A_López-VEOLIA_ENVIRONNEMENT_(VIE.FP)_DOWNGRADE_TO_N(V)：INCREASED_TAX_IN_FRANCE_COMPOUNDS-2012-10-11.ppt

,9.00,8.33,8,analyst,17934,5,679,4,349,100,company report,nat resources & energy multi-utilities equity france,abc global research,veolia environnement (vie fp),neutral (v) target price (eur) share price (eur) potential return (%) note: potential return equals the percentage difference between the current share price and the target price dec 2011 a 2012 e 2013 e,downgrade to n(v): increased tax in france compounds challenging economic climate transformation in progress, but business hit by deterioration in economic environment and changes in french taxation,hsbc eps hsbc pe performance absolute (%) relative (%),0.58 14.3 1m -10.1 -9.0,0.49 17.0 3m -7.9 -15.6,0.86 9.7 12m -22.3 -31.2, target price reduced to eur9 from eur11.5 on the back of revised estimates; lower peer group multiples; higher beta; and higher tax; rating downgraded to neutral (v),note: (v) = volatile (please see disclosure appendix) transformation in progress: by the end of 2012 we estimate that veolia will have reduced its debt from eur14.7bn at the half year to eur11.6bn through selling uk water and us solid waste and deconsolidating its transport jv (vtd) and berlinerwasser debt. this gives it,9 october 2012 verity mitchell*,the scope to invest in future growth. an upcoming catalyst is the announcement of the appointment of a new chief operating officer expected imminently. this is important to,veolia: the coo will manage the asset disposal process and reduce costs in france. hsbc bank plc,+44 20 7991 6840 adam dickens* analyst hsbc bank plc +44 20 7991 6798 jos a lpez* analyst hsbc bank plc +44 20 7991 6798 view hsbc global research at: *employed by a non-us affiliate of hsbc securities (usa) inc, and is not registered/qualified pursuant to finra regulations issuer of report: hsbc bank plc disclaimer & disclosures this report must be read with the disclosures and the analyst certifications in the disclosure appendix, and with the disclaimer, which forms part of it,france challenges to earnings growth: investors are sceptical that veolia can deliver cost cutting in france despite managements assurances that staff reductions will largely be achieved through retirement or voluntary redundancies. the market will be looking closely at whether it is able to fulfil its cost cutting promises and also whether contracts will be renewed at lower margins and returns. industrial and commercial production in europe remains depressed and low recyclate prices offer little positive news for 2013 earnings. political risk perception is also much higher than we have seen previously due to the change in taxation charges in france. any growth in earnings ex france will restore confidence that veolia is able to diversify political risk. tp cut to eur9 from eur11.5 on the back of revised estimates; rating downgraded to neutral (v). we use the average of three valuation methods to value veolia: dcf, ddm and sum-of-parts based on peer group multiples. our revised target price is now eur9 (from eur11.5), on the back of revised estimates and updated peer group multiples because: in its 1h result, veolia flagged that weakness in certain industrial sectors affected the business of the environmental services division, and we include new french dividend tax and reduced tax allowances on debt downgrading earnings. veolia will have to deliver several quarters of recurring operating profit before investors are confident about the investment proposition. index sbf-120 enterprise value (eurm) index level 2,660 free float (%) ric vie.pa market cap (usdm) bloomberg vie fp market cap (eurm) source: hsbc source: hsbc,veolia environnement (vie fp) multi-utilities 9 october 2012 financials & valuation financial statements,valuation data,abc,year to,12/2011a,12/2012e,12/2013e,12/2014e,year to,12/2011a,12/2012e,12/2013e,12/2014e,profit & loss summary (eurm),ev/sales,0.7,0.6,0.6,0.6,revenue ebitda depreciation & amortisation operating profit/ebit net interest pbt,29,647 3,152 -1,452 1,700 -748 212,28,719 2,567 -1,072 1,494 -781 714,29,190 2,729 -1,165 1,564 -695 869,30,110 3,032 -1,463 1,569 -691 879,ev/ebitda ev/ic pe* p/book value fcf yield (%) dividend yield (%),6.8 1.2 14.3 0.6 -4.0 8.4,7.0 1.3 17.0 0.6 60.2 8.4,6.4 1.2 9.7 0.6 6.0 8.4,5.7 1.2 9.0 0.6 -1.2 8.4,hsbc pbt taxation net profit hsbc net