To research a book that Real Money contributors Tim Melvin, Roger Arnold and I are writing together, I've spent a lot of time thinking about water, energy and utility stocks. In particular, I've spent a fair amount of time reviewing the intersection of water and electricity.
As background, two critical success factors for emerging economies are electric power and water. No country can sustain a growing economy unless both commodities are widely available. China understands this dynamic and is aggressively building infrastructure.
When it comes to water and energy, one company China might want to look at is Veolia Environmental (VE), the world's largest water company. And being the world's largest is one of Veolia's challenges.
Recently there has been a change in management, and the new crew has concluded that Veolia grew too fast, assumed too much debt and found itself operating in some of the wrong markets. As a result, Veolia is adjusting its strategic plans, trimming back regions and selling assets. It will try to do this without jeopardizing the dividend.
Last year, Veolia's dividend was an incredible €1.21 per share (or approximately $1.70). Be careful, there are analysts who believe the company could cut the payout. But it may not right away: Reuters recently reported that Veolia's board "confirmed it would maintain a high dividend pay-out ratio."
There is good reason to believe the dividend won't be slashed -- at least not right now. It is difficult for any board of directors to reduce dividends. Shareholders rely on utilities for income; when a utility announces it may reduce dividends, it puts a huge black mark on the company, shareholders flee and a rougher crowd takes their place.
But anyone thinking Veolia is just a utility would be making a big mistake. While Veolia does own a large water utility subsidiary, it is also owns a waste management subsidiary, an energy services subsidiary and a transportation subsidiary. Together, these subsidiaries operate in 77 countries and have 317,000 employees.
One subsidiary that could make the challenge to the dividend a little easier is the energy services subsidiary. In France, this subsidiary is called Dalkia. In the U.S., it is referred to as Veolia Energy. In either case, Dalkia's origins are connected to Electricite de France SA (EDF), which currently owns 34% of the subsidiary.
Over the last several years, Dalkia acquired two energy companies, Thermal North America and Trigen Energy. This combination provided Veolia with a significant footprint in the North American energy markets. With these acquisitions, Dalkia can offer district energy, combined heat and power, facility operations and renewable energy capabilities. Collectively, these activities represent approximately 22% of Veolia's 2009 revenues.
Several companies compete against Dalkia. Chief among them is Pepco Energy Services, the non-regulated subsidiary of Pepco Holdings (POM). In fact, prior to Veolia's acquisition of Trigen, Pepco Energy Services and Trigen partnered in district energy projects.
This raises a critical point about Veolia: While the company may be the world's largest water company, most of Veolia's revenues of are not derived from water utilities. In fact, only 35.8% of the company's 2009 revenue came from water utilities. Perhaps this explains why Veolia's stock prices are more volatile than the average utility -- it isn't a real utility.
If an investor's strategy is to focus on water utilities, then Veolia is not the right company. Instead of Veolia, he should consider American Water Works (AWK) and Aqua America (WTR). American Water has a market capitalization of $4.1 billion and a dividend yielding almost 3.3%. Aqua America has a market capitalization of $2.9 billion and a dividend yielding almost 3%. Both companies limit their operations to North America and their services to water and wastewater.
But if investors find Veolia's 11% dividend too attractive to pass up, perhaps the company's range of services and large geographic footprint can mitigate some of the inherent risk. Veolia represents an interesting intersection of energy and water, but it is not a utility.
Be careful. Institutions have largely ignored Veolia. Their shares are currently trading below the 50-day and 200-day moving averages. The yield serves as a warning; the market believes Veolia's dividend is unreliable. Investing in Veolia for dividends is speculation.