Would we Invest in Suez?
If you have been following financial news lately you might have heard that Veolia, the French water and waste management company, has acquired 29.9% of Suez, another French water and waste management company.
They paid €18 per share. Veolia has expressed that they aim to take a controlling stake in the company. Given this news, we decided to take a look at Suez, and determine if we would invest in the company.
We did not do a deep-dive analysis of Suez. We looked at the financials, and the valuation, of the company to determine if it was worth a further look. This is how we screen potential investments - we do a first pass, and if it looks interesting we look deeper into the company. Below we take you through our analysis.
The first measure we looked at was the operating margin. Companies with high operating margins are able to turn more of their sales into profits, which means more money in the pockets of shareholders. Right off the bat we were not too impressed with Suez.
Over the last ten years the margin has been fluctuating in the 6.5% to 7.5% range.
And the trend is downwards.
That is not great.
We like to invest in companies with higher operating margins, e.g. 20% and above.
The picture does not change when we look at net margins.
The net margins are razor thin over the last ten years.
However, low margins do not necessarily mean that a company is a bad investment (although it’s a good indication).
The company might still generate a decent return on equity.
Unfortunately, Suez’ return on equity is nothing to get excited about either.
Return on equity is quite low, and almost halved over the last 10 years - from 13.0% to 6.7%.
On a positive note, the company is profitable, and is generating a positive return for its shareholders in each of the last ten years.
That’s more than can be said for many companies.
Debt to Equity
In addition to less than stellar return figures, the company has more debt than we are usually comfortable with.
Their debt to equity ratio was 151% at the end of 2019, and currently stands at 196%.
That means they have twice as much debt as equity.
Debt is not necessarily a bad thing, but too much debt can be - especially when times are tough.
If this higher debt was justified by higher margins, and higher returns on equity, we might have seen some potential.
However, given that debt has increased, while operating profit and return on equity have decreased, Suez begins to look less appealing for value-investors like us.
We calculated the fair value of Suez using the company’s free cash flows.
We looked at the history of the free cash flows (cash from operations, less capex), and to its credit, Suez has generated decent free cash flows over the years.
We started with the most recent free cash flow (last twelve months) and assumed it would grow 5% a year, for the next 10 years.
This growth number was based on the historical growth numbers, and might (admittedly) be a bit generous.
We then applied a 2% perpetuity growth rate after that.
Then we discounted all those numbers to present day, using a 10% discount rate.
We think this is a conservative discount rate, and we use it for all our investments.
At first glance the valuation doesn’t look too bad.
Our fair value per share came out at €21.8.
Veolia bought the shares at €18.
That suggests that the shares were actually undervalued.
However, in reality that is probably not the case.
If you take into account the net debt per share, the picture changes.
The net debt per share is about €17.5.
So, Veolia is paying €18 for something that could be worth €21.8, but also comes with a debt load of €17.5.
That does not look like a good deal to us.
Despite only doing a quick analysis of Suez, the numbers do not look attractive enough for us, and we will pass on the company.
Veolia just bought 29.9% of Suez, paying €18 per share.
We decided to take a quick glance at Suez, to see if we thought it was a good investment.
Suez’ financials do not look very attractive, and neither does the valuation.
However, we want to reiterate that we did not do a deep dive on the company - we only looked at the numbers.
There will be factors that we have not taken into consideration, e.g. that Veolia can potentially benefit from certain synergies, which could lead to cost cutting, and consequently higher margins and higher returns on equity.
Our process is based on inspecting the numbers first, to see if the company deserves a closer look.
Suez does not, in our opinion.
There are other opportunities in the market that look much more attractive, and we'd rather focus on those.
All the best,
Lars and Roshni