profit,-188 -541 -490 290,394 -207 506 256,696 -356 503 453,750 -384 487 487,note: * = based on hsbc eps (fully diluted) price relative,cash flow summary (eurm),30,30,cash flow from operations capex cash flow from investment dividends change in net debt fcf equity,1,824 -2,089 -1,138 -547 -488 -268,1,853 2,245 2,339 -421 -3,138 3,819,1,809 -1,329 -1,348 -419 -82 351,2,041 -2,024 -2,023 -435 377 -62,25 20 15 10,25 20 15 10,balance sheet summary (eurm) intangible fixed assets 11,706 tangible fixed assets 8,488 current assets 18,692,11,706 4,520 22,076,11,706 4,153 22,356,11,706 4,214 22,365,5 2010 veolia environnement source: hsbc,2011 rel to sbf-120,2012,5 2013,cash & others,5,724,9,498,9,579,9,202,total assets operating liabilities gross debt net debt shareholders funds invested capital,50,406 14,908 21,089 14,730 7,070 18,254,50,188 14,514 21,089 11,592 7,221 14,291,50,601 14,714 21,089 11,510 7,408 13,921,51,170 15,105 21,089 11,887 7,565 13,977,note: price at close of 05 oct 2012,ratio, growth and per share analysis,year to,12/2011a,12/2012e,12/2013e,12/2014e,y-o-y % change,revenue ebitda operating profit pbt hsbc eps,3.1 -4.9 -14.2 -81.1 -40.7,-3.1 -18.6 -12.1 236.1 -16.1,1.6 6.3 4.7 21.8 75.8,3.2 11.1 0.3 1.1 7.0,ratios (%),revenue/ic (x) roic roe roa ebitda margin operating profit margin ebitda/net interest (x) net debt/equity net debt/ebitda (x) cf from operations/net debt,1.5 -11.9 3.9 -2.7 10.6 5.7 4.2 149.8 4.7 12.4,1.8 5.9 3.6 2.3 8.9 5.2 3.3 115.8 4.5 16.0,2.1 6.7 6.2 2.0 9.3 5.4 3.9 112.6 4.2 15.7,2.2 6.7 6.5 1.9 10.1 5.2 4.4 114.3 3.9 17.2,per share data (eur),eps reported (fully diluted) hsbc eps (fully diluted) dps book value,-0.99 0.58 0.70 14.24,0.97 0.49 0.70 13.83,0.96 0.86 0.70 14.10,0.92 0.92 0.70 14.31,2,veolia environnement (vie fp) multi-utilities 9 october 2012 challenging economic climate asset sales nearly completed, debt deconsolidated external challenges from economic climate and french austerity measures tp reduced to eur9 from eur11.5 on the back of revised estimates; lower peer group multiples; higher beta; and higher tax; rating downgraded to neutral (v),abc,transformation in progress by the end of 2012 we estimate that veolia will have reduced its debt from eur14.7bn at the half year to eur11.6bn through selling uk water and us solid waste and deconsolidating its transport jv (vtd) and berlinerwasser debt. the appointment of a new chief operating officer expected imminently is important to veolia as it will allow the chairman and ceo to focus on the strategic priorities of the group, identifying geographies and divisions that will allow veolia to grow profitably in the future. the coo will manage the asset disposal process and reduce costs in france this will require careful planning so as to persuade the french authorities than veolia remains committed to support french employment. external challenges from economic climate at the 1h results in august 30% of the group revenues were driven by environmental services for veolia. management reported negative impacts on its waste businesses (environmental,services division) due to the deterioration of the economic environment a 5.7% fall in revenue at constant consolidation scope and exchange rates, versus a 1.1% decline in the first quarter. we contend that there is continuing weakness in certain industrial sectors which affects the business of the environmental services division, particularly in france, the united kingdom and germany. we set out below the outlook for ip which suggests that european growth may resume in 2013, especially in germany. globally, china a focus market for veolia and india provide scope for growth in industrial activities. although management remains cautious about 2013 prospects, there also may be some opportunities for revival in the waste management businesses. geographically diversified portfolio future hope? we set out below the revenue split of the two french water companies veolia and suez environnement (sevi.pa, neutral, eur8.55) ,3,veolia environnement (vie fp) multi-utilities 9 october 2012 asia: ip growth,europe: ip growth,abc,16% 12% 8% 4% 0% -4%,c hina india australia hk,6% 4% 2% 0% -2% -4%,germany uk f ranc e,1q 12a,2q 12e,3q 12e,4q 12e,1q13e,2q 13e,1q 12a,2q 12e 3q 12e,4q 12e,1q13e 2q 13e,c hina,hk,australia,india,euroz one f ranc e,germ any uk,source: hsbc estimates and the gdp growth estimates for 2013 in those markets. we note that both veolia and suez environnement have similar exposure to the other european markets, apart from their home country. revenue split in 1h 2012 and gdp growth 2013e,source: hsbc estimates environnement) and veolia environnement to increase prices even as volumes in the uk decline. it has also precipitated the signing of a number of very significant long-term integrated waste management contracts. these will underpin 2013 earnings for these companies and there are a,50%,4.8%,5%,further significant number of public private,40% 30% 20% 10%,1. 