In February 2019, we teased about Veolia’s need for fresh impetus. They delivered. The deal with Suez, initiated in August 2020 and finalised in April 2021, is a game-changer for the French waste and water management company, completely revamping its equity story. Veolia has gone from being a transparent company to a market animator, and now a potential success story.
But to have all lights on and to be fully recognised, the group will have to emancipate itself from several burdens inherited from its inglorious past, especially on the ESG side. A long but worthwhile journey to finally unlock considerable hidden value.
An eventful journey with a happy ending
It wasn’t all smooth sailing. By purchasing the first 29.9% equity stake in Suez from Engie in September 2020, Veolia embarked on an 8-month battle in which moral, legal and capitalist codes were flouted by two ego-driven managers. They finally reached an agreement on April 2021 in which Veolia buys out a large part of its long-time competitor. B Camus, the Suez boss obtained a fair price (€20.5 per share, an all-time high) for sticking to his guns, while A Frérot (Veolia) fulfilled his life’s dream and took his group into another dimension. A win-win situation on the financial side, a lose-lose on the reputational one as too many dirty tricks were deployed.
Admittedly, it was worth the effort. Veolia is on the verge of becoming the world’s leading player in water and waste management. Post-merger, revenue is expected to increase from €27bn to €40bn, and EBITDA from €4bn to €6.5bn. By the way, we reject the idea of a “merger”: Veolia is in effect buying a range of assets. And this is precisely why the deal creates value. It endows Veolia with a fully coherent geographic footprint focused on key areas (the UK, Central and Eastern Europe, the US, Iberia, China…), increasing its ability to capture value-accreting projects at the local level.
The recent €13.4bn contract in Uzbekistan is the epitome of Veolia’s know-how in capturing such projects able to boost the ROCE and to ensure a solid growth foundation for years. In a context of surging commodity prices that strengthens a structurally resilient and riskless business model, it seems highly likely that Veolia will deliver its targets in terms of both synergies and earnings accretion. It also dilutes the exposure to France by 25%, considered as a mature area, especially in water.
Switch on the ESG narrative
Financials are only part of the story. In our view, Veolia has everything to gain by developing an aggressive, clearly-defined ESG investment case. Indeed, the group must build a strong ESG narrative in order to become a benchmark player on its own, able to arise naturally in investors’ minds when it comes to ESG in the same way as renewable power pure plays. It is all the more important as Veolia is not operating in a trendy, highly competitive sector where players are fighting with evermore aggressive targets. It is at the same time a weakness as it reduces visibility, and a strength as Veolia has a free hand to develop its strategy.
We identify two ways to tackle the issue:
* First, and obviously, Veolia is mechanically exposed to ESG-type issues as it operates energy-intensive facilities, recycling waste, water and generating energy. As a result in absolute terms, its scoring metrics are mediocre. However, like for any ‘E’ intensive business, it is the dynamic of its ESG metrics that really matters, and much can be done about this. Veolia has planned to be coal-free by 2030; this must be accelerated. Its Impact 2023 programme must be extended, as the markets require long-term objectives rather than short-term window-dressing measures. Goals must be granularly set and policy levers detailed in order to bring to light a convincing ESG strategy to the eyes of uninitiated investors.
* Second, Veolia’s core business is to improve the energy efficiency of its clients. Water, waste, and energy, the three pillars of the group, are the key elements of the energy transition and at the heart of ESG metrics. It is one of the few players in a position to help its clients on environmental matters so that ESG pressure is a boon for its businesses. We consider this element as largely ignored by the market, while we put it at the heart of our investment case. At the end of the day, the group must firmly materialise its ambition to become “a world-leading player in the ecological transformation” and must base its ambitions on a clearly defined policy to trigger investors’ recognition. Veolia must get the ESG freight train rolling to unlock hidden value.
A questionable governance structure
After the E, the G. Admittedly, the governance structure of Veolia is not up to scratch. We see two major issues:
* The power is concentrated in a few hands, especially with Mr Frérot being Chairman and CEO. Drawing a line between both jobs is a prerequisite to restore investors’ confidence, especially after the turbulent capitalist saga with Suez. It would also help securing investors against historical sulphurous practices in the field of public services contracting with local authorities.
* We also consider that the Board of Directors membership, French-centric to excess (11 members out of 12), is out of wack with Veolia’s international ambitions. Veolia is operating in more than 40 countries with France representing c. 15% of the post-merger top line and crystallising only a very small part of the growth. This geographical diversity is the strength of the company and not representing it on the Board is a mistake. Correcting this aspect would strengthen the power of its many local footprints and make the company a more agile and knowledgeable player.
Valuation is the attraction
Unsurprisingly, all valuation metrics point to the same direction: green. Even with a 10% discount on peers. Even with a conservative 3% EBITDA growth rate for out-years in our DCF. Uncertainties related to the group’s ability to consolidate Suez’s assets successfully and deliver synergies appear over discounted, offering a very attractive risk/reward. The FY22e EV/EBITDA of 7.2x is at its lowest since 2012, ignoring the value created through the deal. A rerating could take time as Veolia’s share price was last seen at €40 back in … June 2008. The stock could be regarded as a Buy as the market discovers its complete overhaul and a Hold in that it has long ESG legs. In short, a Buy & Hold must.