Company Reports

On June 9, French President Emmanuel Macron called a snap parliamentary election after his party was trounced by the right-wing populist party Rassemblement National at the European elections. The two-round parliamentary election will be held on June 30 and July 7. Since the announcement, the spread between the 10-year French and German government bond yield rose by 26 basis points to 0.74%. French stocks underperformed, including large utilities Engie and Veolia. The former decreased by 10% between June 7 and June 13 and the latter by 5%, while the Morningstar Europe utilities index was down by 1%. We think the selloff is overdone and offers an entry point. We confirm our fair value estimates of EUR 18 for Engie and EUR 38.5 for Veolia that yield 8.1% and 5.3%, respectively.

Utilities have reversed part of their first quarter’s fall, thanks to a strong rebound in power prices. Moreover, the deep undervaluation of renewables developers has driven takeovers by big investment firms at very high multiples. Neoen’s main shareholders accepted an offer at 18 times the EBITDA. The sector is still significantly lagging the market in 2024 because of high interest rates. Should they fall, it would boost the sector.

The market is failing to appreciate the transformation that Veolia has undergone in the last several years. This transformation, most notably a greater reliance on high-quality businesses such as hazardous waste management and water technologies, prompted us to upgrade our economic moat rating to narrow from none. Veolia's new business mix should deliver steadier, higher returns over time. Perhaps more importantly, the market is also failing to appreciate the company's long-term earnings potential, as it is anchored on the 2024-27 GreenUp plan disclosed in March. However, we think the plan understates Veolia's 2027 earnings potential. At our updated EUR 38.50 fair value estimate, Veolia offers 27% upside.

Veolia is the world's largest water company. Treatment and distribution of water accounts for about 40% of the turnover. It comprises municipal concessions including the French domestic market and regulated water businesses in the US, Chile, and Catalonia. The water distribution activity is uncyclical and indexed to inflation. It deserves an economic moat thanks to efficient scale and the duration of the concessions, which are intangible assets. Water technologies account for about 25% of the water division. We believe it exhibits an economic moat thanks to switching costs as the business exhibits ''razor-and-blade'' features driving highly recurring revenue.

We maintain our EUR 36 fair value estimate after narrow-moat Veolia released first-quarter results in line with company-compiled consensus and confirmed its 2024 guidance. Shares are materially undervalued.

We are withdrawing no-moat Engie from our Best Ideas list after a 64% total return since we added the stock to the list in August 2021, compared with the S&P 500's total return of 25%. This strong outperformance was fueled by: (1) record results in 2022 and 2023 since Engie was one of the main winners of the energy crisis among European utilities because of its high exposure to power prices and clean spark spreads; (2) the derisking of the equity story after an agreement with the Belgian government for the transfer of Engie's nuclear liabilities to it.

We raise our fair value estimate for Veolia to EUR 36 from EUR 32.50 after upgrading our economic moat rating to narrow from none. Our new fair value involves a 2024 P/E of 17, enterprise value/EBITDA after concession renewal expenses of 7.8, free cash flow yield of 3.5%, and dividend yield of 3.9%. We see the shares as undervalued as the market is neglecting the group's transformation that reduced its cyclicality by increasing the weight of moaty activities.

Veolia Environnement is the world's largest water company. Treatment and distribution of water accounts for about 40% of the turnover. It comprises municipal concessions including the French domestic market and regulated water businesses in the US, Chile, and Catalonia. The water distribution activity is uncyclical and indexed to inflation. It deserves an economic moat thanks to efficient scale and the duration of the concessions, which are intangible assets. Water technologies account for about 25% of the water division. We believe it exhibits an economic moat thanks to switching costs as the business exhibits ''razor-and-blade'' features driving highly recurring revenue.

No-moat Veolia held a presentation of its US business in New York on April 18, a field trip to its largest water treatment facility in New Jersey and to its largest US hazardous waste facility on April 19 in Port Arthur. We attended all of those, along with a few investors and another sell-side analyst. We confirm our EUR 32.50 per share fair value estimate. Shares are undervalued as the market neglects Veolia’s structural growth drivers.