3%,1. 5%,1.8%,2.5%,4% 3% 2%,partnerships (ppp) waste contracts that will be let in the next two to three years. veolia may use the proceeds from its uk water sale to reinvest in building new waste facilities with more resilience to waste volumes and with access to renewable,0%,1%,subsidies for energy from waste.,f rance germany vie sevi,uk as ia pac gdp grow th 2013e,row,low recyclate prices persist,source: company data, hsbc estimates veolia will need to focus in growing its business in higher growth markets in asia pacific and uk. uk a growth opportunity: water and waste management have been identified by the uk government as being of strategic importance in economic recovery. the uk has an aggressive approach to ensuring a decrease in the volumes of waste sent to landfill through a ratcheting up of the landfill tax from its current level of gbp48 per tonne to gbp80 by 2015. this has allowed the uk divisions of waste management companies under our coverage viridor waste (pennon pnn.l, neutral, 731p), sita (suez 4,we set out below the recent trend in prices of paper and plastic in uk as a proxy for the global trends. we see the deterioration in h1 has not continued so this may stabilise h2 revenues. we expect margin stability for h2. 2012 response from the company we look to veolia to update the market at q3 on the progress of the accelerated programme of cost cutting announced at h1. reduction of investments by eur500m in 2012-2013. eur50m in additional targeted net cost reductions, with an increase to eur170m,veolia environnement (vie fp) multi-utilities 9 october 2012 uk domestic mill prices (gbp per tonne) 120 105 90 75,plastic film (gbp per tonne) 180 155 130 105,abc,60 45 30 apr-12 may -12 jun-12 sorted office w aste mix ed papers,jul-12,aug-12 sep-12 new s and pams old kls (cardboard),80 55 30 apr-12 may -12 export 80:20,jun-12 jul-12 export 90:10,aug-12 sep-12 ex port 95:5,source: l (from eur120m) in 2013 and to eur470m (from eur420m) in 2015. other objectives for 2012-13 asset disposals of eur5bn. 60% of this is already signed or completed. reduce the group net financial debt below eur12bn. dividend payment of eur0.70 for fy2012. other objectives post-2013 organic revenue growth of over 3% p.a. growth in adjusted operating cash flow of over 5% p.a. debt leverage ratio (net financial debt/(operating cash flow before changes in working capital +principal payments on operating financial assets) of 3.0x. return to a dividend payout ratio in line with the companys historical average. french taxation recent share price weakness of veolia relative to our european universe has been exacerbated in our view by increases in taxation of corporates in france. we have increased the taxation on dividends in line with the governments policy of 3%, representing a eur16m hit to net income. there are also proposed reductions in tax,source: l allowances on interest which may have more of a material effect on veolia in the future. change in estimates we have revised our estimates based upon a much more pessimistic view of earnings growth in veolias businesses after the h1 results. in addition we have incorporated the increase in number of shares outstanding as a result of the option of scrip dividend for 2011 diluting eps. there are three permutations of changes in estimates: those that are a function of reduced underlying profits from the deteriorating economic conditions we highlight above. this is clearly indicated in the reduction in ebitda. change in scope we are removing the contribution from berlinerwasser from ebitda and ebit as veolia post rwes sale will hold only a 25% stake. this however is equity accounted. the change in scope also reduces net debt as we assume the debt from vtd and berlinerwasser is now deconsolidated, thus reducing the interest charge. we also assume