INDEPENDENT RESEARCH Utilities · We are initiating coverage of the French Environmental Services sector with a BUY recommendation for Veolia Environn4ement (Fair Value EUR17, +2%

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INDEPENDENT RESEARCH Utilities 30th September 2014 Fighting for growth

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VEOLIA ENVIRONNEMENT BUY FV EUR17 Bloomberg VIE FP Reuters VIE.PA Price EUR13.585 High/Low 14.695/11.2155 Market Cap. EUR7,639m Enterprise Val EUR16,081m PE (2014e) 40.1x EV/EBIT (2014e) 17.7x

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

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).

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 2015-17 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 2015-17 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.

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STOXX EUROPE 600 UTILITIES E STOXX EUROPE 600

29/09/14

Source Thomson Reuters

Analyst: Xavier Caroen 33(0) 1.56.68.75.18 [email protected]

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Table of contents

1. Fighting for growth .................................................................................................................... 3

2. Suez Environnement vs. Veolia ............................................................................................... 5

2.1. Profitability.......................................................................................................................................... 6

2.2. Margin & ROCE evolution .............................................................................................................. 8

2.3. Earnings and dividend growth ...................................................................................................... 10

2.4. Leverage & balance sheet ............................................................................................................... 11

2.5. Geographical exposure ................................................................................................................... 12

2.5.1. Both groups still too highly exposed to Europe .......................................................... 12

2.5.2. Development in international activities remains a key driver .................................... 13

2.6. Sensibility to economic recovery in Europe ............................................................................... 14

2.6.1. Sensibility analysis .............................................................................................................. 14

2.6.2. Europe could be a driver, but not today ........................................................................ 15

2.7. Valuation & share price performance .......................................................................................... 16

2.7.1. Historical Valuation ........................................................................................................... 16

2.7.2. Veolia vs. Suez Environnement ...................................................................................... 18

2.7.3. Share price performance ................................................................................................... 20

3. Risk reward more appealing with VIE .................................................................................. 22

Veolia Environnement (BUY, FV EUR17) .............................................................................. 25

Heading into the right direction ................................................................................................................ 25

Suez Environnement (NEUTRAL, FV EUR14) ..................................................................... 55

Fairly valued .................................................................................................................................................. 55

Bryan Garnier stock rating system .............................................................................................. 95

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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 H2 2013 and in H1 2014 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 2020.

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

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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% 2014-24e 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).

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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

Source: Company Data; Bryan, Garnier & Co ests.

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 - 2015e 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%


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We grade a 2 when we judge Veolia or Suez Environnement is better positioned than its French peer

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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 (400-450bp 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

Source: Company Data; Bryan, Garnier & Co ests. At present, Suez Environnement is better armed than Veolia with net margin more than double that at Veolia.

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Fig. 4: Indicators explaining the difference in profitability (1/2)

Environmental sales per employee (2013) EUR French water market, % by operator


Fig. 5: Indicators explaining the difference in profitability (2/2)

Fixed costs reduction annual net gain (EURm) EBITDA margin by business (%)


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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 (2008-18e)


Fig. 7: EBITDA margin gain, 2013-18 SEV vs. VIE


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Fig. 8: ROCE evolution – VIE vs. SEV


Fig. 9: ROCE evolution by business – VIE vs. SEV

ROCE evolution by business - SEV ROCE evolution by business - VIE


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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


Fig. 11: Dividend growth– VIE vs. SEV

Dividend VIE vs. SEV Dividend yield VIE vs. SEV


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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 2015.

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

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 H1 2014 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.

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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).

2.5.1. 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)


Fig. 14: Environnement sales by region – SEV vs. VIE

Environment sales by region – SEV (2014e) Environment sales by region – VIE (2014e)


Europe ; 73%

North America; 5.5%

South America; 6%

Oceania; 7%

Asia; 3%

Other International;

6%

Europe77%

International23%

Europe ; 73%

North America; 5.5%

South America; 6%

Oceania; 7%

Asia; 3%

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Europe74%

International26%

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2.5.2. 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 2017-18.

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)


Europe ; 66%

International; 33%

Europe ; 65%

International; 35%

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2.6. Sensibility to economic recovery in Europe

2.6.1. 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






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






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.

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2.6.2. 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

Source: Company Data; Bryan, Garnier & Co ests.; IBES

In view of IMF expectations for GDP growth over 2015-16e, 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


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2.7. Valuation & share price performance

2.7.1. 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 2012

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. 2008 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.

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Fig. 21: Market cap evolution (EURbn) vs. EBITDA FY1 estimates (EURbn)

VIE market cap. vs EBITDA FY1 SEV market cap. vs EBITDA FY1


Fig. 22: EV/EBITDA FY1/FY2

VIE vs. SEV – EV/EBITDA FY1 VIE vs. SEV – EV/EBITDA FY2


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%).

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Utilities

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Fig. 23: P/E FY1/FY

VIE vs. SEV – P/E FY1 VIE vs. SEV – P/EFY2


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.

2.7.2. Veolia vs. Suez Environnement Within this section we compare both Veolia and Suez Environnement on 2014-17e multiples. We adjusted both EBITDA to get clean EV/EBITDA multiples. We made two adjustments: 1/on Veolia EBITDA we adjusted 2014-17e 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 2 112 2 426 2 635 2 864 3 099

Adjustments 314 281 286 292 298

EBITDA adjusted 2 426 2 707 2 921 3 156 3 396

% of sales 10.5% 11.4% 11.9% 12.5% 13.1%

Market capitalization 7 638 7 638 7 638 7 638 7 638

Net debt (+) 8 062 7 989 7 782 7 678 7 479

Pensions and other provisions ( + ) 2 220 2 220 2 220 2 220 2 220

Minorities (+) @ Market value (14x) 1 260 913 936 959 983

Associates & JVs ( - ) @ Book value 3 100 2 300 2 300 2 300 2 300

EV 16 081 16 460 16 276 16 195 16 021

Implied EV/EBITDA multiple 6.63x 6.08x 5.57x 5.13x 4.72x


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Fig. 25: EV/EBITDA adjusted multiples for Suez Environnement


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 (2014-24e CAGR at +8% for Veolia versus +5% for Suez Environnement).

Fig. 26: Veolia – Suez Environnement EV/EBITDA multiples – premium/discount


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.

6.63x6.08x

5.57x5.13x

4.72x

7.12x6.47x 6.20x

5.89x 5.62x

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2014e 2015e 2016e 2017e 2018eVeolia EV/EBITDASuez Environnement EV/EBITDAImplied premium/discount (VIE/SEV)

Suez Environnement 2014e 2015e 2016e 2017e 2018e

EBITDA reported 2 622 2 703 2 846 3 017 3 176

Adjustments (129) 0 0 0 0

EBITDA adjusted 2 493 2 703 2 846 3 017 3 176

% of sales 17.4% 18.2% 18.5% 18.8% 19.2%

Market capitalization 7 082 7 082 7 082 7 082 7 082

Net debt (+) 7 312 7 531 7 646 7 694 7 722

Pensions and other provisions ( + ) 1 993 1 993 1 993 1 993 1 993

Minorities (+) @ Market value (14x) 3 052 2 562 2 613 2 666 2 719

Associates & JVs ( - ) @ Book value 1 676 1 676 1 676 1 676 1 676

EV 17 763 17 492 17 659 17 759 17 840

Implied EV/EBITDA multiple 7.12x 6.47x 6.20x 5.89x 5.62x

Utilities

20

Fig. 27: Veolia – Suez Environnement EV/EBIT multiples – premium/discount


2.7.3. 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

2010 2011 2012 2013 2014ytd 2013-14ytd

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 – 2011


15.76x

12.92x

11.23x10.15x

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Fig. 30: SEV vs. VIE share price performance (rebased 100 – 2012/13)

VIE vs. SEV – 2012 VIE vs. SEV – 2013


Fig. 31: SEV vs. VIE share price performance (rebased 100 – 2013/14)

VIE vs. SEV – 2014ytd VIE vs. SEV – 2013/14ytd


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).

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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 2015-16 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 2015-16 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


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Fig. 33: Comparison analysis – Veolia vs. Suez Environnement – (2>1)


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 2016-2024e 14.0 -1.3% 2.5%

Assuming 1% of costs reduction for 2016-2024e (with retention rate of 60% and then 40%) 17.0 19.8% 3.7% Assuming 1% of costs reduction for 2016-2024e (with retention rate of 100%) 19.0 33.9% 3.9%


Fig. 35: Suez Environnement sensibility analysis to costs reduction

Suez Environnement TP per share Upside Net margin 2020e




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r r

INDEPENDENT RESEARCH Veolia Environnement 30th September 2014 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%

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.

YE December 12/13 12/14e 12/15e 12/16e Revenue (EURm) 22,315 23,069 23,811 24,463 EBIT(EURm) 490.50 906.80 1,193 1,363 Basic EPS (EUR) -0.26 0.56 0.93 1.13 Diluted EPS (EUR) -0.29 0.34 0.80 1.01 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 5.5 5.8 6.8 7.4

86

91

96

101

106

111

116

VEOLIA ENVIRONNEMENT STOXX EUROPE 600

29/09/14



Veolia Environnement

26

Income Statement (EURm) 2011 2012 2013 2014e 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 1,095 491 907 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 83.6 303 79.5 614 892 1,072 1,222 Exceptionals 0.0 (49.3) (318) (50.0) 0.0 0.0 0.0 Tax (521) (159) (128) (211) (306) (368) (419) Profits from associates 12.0 30.0 (51.5) 177 90.9 96.1 102 Minority interests (173) (136) (114) (90.0) (65.2) (66.9) (68.5) Net profit (490) 394 (135) 314 521 638 734 Restated net profit (490) 394 (151) 191 451 568 664 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) 93.2 115 (120) Income tax paid 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Capex, net (2,630) (2,471) (1,227) (1,453) (1,527) (1,569) (1,614) Financial investments, net 1,493 2,899 895 490 0.0 0.0 0.0 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) 602 612 993 1,128 1,026 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 5.45 4.05 4.13 4.74 5.35 5.92 6.34 Tax rate 623 52.53 161 34.30 34.30 34.30 34.30 Net margin -1.71 1.34 (0.61) 1.36 2.19 2.61 2.92 ROE (after tax) -4.98 4.63 -1.56 2.00 4.69 5.78 6.55 ROCE (after tax) 2.39 4.39 5.53 5.77 6.76 7.42 7.90 Gearing 152 126 84.01 83.30 81.70 77.78 74.29 Pay out ratio (123) 88.21 (242) 65.00 65.00 65.00 65.00 Number of shares, diluted (000) 496 496 523 562 562 562 562 Per Share data (EUR) EPS (0.99) 0.79 (0.26) 0.56 0.93 1.13 1.31 Restated EPS (0.99) 0.79 (0.29) 0.34 0.80 1.01 1.18 % change -185% -% -136% -% 136% 25.9% 17.0% BVPS 14.25 14.32 15.69 14.39 14.62 15.05 15.66 Operating cash flows 4.40 4.01 3.50 3.67 4.48 4.80 4.69 FCF (0.15) (0.63) 1.15 1.09 1.77 2.01 1.82 Net dividend 1.21 0.70 0.70 0.70 0.70 0.70 0.77


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%).


27

Table of contents

1. Investment Case ........................................................................................................................................ 28

2. A new Veolia ............................................................................................................................................. 29

2.1. Lower France, more international ................................................................................................ 30

2.2. More geared to value-added markets ........................................................................................... 31

2.3. More financially and operationally flexible ................................................................................. 33

3. Flaws still exist........................................................................................................................................... 35

3.1. French water business still weighing on group’s margin in the short term........................... 35

3.2. A margin growth story still highly dependent from restructuring .......................................... 37

4. Yet risk reward is appealing .................................................................................................................... 40

5. Our forecasts ............................................................................................................................................. 42

5.1. Veolia Water ..................................................................................................................................... 43

5.2. Veolia Waste ..................................................................................................................................... 44

5.3. Veolia Energy Services ................................................................................................................... 44

5.4. What we expect for 2014 vs. group’s targets? ............................................................................ 46

6. Valuation .................................................................................................................................................... 48

Appendice: What is Veolia Environnement? ............................................................................................. 49

Three business activities ............................................................................................................................. 49

Waste ............................................................................................................................................................. 50

Water activities ............................................................................................................................................. 51

Energy ........................................................................................................................................................... 53

Bryan Garnier stock rating system............................................................................................................... 94


28

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 2014. 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).


