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Morningstar | Profit warning reflects lower organic growth potential than had been priced in.

Suez's historical business is water distribution in France, where the group has long benefited from long-term contracts with municipalities offering comfortable margins. Since 2010, however, the group has been hit by massive contract renewals, which have significantly affected margins. Though most of these renegotiations are over, pricing remains under pressure due to low inflation, and volumes are in structural decline. The other core historical business of the group is waste treatment in Europe. The business' high fixed costs and high sensitivity to industrial production have hurt it since the economic downturn in Europe. Despite significant efforts to reduce the cost base, the waste-treatment EBITDA margin slid from 16% in 2008 to 11.5% in 2017 as overcapacity weighed on prices. We forecast EBITDA margin to partially recover, stabilizing to around 13% in 2020. Key to that will be cost-cutting and increased volumes. To offset declining profitability in Europe, the group has expanded internationally, notably in China, the Middle East, and Australia. We think that activity in those areas will see continued high growth due to urbanisation, economic growth, and demographics. However, we anticipate limited margin expansion, given the absence of a moat. The acquisition of GE Water increased the weight of international activities and bridged the gap with Veolia in the industrial water segment. However, we see no value creation from this acquisition, given the high price paid: 12.5 times enterprise value/EBITDA before synergies. Financial discipline in this capital-intensive business is key, and Suez boasts a good track record in terms of return on capital, compared with Veolia. Nonetheless, the acquisition of GE Water will be dilutive to return on invested capital, or ROIC, in 2018. The dividend has been flat since 2008, and management tends to allocate capital to acquisition. Barring any other sizeable acquisition, we forecast that the dividend will grow again as of 2019, by 2% per year though 2022. This is well below the 10% annual growth that we forecast for peer Veolia.