Utilities. Fighting for growth INDEPENDENT RESEARCH. Utilities

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1 INDEPENDENT RESEARCH 30th September 2014 Utilities Utilities Fighting for growth VEOLIA ENVIRONNEMENT BUY FV EUR17 Bloomberg VIE FP Reuters VIE.PA Price EUR High/Low / Market Cap. EUR7,639m Enterprise Val EUR16,081m PE (2014e) 40.1x EV/EBIT (2014e) 17.7x We are initiating coverage of the French Environmental Services sector with a BUY recommendation for Veolia Environnement (Fair Value of EUR17, 24% upside potential) and a NEUTRAL rating for Suez Environnement (Fair Value of EUR14, 7% upside potential). SUEZ ENVIRONNEMENT NEUTRAL FV EUR14 Bloomberg SEV FP Reuters SEVI.PA Price EUR13.11 High/Low 15.42/11.99 Market cap. EUR7,082m Enterprise Val EUR17,763m PE (2014e) 23.8x EV/EBIT (2014e) 14.1x 29/09/ Source Thomson Reuters STOXX EUROPE 600 UTILITIES E STOXX EUROPE 600 Mature markets in Europe: In structural terms, both the waste and water markets in Europe offer limited upside to Suez Environnement and Veolia. While direct exposure to the European economic cycle should tend to soften due to the increasing share of international activities, both entities have to play it by hear in Europe given the low visibility on a potential industrial recovery. Our estimates are not based on a strong rebound (only +0.4%/year) in European waste volumes implying that any surprise in the region could drive up our earnings. In contrast, a fresh downturn (-1% in waste volumes) would negatively impact our earnings by an average 5%. Fighting for growth through new services: Markets are mature in Europe, yet both environmental and economic constraints for industrials may create strong upside for entities like Veolia and Suez Environnement, especially in the Oil & Gas and Mining markets. VIE is currently better positioned than SEV, especially in the Industrial water market (EUR1bn sales vs. EUR300m) and therefore offers stronger upside on its earnings. Earnings growth only matters: In such a deflationist European market, growth is only set to stem from 1/new services, 2/international development and 3/fixed cost reductions. Although both groups are addressing these three earnings growth drivers seriously, Veolia currently appears to offer stronger upside than its French peer Suez Environnement, which has already achieved solid profitability levels. We favour Veolia over Suez Environnement: After comparing both entities on several metrics/criteria, we deduce that VIE currently offers stronger upside potential than SEV (EPS CAGR 14-24e at 23.1% for VIE vs. 12.6% for SEV). Risk/reward seems more appealing for VIE which offers 24% upside vs. only 7% for SEV. Analyst: Xavier Caroen 33(0) xcaroen@bryangarnier.com r r

2 Utilities Table of contents 1. Fighting for growth Suez Environnement vs. Veolia Profitability Margin & ROCE evolution Earnings and dividend growth Leverage & balance sheet Geographical exposure Both groups still too highly exposed to Europe Development in international activities remains a key driver Sensibility to economic recovery in Europe Sensibility analysis Europe could be a driver, but not today Valuation & share price performance Historical Valuation Veolia vs. Suez Environnement Share price performance Risk reward more appealing with VIE Veolia Environnement (BUY, FV EUR17) Heading into the right direction Suez Environnement (NEUTRAL, FV EUR14) Fairly valued Bryan Garnier stock rating system... 95

3 Utilities 1. Fighting for growth Despite being positioned on different markets and through different subsidiaries, Suez Environnement and Veolia are always seen by the market as pure competitors in both the waste and water markets. Still heavily exposed to Europe (74% of sales are generated in Europe for Veolia, post Dalkia deal; 72% for Suez Environnement) and in particular to France (34% for Veolia; 37% for Suez Environnement) both groups are operating in mature areas where waste and water volumes are under pressure, as are prices, forcing these players to fight for new markets and new services. Today only a third of Veolia and Suez Environnement's revenues are generated with industrial customers whereas two thirds is still generated with municipalities where competition and pricing pressure is stronger. Further development with industrials is therefore set to be key for Suez Environnement and Veolia, given that in addition to the higher earnings growth it could generate compared with contracts with municipalities, this should also reduce the level of capex needed by projects, given that industrial clients are likely to remain owners of the assets. Recent industrial contracts won by both entities in H and in H clearly confirm the strong interest from major companies to work with water, waste and waste treatment experts, especially from Oil & Gas and Mining industries; two markets estimated by Veolia at EUR20bn each by Through their international subsidiaries, both groups are therefore set to fight for further growth, while in more mature markets (Europe mainly) they will mainly benefit from regulatory changes pushing for a higher level of recycling processes in both the water and waste markets and for a higher level of services offered to both industrial and municipal customers. In this report we do not analyse the different growth potential markets the two groups will fight for, but focus more on comparing both entities (profitability, balance sheet, earnings growth, dividend yield...), with the aim of determining which one offers the most attractive risk/reward. We have assumed in our models that waste and water earnings are triggered by the following major trends: For municipalities: Growing demand in new regions Growing demand for more sophisticated solutions for cities in mature economies Energy efficiencies Circular economy Environmental constraints Contract privatisations 3

4 Utilities For industrials: Circular economy CSR change/environmental constraints Need for more energy efficiency Need for water access in growing areas (Oil & Gas, Mining) On top of these high growth potential markets/solutions, further fixed cost reductions will be needed and should clearly drive a strong part of the earnings growth we anticipate over the next 10 years for both entities (>15% e CAGR EPS BG). Our conclusion is that both groups are quite well positioned to benefit from growth from emerging markets, and from the shift to a greener usage of water while increasing usage of recycled materials in more mature markets. Based on our comparison, we conclude that Veolia currently offers a more attractive risk/reward than Suez Environnement (+24% upside on Veolia, versus 7% for Suez Environnement). We are initiating coverage of the French Environmental Services sector with a BUY recommendation for Veolia Environnement (Fair Value EUR17, +24% upside potential) and a NEUTRAL recommendation for Suez Environnement (Fair Value EUR14, 7% upside potential). 4

5 Utilities 2. Suez Environnement vs. Veolia In this section we compare both entities on different criteria (margin, geographical exposure, growth potential, dividend payout...) to get a clear picture of each stock in both the water and waste sectors and to see which is better positioned to generate earnings growth, and most importantly to offer upside to investors. The conclusion from this analysis is summarised below (table and graph). Fig. 1: Radar comparison Veolia vs. Suez Environnement We grade a 2 when we judge Veolia or Suez Environnement is better positioned than its French peer Upside to current share price Sensibility to economic recovery in Europe Leverage Profitability Exposure to Industrial Water Margin evolution Earnings growth Premium (+) /discount ( - ) vs. 5Y average Exposure to non-european markets Dividend yield Valuation Veolia Dividend growth Suez Environnement Through this graph we have identified twelve main metrics/criteria that we judge as determinant for the investment case: profitability, exposure to industrial Water, margin evolution, earnings growth, exposure to non-european markets, valuation & upside to historical average, dividend growth and dividend yield, sensibility to economic recovery in Europe, leverage and potential upside to current share price upside to current share price. We grade a 2 when we judge Veolia or Suez Environnement is better positioned than its French peer. We can deduce from this graph Suez Environnement is only better on three main criteria: sensibility to economic recovery, leverage and profitability. On all other criteria, Veolia offers either stronger upside or a better position. Below is an overview of the main metrics. Fig. 2: Main metrics VIE vs. SEV Veolia Suez Environnement LFL EBITDA growth 14e/15e 8.0% 5.0% Adjusted 2015e EBITDA margin 11.4% 18.2% Earnings growth potential (14-24e) - EPS CAGR 23.1% 12.6% Balance sheet e Gearing 81.7% 113.9% Leverage- 2015e Net debt/ebitda 3.03x 2.79x Dividend yield 2015e 5.1% 5.0% Adjusted EV/EBITDA 2015e 6.12x 6.47x Premium (+) /discount ( - ) vs. 5Y average -8.7% 1.1% 5

6 Utilities 2.1. Profitability Both groups are present in the waste and water markets through different structures, which makes it difficult to undertake a perfect comparison of the profitability of each of the businesses. At first glance, Suez Environnement clearly generates higher margins than Veolia (at all levels), but is close to its highest all-time profitability level achieved in 2007 and 2008 (EBIT margin of 8.8% and net margin above 4% at that time) while Veolia offers upside potential. In our model for 2014 we estimate Suez Environnement could generate restated EBIT margin of 7.8% compared with 4.4% for Veolia. We see five main reasons why Suez Environnement currently boasts higher profitability than Veolia: Lower exposure to French water market (Veolia is the leader in the market, implying higher sensitivity to pricing adjustments from major contract renegotiations). Consolidation of Agbar Chile in Water Europe, which massively boosts the business margin ( bp positive impact on EBITDA margin) thanks to a high profitability. Veolia does not boast such a gem in the sector. Lower sales to employees ratio (environmental revenues only), confirming the cost structure of Veolia is definitively too high for this business Higher exposure (slightly) to non-european markets where profitability is higher. Stronger cost-cutting gains, given that the plan started in 2010 while Veolia only started in 2012, despite a lower cost base. The cumulated net gain is estimated at EUR700m for Suez Environnement from 2010 to 2014 versus only EUR370m for Veolia (between 2012 and 2014). Fig. 3: Profitability level by firm 20.0% 18.0% 17.4% 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 10.5% 7.8% 4.4% 2.1% 0.8% SEV VIE 0.0% 2014e Restated EBITDA margin 2014e Restated EBIT margin 2014e Restated Net profit margin At present, Suez Environnement is better armed than Veolia with net margin more than double that at Veolia. 6

7 Utilities Fig. 4: Indicators explaining the difference in profitability (1/2) Environmental sales per employee (2013) EUR VIE SEV excluding Agbar SEV Public; 1.90% French water market, % by operator Others; 33.30% Saur; 10.80% Veolia; 34.50% Suez Environnement; 19.50% Fig. 5: Indicators explaining the difference in profitability (2/2) Fixed costs reduction annual net gain (EURm) EBITDA margin by business (%) % 25.0% 26.7% % % 10.0% 8.3% 11.4% 12.2% % e 0.0% Water Waste Fixed costs reduction SEV - net gain Fixed costs reduction VIE 2014e VIE EBITDA margin 2014e SEV EBITDA margin 7

8 Utilities 2.2. Margin & ROCE evolution What matters for investors most is not today s margin but tomorrow s. We consider Veolia has higher margin growth potential than Suez Environnement given 1/the delay in implementing cost reductions versus Suez Environnement, which has already achieved most of the cuts and 2/ the strategic change the group is entering through recent value-added acquisitions (Proactiva, Dalkia International). Restructuring efforts implemented by the group will start to bear fruit and will have a higher impact on the group s profitability given its low margin today. Fig. 6: EBITDA margin evolution SEV vs. VIE ( e) 20.0% 18.0% 16.0% 14.0% 12.0% 10.0% 8.0% e2015e2016e2017e2018e SEV EBITDA margin (lhs) VIE EBITDA margin (rhs) 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Fig. 7: EBITDA margin gain, SEV vs. VIE 4.5% 4.0% 3.9% 3.5% 3.0% 2.5% 2.0% 2.0% 1.5% 1.0% 0.5% 0.0% VIE SEV 8