a further ceur900m proceeds from non-core disposals in 2013 which we net off against our eur2.5bn investment assumption.,5,2013e,new,veolia environnement (vie fp) multi-utilities 9 october 2012 french corporate tax changes. we include the 3% tax on dividends in our estimates. we are also assuming a lower tax allowance for interest for 2013 and 2014. in our sop we are using a lower waste peer group ebitda multiple as we have removed us waste given that veolia has sold its solid waste business in the us. us waste traded at over 6x compared to the european peers at c4.9x. veolias observed adjusted beta according to bloomberg has increased from 1.1 to 1.2 in our view this reflects increased political risk,we have cut our dividend growth assumption of 5% in 2013e to zero to keep it constant at eur0.70. with the additional tax incidence of 3% on dividend distribution, veolia will have to be more prudent about dividend growth. we have also cut our terminal dividend growth rate from 3% to 2%. we have increased our adjusted beta from 1.1 to 1.2. in our stage 2 dcf valuation we have increased our ebitda margin from 9% to 9.2% reflecting the effect of positive cost cutting measures. under our research model, the neutral band for stocks with a volatility indicator is 10ppts above,abc,change in estimates (eurm) 2012e 2012e % new old change,2013e % old change,and below the hurdle rate of 9.0% for eurozone stocks. our target price implies a potential return of 8%, which is within the neutral band; therefore, we,ebitda ebit net income eps (eur),2,567 1,494 256 0.49,3,028 1,681 322 0.63,-15% -11% -21% -22%,2,729 1,564 453 0.86,3,088 1,564 422 0.83,-12% 0% 7% 4%,downgrade our rating to neutral (v). potential return equals the percentage difference between the current share price and the target price, including,source: hsbc estimates target eur9 from eur11.5, rating cut to neutral (v) we use the average of three valuation methods to value veolia: dcf, ddm and sum-of-parts based on peer group multiples. our revised target price is eur9, down from eur11.5 previously, on the back of updated peer group multiples and revised estimates. we have cut our ebitda estimates for underlying business performance but also because we are deconsolidating belinerwasser from 2013. this has affected our sum-of-parts valuation. in addition our sum-of-parts is negatively affected by updated peer group multiples and revised estimates. 6,the forecast dividend yield when indicated. restoring the faith will take time and effort investors in the europe and the us we have talked to are nervous about further fiscal measures in france, so veolia faces an additional risk premium external to its own business. industrial and commercial production in europe remains depressed and low recyclate prices offer little positive news for 2013 earnings. we continue to expect that veolia will have to deliver several quarters of recurring operating profit before investors are confident about the investment proposition. in addition, any growth in earnings ex france will restore confidence that veolia is able to diversify political risk.,8.5,veolia environnement (vie fp) multi-utilities 9 october 2012 change in tp (eur),abc,12 10,11.5,0.7,9.0,8 6 4 2,0 -2,-1.2,-0.6,-0.4,-0.7,old tp,change in,ddm/div idend,beta change,dcf stage2,sotp multiples,new tp,estimates,grow th,assumptions source: hsbc estimates,risks to our rating,wacc inputs and dcf valuation,downside risks: a continued cyclical downturn in waste volumes in 2013; falling volumes/prices in this segment may not be balanced by growth in other parts of the waste value chain; risk of losing contracts in france to the competition or because of insourcing by municipalities; and margin erosion through price escalation. also further negative fiscal measures in france. in the medium term the risk is that veolia fails to achieve cost,wacc inputs cost of debt pre-tax cost of debt marginal tax rate cost of equity risk-free rate equity risk premium additional risk beta was 1.1 debt - 83% equity - 17% cost of capital source: hsbc estimates,6.0% 35.0% 3.0% 6.0% - 1.20 3.9% 10.2% 5.0%,equity valuation + dcf value + st marketable assets + value of associates + other assets ev (asset side) - net debt (+ if net cash) - quasi debt (pension) - value of minorities total non-equity claims value of equity value per share (eur),eur m 11,336 357 2,092 5,910 19,695