There can be little doubt that we’re saddled with a ‘risk-off’ investment environment as we move into the new year. Crude oil prices contracted by around 45 per cent over the second half of 2014, while support was gradually withdrawn for currencies with a deteriorating risk profile, most notably the euro. That’s saying nothing of the rouble’s recent collapse, or the fall-away in bond prices (and currencies) for other emerging market economies like Brazil and Mexico. So if you’re actively seeking to diversify your portfolio from a geographical perspective, the number of viable risk/reward options has been whittled down of late. However, we think we’ve identified a relatively low-risk multi-utility that is well positioned to benefit from a likely loosening in ECB monetary policy – Paris-listed Veolia Environnement SA (FR: VIE).
- Diversification and scale benefits
- Stream-lined business model
- Healthy yield/rising free cash flow
- Possible boost from ECB monetary policy
- Worries over French economy
- Underperforming waste management business
The group, with a market value of €7.91bn (£6.2bn), is a constituent of France’s benchmark CAC 40 index. It is engaged in three main service and utility areas: water, waste management and energy services. 2013 adjusted operating profits for these divisions came in at €438m, €373m and €203m respectively. Veolia and its subsidiaries, many of which would be familiar to UK residents, operate in nearly 50 countries across the world. Around a quarter of group revenues are still generated in France, with another third attributable to the rest of Europe, while markets elsewhere (and Veolia’s global businesses) account for 37 per cent of the top line. At a time when ‘defensives’ are coming into vogue, an investment in Veolia presents reduced downside risk due to its diversified (and largely predictable) revenue streams, combined with the scale benefits of a multi-disciplined utility.
However, the salient point to take on-board is that Veolia has been streamlining its business model over the past two years in a bid to optimise the most profitable parts of the group, thereby providing maximum return on investments. For a mixed utility the size of Veolia this obviously isn’t an overnight process, but its focus on bottom-line growth is emerging as the default position among industry rivals. Put simply, an early realisation of the necessity to put its house in order has placed Veolia ahead of the curve, as the prevailing industry-wide push for market expansion gives way to rationalisation strategies.
| VEOLIA ENVIRONNEMENT (VIE) | ||||
|---|---|---|---|---|
| ORD PRICE: | 1,408¢ | MARKET VALUE: | €7.9bn | |
| TOUCH: | 1,408-1,410¢ | 12M HIGH / LOW: | 1,485¢ | LOW: 1,112¢ |
| DIVIDEND YIELD: | 5.0% | PE RATIO: | 18 | |
| NET ASSET VALUE: | 1,459¢ * | NET DEBT: | 51% | |
| Year to 31 Dec | Turnover (€bn) | Pre-tax profit (€m) | Earnings per share (¢) | Dividend per share (¢) |
|---|---|---|---|---|
| 2012 | 29.4 | 273 | 70 | 70 |
| 2013 | 22.3 | -47 | -24 | 70 |
| 2014** | 22.4 | 524 | 58 | 70 |
| 2015** | 23.0 | 672 | 79 | 70 |
| % change | +3 | +28 | +36 | - |
Avg vol (30-day): 2.4m Matched Bargain Trading BETA:1.06 * Includes intangible assets of €6.3bn, or €11.21 a share. ** Forecasts supplied by Natixis | ||||
To this end, the group has established an integrated business model by employing the same organisational practices across its markets, albeit with a focus on growth regions. Last March, for instance, the group struck an agreement with Electricite de France SA (EDF.FR) on a jointly owned energy-generation business - Dalkia. Under the terms of the agreement, EDF takes Dalkia’s operations in France, while Veolia took charge of all international activities. This not only put to bed a two-year old dispute, but it allowed Veolia to reduce its exposure to the French electricity market in favour of what it sees as more lucrative options abroad.
A dividend yield around the 5 per cent mark would provide investors with a reasonable income stream as the benefits of the turnaround process start to accrue. French investment bank Natixis predicts that while Veolia’s revenues will only rise by 7 per from 2014-16, its net profit will increase by 81 per cent and EPS will hit 112¢ in 2016. This demonstrates that efficiencies, rather than revenue growth, should underpin the group’s ability to cover dividends over the long-term.
The reorganisation process is expected to deliver cumulative cost savings of €750m by the end of next year and there is also a major project under way designed to improve the group’s tax efficiencies. And an overhaul of the group’s purchasing function could also drive earnings growth.
Of course, given that Veolia is a constituent of the Paris bourse benchmark, its valuation (adjusted beta 1.04) will be predicated to a degree on the perceived health of the French economy – and the portents there are far from encouraging. That said, both President Hollande and the ECB have plenty of motivation for bold action. There are also fears that revenues for regulated utilities in Europe could contract if inflation continues to slide. Investors will also have to take on board continued weakness in volume growth for its Waste Management businesses; an area of the global business that continues to underperform.