9 Utilities Fig. 8: ROCE evolution VIE vs. SEV 12% 10% 8% 6% 4% 2% 0% e 2015e 2016e 2017e 2018e Veolia Suez Environnement Fig. 9: ROCE evolution by business VIE vs. SEV ROCE evolution by business - SEV ROCE evolution by business - VIE 14.0% 10.0% 12.0% 10.0% 9.0% 8.0% 7.0% 8.0% 6.0% 6.0% 5.0% 4.0% 4.0% 3.0% 2.0% 2.0% 1.0% 0.0% e 2015e 2016e 2017e 2018e 0.0% e 2015e 2016e 2017e 2018e Group ROCE after tax Waste Europe Water Europe International Group ROCE after tax Water Waste Energy 9

10 Utilities 2.3. Earnings and dividend growth Linked mechanically to margin growth, we see stronger upside at Veolia than at Suez Environnement. On top of the restructuring efforts both groups should continue making, we believe Veolia's EPS growth should outstrip margin growth, helped by a lower tax rate (tax credit generated over past years while France was loss making) and by a lower cost of debt. We see less upside at Suez Environnement in view of lower leverage and its healthier financial situation. We expect a 23.1% EPS CAGR for Veolia, versus 12.6% for Suez Environnement. In terms of dividend, we do not expect any growth before 2017 for both stocks given that the current payout ratio is already above the 65-75% market average. The stocks' yields are similar, except that Veolia is currently benefiting from healthy investor appetite for a script payment, which limits the cash-out impact. By 2015, we anticipate sufficient FCF growth at Veolia to finance in cash the EUR0.7 dividend payment we forecast, making this yield as safe as Suez Environnement. We bet on a 9.6% dividend CAGR for Veolia versus 6.1% for Suez Environnement. Fig. 10: EPS growth (BG definition) VIE vs. SEV e 2015e 2016e 2017e 2018e 2019e 2020e 2021e 2022e 2023e 2024e VIE EPS BG SEV EPS BG Fig. 11: Dividend growth VIE vs. SEV Dividend VIE vs. SEV Dividend yield VIE vs. SEV % % % 10% 8% 6% 4% % e 2015e 2016e 2017e 2018e Veolia dividend Suez Environnement dividend 0% e 2015e 2016e 2017e 2018e VIE Yield SEV Yield 10

11 Utilities 2.4. Leverage & balance sheet Leverage ratios have always been high in the industry given the hefty amount of capex needed to generate growth. Both groups suffered from the 2008 financial crisis, which affected private and industrial water demand and waste production, and then contributed to significantly increasing the group s leverage ratios (lower EBITDA, higher net debt due to lower earnings, and WCR swing). Suez Environnement was at that time in a better and healthier financial situation given its already higher profitability and its lower costs base. Veolia on the contrary had no choice but to enter into a massive disposals phase to optimise its balance sheet and generate greater flexibility to further invest in high growth potential areas/markets. Both entities are now entering into a net debt stabilisation phase given that value added M&A deals have become the key priority for the sector to accelerate market share gains. Leverage ratio is therefore under control with both entities aiming to remain close to the 3.0x net debt/ebitda limit. Through EBITDA growth and capex stabilization Veolia is even targeting to fully finance in cash its EUR0.7 dividend payment by We see no structural challenge on this side especially after the strong surge in sovereign rates which allowed entities like Veolia and Suez Environnement to reduce their cost of debt. We bet on a stabilization for Suez Environnement while see some further upside for Veolia which still have a net cost of debt of 5.1% at end of June (vs. 4.4% for Suez Environnement). Fig. 12: Net debt & Net debt/ebitda VIE vs. SEV VIE Net debt & Net debt/ebitda SEV Net debt & Net debt/ebitda x x x 4.00x 3.00x 2.00x 1.00x x 2.50x 2.00x 1.50x 1.00x 0.50x e2015e2016e2017e2018e 0.00x e2015e2016e2017e2018e 0.00x VIE net debt Net debt/ebitda SEV net debt Net debt/ebitda Source: Company Data; Bryan, Garnier & Co ests, On 24th September, Moody s confirmed its stable outlook on Veolia and its Baa1 rating following the fairly reassuring H figures published by the group. Potential upside could emerge if the group is able to achieve an RCF/net debt ratio of around 20% on a sustainable basis (15.6% as of 30th June 2014). The Convergence programme is expected to positively contribute to its ratio upgrade. As for Suez Environnement, Moody s is unlikely to upgrade its rating (A3) given the limited potential increase/improvement of its credit ratios in the short to mid-terms. We therefore see stronger upside for Veolia over the short to mid-terms. 11

12 Utilities 2.5. Geographical exposure In this section we analyse both groups geographical exposure and compare what type of business they are developing in the main regions. Veolia remains today more exposed than Suez Environnement to sales generated in Europe (73% for SEV versus 77% for VIE, after Dalkia deal). Spread remains the same comparing Suez Environnement with new Veolia (integrating Dalkia International and excluding Dalkia France) yet is difference is slightly lower when comparing only environmental revenues (waste & water) with sales generated by Veolia representing 74% vs. 73% for Suez Environnement (same split as figure 4 as SEV is only present on waste and water businesses) Both groups still too highly exposed to Europe Fig. 13: Total sales by region SEV vs. VIE Total sales by region SEV (2014e) Total sales by region VIE (after Dalkia deal) (2014e) Asia; 3% Oceania; 7% Other International; 6% South America; 6% North America; 5.5% International 23% Europe ; 73% Europe 77% Source: Company Data; Bryan, Garnier & Co ests, Fig. 14: Environnement sales by region SEV vs. VIE Environment sales by region SEV (2014e) Environment sales by region VIE (2014e) Asia; 3% Oceania; 7% Other International; 6% South America; 6% North America; 5.5% International 26% Europe ; 73% Europe 74% Source: Company Data; Bryan, Garnier & Co ests, 12

13 Utilities Development in international activities remains a key driver Both entities are clearly aiming to develop further the revenues generated from regions outside Europe, given the high level of maturity in demand and the stronger pricing competition Veolia and Suez Environnement are facing in the Old Continent. Veolia is currently better positioned than Suez Environnement as 38% of its total revenues are generated outside Europe (44% if we only take the revenues coming from environmental businesses) and the group aims to generate more than 50% of sales from growing markets, especially in India and in Asia over the next three/four years. As for Suez Environnement, the objective is to grow the International business by 7-8% per year, versus 2-3% for the European activities. This would imply SEV revenues from International could represent 33% by We view the new structure of Veolia as more coherent and more flexible today. The aim here is to have only one Veolia by country, implying the different businesses (waste, water and energy) will all be integrated into a common new structure. We expect this move to positively impact the group s commercial presence worldwide by obtaining more visibility and credibility toward clients. Cost reductions from lower operating costs by country (one head office per country instead of two or three) would also positively impact the group s margin and ROCE. This change in communication style would however complicate the comparison analysis with Suez Environnement's performance in the future. Fig. 15: Environnement sales by region SEV vs. VIE Environment sales by region SEV (2018e) Environment sales by region VIE (2018e) International; 33% Europe ; 66% International; 35% Europe ; 65% Source: Company Data; Bryan, Garnier & Co ests, 13

14 Utilities 2.6. Sensibility to economic recovery in Europe Sensibility analysis Through their direct exposure to both water volumes and waste volumes in Europe, Suez Environnement and Veolia remain structurally exposed to any rebound/collapse in the European economy. Given the increasing development of sales generated outside Europe, direct exposure to the Old continent will tend to reduce over the year with the contribution in euro terms remaining the same (all other factors remaining equal) although the contribution in % to the groups' EPS is likely to fall. We have summarised below only the sensibility to a +/- 1% change in volume and in pricing, in both the waste and water businesses in Europe. Fig. 16: Suez Environnement: Sensibility table 2014e 2015e 2016e 2017e 2018e 2019e 2020e EBITDA sensibility to +/- 1% change in Waste Europe volume 1.3% 1.3% 1.2% 1.2% 1.1% 1.1% 1.0% +/- 1% change in Waste Europe prices 0.4% 0.4% 0.4% 0.3% 0.3% 0.3% 0.3% +/- 1% change in Water Europe volume 0.6% 0.6% 0.5% 0.5% 0.5% 0.5% 0.4% +/- 1% change in Water Europe prices 0.4% 0.4% 0.4% 0.3% 0.3% 0.3% 0.3% Net income sensibility to +/- 1% change in Waste Europe volume 8.6% 5.4% 4.7% 4.1% 3.7% 3.4% 3.1% +/- 1% change in Waste Europe prices 2.5% 1.5% 1.3% 1.2% 1.1% 1.0% 0.9% +/- 1% change in Water Europe volume 3.7% 2.3% 2.0% 1.8% 1.6% 1.5% 1.3% +/- 1% change in Water Europe prices 2.5% 1.5% 1.3% 1.2% 1.1% 1.0% 0.9% Fig. 17: Veolia: Sensibility table 2014e 2015e 2016e 2017e 2018e 2019e 2020e EBITDA sensibility to +/- 1% change in Waste volume 1.7% 1.4% 1.3% 1.2% 1.1% 1.0% 1.0% +/- 1% change in Waste prices 0.9% 0.8% 0.8% 0.7% 0.6% 0.6% 0.6% +/- 1% change in Water volume 1.4% 1.2% 1.1% 1.0% 1.0% 0.9% 0.8% +/- 1% change in Water prices 0.7% 0.6% 0.6% 0.5% 0.5% 0.4% 0.4% Net income sensibility to +/- 1% change in Waste Europe volume 12.1% 5.1% 4.1% 3.5% 3.0% 2.5% 2.2% +/- 1% change in Waste Europe prices 6.9% 2.9% 2.3% 2.0% 1.7% 1.5% 1.3% +/- 1% change in Water Europe volume 10.3% 4.4% 3.5% 3.0% 2.6% 2.2% 1.9% +/- 1% change in Water Europe prices 5.2% 2.2% 1.7% 1.5% 1.3% 1.1% 0.9% We can deduce from these two tables that Veolia is more sensitive to volumes and pricing effects than its French peer Suez Environnement. This over-sensitivity in terms of EPS at Veolia is notably due to its lower profit margin (2014e net margin of 0.8% vs. 2.1% for Suez Environnement) and to the fact that is more exposed than Suez Environnement to industrial clients. 14

15 Utilities Europe could be a driver, but not today Given that we do not expect any economic and industrial recovery in Europe on the short term we see this stronger exposure at Veolia as negative. Recent French and European industrial statistics have clearly confirmed that a recovery is not yet materialising, thereby adding weight to both groups expectations for 2014 in terms of waste volumes (no growth expected from market). As explained above, sensitivity to waste volumes growth is quite strong for both stocks, as well as the correlation between organic growth in waste activities and industrial production and GDP growth in Europe. By comparing VIE's historical organic sales growth in its waste business with GDP growth in the Euro zone we calculate a correlation of 0.9 and a leverage effect of 2.4x. 90% of change in the group s waste business activities is therefore explained by GDP growth in the Euro zone. Fig. 18: Strong correlation between GDP growth and growth in waste 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% -15.0% Waste organic growth (VIE figures) GDP Growth in Eurozone ; IBES In view of IMF expectations for GDP growth over e, we can therefore deduce slight growth in volumes treated, but not a strong recovery. In our models for SEV and VIE we currently anticipate a <1% rebound in waste volumes coming from market growth. Fig. 19: IMF GDP growth expectations for the Eurozone 3.0% 2.0% 1.0% 2.0% 1.6% 1.1% 1.5% 1.5% 0.0% -1.0% -2.0% -3.0% -4.0% -0.7% -0.4% -5.0% -4.4% e 2015e 2016e 15

