Morningstar | Free cash flow concerns are overdone.
Veolia is the historical leader in water distribution and treatment in France. Since 2010, it has been affected by a massive wave of contract renewals, which halved its units’ profits. We believe this business' profitability has bottomed and should rebound, as incremental cost-cutting will offset continuing price pressure. Veolia’s other main historical business is waste management, which is highly cyclical. It was hit by economic crises in Europe over 2009-13. Since 2015, economic revovery in Europe has boosted the volumes of processed waste, enhancing margins. The group intends to increase the profitability and structural growth of this business by developing new businesses, notably in circular economy. Veolia’s third main business is energy, to which Suez has no significant exposure. This business line encompasses activities such as energy services, heating and cooling networks, and electricity. In all, this business is much more defensive than waste management. Since the Great Recession, Veolia’s top management has succeeded in halving debt, driving over EUR 1.3 billion in costs out of the firm’s businesses, and increasing returns on capital, which were historically well below those of Suez, by refocusing the group. In 2017, organic revenue growth resumed strongly after coming in below market expectations in 2016. In 2018, we expect revenue to slightly decline due to a weakening dollar, expropriation in Gabon, and a fall in recycled raw material prices. Beyond 2018, we anticipate revenue to grow annually by 2.9% on average through 2022, which is well above our estimates for peer Suez, reflecting better positioning, in our view. Still, continuing cost-cutting will remain the main profitability driver. Solid free cash flow generation provides headroom to increase the dividend in line with results and conduct bolt-on acquisitions. This reflects better stewardship than peer Suez, which has more limited financial headroom after the costly acquisition of GE Water.Veolia Environnement provides environmental management services to public authorities, industrial and commercial services customers, and individuals worldwide. These services include the supply of water, the treatment and recovery of municipal or industrial effluent, waste collection, processing and recycling, the supply of heating and cooling services and the optimization of industrial processes. Co.'s business operations are conducted through three divisions, each specializing in a single business sector: Veolia Eau (Water), Veolia Energie (Dalkia, Energy Services) and Veolia Proprete (Environmental Services).
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