29

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 2014-24e 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 2016-17 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.


30

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


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 2014.

France51%

RoEurope26%

Asia10%

USA7%

RoW6%

France34%

RoEurope43%

Asia10%

USA7%

RoW6%


31

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 2020. 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 EUR900-950m 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).

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 H1 2014 it obtained contracts with Ecopetrol America (USD73m), with BP (USD75m) and with FPCC (EUR15m). All major contracts awarded in H1 2014 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 H1 2014 came from industrials) and to the seven potential markets (40% of sales growth in H1-14 came from new markets).

Fig. 2: Veolia: H1 2014 sales growth by customer type vs. 2013

New H1 2014 sales by customer 2013 sales by customer


Industrials ; 60%

Municipalities; 40%

Industrials ; 35%

Municipalities; 65%

60% of sales growth in H1-2014 came from industrials


32

Fig. 3: Veolia: H1 2014 sales growth by category

New H1 2014 sales by type of contract New H1 2014 sales by type of growth


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


New contracts; 60%

Renewals; 40%

Thematic growth

markets; 40%

Others; 60%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

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0

500

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2 500

2014 2015 2016 2017 2018 2019 2020

Sales EBITDA % of group's sales

Veolia targets 5% to 10% market share by 2020 on Oil & Gas and Mining industrials markets


33

2.3. More financially and operationally flexible The group is now entering a growth and structure optimisation phase, after having focused most of its 2009-12 strategy on reducing net debt (EUR10.2bn net debt impact following 2009-14e 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)


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 2 112 2 426 2 635 2 864 3 099 EBITDA margin 9.2% 10.2% 10.8% 11.4% 12.0%

OFA reimbursement 200 200 200 200 200

Operating cash-flow after tax and financials 1 507 2 024 2 200 2 143 2 322 Gross capex (1 453) (1 527) (1 569) (1 614) (1 660)

FCF before dividends 54 497 631 529 662

Dividends (247) (394) (394) (394) (432)

Cash flow post dividends (193) 103 238 136 230

Net debt reported 8 062 7 989 7 782 7 678 7 479

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

Source: Company Data; Bryan, Garnier & Co ests.Source: Company Data; Bryan, Garnier & Co ests.

1 107 1 275 1 195

5 091

1 000490

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14 000

16 000

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2009 2010 2011 2012 2013 2014e

Disposals (EURbn) Net debt

Dividend is set be fully paid in cash in 2015


34

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.

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


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).

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

2008 2009 2010 2011 2012 2013 2014e 2015e 2016e 2017e 2018

Veolia dividend Suez Environnement dividend

0%

2%

4%

6%

8%

10%

12%

14%

16%

2008 2009 2010 2011 2012 2013 2014e 2015e 2016e 2017e 2018e

VIE Yield SEV Yield

By 2017 both entities should be able to increase dividends


35

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.

3.1. French water business still weighing on group’s margin in the short term

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


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.

Veolia; 34.50%

Suez Environnement;

19.50%

Saur; 10.80%Public; 1.90%

Others; 33.30%

Veolia is the market leader with almost double the revenues of its French peer Suez Environnement


36

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


Fig. 10: Veolia – Water EBITDA & EBITDA margin evolution


1 172

833 869 982

1 075

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2012 2013 2014e 2015e 2016eEBITDA French Water EBITDA Water

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2011 2012 2013 2014e 2015e 2016e 2017e 2018e

Water EBITDA Water EBITDA margin


37

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.

Fig. 11: Veolia: convergence plan targets

2011 2012 2013 2014 2015

Announced during 2011 investor day - 60 120 220 420

Raised objectives - 60 170 270 470

Updated objectives (cumulated) - 60 170 400 750

Implied gain per year - 60 110 230 350 Achieved gain - 60 118 - -

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 2015. 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

Veolia targets to adjust its cost base by EUR750m by 2015


38

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 2016-20 period and a 40% retention rate for 2021-24 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 2016-24e. Assuming no cost reductions over 2016-24e would lead to a Fair Value of EUR14 instead of EUR17.

Fig. 12: Veolia: Convergence plan – Costs reduction by applications


Purchasing; 19%

Organization; 48%

Margin improvement

(contracts); 8%

Technical optimisation;

14%

IT; 4%

External charges cut; 5%

Others; 2%

Assuming no cost reductions over 2016-24e would lead to a Fair Value of EUR14 instead of EUR17.


39

Fig. 13: Veolia – Costs reduction contribution to EBITDA (after inflation costs for 2016-24e) - EURm


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 2016-2024e 14.0 -1.3% -26.3% 2.5%

Assuming 1% of costs reduction for 2016-2024e (with retention rate of 60% and then 40%) 17.0 19.8% -10.5% 3.7% Assuming 1% of costs reduction for 2016-2024e (with retention rate of 100%) 19.0 33.9% 0.0% 3.9%


60

118

184

280

131 134 137 140 143

98 101 103 107

0.0%

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0

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200

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300

Net fixed costs reduction plan EBITDA margin


40

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 2015-16 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 2015-16 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


0%

2%

4%

6%

8%

10%

12%

2013 2014e 2015e 2016e 2017e 2018e


0%

2%

4%

6%

8%

10%

12%

2007 2008 2009 2010 2011 2012 2013 2014e 2015e 2016e 2017e 2018e



41

Fig. 16: Comparison analysis – Veolia vs. Suez Environnement – (2>1)


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




Fig. 18: Suez Environnement sensibility analysis to costs reduction

Suez Environnement TP per share Upside Net margin 2020e




0

0.5

1

1.5

2Profitability


Margin evolution

Earnings growth


Valuation

Dividend growth

Dividend yield




Leverage


In our base case we see 34% upside to the current price, versus 27% for Suez Environnement.


42

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.

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 2015.

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


Water45%

Waste 37%

Dalkia18%

Water39%

Waste 43%

Dalkia18%

Our 2014 adjusted EPS estimate stands at EUR0.34 and our 2015 adjusted EPS (with hybrid costs) stands at EUR0.80 per share


43

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 2012 2013 2014e 2015e 2016e

Sales 12 078 10 222 10 459 10 598 10 834 YOY growth - -15.4% 2.3% 1.3% 2.2%

EBITDA 1 172 833 869 982 1 075 % of sales 9.7% 8.1% 8.3% 9.3% 9.9%

Adjusted operating income 674 438 420 517 600 % 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.


44

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 2014.

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 2012 2013 2014e 2015e 2016e

Sales 9 083 8 076 8 460 8 671 8 931 YOY growth - -11.1% 4.8% 2.5% 3.0%

EBITDA 1 048 847 968 1 077 1 169 % of sales 11.5% 10.5% 11.4% 12.4% 13.1%



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 H1 2014 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.


45

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 2012 2013 2014e 2015e 2016e

Sales 7 665 3 757 3 885 4 271 4 420 YOY growth - -51.0% 3.4% 9.9% 3.5%

EBITDA 544 229 364 457 483 % of sales 7.1% 6.1% 9.4% 10.7% 10.9%




46

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. 2013 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.

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. 2013. In our model we anticipate the group will generate EUR354m in net recurring income, up 59% vs. 2013. This growth integrates the Dalkia move.

In our model we anticipate the group will generate EUR354m in net recurring income, up 59% vs. 2013.


47

Below are our estimates for 2014-17e.

Fig. 23: Veolia: BG estimates

Estimates EURm 2012 2013 2014 2015 2016 2017

Revenues 29 439 22 315 23 069 23 811 24 463 25 155 o/w Water 12 078 10 222 10 459 10 598 10 834 11 098

o/w Waste 9 083 8 076 8 460 8 671 8 931 9 199

o/w Energy (Dalkia) 7 665 3 757 3 885 4 271 4 420 4 575

o/w Transport - - - - - -

EBITDA (CAFOP) margin 2 723 1 796 2 112 2 426 2 635 2 864 % of sales 9.2% 8.0% 9.2% 10.2% 10.8% 11.4%

o/w Water 1 172 833 869 982 1 075 1 170

o/w Waste 1 048 847 968 1 077 1 169 1 276

o/w Dalkia 544 229 364 457 483 511

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 1 095 491 907 1 193 1 363 1 504 % of sales 3.7% 2.2% 3.9% 5.0% 5.6% 6.0%

Non recurrent elements (99) (318) (50) 0 0 0

Share of adjusted net income of joint ventures and associates 30 179 167 81 86 92

Adjusted operating income (RESOP) 1 194 922 1 093 1 274 1 449 1 596 % of sales 4.1% 4.1% 4.7% 5.3% 5.9% 6.3%

o/w Water 674 438 420 517 600 684

o/w Waste 356 373 417 529 604 649

o/w Energy (Dalkia) 299 203 268 265 279 294

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 386 27.3 0.0 0.0 0.0 0.0

Net income reported 393.8 (135.3) 313.7 520.9 637.8 734.2 Net income adjusted - VEOLIA Estimates 393.8 223.0 353.7 510.9 627.8 724.2

Net income adjusted - BG Estimates 393.8 (151.3) 190.7 450.9 567.8 664.2

EPS reported - (0.26) 0.56 0.93 1.13 1.31 EPS adjusted - VEOLIA Estimates 0.79 0.43 0.63 0.91 1.12 1.29

EPS adjusted - BG Estimates - (0.29) 0.34 0.80 1.01 1.18

Dividend 0.70 0.70 0.70 0.70 0.70 0.77

Net margin 1.3% -0.7% 0.8% 1.9% 2.3% 2.6%



48

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

2015E

EBITDA 2015E

Method % Weigh of EV

Value per share

Water 6 732 6.9x 982 DCF 44% 12.3

Waste 6 521 6.1x 1 077 DCF 43% 11.9

Dalkia International 2 725 6.0x 457 DCF 18% 5.0

Others (636) 7.0x (91) 7x EBITDA -4% (1.2)

Implied EV 15 342 6.3x 2 426 28.0 Net debt at end 2014e (8 062) (14.7)

Integration of hybrid @ 100% (1 500) (2.7)

Provisions @ book value (H1-14) (2 220) (4.1)

Minority interest @ Market value (14x) (1 260) (2.3)

Operating financial assets (H1-14) 1 698

Other financial assets (H1-14) 3 177

Associates & JVs @book value (exc. Dalkia International) (H1-14) 2 300 4.2

Total implied Equity value 9 475 17.3 Number of shares (net of owns shares) 548.0

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 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.

Our SOTP yields to a fair value of EUR17 per share


49

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


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%).

Water 46%

Waste38%

Energy16%

Waste44%

Water 42%

Energy14%


50

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 (H1 2014 metrics).

Fig. 27: Veolia: Waste revenue by activity (H1-14)


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 H1 2014 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.

Urban cleaning and

collection19%

Non Hazardous industrial

waste collection

and services22%

Hazardous industrial

waste collection

and services17%

Sorting & Recycling

15%

Hazardous waste

treatment9%

Waste-to-energy from

non hazardous

waste10%

Landfilling of non-

hazardous and inert

waste8%


51

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 (2011-14e)


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 2013. 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.

9 011 9 083

8 076

8 460 11.3%

11.5%

10.5%

11.4%

9.8%

10.0%

10.2%

10.4%

10.6%

10.8%

11.0%

11.2%

11.4%

11.6%

11.8%

7 400

7 600

7 800

8 000

8 200

8 400

8 600

8 800

9 000

9 200

2011 2012 2013 2014e

Sales % of sales


52

Fig. 29: Veolia: Water revenues (H1-14)


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 (2011-14e)


France43%

Europe excl.