16 Utilities 2.7. Valuation & share price performance Historical Valuation In this section we compare historical valuations at both Veolia and Suez Environnement using EV/EBITDA and P/E 5Y average multiples. We have identified a strong correlation existing between both stocks (0.7 since 2012) thereby making a long/short investment case complicated. The market is today valuing Veolia and Suez Environnement at 8-7.1bn respectively despite their different sizes, different dividend yields and different earnings growth potential. Veolia has strongly benefited from the market run on the utilities sector since the beginning of the year (SX6P up 15.6% YTD versus +4.3% for SXXP) with the share price gaining 15% versus 0.7% for Suez Environnement. Fig. 20: Market cap evolution (EURbn) Market cap. evolution since SEV IPO Market cap. evolution since Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 VIE Market cap. SEV Market cap Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 VIE Market cap. Sep-13 Nov-13 Jan-14 Mar-14 May-14 Jul-14 SEV Market cap. Sep-14 Source: Company Data; Bryan, Garnier & Co ests,.ibes We have compared changes in both groups' market capitalisations since Suez Environnement's IPO in 2008 and see a strong correlation (coefficient of 0.7 since 2008) between both entities implying the market is playing both investment cases in the same way. This strong correlation makes complicated a long/short call given the limited potential return investors would obtain on a long-term position. When looking at change in market capitalisation versus change in EBITDA (consensus) we clearly observe two different trends: 1/Veolia's market capitalisation has collapsed since 2008 in line with the EBITDA decline (from EUR4.5bn expected by the market in 2008 to EUR2bn expected for 2014), impacted by disposals, the financial crisis and scope effects; and started to stabilise at around EUR6-7bn (-54% vs market cap) after management unveiled a far more coherent long-term strategy; whereas for 2/Suez Environnement the market did not strongly penalise the group's stable EBITDA over the period with 2014 market capitalisation only down 15% compared with the IPO level. 16

17 Utilities Fig. 21: Market cap evolution (EURbn) vs. EBITDA FY1 estimates (EURbn) VIE market cap. vs EBITDA FY1 SEV market cap. vs EBITDA FY Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 VIE Market cap. VIE EBITDA FY1 SEV Market cap. SEV EBITDA FY1 Source: Company Data; Bryan, Garnier & Co ests,.ibes Fig. 22: EV/EBITDA FY1/FY2 VIE vs. SEV EV/EBITDA FY1 VIE vs. SEV EV/EBITDA FY Aug-08 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 VIE FY1 SEV FY1 Average VIE FY1 Average SEV FY1 VIE FY2 SEV FY2 Average VIE FY2 Average SEV FY2 Source: Company Data; Bryan, Garnier & Co ests,.ibes Veolia's historical (5Y) average EV/EBITDA FY1 multiple stands at 7.1x versus 6.7x for Suez Environnement (+6%). As for FY2, the historical multiple stands at 6.7x for Veolia and at 6.4x for Suez Environnement (+6%). 17

18 Utilities Fig. 23: P/E FY1/FY VIE vs. SEV P/E FY1 VIE vs. SEV P/EFY Sep-08 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 VIE FY2 SEV FY2 Average VIE FY2 Average SEV FY2 VIE FY1 SEV FY1 Average VIE FY1 Average SEV FY1 Source: Company Data; Bryan, Garnier & Co ests,.ibes Veolia's historical (5Y) average P/E FY multiple stands at 19.6x versus 16x for Suez Environnement (+22.5%). As for FY1, the historical multiple stands at 14.5x for Veolia and at 14.1x for Suez Environnement (+3%). In our analysis we only use the FY2 historical multiple as it takes into account a more resilient EPS for both Suez Environnement and Veolia. In the past Veolia was more expensive than Suez Environnement (between +3% and +6%, based on FY2 estimates) given its higher growth potential in our view Veolia vs. Suez Environnement Within this section we compare both Veolia and Suez Environnement on e multiples. We adjusted both EBITDA to get clean EV/EBITDA multiples. We made two adjustments: 1/on Veolia EBITDA we adjusted e metrics with integration of OFA reimbursement given that Suez Environnement is putting these charges below the EBITDA line while Veolia is not; 2/we integrate the contribution from associates and JVs on Veolia EBITDA given Suez Environnement is integrating at this level (Veolia is integrating it at the EBIT level only). Fig. 24: EV/EBITDA adjusted multiples for Veolia Veolia 2014e 2015e 2016e 2017e 2018e EBITDA reported Adjustments EBITDA adjusted % of sales 10.5% 11.4% 11.9% 12.5% 13.1% Market capitalization Net debt (+) Pensions and other provisions ( + ) Minorities Market value (14x) Associates & JVs ( - Book value EV Implied EV/EBITDA multiple 6.63x 6.08x 5.57x 5.13x 4.72x 18

19 Utilities Fig. 25: EV/EBITDA adjusted multiples for Suez Environnement Suez Environnement 2014e 2015e 2016e 2017e 2018e EBITDA reported Adjustments (129) EBITDA adjusted % of sales 17.4% 18.2% 18.5% 18.8% 19.2% Market capitalization Net debt (+) Pensions and other provisions ( + ) Minorities Market value (14x) Associates & JVs ( - Book value EV Implied EV/EBITDA multiple 7.12x 6.47x 6.20x 5.89x 5.62x We deduct from these adjustments, that today Veolia is trading at 6.6x its 2015e EBITDA, versus 7.1x for Suez Environnement which implies a discount of 7%. This discount is raising to 16% on 2018 multiples driven mainly by the strongest EBITDA growth we expect for Veolia compared with Suez Environnement ( e CAGR at +8% for Veolia versus +5% for Suez Environnement). Fig. 26: Veolia Suez Environnement EV/EBITDA multiples premium/discount 8.00x 7.00x 6.00x 5.00x 4.00x 3.00x 2.00x 1.00x 0.00x 7.12x 6.63x 6.47x 6.08x 6.20x 5.57x 5.89x 5.13x 5.62x 4.72x 2014e 2015e 2016e 2017e 2018e Veolia EV/EBITDA Suez Environnement EV/EBITDA Implied premium/discount (VIE/SEV) 0.0% -2.0% -4.0% -6.0% -8.0% -10.0% -12.0% -14.0% -16.0% -18.0% Making the similar analysis on EV/EBIT multiples gives us a similar conclusion, with Veolia offering 7% to 16% discount compared with Suez Environnement, despite the higher earnings growth potential and the higher margin improvement. 19

20 Utilities Fig. 27: Veolia Suez Environnement EV/EBIT multiples premium/discount 18.00x 16.00x 14.00x 12.00x 10.00x 8.00x 6.00x 4.00x 2.00x 0.00x 15.76x 15.94x 13.68x 12.92x 12.83x 11.23x 11.94x 10.15x 11.26x 9.19x 2014e 2015e 2016e 2017e 2018e Veolia EV/EBIT Suez Environnement EV/EBIT Implied premium/discount (VIE/SEV) 0.0% -2.0% -4.0% -6.0% -8.0% -10.0% -12.0% -14.0% -16.0% -18.0% -20.0% Share price performance Correlation between the two stocks is very high (0.7) with the market playing both stocks as a European industrial proxy. When looking at historical share price performance we find this strong correlation every year (lowest in 2012 and highest in 2014ytd). Fig. 28: Share price performance VIE & SEV vs. SX6P & SXXP ytd ytd Veolia -6.2% -62.4% 3.1% 29.5% 14.8% 48.4% Suez Environnement -6.9% -42.4% 1.2% 43.0% 0.7% 43.9% SX6P -8.8% -16.8% -2.9% 7.5% 15.6% 24.4% SXXP 8.6% -12.0% 13.2% 17.4% 4.3% 22.4% Fig. 29: SEV vs. VIE share price performance (rebased 100) VIE vs. SEV 2010 VIE vs. SEV VIE SEV VIE SEV Source: Company Data; Bryan, Garnier & Co ests,.ibes 20

21 Utilities Fig. 30: SEV vs. VIE share price performance (rebased /13) VIE vs. SEV 2012 VIE vs. SEV VIE SEV VIE SEV Source: Company Data; Bryan, Garnier & Co ests,.ibes Fig. 31: SEV vs. VIE share price performance (rebased /14) VIE vs. SEV 2014ytd VIE vs. SEV 2013/14ytd Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 VIE SEV Jan-13 Feb-13 Mar-13 Apr-13 May-13 Jun-13 Jul-13 Aug-13 Sep-13 Oct-13 Nov-13 Dec-13 Jan-14 Feb-14 Mar-14 Apr-14 May-14 Jun-14 Jul-14 Aug-14 Sep-14 VIE SEV Source: Company Data; Bryan, Garnier & Co ests,.ibes It is important to notice VIE is strongly outperforming SEV in 2014 (+15% for VIE vs. +0.7% for SEV) yet most of the performance could be justified by correction effect with 2013 as last year SEV outperformed VIE by 14pp (+43% for SEV in 2013 vs. +30% for VIE). 21

22 Utilities 3. Risk reward more appealing with VIE When comparing both entities, Suez Environnement and Veolia together we can clearly see that Suez Environnement currently offers more appealing metrics than Veolia: higher profitability (despite restatements we made to compare both entities given that financial communication from Suez Environnement is more favourable than Veolia), higher ROCE after tax, lower sensibility to European industrial production, and more flexible balance sheet. However, looking forward it appears in our view that Veolia has more to offer than its French peers in terms of both earnings growth and cash generation, given that Suez Environnement is already close to its top financial metrics. In the sector report we compared both entities on different metrics and concluded that 1/earnings growth is set to be stronger at Veolia than at Suez Environnement and 2/that upside and risk reward at Veolia is more appealing than at Suez Environnement. We therefore expect Veolia's ROCE before tax to progressively pick up in to 9%, in line with Suez Environnement. Below is an overview of the comparison analysis we have undertaken between both groups. When comparing ROCE after tax changes, the trend is similar between both groups. However, we do not expect same recovery observed in on ROCE before tax calculation as the tax rate we use for Veolia is higher than the one used for Suez Environnement (due to Agbar notably). Fig. 32: ROCE after tax evolution Veolia vs. Suez Environnement ROCE before tax ROCE after tax 12% 12% 10% 10% 8% 8% 6% 6% 4% 4% 2% 2% 0% e 2015e 2016e 2017e 2018e 0% e2015e2016e2017e2018e Veolia Suez Environnement Veolia Suez Environnement 22