Veolia Environnement is the world's largest water company. Treatment and distribution of water accounts for about 40% of the turnover. It comprises water concessions in France and regulated water businesses in the US, Chile, and Catalonia. The water activity is uncyclical and indexed to inflation.

European utilities have reversed their outperformance in the fourth quarter of 2023 because of a fall in wholesale power prices in the wake of gas prices after a very mild winter, and a pickup in interest rates due to inflation receding more slowly than expected. The former led to some of the companies, most exposed to power prices, cutting their guidance for 2024.

We confirm our EUR 31 fair value estimate after no-moat Veolia released 2023 results in line with the company-compiled consensus and our expectations and disclosed its new three-year strategic plan that includes 2024 and 2027 financial targets also roughly in line with expectations. The firm will pay a dividend of EUR 1.25 on 2023 results, 12% above last year and implying a 4.2% yield, lower than the sector's average. However, Veolia intends to grow the dividend in line with EPS through 2027, involving a high-single-digit growth rate, higher than most utilities. Shares appear fairly valued.

No-moat Veolia announced an acceleration of investments in its energy business to leverage energy transition opportunities. The group will release its full-year 2023 results and hold its triennial capital markets day on Feb. 29. We anticipate a 10% rise in the synergies target from the Suez integration due to the advance already taken. Nonetheless, this seems to be priced in as shares now trade in 3-star territory. We recommend waiting for a pullback to buy the shares. We maintain our fair value estimate of EUR 31.

European utilities are up by 14% year to date, slightly underperforming the broader European markets. Since the end of September, the sector strongly outperformed thanks to the rally in government bonds and solid third-quarter results that drove multiple guidance upgrades although growth slowed down from the second quarter due to higher comps. All in all, companies that are the most exposed to commodity prices are set to exceed their 2022 record profits in 2023. Meanwhile, firms with big retail businesses that were hit by a margin squeeze because of the energy crisis in 2022 will post a significant rebound in earnings.

We confirm our EUR 31 fair value estimate after no-moat Veolia released solid 9-month results and confirmed its 2023 earnings guidance. Veolia also indicated that its net debt position will be lower than it previously expected at year-end, but in line with our expectations. Shares have slipped recently owing to concerns over the impact of the economic slowdown on the group. This offers an entry point for investors as the group has proved in the past that it can increase cost savings in such a situation. Also, the weight of cyclical activities is lower than in the past at 15% of turnover. We forecast a 2023 dividend of EUR 1.22, 9% above 2022, implying a 4.6% yield.

Veolia Environnement SA is the world's largest water company. Treatment and distribution of water accounts for about 40% of the turnover. In France, where Veolia is the historical leader, the business has been affected by a wave of contract renewals since 2010, which reduced profitability, but the bulk of those renewals is over.

We don't plan to materially change our EUR 30.50 fair value estimate after no-moat Veolia released solid first-half results, though they were in line with the company-compiled consensus and management increased its 2023 EBITDA guidance. Shares are trading in 3-star territory.

Veolia Environnement SA is the world's largest water company. Treatment and distribution of water accounts for about 40% of the turnover. In France, where Veolia is the historical leader, the business has been affected by a wave of contract renewals since 2010, which reduced profitability, but the bulk of those renewals is over.

We don't plan to materially change our EUR 30.50 fair value estimate after no-moat Veolia released solid first-quarter results albeit in line with the consensus it polled at the EBITDA level and maintained its 2023 guidance. Shares are in 3-star territory.

We don't expect to materially change our EUR 30.5 fair value estimate after Veolia released 2022 results above consensus it polled for the bottom line, set 2023 guidance in line with consensus, and confirmed its 2024 target. The group will pay a dividend of EUR 1.12 on 2022 results, 12% higher than the previous one and implying a 4% yield. Shares are in 3-star territory.