France30%

RoW7%

Worldwide

activities

20%

11 921 12 078

10 222 10 459

10.7%9.7%

8.1% 8.3%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

9 000

9 500

10 000

10 500

11 000

11 500

12 000

12 500

2011 2012 2013 2014e

Sales % of sales


53

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 (2011-14e)


7 138 7 665

3 757 3 885

8.2%

7.1%6.1%

9.4%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

10.0%

0

1 000

2 000

3 000

4 000

5 000

6 000

7 000

8 000

9 000

2011 2012 2013 2014e

Sales % of sales


54

PAGE LEFT BLANK INTENTIONALLY

r r

INDEPENDENT RESEARCH Suez Environnement 30th September 2014 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%

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 H1 2014 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 (2015-17e) leading to an EPS CAGR of 24.6% over 2014-17e and 12.4% over 2014-24e.

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.

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.

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) 0.69 0.80 0.89 1.01 Diluted EPS (EUR) 0.65 0.55 0.87 0.99 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 6.1 6.6 7.2 7.6

96

101

106

111

116

121

126

SUEZ ENVIRONNEMENT STOXX EUROPE 600

29/09/14



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56

Income Statement (EURm) 2011 2012 2013 2014e 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 687 633 777 839 919 1,015 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 37.4 22.4 31.0 5.8 0.0 0.0 0.0 Minority interests (227) (218) (250) (218) (183) (187) (190) Net profit 323 251 352 435 479 544 619 Restated net profit 270 345 334 297 470 535 610 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 0.0 0.0 0.0 0.0 0.0 0.0 0.0 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) 0.0 0.0 0.0 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 1,135 327 729 725 832 903 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 7.01 7.59 8.08 8.78 8.61 8.96 9.28 Tax rate 25.36 29.34 26.45 27.00 28.00 28.00 28.00 Net margin 1.82 2.29 2.28 2.07 3.17 3.49 3.81 ROE (after tax) 3.97 5.03 4.83 4.26 6.72 7.56 8.42 ROCE (after tax) 4.98 5.68 6.07 6.62 7.17 7.62 8.12 Gearing 111 112 108 111 114 114 112 Pay out ratio 98.48 95.85 99.25 65.00 65.00 65.00 65.00 Number of shares, diluted 489 509 509 540 540 540 540 Per share data (EUR) EPS 0.66 0.49 0.69 0.80 0.89 1.01 1.15 Restated EPS 0.66 0.68 0.65 0.55 0.87 0.99 1.13 % change -12.7% 2.7% -3.4% -16.1% 58.3% 13.9% 14.0% BVPS 10.11 9.56 9.74 9.49 9.71 10.06 10.54 Operating cash flows 3.89 4.63 2.88 3.39 3.45 3.73 3.95 FCF 0.48 2.23 0.64 1.35 1.34 1.54 1.67 Net dividend 0.65 0.65 0.65 0.65 0.65 0.65 0.73


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%)

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57

Table of contents

1. Investment Case ........................................................................................................................................ 58

2. Creating value where it is possible ......................................................................................................... 59

2.1. Water.................................................................................................................................................. 59

2.2. Waste ................................................................................................................................................. 66

2.3. International expansion is key ....................................................................................................... 69

2.3.1. Welcome news so far in North America ....................................................................... 70

2.3.2. Focusing on China is key ................................................................................................. 71

2.4. Still targeting margin expansion through cost reduction .......................................................... 72

3. A convincing H1 2014 performance ..................................................................................................... 75

4. A sound balance sheet ............................................................................................................................. 77

5. Our estimates ............................................................................................................................................ 79

5.1. Water Europe ................................................................................................................................... 80

5.2. Waste Europe ................................................................................................................................... 81

5.3. International ..................................................................................................................................... 82

5.4. What we expect for 2014 vs. group’s targets? ............................................................................ 83

6. Valuation .................................................................................................................................................... 85

Appendices :What is Suez Environnement? .............................................................................................. 86

Water Europe ............................................................................................................................................... 86

Waste Europe ............................................................................................................................................... 88

International ................................................................................................................................................. 91

Bryan Garnier stock rating system............................................................................................................... 94

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58

1. Investment Case

The reason for writing now The market environment remains under pressure in Europe in both the waste and water activities, yet Suez Environnement has shown it has the ability to pass through this cycle thanks to the development of innovative solutions dedicated to high growth potential markets in mature countries (industrial water, smart water, Energy from Waste...) while continuing to expand the capex budget dedicated to emerging countries where demand for new capacities (water and waste capacities) is rising. This commercial strategy, supported by the ongoing fixed costs reduction programme (1% annual cut) should allow the group to generate decent EBITDA growth (+5% CAGR 2014-24e), while distributing a safe and growing dividend.

Valuation We value Suez Environnement via an SOTP calculation, which yields a Fair Value of EUR14 per share, implying 7% upside to the current share price. At the current share price, the share is trading on 6.8x prospective 2014 EBITDA and 23.8x 2014 earnings, implying no discount on average compared with historical multiples. As for 2015 metrics, Suez Environnement is currently trading at 6.5x EBITDA and 15x earnings.

Catalysts The group highlighted four main markets it expects to grow strongly in the future: 1/Industrial Water; 2/Smart Water, 3/Energy from Waste and 4/International. In our model, we have analysed the growth potential each of these markets should bring for the group and estimated it should represent 52% of the EBITDA growth we expect between 2014 and 2024.

Difference from consensus Given the change in IFRS rules, and the EUR129m capital gain, we find it difficult to assess what the consensus is currently taking into account for 2014 at the EBITDA level. We currently stand 6.7% above the 2014 consensus and 4.5% above the 2015 consensus.

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). A sharp deterioration in the economic backdrop in Europe would have a stronger effect on our investment case and the share price than the group’s earnings (+/- 1% change in Waste Europe volume has a EUR30m impact on group’s EBITDA).

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59

2. Creating value where it is possible In a world where higher natural resources consumption is now seen as negative, the utilities sector is affected through its assets in Europe by both a natural and/or a forced decline in waste and water consumption per inhabitant for both economical and/or environmental reasons. Suez Environnement, like its French peer Veolia, is therefore facing these unfavourable trends in its natural region, affecting the group’s growth prospects over the mid and long terms. The group therefore has no choice but to find new businesses where value creation will be stronger than the natural decline observed on more traditional activities. On top of the traditional self-help methods (cash control and fixed costs reduction) the group has identified four main markets/trends it will position to either boost earnings growth or value creation (through higher ROCE or return to shareholders for instance). In the Water business (49% of group’s sales) the group targets growth in the industrial market (market estimated by GWI at EUR21bn by 2018 vs. EUR15bn in 2014, implying a CAGR of 9% for the period), and more specifically in the Oil & Gas market (CAGR expected at +15%); while continuing to expand its market share in Southern European countries where the group aims to take a part of both consolidation/privatisation phases in the market (recent stake increase in ACEA and move with La Caixa are two moves in line with this strategy). As for the Waste market (51% of group’s sales) the group’s targets are to expand in the waste recovery business in mature markets while continuing to expand in more emerging areas where demand for new capacity remains strong.

Given the dominant position of the group in its traditional markets, we believe these new markets will generate solid earnings growth drivers for the group in the next decade, helped by potential acquisitions. In our model, we are forecasting a CAGR in EBITDA of 5% between 2014 and 2024, mainly driven by both Waste Europe and International businesses (respectively 5.3% and 5.0% CAGR 2014-24).

2.1. Water In this business, Suez Environnement, like its French peer Veolia, is suffering from a structural decrease in volumes in mature countries driven mainly by the maturity of the market and the natural development of the water management processes which are driving down water consumption per inhabitant. The group has clearly unveiled its ambitions in Southern European countries and also aims to expand its market share in the industrial water market by developing high value added solutions dedicated to industrial customers (Petrobras, Thales, Tractabel Energia...).

Industrial water & Smart water

Industrial water Highlighted several times by the group as a key market for the next 10 years, the industrial water market is estimated at USD15bn of revenues this year (GWI 2014 estimates) and is expected to grow by 9% every year until 2018 to USD21bn with most growth potential stemming from the Oil & Gas (+15% CAGR) and Mining markets (+12% CAGR). We assume a slight market share gain (less than 100bp) by the group in this market and expect total sales to grow from EUR300m in 2013 (excluding revenues from equipments) to EUR650m by 2024. The group’s market share is expected to grow from 2.5% in 2013 to 3% by 2018 thanks to aggressive and selective commercial development on a worldwide basis.

The group therefore has no choice but to find new businesses where value creation will be stronger than the natural decline observed on more traditional activities

SEV has strong ambitions in Southern European countries on water market.

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60

We are forecasting annual sales growth of 10% for 2014-18 followed by 5% over 2018-24, and also expect an accretive impact on the group’s profitability and ROCE from lower direct competition and strong pricing power.

Fig. 1: Suez Environnement: Industrial water potential market (2014-18e) USDbn

Source: Company Data; Bryan, Garnier & Co ests. GWI 2014

The group aims to develop specific skills in the various markets highlighted in the chart above. The Oil & Gas market is one of these markets expected to grow at a higher pace than the global industrial market, at around 15% per year between today and 2018 (vs. +9% CAGR for the total market) and Suez Environment has already mentioned it will specifically target the upstream market (onshore and offshore), the refining and petrochem markets and the unconventional oil & gas markets in North America and China. This market is expected to represent more than USD3bn of potential revenues, versus USD1.8bn today. The second market the group is targeting to grow is the Mining market where the need for desalination plants in both North America and Latin America is rising strongly (+12% CAGR between today and 2018). The contract awarded by Degrémont with Codelco clearly confirms the group has the legitimate knowledge and expertise to work with these industrials and to offer them alternative and innovative solutions to face new ecological challenges/constraints.

0

5

10

15

20

25

2014 2018

Pulp & Paper

Microelectronics

Food & Beverage

Pharma

Petrochem

Power

Mining

Uprstream Oil & Gas

15

21

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61

Below are the different priority areas Suez Environnement aims to develop by 2020.

Fig. 2: SEV: Priority areas by industry

Market in 2014 (USDbn) Market in 2018 (USDbn) CAGR

Oil & Gas 1.8 3.1 15%

Upstream (Onshore & Offshore) - -

Refining & Petrochem (Middle East, China, USA, Canada) - -

Unconventional Oil & Gas (North America & China) - -

Mining 1.2 1.9 12%

Desalination (North America & Latin America) - -

Power 3.8 5.3 9%

Services, O&M and mobiles services - -

Pharmaceuticals 0.8 1.0 7%

Services (Industrial parks) - -

Food & Beverages 3.8 4.9 7%

Services, O&M (France, UK, Spain) - -

Pulp & Paper 1.4 1.6 4%

Development of Ozonia (UV and ozone) - -

Latin America - -

Source: Company Data; Bryan, Garnier & Co ests. GWI 2014

We expect this market to contribute roughly one third of sales growth in Suez Environnement's Water Europe business unit between now and 2024, representing by this date around 12% of business revenues and 3% of the group’s total sales versus respectively 8% and 2.5% today.

Fig. 3: Suez Environnement: Industrial water (EURm) 2011-2018e


2.2%

2.3%

2.4%

2.5%

2.6%

2.7%

2.8%

2.9%

3.0%

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0

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200

300

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2011 2012 2013 2014e 2015e 2016e 2017e 2018e

Suez Environnement - Water industrial market sales Market share

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Smart water The group also has strong ambitions in this market, which should allow it got grow in markets/regions where water consumption per inhabitant is structurally declining. Differentiation is key in this market and the group is therefore working on new solutions and new services to address previously unaddressed customers. The group will then provide and deploy smart metering systems all around Europe, or will provide systems allowing higher optimisation of the water system (alerts, leak detection, helium gas leak detection...).

