly-regarded in the investment community, as the Seeking Alpha Quant A grade for momentum attests. Veolia's key business activities are water delivery, waste management, and supplying energy, all essential to modern life and industrial production.

Water is fundamental for nearly every manufacturing and production process. This "Industry accounts for around 40% of total water abstractions," according to a professional group of water techs, Aqua Tech. Effective waste management ensures sustainable living conditions; it mightily contributes to good health and human longevity. American scientists long ago warned the public of the critical energy-water nexus:

Water and energy are resources that are reciprocally and mutually linked, because meeting energy needs requires water, often in large quantities, for mining, fuel production, hydropower, and power plant cooling, and energy is needed for pumping, treatment, and distribution of water and for collection.

There are notable differences between VEOEF and VEOEY. The former is classified as an American Depositary Share (ADS); i.e., VEOEF is an equity share of a non-U.S. company that is held by a U.S. depositary bank and is available for purchase by U.S. investors. F represents a foreign stock trading on NASDAQ. The entire issuance of shares, usually tagged with Y at the end of a symbol represents a foreign company called an American Depositary Receipt (ADR). In this case, the dividend is the same (3.75% Forward Yield), the PE ratios are 27.76 for VEOEF and 29.98 for VEOEY, and both have market capitalizations of $23.19B.

There are two differences. The EPS of VEOEF is $1.19 and the average daily trading volume is light (226). VEOEY has an EPS of $0.55 and an average daily trading volume of +34K shares. We suggest retail value investors consult with a tax attorney or accountant before buying one or the other.

In terms of momentum, VEOEY's share price growth is 46.2% over 5 years, 40% over the last 12 months, and 26.6% YTD. VEOEF's share price grew 43% over 5 years, 35% in the last year, and 24% YTD.

Veolia designs and provides water, waste, and energy management solutions worldwide. In August 2022, the company announced folding SUEZ SA into Veolia after a cash tender offer was agreed to. Veolia agreed to retain all of the water business of SUEZ in France and left NEW SUEZ with the water business in Africa, India, and China. The company boasts "an active acquisition program to support our continued growth."

Veolia Environnement acquired 17 businesses stimulating its growth spurt. Before SUEZ, Veolia bought SULO Group for $1.68B. 47% of its acquisitions are characterized as environmental operations and 14% in business services. The SUEZ acquisition brought ~$7.8B in revenue , nearly a 50% jump in revenue for 9 months, in 2022.

Revenue And Earnings

Revenue and earnings continued growing through Q4 '22 positioning management to be able to claim an "ambitious objective for 2023 of 5% to 7% growth in EBITDA… while confirming the EPS accretion of around 40% in 2024."

Veolia maintains a strong footprint in more than 50 cities in China spread across 100 sites. The company operates waste and wastewater treatment, solid and hazardous waste treatment, energy management, and resource recovery for industrial use. Among the latest developments in other countries Veolia's designing and building the largest energy-efficient desalination plant in Abu Dabi.

In France , Veolia aims to make its water and waste services energy self-sufficient to reduce energy consumption by 5% through the use of biogas from organic waste and sludge, increasing availability of electricity from non-recyclable waste, installing panels, and making better use of biofuels from used food oils the company collects. Waste treatment and recycling are its priorities moving forward.

The company also engages in the operation and maintenance of heating and cooling networks; development of energy services to reduce the energy consumption and CO2 emissions of buildings; optimization of industrial utilities, such as steam generation, cooling, electricity, compressed air; and energy use related to processes and industrial buildings, as well as produce electricity from biomass. The company, formerly known as Vivendi Environnement, founded in 1853, changed its name to Veolia Environnement SA in 2003.

Building Out

In our opinion, Veolia Environnement is a potential long-term opportunity, especially shares of VEOEY, for retail value investors. Wait until the share price dips again. Veolia's PE ratio of 27.57 is below the peer average for (utilities) water companies of 38.31. Veolia stock is expensive in comparison to the PE ratio of the U.S. utility sector which averages 25, and the diversified utilities group of companies with an average PE ratio of 21.21. Veolia's PE ratio is higher than the 5 peer companies highlighted by Seeking Alpha.

The share price historically dives on bad macroeconomic news but historically steadily climbs back into the $16 to $18 range per share. The high was $18.20 in early 2022. The most recent low was $9.20 per share last October. We estimate the share price has been ticking up again in anticipation of the August 2, '23 announcement that its Q2 '23 EPS will be reported nearly double (+$0.52) that of $0.29 Y/Y. Historically, quarterly earnings reports are mixed when it comes to beating analysts' earnings estimates. Apparently, it is easier for Veolia to grow revenue than earnings, as this chart dramatically attests:

Seeking Alpha analysts consistently rate the stock as a buying opportunity. Going back to 2021, 9-out-of-10 analysts assessed the stock as a buy. The S.A. Quant Rating is and has been for most of 2023, a strong buy. All the S.A. Factor Grades support our bullish position but the metrics and other factors are cause for skittishness.

Organic revenue growth as of March '23, rose nearly 20% Y/Y. EBIDA was up 8% and EBIT +14%. Annual FY '22 revenue hit $49.5B and estimated revenue for FY '23 is $52.8B. ROE is ~8.4%. That brings us to the first risk in the numbers.

Risks

Debt is $30.6B but admittedly it has been used primarily to expand the business. Nevertheless, the debt-to-equity ratio of 104.7% is high. The company holds $14.4B in cash and equivalents, and its enterprise value is $45.75B.

The second risk we see in these numbers lies with a thin net income margin of little more than 1%. The sense of risk might be reflected by the stock's high volatile rating sporting a Beta of 1.18.

A third risk to be aware of is the insecurity dominating the dividend. It gets low grades from S.A. Quant for safety and growth, and a mediocre C+ for consistency. The dividend payout ratio has recently been about 120%; the free cash flow yield to dividend is less than 1%; debt/equity, debt/capital, net income margin, and estimated sustainability of the growth rate, plus other metrics justify the worries about the dividend.

Fourth, net operating cash flow through 2022 rose 20.78% to $3.64B from $3.01B Y/Y. Net operating cash flow from 2022 sales was only ~8.5%; that is down from 10.57% the year before. Free cash flow at the end of 2022 was -33.38%. The yield was 0.98%. Thus, the heavy reliance on debt to build out the company and sustain operations may jeopardize future dividend payouts and yields.

A fifth factor contributing to the sense of risk if not an actual risk is the unknown; we cannot find substantial information about ownership and insider trading. This may be because as a "foreign private issuer," Veolia is exempt from having to disclose "short-swing" profit with respect to their purchases and sales of shares. Nor are they " required to file periodic reports and financial statements with the SEC as frequently or as promptly as U.S. companies with securities registered under the Exchange Act. Accordingly, there may be less information concerning our company publicly available from time to time than there is for U.S. companies at those times." Simply Wall St claims just 0.03% of the shares are owned by individual insiders who thus have limited stake in the company's performance.

Takeaway

A dip in the share price may justify a moderate buy opportunity of Veolia Environnement SA shares. On the whole, the risk to retail investors might be more marginal than a serious threat but the risks might also be the cause of the stock's volatility and it being undervalued. But we do not foresee any special event that is going to move the share price into the mid-$20s where it might otherwise be with better margins and bigger earnings. Nevertheless, Veolia is a company thriving and progressively pursuing the environmental sustainability actions the world so desperately needs.

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