(The following statement was released by the rating agency)
Nov 15 - Fitch Ratings has revised the Outlook on Veolia Environnement (Veolia) to Negative from Stable and affirmed the Long-term Issuer Default Rating (IDR) and senior unsecured rating at ‘BBB+'.
The revision of the Outlook to Negative reflects a further delay in Fitch’s forecast for Veolia’s leverage (lease-adjusted net debt/EBITDAR) reduction to around 4.7x, previously identified as a negative rating guideline.
Despite management’s strong commitment to debt reduction in the medium term and the realisation of material disposal proceeds in FY12, Fitch considers cash flow generation and deleveraging in the next 12-18 months to be limited by a combination of still weak economic conditions and operational difficulties, a delay in the Transdev disposal and still sizeable gross investments.
Fitch also considers Veolia’s funds from operations (FFO) fixed charge coverage as relatively weak. Although this should strengthen from FY13 following some reduction in debt and interest payments, fixed charge coverage is likely to be below 3.0x.
Fitch believes the negative effects of economic conditions and operational difficulties will persist in the short to medium term. Contract erosion looks set to continue to dampen the performance of the Water division, given the number of contracts to be renewed and negotiated over the next two years. The agency expects that it will take time for the average contract pricing to return to previous higher levels.
Softer economic fundamentals are likely to keep raw material prices low and thus hamper a recovery in the Waste division whilst operational difficulties in southern Europe, together with increased competition are set to continue to offset favourable energy prices in the Energy division. Fitch does not anticipate the Energy division’s operations in Italy to improve in the short term.
To date, the success of Veolia’s disposal plan has been mixed. Whilst disposal proceeds of the company’s UK Water and US Waste businesses were greater than initially anticipated by Fitch, the timetable for the complete sale of Transdev, has been further extended to FY14. Fitch has assumed additional disposals in line with the company’s strategic plan to dispose of EUR5bn in assets. Regarding Transdev, this includes the EUR300m repayment of Veolia’s total EUR900m shareholder loans in FY13, and the repayments of the remaining shareholder loans and sale of its 40% stake in FY14. If there are any indications that Transdev’s disposal continues to be delayed or there is a reduction in the proceeds and/or number of smaller disposals, this may warrant further negative rating action.
Fitch emphasises that management’s guidance of EUR3.2bn-EUR3.4bn gross investments in FY12 was in excess of the agency’s estimates. This was due to the delays in the completion of disposals in FY12 and the related capex spend, as well as unexpected purchases of minority interests. Fitch expects that gross investments will reduce to around EUR2.8bn in FY13 and combined with maintaining dividend payments in line with those paid in FY12, this will also be crucial in ensuring the company is able to reduce leverage.
Veolia’s restructuring plan appears clearly defined and its intention to reorganise and reduce the group’s geographical coverage as well as focus on value-added product offerings appear to be healthy steps in helping to rationalise its cost base. Veolia has historically exceeded its restructuring targets, but previous restructuring measures have not resulted in the degree of streamlining and re-focusing of the business needed to fully protect the company’s EBITDA generation. Moreover, whilst Veolia plans to target growth areas, these also increase the group’s exposure to the group’s water division as well as emerging markets. In the medium term, these heighten the potential for more volatile earnings, particularly given the current difficulties in the Water division, but equally less-proven markets and increase business risk.
The affirmation of Veolia’s ratings is supported by the company’s international diversification with a strong focus on developed markets, good revenue visibility through long-term contracts and many leading positions in its operations. Its Water and Energy businesses are sensitive to unfavourable weather conditions and the Environmental division can be negatively impacted by low raw material prices, the latter tends to be partially offset by the Energy division.
The company’s ratings also benefit from strong liquidity. At end-H112, the group had cash and cash equivalents of around EUR4.6bn and EUR4.0bn in undrawn credit lines, which was more than sufficient to cover short-term debt of around EUR4.5bn. Free cash flow was negative EUR659m, before proceeds from disposals and excluding negative working capital movements of EUR609m, which are expected to partially reverse by the year end on account of seasonality.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Further operational pressures and delay in business restructuring leading to an expected FFO net adjusted leverage in excess of 4.7x on a sustainable basis and a lack of improvement in expected FFO fixed charge coverage towards 3.0x.
Positive: The current Rating Outlook is Negative. As a result, Fitch’s sensitivities do not currently anticipate developments with a material likelihood, individually or collectively, of leading to a rating upgrade. Future developments that may nonetheless potentially lead to a positive rating action include
- Better than expected operations and timely and successful business restructuring with expected FFO net adjusted leverage falling to below 4.0x on a sustainable basis and expected FFO fixed interest cover improving to above 3.5x.