In 2013, revenues generated by this market represented EUR300m after an increase of 11% compared with 2012, and represented 7% of 2013 Water Europe revenues. We are forecasting a 10% CAGR between now and 2016 followed by 5% annual sales growth beyond 2016. The addressable market is estimated by Global Water Intelligence at USD20bn by 2020.

Fig. 4: Suez Environnement: Smart Water revenues (2011-2018e) - EURm


So far the group has already installed 1.8m smart meter systems in Europe and targets to expand its footprint to other mature areas. This new market should first bring growth to a highly mature market, but will also allow the group to increase its ROCE thanks to lower capital-intensive contracts. The group’s traditional and historical way of working in the water market is very capital intensive (EUR6.7bn of capital employed at end 2013, for total revenues of EUR4.5bn and EBIT of EUR530m, implying an ROCE before tax of 7.8%) and has suffered from strong pricing pressure and a structural decline in volumes without cutting the amount of employed capital. Back in 2008, the group’s ROCE (before tax) in this division was close to 12%.

In our model, with this new type of business we anticipate a rebound in ROCE and anticipate a return to the +10% threshold by 2022.

We estimate this market could contribute roughly one third, or 28%, of sales growth in Suez Environnement's Water Europe business unit between today and 2024, to the represent 11% of business revenues and 3% of the group’s total sales versus respectively 8% and 2.5% today.

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Commercial successes in both markets Recent newsflow from the company clearly confirm the strategy in these two markets is paying off. Over the past six months, Suez Environnement has won sizeable contracts in both the Industrial water and Smart water markets, allowing different businesses (Water Europe & Degrémont) to offset declining traditional activities in mature markets.

Fig. 5: Recent SEV contracts

Business Country Amount (EURm) Timelife Announced in…

Industrial Water

Reduction of environmental impact Delta Electricity Australia - 2 years Q2-14

PetroChina China €34m - Q4-09

Qatargas

Production warranty Klabin Brazil €30m - Q3-14

Petrobras Brazil - - Q2-14

Codelco Chile - - Q1-14

Water and energy consumption optimisation West Basin US €37m 5 years Q1-14

Tractebel Energia Brazil €4m 4 years Q1-13

Heineken UK - - Q1-14

Costs and capex control ENI Italy €5m - Q2-12

Petroineos UK - - Q1-14

Smart Water & Concessions

Canal de Navarra Spain €70m 30 years H2-14

Versailles - Saint Cloud France €250m 12 years


Building franchises through M&A deals? To increase its market share and expand its expertise the group has also been active in the M&A market. During the lat analysts' meetings, management mentioned its target for new M&A deals several times. Several selective acquisitions could potentially add further earnings growth for the group next year, especially in growth areas like Smart Water and Industrial Water businesses. With a potential M&A envelope of EUR500-750m (management said it could go to 3x EV/EBITDA or slightly above implying EUR500-750m in potential capex dedicated to external growth) the group has already started to expand its footprint in Europe and internationally with the purchase of Process Group and the acquisition of a stake in Evatherm.

Process Group Acquired in June 2014 for an EV estimated at EUR80-90m (at an estimated multiple of 10x EV/EBITDA), Process Group is a highly reputable company in the industrial market, and is a means for the group to extend its geographical footprint in the Middle East, South East Asia and Australia while reinforcing its technical expertise and portfolio towards the Upstream and Downstream Oil & Gas industry. Based in Melbourne (Australia), Singapore and Abu Dhabi (United Arab Emirates), Process Group is specialised in engineering, design, fabrication, commissioning of equipment for the global Oil & Gas industry. Process Group deals with complex and challenging projects requiring

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technology solutions such as Gas dehydration, Gas sweetening, produced water treatment and sand management. Founded in 1978, the company has 120 employees of several nationalities and achieved an annual turnover of about EUR60m. Evatherm In July 2014, Suez Environnement announced it had taken a stake in Evatherm, a Swiss engineering company specialised in evaporation and crystallisation technologies. Though this technological deal, the two companies are to develop innovative solutions for water savings and zero liquid discharge (“ZLD”), by combining Evatherm’s extensive expertise in evaporation and crystallisation with the group’s capabilities in water and wastewater treatment. This move is perfectly in line with Suez Environnement's strategy to expand in the industrial water market as it should help enlarge Degrémont’s industrial solutions with final customers. We estimate these two acquisitions involved a total amount of less than EUR110-120m and should contribute to the group’s EBITDA (2015) for around EUR10-15m (Process Group only) on an annual basis.

A water business more exposed to Southern European countries Through the deal made with La Caixa (announced in July 2014), Suez Environnement clearly reiterated and added weight to its strong ambitions in southern European countries (in the water business predominantly). We view this deal as value creative for the group as it will not only increase its exposure to the promising Spanish and Chilean water markets but will also have a positive impact on the group’s EPS for a limited amount of cash-out (EUR25m positive net impact on group’s net income; integrated in our model).

Suez Environnement acquired the remaining 24.14% in Agbar shares owned by La Caixa in exchange for 22 million new shares (in Suez Environnement, representing a 4.1% stake post closing with four-year lock-up period) and EUR299m in cash that La Caixa acquired a 15% stake in Aigües de Barcelona from Agbar and a 14.5% stake in Aguas de Valencia from Suez Environnement. La Caixa also pledged to buy existing Suez Environnement shares on the market with the aim of reaching a stake of up to 7% in the next twelve months.

With the recent raise in the ACEA stake (from 8.5% to 12.5%, last February) and the purchasing of its remaining stake in Agbar, Suez Environnement is now becoming a leader in water in southern Europe and this should help strengthen its dominant position in both concessions and new services.

Both countries (Spain and Chile) offer strong upside in the water business thanks to potential privatisations and a stronger need for environmental infrastructures. Tariffs and volumes should remain positive over the medium to long terms allowing the group to grow its Water Europe business.

The group’s financial structure has now been simplified (more efficient Water Europe division, and lower minorities in the P&L) while the shareholding structure has been reinforced with new strategic partners.

Suez Environnement is now becoming a leader in water in southern Europe

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Fig. 6: Suez Environnement: overview of deal with La Caixa


We estimate these acquisitions (ACEA and Agbar) cost a total EUR269m (EUR200m for La Caixa deal and EUR69m for the ACEA deal with GDF Suez) and should contribute to the group’s EBITDA (2015) for around EUR20m (ACEA only as Agbar was already consolidated at 100%) on an annual basis.

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2.2. Waste This business is the most cyclical activity for the group given its exposure to the European industry. Suez Environnement's structure makes difficult a comparison with Veolia since Suez Environnement communicates on its waste activity in Europe, while Veolia still communicates on its entire waste activities (despite the new organisation). Most metrics/estimates we highlight/use in this section therefore affect the waste Europe business.

Mainly sensible to industrial activity and to commodities prices, this business explains why Suez Environnement is seen and played by the market as a cyclical stock. However, a closer look shows that a +/- 1% change in treated European volumes only has a EUR30m impact on the group’s EBITDA (3.5% of Waste Europe 2015e EBITDA; and only 1.1% of group’s 2015e EBITDA). Despite this limited exposure, we agree with the market that current growth (sales and earnings) is very restricted given the maturity of these activities in Europe. While earnings are not under pressure, they offer limited upside potential and this explains why the group is looking at new opportunities outside of its more traditional activities. We have identified three main growth areas: 1/Energy from Waste (EfW); 2/Alternative fuel and 3/Gas recovery solutions, but are only focusing our analysis on the EfW development, in UK particularly.

Growing in the UK waste business We estimate Suez Environnement should be able to generate earnings growth in its Waste Europe business thanks notably to the market transition which is driving up the UK waste market. This market, which was estimated at 259m tonnes by Eurostat (in 2010), is entering a strong transition phase with the government aiming to expand recovery treatment processes (composting, material recycling, and energy recovery) within the total treatment process from 25% today (out of the total solid waste market) to 75% by 2020. The final objective is to divert as much as possible from landfills to recovery in the country, which represented 49% of total waste treatment in 2011 (vs. 38% in Europe 27 and 31% in France).

Fig. 7: Evolution of UK municipal solid waste treatment mode 2002-11 (%)


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Fig. 8: Annual waste volumes per capita and split of treatment mode (2010 data updated in April 2012)

Source: Company Data; Bryan, Garnier & Co ests. Eurostat

With SITA UK, the group has quite a strong position in the country (number three) and limited sales and earnings exposure to landfill in the region (6% of SITA UK sales excluding the landfill tax and 14% in total), implying that the group could strongly benefit from this growing market. The group expects a 6% increase in the commercial, industrial and demolition waste markets out to 2030, with stable growth in the municipal market.

In our model, we assume 2.5% volume growth in 2014 and 1% in 2015 for SITA UK, which is quite cautious in our view. The group will focus on two main markets to fully benefit from the market change in the UK:

Focus on the energy from waste (EfW) and recycling markets, with important projects in the pipeline: For this market, the objective is to obtain a balanced portfolio of public and private contracts.

Develop commercial, industrial and municipal markets with a broad solution portfolio including energy, RDF (Refused Derived Fuel), SRF (Solid recovered fuel), MRF (Material Recycling Facilities) and composting.

Recent contracts won by the group last year and in H1 2014 (Merseyside; Cornwall; West London, Durham) confirm that its strong commercial presence and leadership position are starting to bear fruit in the region. The new contracts awarded in the UK are destined to impact the group’s growth by 2016/17; although the Suffolk project (awarded several years ago) will start contributing to the sales growth we expect in the region next year.

By extrapolating the Clermont-Ferrand volumes and capex data, we estimate that the new projects recently won by the group in the waste business could contribute positively to the group’s

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outperformance versus industrial growth in the region. As for 2014, management has already communicated that new capacities should contribute to 1.3% of volume growth versus 2013, and we estimate the impact for 2015-17 at respectively 1.4%, 1.1% and 3.0%.

Fig. 9: SEV: impact of new EfW capacities on EBITDA

Impact EBITDA (bridge calculation)

New capacities Country BS Reception Capex Implied waste volume / year

2014e 2015e 2016e 2017e

Clermont-Ferrand France OFF janv-14 210 210 000 5.3 0.0 0.0 0.0

South Tyne & Wear UK OFF Q2-14 225 225 000 2.8 2.8 0.0 0.0

Suffolk UK ON Q4-14 230 230 000 0.0 28.8 0.0 0.0

Surrey UK ON Q4-16 110 110 000 0.0 0.0 0.0 13.8

Cornwall UK OFF Q2-16 200 200 000 0.0 0.0 2.5 2.5

Poznan Poland OFF Q3-16 180 180 000 0.0 0.0 1.1 3.4

West London UK OFF Q3-16 270 270 000 0.0 0.0 1.7 5.1

Merseyside UK OFF Q3-16 290 290 000 0.0 0.0 1.8 5.4

Total (€m) 1 715 1 715 000 8.1 31.6 7.1 30.1

New volumes (mtons)- 0.32 0.34 0.29 0.77 Impact on annual volumes 1.3% 1.4% 1.1% 3.0%


We estimate the EBITDA impact stemming from these new capacities (taking into account different assumptions per plant depending whether or not the plant is consolidated in the balance sheet) of around EUR8m for 2014e, EUR31.6m for 2015e, EUR7m for 2016 and EUR30m for 2017. As for volume growth stemming from industrial recovery, we still have a cautious stance and then forecast 0% growth in volumes (in line with group’s guidance) for 2014e and 0.4% for 2015e and 2016e.

Most of the group’s earnings growth between now and 2017 in the Waste Europe business is therefore set to stem from new capacities and not from industrial recovery in the region.