23 Utilities Fig. 33: Comparison analysis Veolia vs. Suez Environnement (2>1) Upside to current share price Upside to share price Leverage Profitability Exposure to Industrial Water Margin evolution Earnings growth Sensibility to economic recovery in Europe Exposure to non- European markets Premium (+) /discount ( - ) vs. 5Y average Dividend yield Veolia Valuation Dividend growth Suez Environnement We see stronger upside at Veolia than at Suez Environnement if new restructuring efforts are made given that today Veolia's net profit is lower than Suez Environnement's, implying that sensibility to potential earnings growth is stronger. In our base case we see 34% upside to the current price, versus 27% for Suez Environnement. As for a bear case, the conclusion is also favourable to Veolia with 1.3% downside vs. -16% for Suez Environnement. Fig. 34: Veolia sensibility analysis to costs reduction Veolia TP per share Upside Net margin 2020e Assuming 0% of costs reduction for e % 2.5% Assuming 1% of costs reduction for e (with retention rate of 60% and then 40%) % 3.7% Assuming 1% of costs reduction for e (with retention rate of 100%) % 3.9% Fig. 35: Suez Environnement sensibility analysis to costs reduction Suez Environnement TP per share Upside Net margin 2020e Assuming 0% of costs reduction for e % 2.9% Assuming 1% of costs reduction for e (with retention rate of 60% and then 40%) % 4.5% Assuming 1% of costs reduction for e (with retention rate of 100%) % 5.6% 23

24 24 Utilities

25 INDEPENDENT RESEARCH 30th September 2014 Veolia Environnement Heading into the right direction Utilities Fair Value EUR17 (price EUR13.59) BUY Coverage initiated Bloomberg VIE FP Reuters VIE.PA 12-month High / Low (EUR) 14.7 / 11.2 Market capitalisation (EURm) 7,639 Enterprise Value (BG estimates EURm) 16,081 Avg. 6m daily volume ('000 shares) 1,922 Free Float 76.8% 3y EPS CAGR NM Gearing (12/13) 84% Dividend yields (12/14e) 5.15% YE December 12/13 12/14e 12/15e 12/16e Revenue (EURm) 22,315 23,069 23,811 24,463 EBIT(EURm) ,193 1,363 Basic EPS (EUR) Diluted EPS (EUR) EV/Sales 0.7x 0.7x 0.7x 0.7x EV/EBITDA 8.8x 7.6x 6.8x 6.2x EV/EBIT 32.2x 17.7x 13.8x 11.9x P/E NS 40.1x 16.9x 13.5x ROCE /09/ Source Thomson Reuters VEOLIA ENVIRONNEMENT STOXX EUROPE 600 We are initiating coverage of Veolia with a Buy recommendation and a Fair Value of EUR17 per share. Industrial recovery in Europe is unlikely to pick up in the short term thereby putting pressure on cyclical stocks like Veolia and Suez Environnement, although the majority of earnings growth is expected to come from cost reductions or growth in International activities. Veolia is entering phase 3 of its transformation phase, and is now targeting growth and structure optimisation at the same time, after having successfully reduced net debt. We currently estimate that VIE offers stronger earnings growth potential than SEV (EPS CAGR 14-24e of 23.1% vs. 12.6% for SEV). Buy, with Fair Value of EUR17 per share. Further restructuring efforts beyond 2015? Given the limited growth expected in Europe in both the water and waste activities, implementing cost reductions has become the key driver behind the investment case. We see room for further cuts beyond 2015 (in line with SEV's annual cost-cutting programme) and this could prompt a significant EPS increase in years to come. Balance sheet optimisation and cash-flow generation should progressively pick up, despite uncertainties in Europe. Entering phase 3 of transformation phase: Europe still represents >75% of the group s sales yet thanks to 1/recent value/growth creative acquisitions (Proactiva, Dalkia International) and 2/ the strong focus on development with industrials (Oil & Gas; Mining, dismantling...) we anticipate 1/a reduction in sales/ebitda exposure to Europe and 2/ higher growth from Europe compared with previous years with increasing exposure to industrials generating stronger growth. Structure optimisation will continue in the meantime allowing further cost cuts and a better commercial approach. Buy, FV at EUR17: Our SOTP valuation of Veolia puts Fair Value at EUR17 per share, leading to a Buy recommendation. We consider upside to margins and the current share price offer an attractive reward on the investment case especially compared with Suez Environnement, which is already close to its peak margin. Analyst: Xavier Caroen 33(0) xcaroen@bryangarnier.com r r

26 Veolia Environnement Income Statement (EURm) e 2015e 2016e 2017e Revenues 28,577 29,439 22,315 23,069 23,811 24,463 25,155 Change (%) 2.6% 3.0% -24.2% 3.4% 3.2% 2.7% 2.8% EBITDA 2,853 2,723 1,796 2,112 2,426 2,635 2,864 EBIT 829 1, ,193 1,363 1,504 Change (%) -53.3% 32.1% -55.2% 84.9% 31.6% 14.3% 10.3% o/w JVs net result NM NM NM NM NM NM NM Financial results (758) (822) (538) (469) (392) (387) (384) Pre-Tax profits ,072 1,222 Exceptionals 0.0 (49.3) (318) (50.0) Tax (521) (159) (128) (211) (306) (368) (419) Profits from associates (51.5) Minority interests (173) (136) (114) (90.0) (65.2) (66.9) (68.5) Net profit (490) 394 (135) Restated net profit (490) 394 (151) Change (%) NM NM NM NM NM 25.9% 17.0% Cash flow statement (EURm) Operating cash flows 2,185 1,991 1,829 2,065 2,520 2,697 2,639 Change in working capital (40.7) 103 (4.3) (67.7) (120) Income tax paid Capex, net (2,630) (2,471) (1,227) (1,453) (1,527) (1,569) (1,614) Financial investments, net 1,493 2, Dividends (547) (547) (191) (247) (394) (394) (394) Other (203) (2,015) (1,861) (673) (619) (642) (408) Net debt 14,730 11,283 8,177 8,062 7,989 7,782 7,678 Adjusted net debt (ex-loans to JVs) NM NM NM NM NM NM NM Free Cash flow (73.5) (311) ,128 1,026 Company description Former subsidiary of Vivendi Universal, Veolia Environment is the leading company in the environmental services sector. The group operates in water (35% of sales), waste (27%), energy services (22%) and transportation (16%). Amongst the major shareholders are: Caisse des Dépôts (8.9%), Dassault familly (6%) and Groupama (5.2%). Balance sheet (EURm) Tangible fixed assets 8,488 4,706 4,161 3,747 3,835 3,925 3,972 Intangibles assets 5,910 3,299 2,819 2,819 2,819 2,819 2,819 Cash & equivalents 5,724 4,998 4,274 4,476 4,550 4,763 4,879 current assets 16,225 12,359 12,864 13,329 12,908 13,012 13,364 Other assets 14,059 13,114 12,125 12,154 12,182 12,207 12,234 Total assets 50,406 38,477 36,242 36,524 36,294 36,727 37,268 L & ST Debt 16,707 12,131 9,497 9,497 9,497 9,497 9,497 Others liabilities 40,571 29,979 26,559 26,999 26,675 26,896 27,131 Shareholders' funds 9,835 8,498 9,683 9,525 9,620 9,831 10,137 Total Balance sheet 50,406 38,477 36,242 36,524 36,294 36,727 37,268 Capital employed 12,908 12,470 12,211 12,399 12,568 12,973 13,386 Ratios Operating margin Tax rate Net margin (0.61) ROE (after tax) ROCE (after tax) Gearing Pay out ratio (123) (242) Number of shares, diluted (000) Per Share data (EUR) EPS (0.99) 0.79 (0.26) Restated EPS (0.99) 0.79 (0.29) % change -185% -% -136% -% 136% 25.9% 17.0% BVPS Operating cash flows FCF (0.15) (0.63) Net dividend

27 Veolia Environnement Table of contents 1. Investment Case A new Veolia Lower France, more international More geared to value-added markets More financially and operationally flexible Flaws still exist French water business still weighing on group s margin in the short term A margin growth story still highly dependent from restructuring Yet risk reward is appealing Our forecasts Veolia Water Veolia Waste Veolia Energy Services What we expect for 2014 vs. group s targets? Valuation Appendice: What is Veolia Environnement? Three business activities Waste Water activities Energy Bryan Garnier stock rating system

28 Veolia Environnement 1. Investment Case The reason for writing now With the 2009 appointment of Antoine Frérot as the new CEO, the group embarked on major strategic changes to focus on more value added markets, while expanding its exposure to industrial customers and emerging markets. Disposals were made to optimise the balance sheet, while reducing fixed costs became a clear priority. While Phase 1 (balance sheet optimisation) was perfectly handled, and Phase 2 is currently running (reducing fixed costs), the group will now start to enter into Phase 3 (growing phase) to boost earnings by addressing new high growth potential markets (industrial customers and international) and by implementing further cost reductions. Valuation We value Veolia via an SOTP calculation, which yields a Fair Value of EUR17 per share, implying 24% upside to the current share price. At the current share price, the share is trading on 7.7x prospective 2014 EBITDA and 40.5x 2014 earnings, implying an 8% premium on average compared with historical multiples. As for 2015 metrics, Veolia is trading at 6.8x EBITDA and 17.1x earnings. Catalysts In H2 the group will start to consolidate Dalkia International over Dalkia France following the deal with EDF. This move should bring additional growth for the company yet may generate potentially some operational tensions following the owner change. The group is also running the company through a new structure (by region vs. by business before). More communication from management on this new organisation (through an investor day?) would clearly go down well with investors. Difference from consensus Given the change in the group s structure and the accounting impact from the Dalkia move with EDF (impact in H2 2014) it is difficult to assess how we are positioned versus both EBITDA and EPS for As for 2015, the consensus is more representative. We are in line with market expectations. Risks to our investment case We do not expect a recovery in the European industrial segment in 2015 and 2016 (only +0.4% growth in waste volumes for Europe in our model). However, a sharper deterioration in the economic backdrop in Europe could have a strong impact on our investment case and the share price, although the impact should remain limited on group s earnings (+/- 1% change in Waste Europe volume has a EUR30m impact on the group s EBITDA). 28

29 Veolia Environnement 2. A new Veolia With the 2009 appointment of Antoine Frérot as the new CEO, the group embarked on major strategic changes to focus on more value added markets, while expanding its exposure to industrial customers and emerging markets. Disposals were made to optimise the balance sheet, while reducing fixed costs became a clear priority. While Phase 1 (balance sheet optimisation) was perfectly handled, and Phase 2 is currently running (reducing fixed costs), the group will now start to enter into Phase 3 (growing phase) to boost earnings by addressing new high growth potential markets (industrial customers and international) and by implementing further cost reductions. The aim to develop further outside Europe while restructuring or at least optimising the group s cost base in Europe is strong, and puts Veolia in a good position, where both employees and managers are looking in the same direction. We view this new phase as the most complex as the group needs to work on both structure optimisation and on earnings growth at the same time, whereas during phase 1 (net debt reduction) and phase 2 (costs reduction implementation phase) management was fully dedicated to one specific target instead of two different targets for phase 3. Recent metrics unveiled by the group (2013 and H1 2014) clearly confirmed that both profitability and the balance sheet are improving, and are more in line with French peer Suez Environnement. Recent acquisitions (Dalkia International swap and Proactiva) could be seen as value creative at the margin and earnings growth level, while in the meantime, efforts to reduce exposure to noncore businesses are creating balance sheet flexibility. Like Suez Environnement, Veolia has identified growth markets with industrials clients following stronger needs for industrial expertise in both the water and waste markets. Driven mainly by environmental and economic constraints these markets (Oil & Gas, Mining, dismantling...) would allow Veolia to reduce exposure to municipalities while reducing the amount of capital employed (on contracts with industrials, capex can be directly financed and supported by clients). Today 35% of the group s revenues stem from industrials clients, and management aims to expand this ratio to more than 50% in the next five years. We forecast solid earnings growth for the group in years to come and believe Veolia will be able to reach its midterm target (EUR500m net recurring income by 2015, allowing the group to fully finance dividend payment in cash) and believe that by 2016, a new cost-cutting programme should start to contribute again to the group s operating leverage. Like for Suez Environnement, we are forecasting a 1% annual cut in costs (and assume a 60% retention rate, to take into account both implementations and inflation costs) which should allow the group to 1/grow its EPS by 23.1% on average (CAGR e on BG EPS) versus 12.6% for Suez Environnement and 2/to finance in cash its EUR0.7/share dividend payment. We do not expect an industrial recovery in Europe (only +0.4% of volumes growth in the region for waste business) but anticipate a solid contribution from Proactiva and from activities outside Europe. We see upside to consensus estimates and see no reason why Veolia will not continue its structure optimisation phase especially in a world where deflation is becoming a new challenge. 29

