The sovereign debt crisis has led to price anomalies between comparable stocks listed in Britain and on the Continent. Over the past six months, the UK utilities index, being a natural safe haven at times of stress, has broadly flatlined. That’s not the case in Europe, where shares in Suez Environnement, Europe’s second-largest water and waste (50:50 split) operator, have dropped 30%. This fall presents an opportunity because it seems more driven by sentiment than substance. However, there are a couple of issues to watch for.
Trading in the third quarter was hit when the firm took a one-off €185m charge relating to the construction of Australia’s biggest desalination plant in Melbourne. The project has been dogged by strike action and poor weather, but is now more than 80% complete. Once it becomes fully operational under a 30-year agreement, the new facility should be able to pump 450,000 cubic metres of sea water a day – boosting Suez’s top line by €1.6bn a year. The rest of the group is ticking along nicely, however. Jean-Louis Chaussade, the chief executive, announced a 7.1% jump in like-for-like sales to €10.9bn for the nine months to September, producing an EBITDA (EBITA adjusted for depreciation) of €1.8bn and margins of 16.8%.
A second worry relates to the possible impact if Europe lurches back into recession. The danger is that, if GDP shrinks, lower industrial waste volumes and water consumption would damage earnings in the firm’s treatment, collection and recycling businesses. Declining commodity prices could also dent proceeds from its reclaimed materials, further squeezing margins. That said, there was little evidence of this in October, with the European waste arm posting organic growth of 9.7% in the year to date.
Suez Environnement (Paris: SEV), rated a BUY by Espirito Santo
Neither issue should detract from the powerful forces driving the company’s long-term heath. These include ongoing urbanisation in developing nations, the rise in environmental regulations and the scarcity of natural resources (such as drinking water) in China. There is also increasing political awareness of water scarcity in its most important markets – both France and Spain suffered protracted droughts over the summer.
Attractive business opportunities for Suez are sprouting up in Europe as governments seek to reduce their debt piles and privatise their domestic water interests. The UK did this in the 1980s, and Spain is shortly planning to do the same. Many Spanish cities, including Madrid, are aiming to dispose of their municipal services to both urgently raise cash, and secure the vital investment needed to bring them in line with new EU rules on water quality.
Analysts are penciling in turnover and EBITDA of about €14.6bn and €2.2bn respectively. A 6.5% dividend yield is also on offer. I rate the group on seven times EBITDA. After adjusting for net debt of €7.8bn, that produces an intrinsic worth of about €14.50 a share.
Finance group Espirito Santo has a price target of €17.50, and annual results are scheduled for 8 February.
Rating: BUY at €9.94