Fig. 10: Suez Environnement – Waste Europe volumes treated (m tons)


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Fig. 11: Waste Europe volume growth 2013-16e


2.3. International expansion is key The group’s sales exposure to non-European countries is key especially as the growth potential for further water and waste infrastructures stems mainly from these regions and more specifically, from emerging countries. As of today, Suez Environnement still generates 73% of revenues from Europe with France remaining the first market with 37% of the group’s revenues derived from the region. Management has not officially unveiled long term guidance on its international expansion yet reiterated several times that it is aiming to grow by around 8-10% per year in the mid-term in these regions. Given that International business currently receives the highest part of net capex envelopes (35% in H1 2014) we are confident that the EBITDA contribution at the group level will progressively increase to 26% by 2020 versus 23% today.


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2.3.1. Welcome news so far in North America This region currently represents just 5.5% of group’s revenues (60% regulated/40% non regulated) and was not particularly highlighted by the group as being a key market although the recent contracts awarded by both Degrémont and United Water provided welcome news and suggest the group’s visibility in the region could continue to increase over the medium term enabling further contracts signatures.

Recent contracts awarded to the group in this market have been quite large compared with what the group was able to sign in the past. During H1 2014 three contracts were signed: 1/Nassau (EUR1bn; 20 years), 2/Edmonton (EUR54m; five years) and 3/West Bassin (EUR37m; five years). Infrastructure in the US is quite obsolete, implying further new investments (both maintenance and growth capex) will be needed in the mid-term and placing Suez Environnement in a good position to increase its market share especially via its subsidiary United Water.

In our model we are forecasting sales growth of 3.5% in region, with 2% growth stemming from volumes and 1.5% from prices. H1 2014 numbers were negatively impacted by a disadvantageous weather impact (higher than expected rainfall affecting water consumption by private households) although this decline in volumes was partially offset by positive price adjustments. It is important to notice here that 60% of United Water sales are made on regulated assets, which gives strong visibility on future cash flows. In 2015 we integrate the annual contribution from Nassau contract (USD1.2bn over 20 years).

Fig. 12: Suez Environnement: North American revenues (EURm)


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2.3.2. Focusing on China is key The group is to focus on developing its water and waste businesses in China, which harbours huge growth potential with both consumption and industrialisation continuing to develop rapidly. The Chinese government is focusing on developing greener consumption and production processes, which will require heavy investments in waste business in the future. For the water business, the country faces a structural water shortage. Before the change in IFRS rules (implemented for 2014 numbers) the group's 2013 sales stood at EUR400m in this market with water contributing EUR282m and waste EUR118m, double the level of 2008 (EUR207m). The management objective was to continue generating double-digit growth in the years to come, while keeping the risk profile of future projects under control.

In the waste business (EUR140m in 2013 estimated sales, 29.5% of group sales in China, before change in IFRS rules), we believe Suez Environnement will have no choice but to form a partnership with large national players if it wants to expand. As for margin expansion, the group could also focus on more value-added segments, where great expertise is required. The group has strong ambitions for both the hazardous waste and energy for waste markets.

In the water business (EUR330m in 2013 estimated sales, 70.5% of group’s sales in China, before change in IFRS rules), Suez Environnement has no choice to address market through JVs (legal obligation), while increasing its presence in industrial parks, where there growth potential is massive. The need for waste recovery will gradually increase in the years to come especially if waste generation levels by inhabitant move closer to European and North American levels (respectively 487kg per inhabitant/year in Europe 27 and 760kg in the US).

Commercial successes were strong during the first semester in the region, comforting group’s position on both markets. In February the group was awarded a sludge drying contract in Yangzhou via the Yangzhou Sino-French Environment Company Limited joint venture. This 30-year contract represents cumulative revenues of EUR234m (SEV’s share amounts to EUR24m). In March Sita Waste Services signed a contract to build and operate a new hazardous waste treatment and waste-to-energy recovery plant in the Nantong economic and technological development area, as part of a joint venture with Shanghai Chemical Industry Park Investment Corporate (“SCIP”) and Nantong Economic Technology and Development Area Company (“NETDA”). This 30-year contract represents cumulative revenues of EUR575m:

Following the change in IFRS rules (11 & 12) Chinese contributions from water business are not proportionally consolidated anymore as the group was present on this market through JVs. The group is now only consolidating its waste activities in China while integrating net profit generated from its water activities in the region at the EBITDA level. The Group is not communicating on the net contribution of its Chinese activities on EBITDA and EPS level yet we estimate this contribution at around EUR30-35m/year on net income. This should grow by 10-15% on annual basis.

We estimate Chinese contribution at around EUR35-35m/year on net income. This should grow by 10-15% on annual basis.

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2.4. Still targeting margin expansion through cost reduction

As explained earlier in this report, the group's geographical position (Europe still contributing at 73% group’s revenues) makes it more difficult to grow in the worldwide waste and water market. Earnings growth is therefore set to stem from new solutions and from new markets (smart water, industrial water, EfW...), from international development but also from fixed costs reduction. Inflation is reaching a low point in Europe, yet pricing pressure stemming from public contract renegotiations (French water market for instance) is weighing on the group’s margin and on earnings growth.

The group implemented the Compass cost optimisation programme in 2010 with the aim of reducing breakeven by EUR250m between 2010 and 2012, although it has been progressively revised up, as cuts were faster than expected. Between 2010 and 2013, the group managed to reduce fixed costs by EUR580m (EUR120m in 2010, EUR130m in 2011, EUR150m in 2012 and EUR180m in 2013), representing 4.5% of operating expenses.

The group’s 2014 target is to reduce costs by a further EUR125m and already half of this target was reached during the first half (EUR60m). Waste Europe business is the unit the most affected by the cost-cutting programme (44%), which explains why we expect a rebound in the business unit's ROCE. If deterioration in Europe is stronger than firstly anticipated, group has the ability to increase it Compass costs reduction program.

Fig. 13: Suez Environnement: Compass program H1 2014 contribution

Cost cutting split H1 2014 Cost cutting by division H1 2014


Purchasing; 39%

Operating costs; 41%

G&A; 20%

Waste Europe; 44%

Water Europe; 31%

International; 24%

Others; 1%

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Fig. 14: Suez Environnement – Compass programme net contribution to EBITDA

& EBITDA margin (excluding CEM impact in 2014e)


As for 2015 and beyond, we expect further cost cuts as we continue to assume the group will be able to reduce its operating costs by 1% annually. To reflect the inflation costs (lower in Europe today, and higher in emerging markets) the group is facing we assume that Suez Environnement will only keep 60% of its annual gain during between 2015 and 2020 and then only 40% between 2020 and 2024 (higher costs from emerging markets, where inflation is stronger). The group is communicating on an annual net costs reduction gain and assumes that these gains will be kept internally as it will allow the group to offset a part of the natural inflation, and the deteriorating pricing environment (margin will deteriorate without this costs cut) In our model we assume a part of the cuts will offset margin deterioration coming from inflations and negative pricing environmental. We then assume a retention rate of 60% and then 40% (higher inflations rate in emerging markets where the group will develop).

Fig. 15: Suez Environnement: Compass programme estimates (EURm) 2015e-2024e


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Thanks to the Compass programme contribution we estimate in our model and the lower capital intensive capex model the group is aiming to develop, we expect ROCE (after tax) for all businesses to gradually pick up over the medium term. We are forecasting a rise in group ROCE (after tax) from 6.6% in 2014 to 9.3% in 2020e (in line with group’s mid-term target to reach a ROCE after tax of 9%). As explained earlier, Waste Europe ROCE is expected to grow at a faster pace than other activities, given the higher cost efforts implemented in this business and the rise in new services/addressed markets in which capex allocation will be lower.

Fig. 16: Suez Environnement: ROCE after tax by business unit (2008-20e)


The ROCE deterioration on Water Europe is coming from the Agbar integration (through different phases) which due Agbar Chile and its presence on a regulated market has a much lower ROCE than the rest of the water business of the group in Europe.

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3. A convincing H1 2014 performance The group posted quite a convincing H1 2014 performance in July despite weak stats on European industrial production. The group which is still 73%-exposed to Europe (through sales) is obviously exposed to any industrial rebound in the region given that lower industrial production would negatively impact the waste volumes treated by its different subsidiaries (SITA France; SITA UK/Scand; SITA Benelux/Germany and SITA Central Europe). However, note that at the end of the day, the real impact from European industrial production remains quite limited: a 1% change in European industrial production would affect the group’s EBITDA by only EUR30m (which implies an impact of around 1.1% on group’s EBITDA and an impact of 3.6% on the group’s adjusted EPS).

During H1 thanks to new plants (Clermont-Ferrand & South Tyne & Wear) the group was able to post positive volumes growth in its European waste business (+1.2%) despite a weaker Q2 than Q1 (+0.7% in Q2-14 after a Q1-14 at +1.7%) but confirmed that a rebound is not expected in the second half. Out of the 1.2% in volume growth treated, 100bp stems from the new treatment capacity (market share gain) that the group commissioned and 20bp from market growth.

All in all, during the first half, revenues grew by 0.8% organically to EUR6.9bn helped by solid growth at the Water Europe business. EBITDA was also up organically by 1.6% despite a weak contribution from the Waste Europe business. YOY EBITDA grew by 7.9% helped by the CEM capital gain (EUR129m). Below is an overview of the different elements impacting H1 2014 EBITDA growth.

Fig. 17: SEV: H1-14 EBITDA bridge

H1 2013 EBITDA restated 1 229

o/w perimeter (excluding ACEA integration) 3

o/w FX (61)

o/w Water Europe - organic (with Compass) 52

o/w Waste Europe - organic (with Compass) (4)

o/w International - organic (with Compass) excluding Sydney Water effect 28

o/w ACEA stake integration 6

o/w EUR129m CEM capital gain in 2014 129

o/w Others (26)

o/w one-off effect Sydney Water H1-13 (30)

H1 2014 EBITDA reported 1 326


Water Europe revenues were particularly strong with LFL growth of 3.6% during the period, underpinned by higher volumes in Spain/Chile (Agbar) and by supportive tariff indexations. Margins in the segment also increased, with EBITDA up 4.6% YOY and 8.9% LFL. The business unit suffered from the Chilean peso deterioration during the period (average down 21% YOY in H1-14 vs. H1-13), which negatively impacted EBITDA at Agbar (EBITDA estimated at EUR280m for the period). Volumes were down 0.9% at LDEF, and up 0.4% at Agbar Spain and 3.1% at Agbar Chile; while prices rose by respectively 1.2%, 3.2% and 7.3%.

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In the Waste business as expected the industrial rebound did not materialise, although thanks to new capacities (Clermont-Ferrand & South Tyne & Wear) the group was able to treat a higher amount of waste volumes (+1.2%) notably with strong growth in recovered volumes (+3.4% vs. -1.9% for volumes eliminated) in line with group’s 2016 target to reach a ratio of 2 tons of recovered waste for one 1 ton of eliminated waste. Pressure on raw materials remained strong with a negative trend on paper (-6%) and metals (-7%). EBITDA margin increased slightly despite this timid growth, with the margin widening 20bp to 11.9% thanks notably to strong margin growth in UK. On the contrary, EBITDA in France and Benelux remained stable but declined in Poland.

Fig. 18: Suez Environnement – Waste Europe – Treated volumes during H1 (mt)


As for the International business unit, growth from emerging regions remained strong (Asia +5% LFL; Africa, Middle East and India +8.9% LFL) although business was impacted negatively by delays in orders at Degrémont (impact of 4.7% out of the 7.3% YOY sales decline at International business; with Degrémont revenues being down 16.8% YOY). Dynamism remained strong in Morocco (Lydec) while pricing turned positive in US (+2%). In all, revenues dropped 7.3% affected also by negative FX effects. EBITDA was positively affected by the integration of the capital gain from the CEM disposal (EUR129m), which explained the 34% growth observed during the period. Adjusted for this effect, EBITDA declined by 10%. As for H2, management expects a rebound at Degrémont's business, which will have a more important impact on sales than on EBITDA (dilutive impact given Degrémont margin is far lower than the rest of International activities).