30 Veolia Environnement 2.1. Lower France, more international Through the Dalkia swap deal with EDF (EDF acquiring Dalkia France, while Dalkia International is acquired by Veolia), Veolia has clearly demonstrated it is now focusing a strong part of its commercial efforts outside France and also outside Europe. Not only does the deal have an accretive impact on the group s profitability (90bp impact on EBITDA level), but it also reduces the group s direct exposure to France, its historical market (France represents 34% of group s sales post Dalkia deal, versus 50% before). Being more exposed to Europe and to regions outside Europe will obviously allow the group to grow at a stronger pace than before in markets where demand for both waste and water treatments sites will be driven by demographical growth, which is no longer the case in more mature markets like France. Fig. 1: Veolia: Geographical sales split Veolia: Sales split by region before Dalkia swap Veolia: Sales split by region after Dalkia swap Asia 10% USA 7% RoW 6% Asia 10% USA 7% RoW 6% France 34% RoEurope 26% France 51% RoEurope 43% The Proactiva deal undertaken last year was clearly in line with group s strategy to expand further where needs for new capex are rising every year. Through its 50% stake in Proactiva, Veolia was not fully benefiting from growth potential in the region (Proactiva is present in eight Latam countries and has 120 partners with Latam municipalities), which explains the recent 50% minority stake purchase. Through its presence in both markets (waste and water), Proactiva would allow Veolia to further expand in the region through both brands while reducing the group s profit exposure to mature markets. In our model we expect Proactiva to continue generating solid EBITDA growth in coming years with a contribution expected at around EUR95m by 2018 vs. EUR80m expected in

31 Veolia Environnement 2.2. More geared to value-added markets During its press day in February 2014, the group unveiled the different industrial markets it aims to develop in coming years. Today roughly 35% of the group s revenues are generated with industrials (2/3 of waste revenues, and 18% of water revenues) and management aims to increase this ratio to more than 50% over the next five years. Within the seven promising markets identified by Veolia we believe the group is well positioned in two of them: 1/Mining and 2/Oil & Gas; two markets estimated (for water and waste markets) at EUR20bn each by Access to resources is becoming increasingly limited for such industries while environmental rules/constraints impose more and more new treatments phase to reduce human impact on nature. Veolia like Suez Environnement is today well positioned to offers industrials smart solutions to meet these environmental constraints. Although it is difficult to assess the revenues currently generated by the group in these two markets, we estimate that out of the EUR1bn of water sales with industrials and EUR5.5bn of waste sales, a minimum of EUR m stems from these two markets. When comparing Veolia market data with Suez Environnement (industrials potential market, but only on water business) we forecast a minimum of 12-15% annual growth between 2014 and 2018 allowing Veolia (applying this sales growth) to generate by 2018 around EUR2.1bn of revenues on these two markets (assuming no change in group s market share within these two markets). 60% of sales growth in H came from industrials Recent commercial successes in these two markets clearly confirm that strategic development is well underway. In 2013, Veolia was awarded a contract with Codelco in the mining business and a EUR300m contract with Shell (Carmon Creek) in the Oil & Gas market, whereas in H it obtained contracts with Ecopetrol America (USD73m), with BP (USD75m) and with FPCC (EUR15m). All major contracts awarded in H were made in the Oil & Gas market, and more specifically in the waterwaste treatment segment. These different commercial successes are perfectly in line with the growth the group was able to generate in H1 thanks to industrial clients (60% of sales growth in H came from industrials) and to the seven potential markets (40% of sales growth in H1-14 came from new markets). Fig. 2: Veolia: H sales growth by customer type vs New H sales by customer 2013 sales by customer Municipalities; 40% Industrials ; 60% Municipalities; 65% Industrials ; 35% 31

32 Veolia Environnement Fig. 3: Veolia: H sales growth by category New H sales by type of contract New H sales by type of growth Renewals; 40% New contracts; 60% Others; 60% Thematic growth markets; 40% Veolia targets 5% to 10% market share by 2020 on Oil & Gas and Mining industrials markets In our model we assume the group could maintain a 5% market share on both markets (Oil & Gas and Mining), which is at the low end of the range (5% to 10% market share targeted) targeted by management and which could lead to total revenues from these two markets of around EUR2.1bn for an estimated EBITDA of EUR250m (average margin at waste and water segments). This is expected to represent 8% of our 2020e group EBITDA estimate. Assuming a 10% market share (which implies Veolia needs to grow twice faster than market) would imply total revenues of EUR4.3bn by 2020 with EBITDA at EUR521m (15.8% of our 2020e group EBITDA estimate). Fig. 4: Veolia Revenues/EBITDA generated in Oil & Gas and Mining markets Sales EBITDA % of group's sales 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 32

33 Veolia Environnement 2.3. More financially and operationally flexible The group is now entering a growth and structure optimisation phase, after having focused most of its strategy on reducing net debt (EUR10.2bn net debt impact following e disposals). The recent Proactiva acquisition and Dalkia swap deal will have a positive impact on both margin and cash flow generation and should allow the group to achieve its 2015 FCF=dividend target. Cost reduction and capex control would allow the group to meet this target even if a further deterioration occurs in the European waste business. Fig. 5: Veolia: disposals and net debt reduction (EURbn) e Disposals (EURbn) Net debt Dividend is set be fully paid in cash in 2015 In our model, we estimate Veolia could generate stronger FCF as early as this year (slightly positive FCF company definition) primarily via three main drivers: 1/higher EBITDA contribution, from M&A deals and from the Convergence plan contribution and 2/lower cost of debt, lower financial charges and declining corporate tax and 3/lower gross capex (EUR1.5bn expected versus EUR1.7bn in 2013). We therefore believe the group could deliver its 2015 cash target, allowing dividend payment to be fully financed in cash. Fig. 6: Veolia cash flow table 2014e 2015e 2016e 2017e 2018e EBITDA reported EBITDA margin 9.2% 10.2% 10.8% 11.4% 12.0% OFA reimbursement Operating cash-flow after tax and financials Gross capex (1 453) (1 527) (1 569) (1 614) (1 660) FCF before dividends Dividends (247) (394) (394) (394) (432) Cash flow post dividends (193) Net debt reported Net debt reported /EBITDA ratio 3.8x 3.3x 3.0x 2.7x 2.4x Net debt/cafop + OFA reimbursement (company definition) 3.5x 3.0x 2.7x 2.5x 2.3x 33

34 Veolia Environnement As shown in the table above, the net debt/ebitda ratio including reimbursement of OFA is set to decline from 4.8x in 2012 to 3x in 2015e and 2.7x in 2016e on our calculations. The net cost of debt should continue to decline leading to further FCF growth and a potential improvement in credit ratings (Moody s: Baa1 stable outlook since February 2012 and confirmed in September 2014, S&P: BBB negative outlook since November 2013). If confirmed this news would clearly have a positive impact on the share price. By 2017 both entities should be able to increase dividends As for Suez Environnement, we expect dividend stabilisation until 2017 as the payout ratio between 2014 and 2017 is above the sector average (65-75%). However, by 2017 both entities should be able to increase dividends according to our estimates (assuming the sector average payout we just mentioned) leading to a 2017 yield of 5.3% for Veolia and Suez Environnement. Fig. 7: Veolia vs. Suez Environnement Dividend VIE SEV dividend per share VIE SEV dividend yield % % % 10% 8% 6% % % e 2015e 2016e 2017e 2018 Veolia dividend Suez Environnement dividend 0% e 2015e 2016e 2017e 2018e VIE Yield SEV Yield Within our estimates, both Veolia and Suez Environnement should offer similar dividend yields during the period. The main difference is that by 2015, Veolia's dividend will be fully financed by FCF generation whereas this was not the case before (therefore making the investment case less risky than it was before). 34

35 Veolia Environnement 3. Flaws still exist Veolia is entering an expansion phase that should allow the group to reduce its dependence on the cost reduction programme while reducing direct exposure to European countries. The strong net debt reduction process implemented by the group (net debt of EUR16.5bn in 2008, versus EUR8.2bn expected at end 2014e) thanks to well negotiated disposals (EUR11bn worth of assets disposals between 2009 and 2013 made at good multiples, >9x EV/EBITDA) is now placing the group in a more financial flexible position. However, despite this strong deleveraging process and the change in internal culture that the new CFO is currently trying to implement (implementing recurring costs reduction), the group is still highly exposed to Europe and to very cyclical businesses, which could weigh on its profitability if the situation deteriorates in Europe. We have identified three main negative factors that could potentially weigh on the investment case if the situation deteriorates (Europe, French water business, and costs reduction programme) or at least does not improve French water business still weighing on group s margin in the short term Veolia is the market leader with almost double the revenues of its French peer Suez Environnement Highly present in the French water business (Veolia is the market leader with almost double the revenues of its French peer Suez Environnement), Veolia has suffered more than the rest of the sector given 1/its strong exposure to municipalities (95% of its revenues in French water stem from municipalities; only 5% from industrials) and its 2/strong exposure to the largest contracts (Lyon, Montpellier, Marseille...). Compared with Suez Environnement, the important price renegotiation processes implemented by some municipalities had a major impact on the group s margin, obliging it to restructure its French water business unit. Fig. 8: French water market by operator Others; 33.30% Veolia; 34.50% Public; 1.90% Saur; 10.80% Suez Environnement; 19.50% The low point is expected to be reached in 2015 with revenues still affected by the loss of the Montpellier contract and the +25% price decline of the Lyon contract. Management expects profitability levels to stabilise by 2016 with restructuring efforts impacting the cost structure at full speed. Afterwards management expects contract renegotiations to negatively impact business sales growth by around 2-3% per year. 35

36 Veolia Environnement The group leads the French market with 4,000 contracts and renegotiates 5-6% of its contracts every year. As explained above, Veolia's investment case suffered strongly from this pricing deterioration that has affected earnings since 2009, especially compared with Suez Environnement, which remained pretty unclear on the real impact on its P&L, mainly because the impact is diluted by the strong contribution from Agbar activities (in Spain and in Chile). Stemming this bloodbath would therefore be much appreciated by the markets and investors, especially if the restructuring efforts implemented by the group in its French water unit are paying off. Fig. 9: Veolia French water EBITDA vs. Water EBITDA e 2015e 2016e EBITDA French Water EBITDA Water Fig. 10: Veolia Water EBITDA & EBITDA margin evolution 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% e 2015e 2016e 2017e 2018e Water EBITDA Water EBITDA margin

