Expanded Purchase Recommendation: October 2012

 

The Turnaround Letter recommended this environmental services mid-cap in October 2012:

Veolia Environnement S.A. (VE)

ADR ratio 1:1
36/38 avenue Kl
Paris, 75116
France
Phone: 33 1 71 75 00 00
Fax: 33 1 71 75 10 45
Web Site: http://www.veolia.com
Investor Relations: http://www.veolia.com/en/medias/

2011 Annual and Sustainability Report, click here
Securities Exchange Commission filings, click here
2011 annual report via 20-F SEC Filing, click here

History

Not many companies can claim such a royal charter as Veolia, as it was created at the dawn of the industrial era in 1853 by imperial decree. Its charter was water; it was asked to both irrigate the French countryside and supply water to French towns and cities, the first being Lyon. In the 1880s, the company was expanding beyond France to Italy, Turkey and Portugal. Operations were expanded to wastewater treatment in 1884. In 1912 it stepped beyond horses to begin operating industrial fleets. A half century later the company branched out to offer municipal waste collection services. Its contracting in 1958 to maintain U.S./NATO bases foreshadowed today’s offering of multiservice facilities management services.

The 1980s brought about a consolidation that brought together the businesses that form Veolia today. In 1998, the company’s name was changed to Vivendi; and the following year Vivendi Environnement was created. It encompassed Vivendi Water (Water), Onyx (Waste Management), Dalkia (Energy) and Connex (Transportation). Following the turn of the century, Vivendi Environnement was spun off on the Paris exchange with a listing on the New York Stock Exchange following in October 2001.

In 2002, management embarked upon a restructuring initiative that narrowed the company’s focus; the effort was completed in 2004, a year in which long-term debt declined. But beginning in 2005, management began to build out operations again with an accompanying surge in debt, especially in 2008 with a nearly 18% jump. Though the effects of the latest recession were beginning to be felt in 2008, debt climbed through 2009. And as the recession rolled on, it hit many of Veolia’s customers hard, forcing them to cut back their purchases of Veolia’s services. A new CEO, Antoine Frérot, took over in November 2009, and debt began to come down.

Last year was one of transition with continued mixed operating results. But the year culminated with the announcement in December of a major restructuring initiative that includes the sale of several major assets and the reduction of debt. When the program is completed at the end of 2013, Veolia will have three divisions; water, waste management, and energy services; it will serve both government and commercial customers with a truly global presence. And it will be in much better financial shape.

Turnaround Challenge/Opportunity

While the company entered the last recession with strong operating units, clearly a new reality was developing. In the post recession environment of tighter lending, more restrictive municipal budgets and more subdued worldwide growth prospects, management, in order to preserve the company’s nearly 160 year history, needed to respond. In December 2011, a restructuring was announced that will concentrate Veolia on a few core competencies that coincidentally have strong long-term growth prospects.

The thrust of the divestiture initiatives is to sell its transportation business, known as Transdev, its regulated water operations in the UK, known as Veolia Water UK PLC, and the solid waste activities of its North American subsidiary, Veolia Environmental Services North America. Veolia has already entered into agreements on the sale of the last two segments for about $1.9 billion each. Management has entered into discussion to sell its 50% interest in Transdev, a leading operator of public transportation systems in Europe. Given the market conditions, many anticipated that Veolia would have a hard time selling its assets at attractive prices. The success to date has provided something of an upside surprise.

Veolia’s focus will be on water, waste management and energy services, three segments that grew in 2011 despite the headwinds of the European debt crisis, continued soft markets in Central and Eastern Europe and slow recovery in North America. We expect demand to continue on a long-term growth track in both developed and emerging economies, as the need for water/water treatment, hazardous waste treatment/disposal and energy resources will quite definitely continue to grow.

Since its beginning Veolia has been a water company; and the new Veolia carries on the tradition. The company’s CEO Antoine Frérot authored a book Water: Towards a Culture of Responsibility that was published in 2009. He points out that it takes upwards of 400,000 litres of water to make a car; those jeans you’re wearing, another 11,000 litres. He writes:

For every unit of GDP produced, it is thought that China uses six times as much water as South Korea and ten times as much as Japan. Even if these figures are approximate, and if the structure of their economies goes some of the way to explaining these differences, they certainly signal an immense margin for improvement.

Frérot generally makes the case for the increasing importance of and need to effectively manage water resources. Forbes notes that while China’s population is “nearly five times as large” as that of the US, The country’s “water supply is smaller.” They further point out that some “90 percent of the underground water in Chinese cities” is polluted.