As for cash generation and leverage, the group was able to achieve targeted metrics so far with H1 2014 FCF (company definition, before growth capex) at EUR215m due to the seasonal effect in WCR (stronger in H1 than in H2) and net debt at EUR7.295bn slightly higher compared with the end of last year (+1.55%). The leverage ratio declined to 2.77x (vs. 2.84x at end 2013) thanks to the Clermont Ferrand EfW site deconsolidation and the issue of a new hybrid. The group’s leverage target for 2014 is to remain at around 3x, meaning the end-H1 level was fully in line with this target.

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4. A sound balance sheet The group’s financial structure is sound and healthy despite the high leverage ratio (2.8x at end 2014e) with the group strongly active in debt management (recent launch and repurchase of hybrid bonds) to optimise its gross cost of debt. Compared with other peers in the sector, which had no choice to cut dividends to save cash for capex, Suez Environnement still has the ability to fund both its capex and dividends without using script dividends distribution.

Management has committed to a minimum EUR0.65 dividend per share (floor level) for 2014 and we assume guidance will remain the same for coming years. In our model, we do not see a dividend increase before 2017 (at which point, we assume a 65% normalised pay-out ratio to be closer to European peers), which implies that the group needs to finance EUR350m per year to distribute a EUR0.65 per share dividend to its shareholders (a 5.9% increase compared with what the group is to pay in 2014 as 22m new shares have been created for the deal with La Caixa), while it needs to finance EUR1.2-1.3bn a year in capex, of which roughly 53% is dedicated to maintenance and 47% to development. This means that the group needs to generate EUR1.55-1.65bn in operating cash-flow every year to maintain net debt at current levels (3x in 2013, 3.1x if we integrate 50% of the EUR750m hybrid bond and 3.9x if we take into account all pensions and other provisions). In our model we anticipate the group will be able to generate an average (2014e-2020e) of EUR2.1bn in operating cash flow per year allowing it to 1/ continue investing (around 8% of sales per year) and 2/distribute a EUR0.65 per share dividend (4.6% yield).

As shown table below, we estimate that the group will be able to finance its dividend over 2014-2020 without difficulties, with an accumulated surplus of EUR2.8bn during the period, if we include the extra leverage made possible by the rise in EBITDA (with a leverage limit of 3x EBITDA).

Fig. 19: Suez Environnement: Funding analysis

2014e 2015e 2016e 2017e 2018e 2019e 2020e

EBITDA reported 2 622 2 703 2 846 3 017 3 176 3 327 3 473 EBITDA margin 18.3% 18.2% 18.5% 18.8% 19.2% 19.5% 19.6%

Operating cash-flow 1 829 1 866 2 013 2 134 2 246 2 346 2 439 Capex (1 100) (1 141) (1 181) (1 231) (1 273) (1 317) (1 366)

o/w maintenance capex (580) (602) (623) (649) (671) (694) (720)

o/w growth capex (520) (540) (558) (582) (602) (622) (646)

FCF before dividends 729 725 832 903 973 1 029 1 074

Dividends (331) (351) (351) (351) (397) (440) (483)

Dividends to minorities (112) (101) (103) (105) (107) (109) (111)

Cash flow post dividends 286 273 378 447 469 480 479

Extra leverage made possible by increase in EBITDA 307 242 429 512 478 454 438

Cumulated extra leverage made by increase in EBITDA 307 549 671 941 990 932 892

Funding surplus/ (deficit) 593 821 1 049 1 388 1 459 1 412 1 371

Cumulated surplus/ (deficit) 443 1 414 1 871 2 437 2 847 2 871 2 783

Net debt reported 7 312 7 531 7 646 7 694 7 722 7 741 7 763 Net debt reported /EBITDA ratio 2.79x 2.79x 2.69x 2.55x 2.43x 2.33x 2.24x


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Fig. 20: Debt reimbursement schedule (EURbn & % of total debt)


The group has no short-term pressure on debt repayment (7% to refinance in 2015 and 2016). To further optimise its balance sheet structure, it also issued in June a second hybrid bond for EUR500m (on top of the EUR750m hybrid bond issued in 2010) that was used to partially buy back a part of the previous hybrid (EUR300m out of the EUR750m). After this operation outstanding hybrid bonds issued by the company amount to EUR950m. With this move, Suez Environnement is able to reduce its 2014 reported net debt by around EUR200m as the new bonds will be accounted for as 100% equity under IFRS standards. Suez Environnement will then take account of EUR950m in equity in its net debt calculation versus EUR750m previously (in our SOTP we account for the EUR950m from hybrids as debt).

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5. Our estimates We are forecasting a 3.4% and 3.1% increase in EBITDA respectively in 2014 and 2015 for Suez Environnement, helped by new IFRS rules (+4% YOY compared with restated EBITDA with CEM impact and +3% excluding CEM and FX impact), a positive scope effect and capital gains in 2014. We currently stand respectively 6.7% and 4.5% above the consensus on these metrics, yet believe all scope effects are not yet fully integrated into street estimates. Management is guiding on a 2% EBITDA increase (LFL, excluding FX effect) for 2014 and is not guiding yet for 2015.

Our 2014 adjusted EPS estimate (with hybrid costs and excluding the EUR129m capital gain from the disposal of CEM) stands at EUR0.55 and our 2015 adjusted EPS (with hybrid costs) stands at EUR0.87 per share.

Fig. 21: Suez Environnement – Sales contribution (in %) by business – 2014e


Fig. 22: Suez Environnement – EBITDA contribution (in %) by business-2014e


Water Europe31%

Waste Europe 45%

International24%

Water Europe46%

Waste Europe 29%

International25%

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5.1. Water Europe This business accounts for 31% of group’s revenues and 46% of group’s EBITDA given the high profitability coming from Agbar activities.

For 2014 we are forecasting a 1.5% YOY sales increase to EUR4.54bn, with 0.2% volume growth, a 1.5% price increase (driven mainly by price increases at the Chilean activities), +1.4% in commercial contracts and -1.5% in FX effect. As for EBITDA we stand at EUR1.25bn, up 2% YOY despite negative FX effect (strong Chilean peso depreciation in the period). The group’s performance in this business is to be boosted slightly by the scope effect and changes in IFRS/integration rules (with the group now consolidating its 12.5% stake in ACEA while this was not the case beforehand).

For 2015, we are forecasting a 3.2% YOY sales increase to EUR4.68bn with 0.2% volume growth, and +1.5% in prices. As for EBITDA, we stand at EUR1.3bn, up 4.7% due mostly to a positive contribution from the Compass plan (EUR17m positive impact expected in 2015, net of inflations costs on Water Europe business). We do not expect a rebound in this activity despite the progressive rise stemming from business with industrials and from the smart water industry (sales growth expected at +10%/ year for both businesses). We use similar (cautious) estimates for Veolia (in its European water activities).

Fig. 23: Suez Environnement – Water Europe Sales & EBITDA estimates (EURm)

Water Europe 2012 2013 2014e 2015e 2016e

Sales 4 379 4 469 4 538 4 683 4 814

YOY growth 4.1% 2.1% 3.0% 3.2% 2.8%

o/w volumes -0.3% -1.2% 0.2% 0.2% 0.2%

o/w perimeter -0.4% -0.6% 0.0% 0.0% 0.0%

o/w pricing 3.3% 2.9% 1.5% 1.5% 1.0%

o/w FX 0.0% 0.4% -1.5% 0.0% 0.0%

EBITDA 1 189 1 226 1 251 1 310 1 362

EBITDA margin 27.2% 27.4% 28.0%% 28.3% 28.3%

Operating income 582 533 579 612 639

% of sales 13.3% 11.9% 12.8% 13.1% 13.3%


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5.2. Waste Europe This business accounts for 45% of the group’s revenues but only 29% of its EBITDA given lower profitability.

For 2014, we are forecasting on a 1.2 % YOY sales decline to EUR6.4bn with notably a negative sales contribution from raw materials (-1% expected) and construction (-1.5%). Pricing contribution should remain flat despite the sharp decline observed in Q2 (-3.5% estimated, after a +2.5% observed in Q1) as well as the volume effect (+1.3% expected) thanks to new commissioning/new plants. As for EBITDA we stand at EUR783m down 1%. In our model we estimate the Compass contribution should reach EUR55m (before inflation costs) in the Waste Europe business unit for 2014.

For 2015, we estimate the business unit should be able to grow thanks to a slight recovery in volumes treated in Europe (+1.5% expected o/w +0.4% from market growth +1.3% from new capacities) and to a positive pricing contribution (+0.5%). As such, we are forecasting 1.5% YOY sales growth to EUR6.5bn. Profitability is set to grow again by 70bp to 12.9% implying EBITDA of EUR838m. 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 Sita Central Europe.

Fig. 24: Suez Environnement – Waste Europe Sales & EBITDA estimates (EURm)

Waste Europe 2012 2013 2014e 2015e 2016e

Sales 6 752 6 470 6 394 6 506 6 639

YOY growth 5.2% -4.2% -1.2% 1.7% 2.0%

o/w volumes -1.1% -2.3% 1.3% 1.7% 1.5%

o/w perimeter 1.8% -1.1% 0.0% 0.0% 0.0%

o/w pricing 1.7% 1.6% 0.0% 0.5% 0.5%

o/w FX 0.0% -0.7% 0.0% 0.0% 0.0%

EBITDA 834 790 783 838 882

EBITDA margin 12.4% 12.2% 12.2% 12.9% 13.3%


% of sales 4.6% 4.7% 4.7% 5.3% 5.7%


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5.3. International This business accounts for 24% of the group’s revenues and 25% of EBITDA. Given the rising exposure to emerging markets we expect this business could grow faster than the Waste/Water Europe businesses. In our model, we have assumed the business accounts for 38% of the group’s sales compared with 24% today. It is important to note that with the change in IFRS rules Chinese water activities are not contributing to International revenues anymore, but are still contributing to the group’s EBITDA and EBIT (yet with a different method, as results are now consolidated and not EBITDA & EBIT). This change is therefore set to slightly alter the medium to long-term sales targets of the group but has no impact on EPS.

For 2014, we are forecasting sales growth of 0.3% to EUR3.4bn with poor activities from Degrémont offsetting growth observed in other regions/activities. During the H1 2014 earnings presentation management reiterated its annual sales target for Degrémont (a rebound in the second half) despite the weaker than expected performance in the first half (performance impacted by delays in starting of new contracts, and by non-recurring elements which positively impacted performance in H1 2013, EUR34m). EBITDA is set to be affected (positively) this year by the capital gain from the CEM disposal (EUR129m net positive impact in H1-14 and on full year) and by both negative scope and FX effects. In all, we are forecasting YOY EBITDA growth of 17% to EUR671m, but a 6% decline after excluding the capital gain from the CEM disposal.

Growth is set to return to normal next year, with the Degrémont contribution restored to a more traditional level. We expect YOY sales growth of 7.8% to EUR3.6bn with the majority of sales growth stemming from Asian activities (driven mainly by the waste business) and from the African and Middle Eastern businesses. EBITDA is set to drop 9% YOY (since the 2014 level is boosted by the EUR129m capital gain) but is forecast to grow by 12.3% if we exclude this effect (helped by the contribution from the Compass plan). The Nassau contract will start to positively contribute to business earnings (EUR45m additional sales).

Fig. 25: Suez Environnement – International Sales & EBITDA estimates (EURm)

International 2012 2013 2014e 2015e 2016e

Sales 3 957 3 381 3 391 3 657 3 900

YOY growth -5.7% -14.6% 0.3% 7.8% 6.6%

o/w Degrémont -5.7% - -1.6% 0.6% 0.6%

o/w North America 0.3% - 0.4% 2.0% 0.6%

o/w Asia 2.6% - 3.5% 3.6% 3.8%

o/w Others 0.4% - 1.5% 1.7% 1.7%

EBITDA 463 572 671 620 668

EBITDA margin 11.7% 16.9% 19.8% 16.9% 17.1%


% of sales 8.2% 11.4% 13.9% 10.8% 11.0%


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5.4. What we expect for 2014 vs. group’s targets? As for 2014, management is guiding on five main metrics, based on 1% GDP growth in the eurozone for 2014.

