Thursday September 08, 2011
by Nathan Slaughter, editor Scarcity & Wealth
When it comes to water-related services, France's Veolia (VE) is the biggest fish in the ocean.
The company has operations on all seven continents and works with customers in nearly 70 countries, providing clean drinking water to more than 100 million customers.
Veolia is actively involved in the design and construction of water treatment facilities. Its seawater desalination plant in Bahrain is the biggest in the Middle East. And its Ashkelon reverse-osmosis facility in Israel is the largest of its kind in the world.
The company's strategy also includes partnering with local municipalities. This setup allows the company to hang on to its cash but still rake in heavy recurring revenues.
Veolia has formed these types of alliances all over the world, from Tampa to Shanghai to Paris (where the company oversees the city's 142 water districts).
But there is still plenty of upside in this under-penetrated market. According to Morningstar, just 10% of the U.S. water market is outsourced.
The remaining 90% is still handled directly by municipalities, most of which are deeply in debt and looking to shave red ink from the budget.
Handing over the reins to an experienced manager like Veolia can cut costs by up to 30% and save millions in annual expenses.
Even in a deteriorating global economy, every major city in the world still has to provide basic sanitation and water distribution on a daily basis.
And Veolia typically signs long-term concessions of up to 20 years, which makes for sticky revenue and predictable cash flow.
The company collects more than $50 billion in annual revenues, yet has a market value of just $8 billion. That gives the stock a microscopic price-to-sales ratio of 0.16.
A price-to-book ratio of 0.73 and a price/earnings-to-growth Ratio (PEG) of 0.5 tell the same story -- this is one sharply underpriced stock.
Once valued at more than $95 per share before the recession, VE sunk below $15 last week. Part of the problem is that utilities across the pond have struggled amid Europe's economic slump and budget woes.
But there are also company-specific concerns that have weighed on the stock, including lowered earnings guidance, large asset write-downs, and even accounting improprieties.
The bigger worry is the firm's hefty $20 billion net debt load, much of which comes due in the next few years and may have to be refinanced at higher rates.
These are all valid concerns that must be weighed carefully. But with a price in the mid-teens, these threats have been greatly over-exaggerated.
With the shares trading at half their $34 peak from just a few months ago, the potential triple-digit upside rewards more than outweigh the risks.
Veolia has been in business for more than 150 years. And the company isn't exactly foundering. In fact, it churned out $2.5 billion in operating cash flow during the first half of fiscal 2011.
Much of that income is ladled out to shareholders. This past May, investors were treated to a distribution of $1.71 per share, for a lofty yield of 10.7%.
That level suggests the market is bracing for a dividend cut. I wouldn't rule out the possibility, but even if payments are halved, you can still lock in 5% payout at today's prices.
Action to Take --> I see no reason Veolia can't return to $30 within the next couple years and remain a global leader for decades thereafter.
Learn more about this financial newsletter at Nathan Slaughter's Scarcity & Wealth.