Though having sold its US waste collection business, Veolia will continue to grow its activities in hazardous waste and industrial services, capitalizing on its expertise in bringing cost-effective solutions that are compliant with environmental regulations. Management is currently focusing on the treatment and recycling of hazardous waste, including large public finance projects such as in the UK where they’ve won new contracts in Hertfordshire and the city of Leeds. Demand for cost effective remediation services is being driven by growing environmental awareness that is resulting in increased regulation and higher public expectations in a number of countries and by the increasing rarity of raw materials and energy, which is fostering a move away from landfills to recycling and the transformation of waste treatment and recovery methods.

In the broadest sense, Veolia’s Energy operations are addressing three major challenges; environmental changes that are leading to a relentless trend toward reducing carbon dioxide emissions, ever increasing fossil fuel prices and eventual scarcity and growing urbanization and related industrial development. To meet these challenges, Veolia has developed a range of activities based on energy and environmental efficiency: heating and cooling networks, industrial utilities and energy services. An example of Veolia’s capability is its having won a contract to oversee a heating network covering 80% of the buildings in Warsaw, considered to be the world’s third largest heating network.

Veolia’s strategy is to focus on establishing itself as a leader in the roll-out of new solutions which will accompany the energy revolution of the coming decades towards a more sustainable world that is less energy-hungry and more respectful of the environment and climate stability. Biomass-based offerings and energy-performance contracts are a priority. One such contract is with Val Europe that will provide heat to 600,000 sq. meters of offices using heat recovered from a nearby data center. Management would like to increase industrial revenues by 30-40% over the next few years.

As part of the restructuring, efforts are being made to simplify and streamline the remaining operations. Veolia Environnement Research and Innovation (VERI) will play a critical role. VERI, the company’s research arm, works in collaboration with the operating divisions in order to leverage interdisciplinary expertise to expedite development and deployment of new products and services. Activities are targeting the environmental challenges of rapid urbanization, exploding population growth, scarcity of natural resources, access to water and climate change. More specifically, Veolia is targeting intelligent energy buildings and smart grids, water recycling, new seawater desalination membranes, treatment of new waste materials, eco-neighborhoods and bioresources. Further activities to streamline operations include sharing resources such as procurement, infrastructure systems, information technology and marketing.

Streamlining operations along with cost reduction efforts are expected to save €225 million (Euros) in 2012 and annualized savings of €270 million by 2013. And with the expected proceeds of about €5 billion from its divestitures, management plans on reducing the company’s net debt load from nearly €15 billion to below €12 billion. Despite generally challenging conditions, Veolia was able to generate free cash flow in 2011 of €438 million, up seven percent from 2010. A further €348 million of free cash flow was generated over the first six months of 2012. Overall, the financials appear quite capable of covering, and management appears committed to maintaining, the current dividend. While European dividends can be more variable than in the U.S., and they may be subject to withholding taxes in some circumstances, it is likely that Veolia’s dividend will add meaningfully to the total return in the stock.

Products/Services

The following table shows Veolia revenues by division for the year ended December 31, 2011. The results of operations of Veolia Transdev, the company’s transportation segment, are recorded as a discontinued operation and do not appear in this table.

2011 Revenues – source: company SEC 20-F filing

Assets (in € million)

Water

Environmental
Services

Energy
Services

Total consolidated

Europe

8,732.8

7,098.7

6,534.3

22,365.8

of which France

4,560.1

3,384.2

3,515.1

11,459.4

of which Germany

1,519.3

1,210.2

9.5

2,739.0

of which the United Kingdom

811.6

1,626.0

194.2

2,631.8

of which other European countries

1,841.8

878.3

2,815.5

5,535.6

United States

743.0

1,230.3

314.0

2,287.3

Rest of the world

3,141.3

1,411.2

441.7

4,994.2

of which the Middle East

281.0

105.1

93.4

479.5

of which Oceania

238.6

704.6

49.8

993.0

of which Asia

1,573.3

237.8

100.6

1,911.7

of which Rest of World

1,048.4

363.7

197.9

1,610.0

TOTAL

12,617.1

9,740.2

7,290.0

29,647.3

 

 

Revenue Breakdown by division as of December 31, 2011

Excluding transportation – source: company website


Veolia is the only international company focused on the environmental services sector.  Currently, though having announced its intention to exit the transportation sector, it operates through four divisions, Water, Environmental Services, Energy Services and Transportation.  Veolia provides most of its services under long-term contracts that generate recurring income and provide visibility.  Through tailored provisions reflecting the needs of different markets, these contracts allow for gains in economic performance and environmental efficiency from technical, labor and organizational improvements.  Over the last fifteen years, the company has developed and adapted a range of management models in several countries, thus allowing it to fully benefit from the potential of environmental services markets in high-growth economic countries that have accepted the outsourcing model for the management of public services.