EBITDA: Management is targeting growth of a minimum of 2% at the EBITDA level, on a LFL basis compared with the restated 2013 EBITDA. This implies EBITDA of EUR2.586bn. We currently stand at EUR2.622bn, which implies YOY growth of 3.4%. Excluding scope effects (EUR8m net, including the ACEA consolidation effect), FX effects (EUR90m), and the EUR129m capital gain from the CEM disposal, we stand at EUR2.580m in line group’s target.

Free cash flow (before growth capex): Management is guiding on FCF (before growth capex) at EUR1bn for 2014 as in 2013. We currently stand at EUR1.2bn assuming maintenance capex of EUR580m. Our estimate for 2014 FCF after growth capex stands at EUR730m (excluding cash used for Agbar and Caixa acquisitions), versus EUR330m in 2013.

Compass savings of EUR125m: The group expects Compass to contribute EUR125m in 2014 having reached EUR180m in 2013 and EUR150m in 2012. The group is currently on track to achieve its FY target, having already achieved EUR60m during the first half. In our model we are in line with the group’s guidance. These gains are net of implementation costs, but before inflations costs.

Net Financial debt/EBITDA at around 3x: With EBITDA of EUR2.622bn and net debt of EUR7.53bn, we are estimating a net debt/EBITDA ratio of 2.79x for 2014, below the 3.0x guidance.

Dividend ≥ EUR0.65 per share (2013 amount). We do not expect a dividend increase before 2017 and therefore expect EUR0.65 per share for 2014, 2015, 2016 and 2016.

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Below are our estimates for 2014-17e.

Fig. 26: SEV- BG Estimates

2012 2013 2014e 2015e 2016e

Sales 15 102 14 644 14 328 14 850 15 357

o/w Water Europe 4 379 4 437 4 538 4 683 4 814

o/w Waste Europe 6 752 6 551 6 394 6 506 6 639

o/w International 3 957 3 652 3 391 3 657 3 900

o/w Others 14 4 4 4 4

EBITDA 2 450 2 520 2 622 2 703 2 846

% of sales 0 0 0 0 0

o/w Water Europe 1 189 1 185 1 251 1 310 1 362

o/w Waste Europe 834 797 783 838 882

o/w International 463 581 671 620 668

o/w Others (37) (43) (83) (64) (66)

EBITDA margin 16.2% 17.2% 18.3% 18.2% 18.5%

o/w Water Europe 27.2% 26.7% 27.6% 28.0% 28.3%

o/w Waste Europe 12.4% 12.2% 12.2% 12.9% 13.3%

o/w International 11.7% 15.9% 19.8% 16.9% 17.1%

D&A (1 036) (974) (1 052) (1 102) (1 137)

% of sales -6.9% -6.7% -7.3% -7.4% -7.4%

EBIT Reported 1 146 1 184 1 259 1 279 1 377

% of sales 7.6% 8.1% 8.8% 8.6% 9.0%

Exceptional (94) (5) (15) (15) (15)

EBIT Adjusted 1 052 1 179 1 244 1 279 1 377

% of sales 7.0% 8.0% 8.7% 8.6% 9.0%

Net financials (419) (402) (405) (359) (362)

Profit/ loss at equity accounted companies 22.4 31.0 5.8 0.0 0.0

Pre-tax profit 633 777 839 919 1 015

Tax (186) (205) (192) (257) (284)

Tax rate 29.3% 26.5% 27.0% 28.0% 28.0%

Minorities (218) (250) (218) (183) (187)

Net income reported 251 352 435 479 544

Net income adjusted 345 334 297 470 535

EPS reported 0.49 0.69 0.80 0.89 1.01

EPS BG estimates (with hybrid costs and adjusted for non recurring elements) 0.68 0.65 0.55 0.87 0.99

Dividend 0.65 0.65 0.65 0.65 0.65


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6. Valuation We value Suez Environnement through a SOTP 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 gives us a fair value of EUR14 per share, leading to 6% upside to current share price and implying a Hold rating. At our Fair Value the stock is trading at 6.4x 2015e EBITDA and 15x 2015e earnings.

Fig. 27: Suez Environnement - SOTP

SEV SOTP valuation Value (EURm)

Implied EV/EBITDA

2015e

EBITDA 2015e

Method % Weigh of EV

Value per share

Water Europe 8 520 6.5x 1 310 DCF 45% 15.8

Waste Europe 5 937 7.1x 838 DCF 31% 11.0

International 4 955 8.0x 620 DCF 26% 9.2

Others (451) 7.0x (64) 7x EBITDA -2% (0.8)

Implied EV 18 961 7.0x 2 703 35.2 Net debt at end 2014e (with new IFRS 10-11 rules) (7 312) (13.6)

Integration of hybrid @ 100% (950) (1.8)

Provisions (Book value) (1 993) (3.7)

Minority interest @ Market value (14x; assuming AGBAR is

owned @ 100%)

(2 562) (4.8)

Financial assets 1 384 2.6 o/w Financial assets (marked-to-market) 206 0.4

o/w Eyath (5.5%) 10 0.0

o/w Aguas de Valencia (18.55%) 56 0.1

o/w Chongqing Water Group (6.7%) 140 0.3

o/w Associates ( Book Value, net of CEM disposals) 391 0.7

o/w financial receivables (o/w receivables on concessions) 787 1.5

Total implied Equity value 7 528 14.0 Number of shares (net of owns shares) 538.9

Equity value per share rounded 14.0

Current share price 13.1

Up/Downside 6.8%


Fig. 28: Suez Environnement – DCF assumptions

DCF assumptions WACC used LT growth EBIT margin LT EBIT margin

Water Europe 6.3% 1.0% 13.8% 11.5%

Waste Europe 6.8% 1.0% 7.0% 6.0%

International 7.6% 2.0% 10.1% 8.0%


Our SOTP takes into account the recent capital increase of 22m shares (for La Caixa) and a 1% fixed costs reduction annual contribution (60% retention rate until 2020 and then 40%).

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Appendices:What is Suez Environnement? Suez Environnement provides innovative solutions to individuals and industries in the drinking water, wastewater treatment and waste management segments. The group is divided into three operating divisions (Water Europe, Waste Europe and International) comprising the two main activities of the company, water-related and waste-related activities.

Water-related activities mainly include the production and distribution of drinking water, wastewater treatment and reuse as well as water storage. For its part, the waste management business consists of waste collection and urban sanitation, waste storage, waste treatment and global management of the waste cycle.

The group enables provides 100m people all around the world with drinking water, while almost 70m people benefit from Suez Environnement’s sanitation services. In addition, the group provides its waste collection services to around 60m people, while treating more than 42m tonnes of waste. The company operates around 1,200 drinking water production plants and manages about 150,000km of sewage lines. Overall, the group currently has 79,550 employees in more than 70 countries worldwide.

Water Europe Water Europe’s operating division intervenes throughout the entire water cycle in Western Europe, from catching and producing drinking water to its distribution and the collection of industrial water. Through water Europe, Suez Environnement provides drinking water to about 30m people in Europe and treats the wastewater of more than 30m inhabitants. Water Europe also includes the Chilean unit of AGBAR principally due to consolidation considerations. Globally speaking, the division relies on both of Suez Environnement’s subsidiaries: France’s Lyonnaise des Eaux and Spain’s AGBAR (now fully controlled by the company following the minorities stake purchase from La Caixa in 2014).

Through these subsidiaries, Water Europe is present in France, Italy and Spain, where many previous contracts have recently been renewed. The key Barcelona contract has been renewed on top of an additional wastewater contract (EUR3.5bn, 35 years). Together, both these contracts could amount to about EUR350m in revenues each year for the group.

Water Europe also carries out engineering activities with SAFEGE, whose revenues amounted to EUR105m in 2013. More than two-thirds of SAFEGE’s sales are from France. SAFEGE brings its competences to both public authorities (for 85% of its total sales) and industrials (for 7%). The subsidiary is present in four main business segments, including water and wastewater infrastructures, environment and waste, urban development and transport, energy and telecommunications. SAFEGE used to participate in the construction of hydraulic structures such as pumps, treatment plants and port facilities.

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Fig. 29: Suez Environnement: Water Europe sales by business 2014e


In 2013, water Europe reached EUR4.47bn in revenues, i.e. 30% of Suez Environnement’s total sales. EBITDA reached EUR1.2bn (27.5% EBITDA margin) representing half of the overall EBITDA reported by the group. Between 2009 and 2012, Water Europe reported the highest CAGR in revenues among the company’s three divisions with +11.0% (vs. +2.5% for the international division and +0.1% for waste Europe). The division sold 1,986m cubic metres in 2013, down 2% versus the previous year. Water Europe clearly took advantage of various fee increases: +2% in France on Delegation of Public Services (French DSP), +2.7% in Chile and +5.3% in Spain, all in 2013.

Fig. 30: Suez Environnement: Water Europe – EBITDA & EBITDA margin (2009-14)


The group is now looking for new growth opportunities, among them the development of smart water services whose revenues grew by around 4% in 2013 to EUR300m (o/w -30% from perimeter). Smart water services include innovations and enhancements linked to the global optimisation of water resources. Water Europe is already present in the smart metering business with Ondeo Systems. Suez

Lyonnaise des Eaux51%

Agbar Spain32%

Agbar Chile17%

866

1 035

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Environnement aims to set up 2m smart metres in 2014. The group is highly ambitious in this high-potential segment with a 10%+ CAGR revenues target over 2012-16.

In order to reach this goal, water Europe is looking for new partnerships with industrials and data collectors, as shown by recent partnerships developed between Ondeo Systems and the SFR Business Team or with GE Energy Power & Water. Smart water services have the notable advantage of being fairly low in terms of capital intensity. The global potential of the metering market is estimated at about EUR20bn in the coming decade according to Global Water Intelligence.

Waste Europe The waste Europe operating division manages the full value chain of waste including seven main different sub-activities:

Waste collection

Waste sorting and recycling

Energy recovery

Waste storage

Treatment of complex and dangerous waste

Global management of the waste cycle

Urban sanitation.

Waste Europe is organised around Suez Environnement’s subsidiary, SITA (former Société Industrielle des Transports Automobiles), which encompasses SITA France, SITA Germany, SITA Belgium, SITA Finland, SITA Netherlands, SITA Sweden and SITA UK in Europe.

SITA France remains the main business in the waste Europe unit in terms of revenues, with more than 55% of overall division sales. In the waste management business, Suez Environnement is the leader in France, as well as in Benelux, while winning market share in other European regions, such as the UK and Scandinavia.

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Fig. 31: Suez Environnement: Waste Europe revenues breakdown 2014e


In 2013, the Waste Europe business unit reached EUR6.47bn in revenues, accounting for 44% of Suez Environnement's total revenues for the year. EBITDA reached EUR790m, reflecting a 12.2% EBITDA margin, and representing about one third of the total EBITDA reported by the group.

Last year margin remained stable despite the 3.2% volumes deterioration observed during the year and despite the negative FX effect and the commodity prices cut. EBITDA came out at EUR790m down 4.5% YOY. For 2014, we anticipate a slight rebound (+2.5%) in this business helped by the positive Compass contribution and positive volume growth.