37 Veolia Environnement 3.2. A margin growth story still highly dependent from restructuring Compared with Suez Environnement which already reaches a high margin level for both its waste and water activities, Veolia is still in its margin improvement phase, especially on the water business which suffered strongly from pricing renegotiations with municipalities in France (EUR50m/year of EBITDA deterioration estimated in France since 2012). A strong part of earnings growth we forecast is then expected to come from group s ability to further reduce fixed costs inside different businesses. The group which started to implement its Convergence plan in 2012 was unable to increase its margin in 2012 and 2013 due to unfavourable pricing and volumes environment on both water and waste markets and unfavourable FX effects. Since its implementation in 2012 Veolia was able to reduce its costs by EUR178m (net cumulated effect for 2012 and 2013) and still targets to adjust its costs base by further EUR580m to reach its EUR750m 4 years target. Veolia targets to adjust its cost base by EUR750m by 2015 Fig. 11: Veolia: convergence plan targets Announced during 2011 investor day Raised objectives Updated objectives (cumulated) Implied gain per year Achieved gain EBITDA margin 10.0% 9.2% 8.0% - - Assuming the company is able to reach its EUR400m target by 2014 and its EUR750m target by 2015, this would imply further cost cutting moves of a minimum of EUR230m and EUR350m, respectively. While we admit that current targets are well respected, we believe they will be increasingly difficult, as the easiest fat to trim was already sliced off during the early phases of the programme. Most of the restructuring efforts are dedicated to margin improvement at Veolia s French water business, which faced massive margin deterioration after an important price deterioration following negotiations with municipalities. We estimate that the group has lost about EUR50m of EBITDA per year in its French water business, with a floor expected in To address this drastic margin erosion, the group announced 1,500 job cuts in its French water division, representing 10% of headcount in this business. These restructuring efforts, which are clearly necessary for the group, cost EUR90-100m (impact either in 2013 on the group s P&L) and are set to reduce fixed costs by c. EUR150m (20% of the group s 2015 target of EUR750m). In our model we have taken account of both the 2014 and 2015 Convergence plan targets (respectively EUR230m and EUR350m) and continue to assume further pricing pressure on French water activities and inflation costs. As for the years beyond 2015, the group has still not communicated further reduction targets, but given the reorganisation phase the group is currently entering and the cultural changes (more geared to recurring cost reduction; structure optimization) that the new CFO is starting to implement, we 37

38 Veolia Environnement anticipate further annual cost cutting, in line with Suez Environnement. In our model, we have therefore assumed a 1% annual cost reduction o/w we apply a 60% retention rate for period and a 40% retention rate for period (higher inflation costs given the increasing exposure to emerging markets where costs increased at a stronger pace than in more mature markets). We have assumed the same split by business unit than that which the group targeted for its Convergence plan. Most of the cost cutting is set to stem from optimising organisation costs. The new structure (by region and no longer by business) would allow the group to further reduce its organisation costs given that it will now only have one head office by country instead of three (for each of the businesses). We estimate these cost reductions should represent 40-45% of the EPS CAGR we expect for e. Assuming no cost reductions over e would lead to a Fair Value of EUR14 instead of EUR17. Assuming no cost reductions over e would lead to a Fair Value of EUR14 instead of EUR17. Fig. 12: Veolia: Convergence plan Costs reduction by applications Technical optimisation; 14% External Others; 2% charges cut; 5% IT; 4% Purchasing; 19% Margin improvement (contracts); 8% Organization; 48% 38

39 Veolia Environnement Fig. 13: Veolia Costs reduction contribution to EBITDA (after inflation costs for e) - EURm % % 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0 0.0% Net fixed costs reduction plan EBITDA margin Below is a sum-up of the impact on our Fair value assuming different costs reduction assumptions. We used similar assumptions for Suez Environnement in our model (1% costs reduction, with retention rate of 60% and then 40%). Fig. 14: Veolia: costs control, sensibility to our fair value TP per share Upside Gain vs. TP Implied net margin 2020e Assuming 0% of costs reduction for e % -26.3% 2.5% Assuming 1% of costs reduction for e (with retention rate of 60% and then 40%) % -10.5% 3.7% Assuming 1% of costs reduction for e (with retention rate of 100%) % 0.0% 3.9% 39

40 Veolia Environnement 4. Yet risk reward is appealing When comparing both entities, Suez Environnement and Veolia together (in sector part called: in the research report we published the same day), we can clearly see that Suez Environnement currently offers more appealing metrics than Veolia: higher profitability (despite restatements we made to compare both entities given that financial communication from Suez Environnement is more favourable than Veolia), higher ROCE after tax, lower sensibility to European industrial production, and more flexible balance sheet. However, looking forward it appears in our view that Veolia has more to offer than its French peer in terms of both earnings growth and cash generation, given that Suez Environnement is already close to its top financial metrics. In the sector report we publish the same day we compared both entities on different metrics and concluded that 1/earnings growth is set to be stronger at Veolia than at Suez Environnement and 2/that upside and risk reward at Veolia is more appealing than at Suez Environnement. We therefore expect Veolia's ROCE before tax to progressively pick up in to 9%, in line with Suez Environnement. Below is an overview of the comparison analysis we have undertaken between both groups. When comparing ROCE after tax changes, the trend is similar between both groups. However, we do not expect the same recovery observed in on ROCE before tax calculation as the tax rate we use for Veolia is higher than the one used for Suez Environnement (due to Agbar notably). Yet trend is positive. Fig. 15: ROCE after tax evolution Veolia vs. Suez Environnement ROCE before tax VIE vs. SEV ROCE after tax VIE vs. SEV 12% 12% 10% 10% 8% 8% 6% 6% 4% 4% 2% 2% 0% e 2015e 2016e 2017e 2018e 0% e2015e2016e2017e2018e Veolia Suez Environnement Veolia Suez Environnement 40

41 Veolia Environnement Fig. 16: Comparison analysis Veolia vs. Suez Environnement (2>1) Upside to current share price Sensibility to economic recovery in Europe Leverage Profitability Exposure to Industrial Water Margin evolution Earnings growth Premium (+) /discount ( - ) vs. 5Y average Dividend yield Veolia Dividend growth Valuation Exposure to non-european markets Suez Environnement In our base case we see 34% upside to the current price, versus 27% for Suez Environnement. We see stronger upside at Veolia than at Suez Environnement if new restructuring efforts are made given that today Veolia's net profit is lower than Suez Environnement's, implying that sensibility to potential earnings growth is stronger. In our base case we see 34% upside to the current price, versus 27% for Suez Environnement. As for a bear case, the conclusion is also favourable to Veolia with 1.3% downside vs. 18% for Suez Environnement. Fig. 17: Veolia sensibility analysis to costs reduction Veolia TP per share Upside Net margin 2020e Assuming 0% of costs reduction for e % 2.5% Assuming 1% of costs reduction for e (with retention rate of 60% and then 40%) % 3.7% Assuming 1% of costs reduction for e (with retention rate of 100%) % 3.9% Fig. 18: Suez Environnement sensibility analysis to costs reduction Suez Environnement TP per share Upside Net margin 2020e Assuming 0% of costs reduction for e % 2.9% Assuming 1% of costs reduction for e (with retention rate of 60% and then 40%) % 4.5% Assuming 1% of costs reduction for e (with retention rate of 100%) % 5.6% 41

42 Veolia Environnement 5. Our forecasts The group recently modified its divisional structure and now only communicates a geographical approach vs. a business approach previously. This structure change is set to complicate the comparison analysis we undertaken with French peer Suez Environnement. The previous approach was already inadequate as Veolia was communicating on its three businesses while Suez Environnement was communicating on 1/its waste European activities, 2/its water European activities and 3/its International activities (waste and water combined). We believe Veolia will continue to communicate (through EBITDA, and recurring EBIT) on its old segments despite the new segments. As such, we have decided to continue to use our previous approach to make comparison with Suez Environnement easier. Our 2014 adjusted EPS estimate stands at EUR0.34 and our 2015 adjusted EPS (with hybrid costs) stands at EUR0.80 per share We are forecasting EBITDA growth of 18% and 15% respectively in 2014 and 2015 for Veolia, helped by a positive scope effect (VMS and Proactiva) and by the Convergence plan. We currently stand respectively 3% above and 1% below the consensus on these metrics, but believe all scope effects are not yet fully integrated into street estimates (especially for 2014 with integration of Dalkia International in H2). Management was guiding on a 10% EBITDA increase (excluding FX effect and before Dalkia deal) for 2014 and is not guiding yet for Our 2014 adjusted EPS estimate (with hybrid costs and excluding the EUR53m capital gain notably from the disposal of Marius Pedersen) stands at EUR0.34 and our 2015 adjusted EPS (with hybrid costs) stands at EUR0.80 per share. Fig. 19: Veolia Sales & EBITDA contribution (in %) by business 2014e Veolia 2014e sales by business Veolia 2014e EBITDA by business Dalkia 18% Water 45% Dalkia 18% Water 39% Waste 37% Waste 43% 42

43 Veolia Environnement 5.1. Veolia Water On this business earnings growth will be driver by Proactiva, new contracts, and by costs reduction contribution. Margin deterioration the French water business is set to continue in 2014 and in 2015 following the important contract renegotiations the group had to face with municipalities during past three years. EBITDA in French water segment is expected to stabilize by end 2015 after the 20% price renegotiations that affected group s water contract in Lyon (first year impact in 2014). This business accounts for 45% of group s revenues and 39% of group s EBITDA given margin deterioration observed on French activities. For 2014 we are forecasting a 2.3% YOY sales increase to EUR10.5bn, with notably 1.5% volume deterioration and a negative FX effect. The group s performance in this business is to be boosted slightly by the scope effect (integration of Proactiva, contributing at EUR29m in 2014) and by Convergence plan (EUR66m positive impact) on EBITDA level. For 2015, we are forecasting a 1.3% YOY sales increase to EUR10.6bn with 0.5% volume drop, and positive price increase. As for EBITDA, we stand at EUR869m, up 4.3% due mostly to a positive contribution from the Convergence plan. Most of growth will come from development with industrials, and from Proactiva. We use similar (cautious) estimates for Suez Environnement (in its European water activities). Fig. 20: Veolia: Water business estimates Water e 2015e 2016e Sales YOY growth % 2.3% 1.3% 2.2% EBITDA % of sales 9.7% 8.1% 8.3% 9.3% 9.9% Adjusted operating income % of sales 5.6% 4.3% 4.0% 4.9% 5.5% It is important to notice here that municipalities still account for more than 90% of Veolia water's revenues, and industrials only 10%. The global picture is even more unfavourable when we only look at French water revenues as more than 95% of revenues are generated with municipalities. This sales split explained why the business margin was strongly impacted when the municipalities started to renegotiate prices ahead of local elections. Growth is therefore expected to stem from industrial markets, where Veolia is already present in the US and in China. Global revenues in this segment are expected to reach EUR1.3bn by 2017 on water business. 43

