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Morningstar | Suez 1H Results In Line With Expectations; Sale of Stake in U.S. Water Business at High Price

Suez released first-half results in line with our full-year expectations; reaffirmed its 2018 guidance, which is in line with our estimates; and announced the sale of 20% of its U.S. regulated water business. If cleared, we calculate that the latter would add EUR 0.2 to our fair value estimate. For now, w e maintain our fair value estimate of EUR 11.5 per share and our no-moat, stable trend ratings. Shares are slightly overvalued.

Top-line organic growth came in at 3% in the first half, implying acceleration after the 1.7% posted in the first quarter. EBIT organic growth also accelerated in the second quarter as organic growth came in at 7.5% versus 5.5% in the first quarter. Net income doubled to EUR 90 million, in line with consensus expectations.

The two main drivers of EBIT growth acceleration in the second quarter were GE Water and the international division. GE Water EBIT on a pro forma basis increased from USD 28 million to USD 72 million in the first half, owing to revenue growth and cost reduction. At constant exchange rates, the international division's EBIT increased by 6% due to good momentum in Australia and the Czech Republic. Cost savings increased from EUR 35 million in the first quarter to EUR 55 million in the second, and the group reiterated its EUR 200 million full-year target.

On the negative side, Water Europe was affected by contract losses and declining volumes due to adverse weather conditions in the second quarter. Lastly, negative foreign exchange effect shaved 4% off EBIT.

Suez announced the sale of 20% of its U.S. regulated water activities to PGGM for USD 601 million, to be completed in first-half 2019. That involves attractive multiples: 1.95 times rate base and 2018 P/E of 30 times . We calculate that this disposal will be value-accretive by EUR 0.2 on our fair value estimate, or 1.7%. The dilutive impact on our EPS through 2022 will amount to 1.5% on average. The disposal will enable net debt/EBITDA to fall back below 3 times.

The European waste business' organic revenue growth came in at 3.6% versus 1.4% in the first quarter. Processed volumes were up by 3.2% in the first half, implying a slowdown from the 3.6% posted in the first quarter. Therefore, the second quarter's growth acceleration was driven by price increases for services, in our view. At the EBIT level, top-line growth was offset by a fall in paper and plastic prices, owing to overcapacity stemming form the regulation-driven reduction in imports from China.

Suez reiterated its full-year targets for the water technologies and solutions division, chiefly made up of GE Water. The group targets revenue of USD 2.8 billion and EBIT before the purchase price allocation of USD 200 million. First-half pre-PPA EBIT amounted to USD 72 million, but management indicated during the conference call that two thirds of the business' profitability is typically generated in the second half. With regard to PPA, the group indicated that it should amount to around EUR 45 million on a full-year basis, above our EUR 30 million estimate. Still, the impact on the bottom line should be offset by likely lower restructuring costs than on our estimates.