Finding Value in Europe's Waste

 | May 01, 2012 | 3:30 PM EDT
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The adage "One man's trash is another man's treasure" couldn't be more true of Veolia Environment (VE), a Paris-based global provider of environmental and waste-management services. Veolia is a hybrid utility and waste-management business.

The company has three operating segments: water, environment and energy services. The water segment manages and operates large-scale and customized drinking-water plants, wastewater decontamination and recycling plants, drinking-water distribution networks and wastewater collection networks. In addition, Veolia also designs and builds the infrastructure necessary to provide water services. The environment segment offers waste management and collection services. The energy segment operates and manages industrial utilities as well as other ancillary services to related industries.

Veolia's operations span the globe, including the U.S., Kuwait and Canada. The company is the midst of a significant divestiture of assets so it can de-leverage itself, reduce capital expenditures and generate free cash flow. In the last three years, the company has divested more than $5 billion worth of assets, and it aims to divest another $6 billion to $7 billion over the next three years. Net debt has decreased from more than $22 billion in 2008 to less than $20 billion today. By the end of 2012, Veolia hopes to eliminate another $3 billion in debt.

Veolia is also developing its business operations. It's focusing on initiatives such as treating the most difficult and dangerous pollutants, serving the largest public facilities and proposing solutions to scarcities. In essence, the company is shifting its focus from supply markets to demand markets. This is leading Veolia to secure profitable long-term contracts, such as a $2 billion, 25-year waste-to-energy project in the U.K., a $2 billion, 30-year energy project in Montreal and a partnership with the City of New York to optimize the city's water services.

Despite a challenging year in 2011, all three of Veolia's segments managed to generate positive sales growth, and the company generated $540 million in free cash flow. If it can continue executing on its efforts to eliminate debt, reduce expenditures and focus on high-demand projects, then investors today have a golden opportunity to take advantage of the selloff in Europe to own a high-quality business.

Shares in Veolia trade for $14, off from $30 a year ago. Since nearly 80% of the company's revenue comes from Europe and France, it's easy to understand the selloff. But the company continues to expand its footprint outside Europe.

The company has the ability to generate tremendous cash flow in future years. And that cash is coming back to shareholders: At current prices, shares yield a whopping 10%. That yield is more than three times the yield of Waste Management (WM) or any other large-scale waste management company. Given Veolia's current leverage, the market seems to believe that the dividend will go away or in all likelihood be reduced. Even if it's reduced by half, the yield would still be 5%.

More so, shares look cheap on a long-term basis, trading at 80% of book value. To be sure, the company certainly needs to reduce its debt, and management is spot-on to do so at this juncture. Waste is a stable business with stable cash flows, so Veolia is in a good spot to continue reducing debt and paying a juicy yield. And with shares trading this low, the long-term total return is likely to more than compensate for the risk assumed.


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