Fig. 32: Suez Environnement: Waste Europe – EBITDA & EBITDA margin (2009-14)


In 2013, 14.1m tonnes of waste were recovered by waste Europe while 10.4m tonnes were eliminated. Waste Europe aims at developing its recovery business, while keeping the current balance between

SITA France55%

SITA UK/Scand19%

SITA Benelux/Germa

ny23%

SITA Central Europe

3%

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881834

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2009 2010 2011 2012 2013 2014e

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collection and elimination. The recovery segment already represents 44% of the overall division’s revenues. It mainly consists of transforming waste into energy or recycling primary or secondary raw materials. Suez Environnement announced that it is targeting a ratio of recovered tons to eliminated tons of two for 2016. The division has a current ratio of 1.47 at end H1 2014, highlighting a significant improvement since 2009, when the ratio barely reached one.

The lines drawn by Suez Environnement in its 2008-2012 environmental plan included the optimisation of waste recovery and recycling. The initial target was to reach a 36% recovery rate by 2012. Results are better than expected, from 31.6% in 2008, the recovery rate increased to 43.2% in 2012, with more than 15m tonnes of recycled materials reintroduced into the economy in 2012. SITA, the French leader in the recovery business, recycled more than 15m tonnes of materials in 2012, showing a 22% increase compared to 2008, and consequently reaching EUR3.65bn in revenues.

Fig. 33: Suez Environnement: Waste Europe volumes treated (m of tonnes)


Additionally, the Waste Europe business is the division the most affected by the cost-cutting plan launched in 2010 and dubbed Compass 2. Indeed, the division represented more than 40% out of the total savings in 2013 and more than 44% in H1 2014. The division generated EUR27m in savings in H1 2014.

12.9

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6.3

12.7

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6

8

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2010 2011 2012 2013 2014e

Elimination

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International International activities are divided into four business units, three of which are geographic: SENA (Suez Environnement North America), AMEI (Africa, Middle-East and India), Asia-Pacific, and Degrémont. The division provides both water-linked and waste management solutions to countries outside of western European. The current breakdown between these two activities is about two thirds water to one-third waste. The revenues breakdown of the division is quite well balanced even if led by Asian activities, whose activity represents one third of overall division sales (EUR1.4bn). For a long time, Degrémont was the main contributor to business revenues, although this will not be the case in 2014 as the unit is suffering from the end of important contracts. Degrémont provides water treatment services as well as drinking water production in more than 70 countries around the world. With more than 5,000 employees, the subsidiary is specialised in four main business lines:

Design & Building

Operation & Maintenance

Equipment

B.O.T (Build, Operate and Transfer)


Degrémont28%

North America16%

Asia37%

Africa, Middle-East and India

19%

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Utilities

93


Utilities

94


Utilities

95

Bryan Garnier stock rating system For the purposes of this Report, the Bryan Garnier stock rating system is defined as follows: Stock rating

BUY Positive opinion for a stock where we expect a favourable performance in absolute terms over a period of 6 months from the publication of a recommendation. This opinion is based not only on the FV (the potential upside based on valuation), but also takes into account a number of elements including a SWOT analysis, positive momentum, technical aspects and the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion.

NEUTRAL Opinion recommending not to trade in a stock short-term, neither as a BUYER or a SELLER, due to a specific set of factors. This view is intended to be temporary. It may reflect different situations, but in particular those where a fair value shows no significant potential or where an upcoming binary event constitutes a high-risk that is difficult to quantify. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion.

SELL Negative opinion for a stock where we expect an unfavourable performance in absolute terms over a period of 6 months from the publication of a recommendation. This opinion is based not only on the FV (the potential downside based on valuation), but also takes into account a number of elements including a SWOT analysis, positive momentum, technical aspects and the sector backdrop. Every subsequent published update on the stock will feature an introduction outlining the key reasons behind the opinion.

Distribution of stock ratings

BUY ratings 56% NEUTRAL ratings 37% SELL ratings 7%

Research Disclosure Legend 1 Bryan Garnier shareholding

in Issuer Bryan Garnier & Co Limited or another company in its group (together, the “Bryan Garnier Group”) has a shareholding that, individually or combined, exceeds 5% of the paid up and issued share capital of a company that is the subject of this Report (the “Issuer”).

No

2 Issuer shareholding in Bryan Garnier

The Issuer has a shareholding that exceeds 5% of the paid up and issued share capital of one or more members of the Bryan Garnier Group.

No

3 Financial interest A member of the Bryan Garnier Group holds one or more financial interests in relation to the Issuer which are significant in relation to this report

No

4 Market maker or liquidity provider

A member of the Bryan Garnier Group is a market maker or liquidity provider in the securities of the Issuer or in any related derivatives.

No

5 Lead/co-lead manager In the past twelve months, a member of the Bryan Garnier Group has been lead manager or co-lead manager of one or more publicly disclosed offers of securities of the Issuer or in any related derivatives.

No

6 Investment banking agreement

A member of the Bryan Garnier Group is or has in the past twelve months been party to an agreement with the Issuer relating to the provision of investment banking services, or has in that period received payment or been promised payment in respect of such services.

No

7 Research agreement A member of the Bryan Garnier Group is party to an agreement with the Issuer relating to the production of this Report.

No

8 Analyst receipt or purchase of shares in Issuer

The investment analyst or another person involved in the preparation of this Report has received or purchased shares of the Issuer prior to a public offering of those shares.

No

9 Remuneration of analyst The remuneration of the investment analyst or other persons involved in the preparation of this Report is tied to investment banking transactions performed by the Bryan Garnier Group.

No

10 Corporate finance client In the past twelve months a member of the Bryan Garnier Group has been remunerated for providing corporate finance services to the issuer or may expect to receive or intend to seek remuneration for corporate finance services from the Issuer in the next six months.

No

11 Analyst has short position The investment analyst or another person involved in the preparation of this Report has a short position in the securities or derivatives of the Issuer.

No

12 Analyst has long position The investment analyst or another person involved in the preparation of this Report has a long position in the securities or derivatives of the Issuer.

No

13 Bryan Garnier executive is an officer

A partner, director, officer, employee or agent of the Bryan Garnier Group, or a member of such person’s household, is a partner, director, officer or an employee of, or adviser to, the Issuer or one of its parents or subsidiaries. The name of such person or persons is disclosed above.

No

14 Analyst disclosure The analyst hereby certifies that neither the views expressed in the research, nor the timing of the publication of the research has been influenced by any knowledge of clients positions and that the views expressed in the report accurately reflect his/her personal views about the investment and issuer to which the report relates and that no part of his/her remuneration was, is or will be, directly or indirectly, related to the specific recommendations or views expressed in the report.

Yes

15 Other disclosures Other specific disclosures: Report sent to Issuer to verify factual accuracy (with the recommendation/rating, price target/spread and summary of conclusions removed).

No

A copy of the Bryan Garnier & Co Limited conflicts policy in relation to the production of research is available at www.bryangarnier.com

London Heron Tower 110 Bishopsgate London EC2N 4AY Tel: +44 (0) 207 332 2500 Fax: +44 (0) 207 332 2559 Authorised and regulated by the Financial Conduct Authority (FCA)

Paris 26 Avenue des Champs Elysées 75008 Paris Tel: +33 (0) 1 56 68 75 00 Fax: +33 (0) 1 56 68 75 01 Regulated by the Financial Conduct Authority (FCA) and the Autorité de Contrôle prudential et de resolution (ACPR)

New York 750 Lexington Avenue New York, NY 10022 Tel: +1 (0) 212 337 7000 Fax: +1 (0) 212 337 7002 FINRA and SIPC member

Geneva rue de Grenus 7 CP 2113 Genève 1, CH 1211 Tel +4122 731 3263 Fax+4122731 3243 Regulated by the FINMA

New Delhi The Imperial Hotel Janpath New Delhi 110 001 Tel +91 11 4132 6062 +91 98 1111 5119 Fax +91 11 2621 9062

Important information This report is prepared by Bryan Garnier & Co Limited, registered in England no 3034095 and is being distributed only to clients of Bryan Garnier & Co Limited (the "Firm"). Bryan Garnier & Co Limited is authorised and regulated by the Financial Conduct Authority (the "FCA") and is a member of the London Stock Exchange. Registered address : 110 Bishopsgate, London EC2N 4AY. This Report is provided for information purposes only and does not constitute an offer, or a solicitation of an offer, to buy or sell relevant securities, including securities mentioned in this Report and options, warrants or rights to or interests in any such securities. This Report is for general circulation to clients of the Firm and as such is not, and should not be construed as, investment advice or a personal recommendation. No account is taken of the investment objectives, financial situation or particular needs of any person. The information and opinions contained in this Report have been compiled from and are based upon generally available information which the Firm believes to be reliable but the accuracy of which cannot be guaranteed. All components and estimates given are statements of the Firm, or an associated company’s, opinion only and no express representation or warranty is given or should be implied from such statements. All opinions expressed in this Report are subject to change without notice. To the fullest extent permitted by law neither the Firm nor any associated company accept any liability whatsoever for any direct or consequential loss arising from the use of this Report. Information may be available to the Firm and/or associated companies which are not reflected in this Report. The Firm or an associated company may have a consulting relationship with a company which is the subject of this Report. This Report may not be reproduced, distributed or published by you for any purpose except with the Firms’ prior written permission. The Firm reserves all rights in relation to this Report. Past performance information contained in this Report is not an indication of future performance. The information in this report has not been audited or verified by an independent party and should not be seen as an indication of returns which might be received by investors. Similarly, where projections, forecasts, targeted or illustrative returns or related statements or expressions of opinion are given (“Forward Looking Information”) they should not be regarded as a guarantee, prediction or definitive statement of fact or probability. Actual events and circumstances are difficult or impossible to predict and will differ from assumptions. A number of factors, in addition to the risk factors stated in this Report, could cause actual results to differ materially from those in any Forward Looking Information. Disclosures specific to clients in the United Kingdom This Report has not been approved by Bryan Garnier & Co Limited for the purposes of section 21 of the Financial Services and Markets Act 2000 because it is being distributed in the United Kingdom only to persons who have been classified by Bryan Garnier & Co Limited as professional clients or eligible counterparties. Any recipient who is not such a person should return the Report to Bryan Garnier & Co Limited immediately and should not rely on it for any purposes whatsoever. Notice to US investors This research report (the “Report”) was prepared by Bryan Garnier & Co. Ltd. for information purposes only. The Report is intended for distribution in the United States to “Major US Institutional Investors” as defined in SEC Rule 15a-6 and may not be furnished to any other person in the United States. Each Major US Institutional Investor which receives a copy of this Report by its acceptance hereof represents and agrees that it shall not distribute or provide this Report to any other person. Any US person that desires to effect transactions in any security discussed in this Report should call or write to our US affiliated broker, Bryan Garnier Securities, LLC. 750 Lexington Avenue, New York NY 10022. Telephone: 1-212-337-7000. This Report is based on information obtained from sources that Bryan Garnier & Co. Ltd. believes to be reliable and, to the best of its knowledge, contains no misleading, untrue or false statements but which it has not independently verified. Neither Bryan Garnier & Co. Ltd. and/or Bryan Garnier Securities LLC make no guarantee, representation or warranty as to its accuracy or completeness. Expressions of opinion herein are subject to change without notice. This Report is not an offer to buy or sell any security. Bryan Garnier Securities, LLC and/or its affiliate, Bryan Garnier & Co. Ltd. may own more than 1% of the securities of the company(ies) which is (are) the subject matter of this Report, may act as a market maker in the securities of the company(ies) discussed herein, may manage or co-manage a public offering of securities for the subject company(ies), may sell such securities to or buy them from customers on a principal basis and may also perform or seek to perform investment banking services for the company(ies). Bryan Garnier Securities, LLC and/or Bryan Garnier & Co. Ltd. are unaware of any actual, material conflict of interest of the research analyst who prepared this Report and are also not aware that the research analyst knew or had reason to know of any actual, material conflict of interest at the time this Report is distributed or made available.

INDEPENDENT RESEARCH Utilities · We are initiating coverage of the French Environmental Services sector with a BUY recommendation for Veolia Environn4ement (Fair Value EUR17, +2%

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