WATER: Veolia Water operates at all stages of the water cycle: extraction, treatment, storage and distribution of drinking water; collection, transportation, treatment, recycling and restitution of wastewater.  Veolia’s Water Division has more than 155 years of experience managing public water and wastewater services under public-private partnerships.  Its expertise includes research and development teams and its subsidiary, Veolia Water Solutions & Technologies, that continually develop innovative analytical, treatment, wastewater and recycling techniques spanning the entire water cycle.  Activities include the management of water and wastewater services for municipal and industrial clients and the design/build of technological solutions and facilities necessary to deliver water and wastewater services.  Veolia Water provides municipal and industrial clients with quality services in public health protection, leak reduction, improved productivity (plants and pipelines) and water conservation.

ENVIRONMENTAL SERVICES: Veolia Environmental Services manages municipal and industrial waste processes, from flow logistics upstream to technologically advanced treatments downstream.  As the only global operator to provide a complete range of waste management solutions, Veolia Environmental Services covers the entire waste cycle, including urban cleaning services, soil and site remediation, collection, sorting, transfer, treatment and recycling/recovery.  Though exiting the solid waste collection business in the U.S., it will continue to grow its activities in hazardous waste and industrial services.  Management is seeking to accelerate the company’s presence in Asia, North America and Europe.

Veolia made a strategic decision several years ago to grow its recycling operations.  As raw materials become scarcer and energy needs rise, substantial opportunity exists in extracting the value that remains in three fourths of the world’s four billion tons of annual waste.  For example, Veolia recently went from pilot phase to industrial scale recovery of lithium, a rare metal necessary for recycling electric vehicle batteries.  The basic activities of the Environmental Services division include:

  • Environmental and flow logistics services, including cleaning, site remediation, pipe systems maintenance, and waste collection consolidation and transfer for local authorities and businesses.
  • Hazardous and non-hazardous waste sorting, treatment and recycling, composting, landfilling and physical-chemical treatment.
  • Conversion of waste to energy, organic matter and recycled raw materials.

ENERGY: Energy Services operations are conducted through its 66% ownership of Dalkia, a global provider of energy services to both private- and public-sector clients.  The company sees its role as a decentralized producer of thermal and electrical energy for heating and cooling networks, industrial utilities and energy services.  It operates at all stages of the energy chain from decentralized production to optimizing distribution, containing demand, and generally improving the overall performance of energy systems.  Primary activities include:

  • Energy and climate conditioning (heating and cooling) services
  • Heating and cooling networks
  • Industrial utilities
  • Comprehensive integrated building management services
  • Climate control and power equipment installations and industrial maintenance
  • Public lighting

Management

Antoine Frérot
Chairman and Chief Executive Officer
Age: 53

Antoine Frérotis a graduate of the École Polytechnique (year 1977), engineer at the Ponts et Chaussées corps and holds a doctorate from the École Nationale des Ponts et Chaussées.  He started his career in 1981 as an engineering researcher at the Central Research Office for French Overseas Departments and Territories.  In 1983, he joined the Center of Study and Research of the École Nationale des Ponts et Chaussées as project manager and then become assistant director from 1984 to 1988.  From 1988 to 1990, he was in charge of financial operations at Crédit National.  In 1990, Antoine Frérot joined Compagnie Générale des Eaux as an official representative and, in 1995, became Chief Executive Officer of CGEA Transport.  In 2000, he was appointed Chief Executive Officer of CONNEX, the Transportation division of Vivendi Environnement, and member of the Executive Committee of Vivendi Environnement.  In January 2003, Mr. Frérot was appointed Chief Executive Officer of Veolia Eau, the Water division of Veolia Environnement, and Senior Executive Vice President of Veolia Environnement.  In November 2009, he was appointed Chief Executive Officer, and in December 2010 Chairman and Chief Executive Officer, of Veolia Environnement.

Finance/Valuation

Market Capitalization: $5.33 Billion
Forward P/E = 10.09
Price/Sales = 0.14
Price/Book = 0.59
Total Debt/equity = 2.04
Forward annual dividend rate = 7.10%...subject to withholding taxes in some circumstances.