44 Veolia Environnement 5.2. Veolia Waste This business accounts for 37% of the group s revenues and 43% of its EBITDA given higher profitability. For 2014, we are forecasting on a 4.7 % YOY sales increase to EUR8.5bn with a negative sales contribution from price and volumes of recycled materials (-0.5%) and from FX effect Volumes contribution should remain positive despite the sharp slowdown observed in Q2 (+0.7% estimated, after a +2.8% observed in Q1) as well as service price increase (+0.5%). As for EBITDA we stand at EUR968m, up 11.4% YOY thanks notably to the strong contribution from the Convergence programme and thanks to positive perimeter effect following disposal of VMS and Proactiva acquisition. In our model we estimate the Compass contribution should reach EUR37m (before inflation costs) in the Waste business unit for For 2015, we estimate the business unit should be able to grow again thanks to a positive growth in volumes treated in Europe (+1.5% expected on a worldwide basis with lower volumes growth expected in Europe). As such, we are forecasting 1.5% YOY sales growth to EUR8.6bn. Profitability is set to grow again to 12.5% implying EBITDA of EUR1.08bn. The most negative surprise could come from a lower than expected industrial recovery in Europe, which would then continue to impact the amount of waste volumes the group could treat, especially in Central Europe. Fig. 21: Veolia: Waste business estimates Waste e 2015e 2016e Sales YOY growth % 4.8% 2.5% 3.0% EBITDA % of sales 11.5% 10.5% 11.4% 12.4% 13.1% Adjusted operating income % of sales 3.9% 4.6% 4.9% 6.1% 6.8% 5.3. Veolia Energy Services As of 2014, this business accounts for 17% of the group s revenues and 17% of EBITDA (including Dalkia International in H2) given higher profitability. When consolidated on an annual basis Energy is set to represent 18% of the group s sales and of the group s EBITDA. The business is set to generate solid growth for the group following the swap deal with EDF which is acquiring the Dalkia France business unit from Veolia while Veolia is acquiring Dalkia International in exchange for a cash payment. As for 2014 we are consolidating Dalkia International in H2 (Dalkia France being consolidated in H1 2014), and this alters the growth analysis. In our model we currently stand at EUR3.88bn in sales for 2014 implying YOY growth of 3.4% after the 7% drop observed in H1 (Dalkia France) due to a negative weather effect and the halt to cogeneration gas assets. EBITDA was also impacted in H for similar reasons (EBITDA down 5% to EUR147m). However, since we are integrating Dalkia International in H2 we now anticipate YOY EBITDA growth of 59% to EUR364m. 44

45 Veolia Environnement As for 2015 Dalkia International is to be consolidated on a full year basis. We forecast revenues to grow by 9.9% to EUR4.27bn helped by a scope effect and by a normal climate effect. We are forecasting EBITDA of EUR457m pointing to a 10.7% EBITDA margin Fig. 22: Veolia: Energy business estimates Energy e 2015e 2016e Sales YOY growth % 3.4% 9.9% 3.5% EBITDA % of sales 7.1% 6.1% 9.4% 10.7% 10.9% Adjusted operating income % of sales 3.9% 5.4% 6.9% 6.2% 6.3% 45

46 Veolia Environnement 5.4. What we expect for 2014 vs. group s targets? For 2014, management is guiding on five main metrics. Sales: Veolia is only guiding on LFL sales growth in 2014 vs restated revenues. In our model we anticipate a 3.4% YOY sales growth and are therefore fully in line with the group s guidance. EBITDA: Before the integration of Dalkia International in H2 (and hence the deconsolidation of Dalkia France over the same period) management was aiming to increase group EBITDA by 10% at constant FX rate thanks to 1/good operating leverage, 2/fixed cost reductions, and 3/the Proactiva acquisition. Based on the consolidation of Dalkia International in H2, EBITDA guidance needs to be revised up as the net swap effect of Dalkia's deal with EDF should provide EUR100m in additional EBITDA for Veolia, based on consolidation over six months. New implicit guidance is then not at +10% at constant FX rate but at +15%. We currently stand at +17.6% for 2014e and are therefore slightly above group s target. Recurring EBIT: As for EBITDA, Veolia is forecasting an increase in recurring EBIT. During H1 the group was able to generate 5.8% YOY growth compared with the previous year, helped by a EUR57m capital gain (o/w EUR49m from disposal of Maris Pedersen). Excluding positive one-off impact and non recurring items (provisions...) growth was positive at +9.4%. As for 2014, following the integration of Dalkia International we expect the group to post recurring EBIT of EUR1.1bn, up 25.5% YOY but only 8.9% if we adjust for capital gains and the Dalkia move. In our model we anticipate the group will generate EUR354m in net recurring income, up 59% vs Financial expenses: Management's guidance is for lower financial expenses compared with last year. During H1, the group managed to reduce net financial charges by 26% thanks to net debt reduction and debt optimisation. For 2014 we expect a -15% trend. Recurring net income: based on the above-mentioned factors, the group s net recurring income is expected to grow vs In our model we anticipate the group will generate EUR354m in net recurring income, up 59% vs This growth integrates the Dalkia move. 46

47 Veolia Environnement Below are our estimates for e. Fig. 23: Veolia: BG estimates Estimates EURm Revenues o/w Water o/w Waste o/w Energy (Dalkia) o/w Transport EBITDA (CAFOP) margin % of sales 9.2% 8.0% 9.2% 10.2% 10.8% 11.4% o/w Water o/w Waste o/w Dalkia o/w others (42) (113) (90) (91) (92) (93) EBITDA (CAFOP) margin 9.2% 8.0% 9.15% 10.2% 10.8% 11.4% o/w Water 9.7% 8.3% 9.3% 9.9% 10.5% 11.1% o/w Waste 11.5% 11.4% 12.4% 13.1% 13.9% 14.6% o/w Energy (Dalkia) 7.1% 9.4% 10.7% 10.9% 11.2% 11.4% o/w others Reported EBIT % of sales 3.7% 2.2% 3.9% 5.0% 5.6% 6.0% Non recurrent elements (99) (318) (50) Share of adjusted net income of joint ventures and associates Adjusted operating income (RESOP) % of sales 4.1% 4.1% 4.7% 5.3% 5.9% 6.3% o/w Water o/w Waste o/w Energy (Dalkia) o/w others (135) (92) (12) (37) (34) (31) Net financials (759) (538.2) (468.9) (391.7) (386.8) (384.2) Tax rate 53% 161% 34% 34% 34% 34% Minorities (136) (113.8) (90.0) (65.2) (66.9) (68.5) Result from abandoned activities Net income reported (135.3) Net income adjusted - VEOLIA Estimates Net income adjusted - BG Estimates (151.3) EPS reported - (0.26) EPS adjusted - VEOLIA Estimates EPS adjusted - BG Estimates - (0.29) Dividend Net margin 1.3% -0.7% 0.8% 1.9% 2.3% 2.6% 47

48 Veolia Environnement 6. Valuation We have value Veolia using a SOTP calculation to reflect the different growth potentials in each of its activities and to see how each contributes to the group s Fair Value. Our model yields a Fair Value of EUR17 per share, pointing to 24% upside relative to the current share price and implying a Buy recommendation. At our Fair Value, the stock is trading at 6.8x 2015e EBITDA and 17.1x 2015e earnings. Fig. 24: Veolia: SOTP Value (EURm) Implied EV/EBITDA EBITDA 2015E Method % Weigh of EV Value per share 2015E Water x 982 DCF 44% 12.3 Waste x DCF 43% 11.9 Dalkia International x 457 DCF 18% 5.0 Others (636) 7.0x (91) 7x EBITDA -4% (1.2) Implied EV x Net debt at end 2014e (8 062) (14.7) Integration of 100% (1 500) (2.7) book value (H1-14) (2 220) (4.1) Minority Market value (14x) (1 260) (2.3) Operating financial assets (H1-14) Other financial assets (H1-14) Associates & value (exc. Dalkia International) (H1-14) Total implied Equity value Number of shares (net of owns shares) Equity value per share rounded 17.0 Current share price 13.8 Up/Downside 24% Fig. 25: Veolia DCF assumptions DCF assumptions WACC used LT growth EBIT margin LT EBIT margin Water 6.80% 1.0% 6.8% 5.0% Waste 7.40% 1.0% 8.0% 5.5% Dalkia International 7.50% 1.5% 6.8% 5.5% Our SOTP yields to a fair value of EUR17 per share Our SOTP takes into account the Dalkia swap deal with EDF, a 1% annual fixed cost reduction with a retention rate of 60% and then 40%, and still assumes Transdev will not be sold in the short term. Assuming no further cost reductions beyond 2015 would lead to a Fair Value of EUR14 in line with current share price. The market is therefore still cautious on the earnings growth potential likely beyond 2015 and is still adopting a wait and see attitude regarding the group s ability to retain fixed cost reductions in its margin. We are more confident than the market, given the cultural changes the group is undertaking, and the strong savings potential offered by the previously unoptimised structure. Given the stronger sensibility to industrial recovery compared with Suez Environnement, any positive economical signal would drive up the group s earnings growth potential and share price. We nevertheless remain cautious and expect only 0.4% volume growth in waste Europe. 48

49 Veolia Environnement Appendice: What is Veolia Environnement? This description section is still based on the old communication style of Veolia (based on activities by business vs. by region today), thereby making a growth comparison easier compared with Suez Environnement and easier compared with historical performances (given that we only have H1-13 as historical figures with new divisions).. The main metrics are now divided into five main regions, versus three main businesses before: France, Europe excluding France, RoW, Worldwide region and Dalkia. As for revenues, the group will continue to detail how much stems from water and waste businesses but will not divulge this data at the EBITDA and EBIT levels. Three business activities Veolia Environnement is a European leader in waste-related and water-related activities. Veolia Environnement is above all present in France, while aiming to improve its presence and influence in emerging countries, especially in the Asia-Pacific area. Veolia Environnement s activities are split into three main operating divisions: Water, Environmental Services (Waste) and Energy Services through its subsidiary Dalkia International. Otherwise, the company is still looking for a gradual withdrawal from its transportation business by selling its stake in its Transdev subsidiary. Fig. 26: Veolia: H1-14 sales by business Veolia H1-14 sales by business Veolia H1-14 EBITDA by business Energy 16% Water 46% Energy 14% Waste 44% Waste 38% Water 42% Waste is currently the main earnings contributor for the group (44% of EBITDA) despite being the second sales contributor after the Water business (46% of sales vs. 38% for Waste) and given the group s strategy to strongly develop with industrials, we expect this split to remain similar (in order of contribution to P&L). However in 2015 the split should be slightly modified for both sales and EBITDA with the full-year integration of Dalkia International rather than Dalkia France (higher sales and EBITDA contribution, and higher profitability level). We estimate Energy will not represent 16% of group s sales and 14% of group s EBITDA but respectively 18% and 18%). 49