The recession of 2008/2009 was a defining moment for Veolia, particularly for management to acknowledge that they needed to respond to what would be a new operating environment in which its existing debt burden and requirement for capital expenditures needed to remain competitive, particularly in the U.S. solid waste business, would be restrictive.  Long-term debt grew from 2005 through 2009 at annual rates of 10.3%, 15.8%, 2.9%, 17.9%, 11.3%, respectively, and then the recession hit.  We give credit to the new management team for taking aggressive steps to restructure and pay down debt.  In addition to the sale of assets that is expected to reduce the debt burden to below €12 billion, it is targeting costs savings in 2012 of €225 million (about $290 million at recent conversion rates) and by an annualized €270 million ($348 million) rate beginning in 2013.

While net cash from operations declined in 2011, free cash flow grew to €438 million due to lower net investments related to divestitures and a more selective growth policy.  A further €348 million of free cash flow was generated over the first six months of 2012.  Cash flows appear capable of not only covering the attractive dividend but also of supporting management’s intention of seizing growth opportunities in mature countries where Veolia has leading positions as well as in developing countries.

Veolia Environnement: Consolidated Financial Statements (12/31/2011)

http://www.sec.gov/Archives/edgar/data/1160110/000130817912000090/lveolia20f.htm#_Toc322025039

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

Assets (€ million)

Notes

As of December 31,

As of January 1,

2011 

2010(1)

2009(1)

2009(1)

Goodwill

5,795.9

6,840.2

6,624.6

6,723.3

 

Concession intangible assets

6

4,629.1

4,164.6

3,624.8

3,637.7

Other intangible assets

7

1,280.8

1,505.8

1,437.8

1,535.2

Property, plant and equipment

8

8,488.3

9,703.3

9,379.2

9,423.4

Investments in associates

9

325.2

311.7

268.5

311.6

Non-consolidated investments

10

106.3

130.7

174.6

202.8

Non-current operating financial assets

11

5,088.3

5,255.3

5,275.2

5,298.9

Non–current derivative instruments - Assets

30

742.8

621.1

431.9

508.4

Other non-current financial assets

12

736.5

773.1

753.9

817.3

Deferred tax assets

13

1,263.9

1,749.6

1,588.0

1,552.2

Non-current assets

 

28,457.1

31,055.4

29,558.5

30,010.8

Inventories and work-in-progress

14

1,020.8

1,130.6

978.0

1,013.1

Operating receivables

14

11,427.6

12,488.7

12,241.3

13,093.2

Current operating financial assets

11

357.0

373.3

376.6

452.3

Other current financial assets

12

114.6

132.3

217.7

321.4

Current derivative instruments – Assets

30

48.1

34.6

45.6

142.8

Cash and cash equivalents

15

5,723.9

5,406.8

5,614.4

3,849.6

Assets classified as held for sale

25

3,256.5

805.6

722.6

203.0

Current assets

 

21,948.5

20,371.9

20,196.2

19,075.4

TOTAL ASSETS

 

50,405.6

51,427.3

49,754.7

49,086.2

(1)  Amounts as of December 31, 2010, December 31, 2009 and January 1, 2009 re-presented pursuant to IAS 8,Accounting Policies, Changes in Accounting Estimates and Errors – See Note 1 to the Consolidated Financial Statements.


Equity and liabilities (€ million)

Notes

As of December 31,

As of January 1,

2011

2010 (1)

2009 (1)

2009(1)

Share capital

 

2,598.2

2,495.6

2,468.2

2,362.9

Additional paid-in capital

 

9,796.2

9,514.9

9,433.2

9,197.5

Reserves and retained earnings attributable to owners of the Company

 

(5,324.7)

(4,134.6)

(4,504.0)

(4,599.1)

Total equity attributable to owners of the Company

16

7,069.7

7,875.9

7,397.4

6,961.3

Total equity attributable to non-controlling interests

 

2,765.4

2,928.5

2,670.1

2,530.5

Equity

16

9,835.1

10,804.4

10,067.5

9,491.8

Non-current provisions

17

2,077.1

2,313.9

2,291.1

2,160.2

Non-current borrowings

18

16,706.7

17,896.1

17,647.3

17,063.9

Non–current derivative instruments – Liabilities

29

215.4

195.1

139.3

159.9

Deferred tax liabilities

13

1,891.1

2,101.4

1,951.2

1,936.0

Non-current liabilities

 

20,890.3

22,506.5

22,028.9

21,320.0

Operating payables

14

12,598.6

13,773.9

13,076.9

13,591.8

Current provisions

15

604.8

689.9

749.2

773.1

Current borrowings

18

3,942.3

2,827.1

2,983.1

3,219.7

Current derivative instruments – Liabilities

30

81.5

51.7

84.8

125.9

Bank overdrafts and other cash position items

15

440.2

387.0

454.9

465.7

Liabilities directly associated with assets classified as held for sale

25

2,012.8

386.8

309.4

98.2

Current liabilities

 

19,680.2

18,116.4

17,658.3

18,274.4

TOTAL EQUITY AND LIABILITIES

 

50,405.6

51,427.3

49,754.7

49,086.2

(1)  Amounts as of December 31, 2010, December 31, 2009 and January 1, 2009 represented pursuant to IAS 8,Accounting Policies, Changes in Accounting Estimates and Errors - See Note 1 to the Consolidated Financial Statements.

CONSOLIDATED INCOME STATEMENT

(€ million)

Notes

Year ended December 31,

2011(²)

2010(2) (3)

2009 (1) (2) (3)

Revenue

19

29,647.3

28,764.2

27,847.7

o/w Revenue from operating financial assets

 

383.7

380.9

375.6

Cost of sales

 

(24,919.0)

(23,255.0)

(22,677.9)

Selling costs

 

(595.1)

(574.8)

(539.9)

General and administrative expenses

 

(3,176.0)

(3,139.5)

(3,021.1)

Other operating revenue and expenses

 

60.0

187.2

180.1

Operating income

20

1,017.2

1,982.1

1,788.9

Finance costs

21

(861.5)

(851.6)

(817.5)

Income from cash and cash equivalents

21

113.1

92.7

92.1

Other financial income and expenses

22

(56.3)

(102.5)

(83.2)

Income tax expense

23

(539.0)

(319.0)

(197.8)

Share of net income of associates

9 & 24

12.3

18.0

8.7

Net income (loss) from continuing operations

 

(314.2)

819.7

791.2

Net income (loss) from discontinued operations

25

(2.4)

29.3

25.6

Net income (loss) for the year

 

(316.6)

849.0

816.8

Attributable to owners of the Company

 

(489.8)

558.5

559.0

Attributable to non-controlling interests

26

173.2

290.5

257.8

(in euros)

 

 

 

 

NET INCOME (LOSS) ATTRIBUTABLE TO OWNERS OF THE COMPANY PER SHARE (4)

27

 

 

 

Diluted

 

(0.99)

1.16

1.18

Basic

 

(0.99)

1.16

1.18

NET INCOME (LOSS) FROM CONTINUING OPERATIONS ATTRIBUTABLE TO OWNERS OF THE COMPANY PER SHARE (4)

27

 

 

 

Diluted

 

(0.97)

1.07

1.15

Basic

 

(0.97)

1.07

1.15

NET INCOME (LOSS) FROM DISCONTINUED OPERATIONS ATTRIBUTABLE TO OWNERS OF THE COMPANY PER SHARE (4)

27

 

 

 

Diluted

 

(0.02)

0.09

0.03

Basic

 

(0.02)

0.09

0.03

(1)  In 2009, as part of ongoing efficiency measures, the Group reclassified certain expenses from cost of sales to selling costs and general and administrative expense. These reclassifications had no impact on operating income (see Note 20, Operating income).

(2)  In accordance with IFRS 5, Non-current assets held for sale and discontinued operations, the Income Statements of:

– the whole Transportation business, in the process of being sold (see Note 4)
– Water activities in the Netherlands, divested in December 2010 and Environmental Services activities in Norway, divested in March 2011;
– German operations in the Energy Services division, partially divested in May 2011,
– household assistance services (Proxiserve) held jointly by the Water and Energy Services divisions, divested in December 2011,
– urban lighting activities (Citelum) in the Energy Services division,
are presented in a separate line, Net income from discontinued operations, for the years ended December 31, 2011, 2010 and 2009.
Furthermore, as the divestiture process for Water activities in Gabon and Pinellas incineration activities in the United States was interrupted in the first and second semesters of 2011 respectively, these activities are no longer presented in Net income from discontinued operations.

(3)  Amounts as of December 31, 2010 and December 31, 2009 re-presented pursuant to IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors - See Note 1 to the Consolidated Financial Statements.

(4)  The weighted average number of shares outstanding at December 31, 2011 is 496.3 million (basic and diluted). (See Note 27, Earnings per share).

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