50 Veolia Environnement Waste The division manages the entire waste cycle from waste collection to recycling or processing. All waste types - excluding nuclear waste - are managed by the division: solid waste, liquid waste, hazardous waste and non-hazardous waste. Both industrials and local authorities are part of Veolia s customers. Other activities and services provided by the division include cleaning of public spaces, maintenance of production equipment or treatment of polluted soil. Contract terms generally depend on the service proposed by Veolia Environnement. Collection contracts usually last 1-5 years while waste processing contracts have a wider range, from 1 to 30 years. The division splits its businesses into three main sub-activities: Environmental services and logistics dedicated to both public authorities and industrial companies. This includes urban cleaning (for public authorities) as well as the cleaning and maintenance of industrial facilities (for industrial customers). Sorting and recycling of materials as well as waste recovery enabling the company to create new raw materials to reintroduce them into the economy. Processing including incineration, landfilling and composting. The chart below show the waste revenue split by activity (H metrics). Fig. 27: Veolia: Waste revenue by activity (H1-14) Waste-toenergy from non hazardous waste Hazardous 10% waste treatment 9% Sorting & Recycling 15% Landfilling of nonhazardous and inert waste 8% Hazardous industrial waste collection and services 17% Urban cleaning and collection 19% Non Hazardous industrial waste collection and services 22% The group s activities in this business are well balanced (no activity representing more than 25% of business revenues) thereby making it less dependent on changes in the cycle, or changes in regulations for specific markets. Geographically speaking, the division is still highly present in Europe especially in France for historical considerations with 64% of its H revenues in Europe. However, the division is continuing its geographical expansion. More than 10% of the division s revenues currently stem the Asia-Pacific area. Business development is primarily set to stem from the hazardous waste activities and from growth with industrial customers. 50

51 Veolia Environnement Historically highly dependent on industrial cycles, Veolia is now targeting new markets offering clear visibility on cash-flow with lower investments needed at the start of the projects. The group collects for more than 51m people on behalf of local authorities, operates through 719 treatment plants, and recovers on average 38 million metric tons of waste recovered as materials and energy. Fig. 28: Veolia Waste sales & EBITDA margin ( e) % 11.4% 11.3% % e Sales % of sales 11.8% 11.6% 11.4% 11.2% 11.0% 10.8% 10.6% 10.4% 10.2% 10.0% 9.8% Water activities Veolia Environnement's water operating division provides water and wastewater services to both public authorities (>90% of sales) and industrials. Contracts concluded with public authorities have the particularity of being extended over a large duration, generally between 10 and 20 years and sometimes around 50 years. Contracts signed and operated by Veolia Water can generally take different patterns: public-private partnerships, BOT (Build, Operate & Transfer) contracts or DBO (Design, Build & Operate) contracts. Solutions provided by Veolia Water cover the entire water cycle including wastewater services (collection, treatment and discharge into the environment), recycling, aquifer recharge, desalination and drinking water treatment and production. Through this division, Veolia Environnement provides drinking water to about 94m people all around the world while 62m people are provided with wastewater services of the company. Additionally, the company collected 7bn m3 of wastewater in Through its 83,150 employees, the division is present in about 70 countries especially in Europe (France, Germany, Belgium, Italy or Romania) but also in Asia (Japan, China, and South Korea), Oceania (Australia), Africa (Morocco, Gabon) and in the United States. 72% of water revenues stem from Europe and 42% from France. 51

52 Veolia Environnement Fig. 29: Veolia: Water revenues (H1-14) Worldwi de activitie s 20% RoW 7% France 43% Europe excl. France 30% Most of the group s contracts in the water business are signed with municipalities (around 90% of the group s water sales are exposed to municipalities), thereby meaning it is highly exposed to renegotiations cycles. In this division, Veolia Environnement has developed a strategy split into three main lines. The first one, focusing on high capital intensity municipal activities, consists of fostering organic growth as well as the profitability of its Chinese assets (JVs). It may be conciliated with the streamlining of French activities to offset current pressure on margins. The second part of the strategy is focused on the low capital intensive municipal activities. The main objective is to supply high-value services including state-of-the-art technologies to boost operating margins. Finally, the third part of the strategy includes all the activities toward industrials customers. Through its new offers based on high-value technologies and integrated services, Veolia Water aims to win market share and continue with its current development in emerging countries. Fig. 30: Veolia Water sales & EBITDA margin ( e) % % 8.1% 8.3% % 10.0% 8.0% 6.0% 4.0% % e Sales % of sales 0.0% 52

53 Veolia Environnement Energy In this section we use metrics for Dalkia group (before the split between Dalkia France and Dalkia International) despite the fact that Veolia used to control Dalkia France and that it is now controlling 100% of Dalkia International. We do not have access to all metrics for both entities (number of employees, number of contracts for instance) and this makes analysis difficult. The Energy Services activities of Veolia Environnement are led by its subsidiary Dalkia, which provides energy services to both public authorities and industrials. The company is the leader in its segment in Europe while remaining well ranked in the US. Over 130,000 energy installations are managed by Dalkia. Usually, contracts for operation of urban heating or for cooling networks can last up to 30 years, well above the average duration of thermal and multi-technical installations that last about 15 years. Through its 50,000 employees, the company aims to be present at all levels of the energy value chain, including decentralised production as well as optimising distribution. Industrial companies represent just under 30% of the company s overall revenues, while the global revenue breakdown includes local authorities, industry, housing (multi-family, public and private), non-market services (health, education, etc.), and market services (retail, offices, etc.). Dalkia generally splits its business into three main sectors: Heating and cooling systems. Dalkia current manages more than 800 urban heating and cooling networks all around the world. In this segment, the company is above all present in France, the UK, Eastern Europe and the United States; Industrial Utilities. In this segment, Dalkia provides various services including the optimisation of steam and electricity, other optimisation of the use of process energy and the global energy consumption of buildings. Energy Services for Buildings. Dalkia finally provides integrated services consisting of design, construction and maintenance as well as global energy supply. Fig. 31: Veolia Energy sales & EBITDA margin ( e) % 8.2% 7.1% 6.1% e Sales % of sales 10.0% 9.0% 8.0% 7.0% 6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 53

54 Veolia Environnement PAGE LEFT BLANK INTENTIONALLY 54

55 INDEPENDENT RESEARCH 30th September 2014 Suez Environnement Fairly valued Utilities Fair Value EUR14 (price EUR13.11) NEUTRAL Coverage initiated Bloomberg SEV FP Reuters SEVI.PA 12-month High / Low (EUR) 15.4 / 12.0 Market capitalisation (EURm) 7,082 Enterprise Value (BG estimates EURm) 17,763 Avg. 6m daily volume ('000 shares) 1,138 Free Float 56.8% 3y EPS CAGR 14.8% Gearing (12/13) 108% Dividend yields (12/14e) 4.96% YE December 12/13 12/14e 12/15e 12/16e Revenue (EURm) 14,644 14,328 14,850 15,357 EBIT(EURm) 1,184 1,259 1,279 1,377 Basic EPS (EUR) Diluted EPS (EUR) EV/Sales 1.0x 1.2x 1.2x 1.1x EV/EBITDA 5.7x 6.8x 6.5x 6.2x EV/EBIT 12.1x 14.1x 13.7x 12.8x P/E 20.0x 23.8x 15.1x 13.2x ROCE We are initiating coverage of Suez Environnement with a Neutral recommendation and a Fair Value of EUR14 per share. In a difficult environment in Europe, investing in highly cyclical companies could appear risky yet Suez Environnement's balance sheet is healthy and margin improvement is driven by contracts signed outside of Europe. The investment case is solid although earnings growth potential and upside to current share price offer less reward than Veolia. Solid performance despite weak activity in Europe: Thanks to a strict cost control programme and a fairly good commercial performance outside Europe, Suez Environnement was able to generate positive LFL EBITDA growth in H and should do the same over the year. Thanks to new waste capacities and growth in new businesses (Smart water, Industrial water, EfW) we believe the group can outperform both markets in Europe over the mid-term ( e) leading to an EPS CAGR of 24.6% over e and 12.4% over e /09/14 Close to top margin: Earnings growth potential is strong, yet margin development is quite limited in our view (only 100bp growth potential in our DCF by 2024e vs. 2014e on EBIT) given the already strict cost control programme implemented by management. In our model, we have assumed annual fixed cost reduction of 1% (with a retention rate of 60% over the medium term) believing management has already made the most of the main efforts. In our view, Veolia offers higher upside in margins. Source Thomson Reuters SUEZ ENVIRONNEMENT STOXX EUROPE 600 Neutral, FV at EUR14: Our SOTP valuation of Suez Environnement puts Fair Value at EUR14 per share, leading to a Neutral recommendation. We consider upside to margins and the current share price too limited to offer an attractive reward on the investment case. We prefer Veolia to Suez Environnement. Analyst: Xavier Caroen 33(0) xcaroen@bryangarnier.com r r

56 Suez Environnement Income Statement (EURm) e 2015e 2016e 2017e Revenues 14,830 15,102 14,644 14,328 14,850 15,357 16,017 Change (%) 6.9% 1.8% -3.0% -2.2% 3.6% 3.4% 4.3% EBITDA 2,513 2,450 2,520 2,622 2,703 2,846 3,017 EBIT 1,039 1,146 1,184 1,259 1,279 1,377 1,487 Change (%) 1.4% 10.2% 3.3% 6.3% 1.6% 7.7% 8.0% Financial results (405) (419) (402) (405) (359) (362) (363) Pre-Tax profits ,015 1,124 Exceptionals 52.4 (93.7) (5.2) (15.0) (15.0) (15.0) (15.0) Tax (174) (186) (205) (192) (257) (284) (315) Profits from associates Minority interests (227) (218) (250) (218) (183) (187) (190) Net profit Restated net profit Change (%) -26.6% 27.6% -3.3% -11.0% 58.3% 13.9% 14.0% Cash flow Statement (EURm) Operating cash flows 1,902 2,357 1,465 1,829 1,866 2,013 2,134 Change in working capital (65.3) 305 (68.2) (108) (90.6) (43.9) (43.2) Income tax paid Capex, net (1,410) (1,222) (1,138) (1,100) (1,141) (1,181) (1,231) Financial investments, net (152) (60.9) 151 (53.0) Dividends (281) (601) (556) (331) (351) (351) (351) Other 607 (719) 338 (471) (592) (596) (600) Net debt 7,449 7,436 7,245 7,312 7,531 7,646 7,694 Free Cash flow 233 1, Company description Former subsidiary of Lyonnaise des Eaux, which merged with Suez in 1997, Suez Environnement was listed in 2008, as part of the merger process of GDF with Suez. The group is the number 2 player in the environmental services sector. Its revenues are derived from water (31%), waste (45%) and International (23%) activities. Major shareholders are GDF-Suez (35.7%) and La Caixa (4%) Balance sheet (EURm) Tangible fixed assets 8,783 8,882 7,833 7,934 7,973 8,017 8,062 Intangibles assets 4,046 4,061 4,518 4,518 4,518 4,518 4,518 Cash & equivalents 2,494 2,247 2,506 2,251 2,032 1,917 1,869 current assets 8,361 7,755 8,158 7,947 8,013 8,168 8,458 Total assets 27,061 26,637 26,708 26,583 26,714 26,939 27,306 L & ST Debt 10,071 9,918 7,229 9,999 9,999 9,999 9,999 Others liabilities 10,173 9,859 12,569 9,618 9,721 9,855 10,059 Other assets 3,378 3,691 3,694 3,934 4,178 4,319 4,400 Shareholders' funds 4,946 4,864 4,963 4,963 4,963 4,963 4,963 Total Balance sheet 27,061 26,637 26,708 26,583 26,714 26,939 27,306 Capital employed 17,356 16,910 16,130 14,163 14,246 14,334 14,430 Financial Ratios Operating margin Tax rate Net margin ROE (after tax) ROCE (after tax) Gearing Pay out ratio Number of shares, diluted Per share data (EUR) EPS Restated EPS % change -12.7% 2.7% -3.4% -16.1% 58.3% 13.9% 14.0% BVPS Operating cash flows FCF Net dividend