French Utility Veolia Environnement S.A. Affirmed At 'BBB' Despite COVID-19 Operating Uncertainty; Outlook Stable

  • We consider Veolia Environnement S.A.'s business mix more agile than before the group transformation launched in 2012, with a substantial contribution from the water concession business (44% of group EBITDA).
  • That said, the company is exposed to the COVID-19 pandemic and associated economic downturn, which could lead to operating underperformance, notably in its waste (36% of 2019 EBITDA) division, and to a lesser extent its energy (20%) business.
  • Veolia currently has some rating headroom and we believe remedy measures, such as a capital expenditure (capex) reduction, could mitigate the negative effects, and we note its new 2020-2023 strategic plan with a focus on continuous organic growth, primarily in hazardous waste where it is a global leader.
  • We are affirming our 'BBB' long-term issuer credit rating on Veolia.
  • The stable outlook reflects our expectation that Veolia will be able to counter operational challenges following the COVID-19 pandemic and expected consequent recession in Europe (61% of 2019 EBITDA), maintaining S&P Global Ratings-adjusted funds from operations (FFO) to debt above 20% over 2020-2023.
PARIS (S&P Global Ratings) March 27, 2020—S&P Global Ratings today took the rating actions listed above.
In our initial assessment of the COVID-19 pandemic's effects, we expect Veolia to use strong remedy measures to maintain credit metrics in line with rating requirements.
The quick spread of COVID-19 has affected Veolia's operations. As of Feb. 29, 2020, Veolia expected a 1% decrease in total projected EBITDA due to slower Chinese operations and a construction halt at new hazardous waste plants. With the subsequent spread of COVID-19 in Europe (61% of 2019 EBITDA) and lockdowns in some countries, we assess the waste (36% of 2019 EBITDA) business as highly sensitive to business cycles. We currently expect the spread of COVID-19 to lead to some negative EBITDA effects in 2020 with a strong rebound in 2021, based on the assumption that lockdown measures could be lifted in four-to-six weeks and industrial production picks up after this. We believe that Veolia could currently mitigate the economic effects by scaling down its capex or dividend program, among other measures. Should the lockdown be more severe or its effects more prolonged, we would revise our base-case assumptions.
Veolia's strategic plan is to accelerate growth in the rapidly expanding, but more volatile, hazardous waste business, with the more stable water concession business remaining the backbone.
On Feb. 28, 2020, Veolia announced its 2020-2023 strategic plan. The group's new plan heavily focuses on investment in high growth businesses (hazardous waste, waste recycling and recovery, energy efficiency, industrial ecology, or new innovative solutions) and divesting mature assets (such as District Heating in the U.S.) while maintaining strong operations in its core business--water treatment. The group also aims to provide new innovative solutions to both industrial and municipal customers to become a leader in ecological transformation. We expect the water business to represent 33% of EBITDA by 2023 (down 5% from 2019 levels) while the hazardous waste business is expected to expand to 17% (up 5% from 2019 levels).
Veolia's new business mix is expected to be more flexible, but the current economic slowdown due to COVID-19 will be a key test.
Operating among four businesses in the environmental services sector, Veolia offers a wide range of solutions for industrials and residential businesses. The group's global implementation, brand recognition, and strong knowhow are key advantages for it to develop in current or neighbouring markets through small acquisitions. The successful business repositioning of Veolia, which started in 2012, led us to revise the management and governance score to satisfactory from fair previously.
We expect credit metrics to remain at a level consistent with the current rating over 2020-2023.
Under the new plan, Veolia aims to expand its reported EBITDA to €4.7 billion-€4.9 billion by 2023 from €4 billion currently, efficiently increasing its reported FFO to debt to about 22% and maintaining reported debt to EBITDA below 3.0x. This EBITDA increase stems both from heavy investment in high growth businesses and continued cost savings, amounting to €250 million annually (€1 billion over the business plan horizon). We anticipate dividends will increase in line with net income and expect an acceleration of capex at the beginning of the plan, leading to strong EBITDA growth toward the end. However, we understand from the group that, although committed, both capex and dividends are flexible to enable it to maintain reported leverage below 3x at all times.
S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the COVID-19 outbreak. Some government authorities estimate the pandemic will peak in June or August, and we are using this assumption in assessing the economic and credit implications of the pandemic. We believe measures to contain COVID-19 have pushed the global economy into recession and could cause a surge of defaults among nonfinancial corporate borrowers (see "COVID-19 Macroeconomic Update: The Global Recession Is Here And Now" and "COVID-19 Credit Update: The Sudden Economic Stop Will Bring Intense Credit Pressure," published March 17, 2020, on RatingsDirect). As the situation evolves, we will update our assumptions and estimates accordingly.
The outlook reflects our anticipation that Veolia will use strong remedy measures to offset potential operational underperformance related to the COVID-19 lockdown in Europe and consequent recession, which is our current assumption based on a European lockdown of four-to-six weeks. We currently project that Veolia will post credit metrics commensurate with a 'BBB' rating on a sustainable basis, including adjusted FFO to debt above 20% on average over 2020-2023 (22.5% at year-end 2019 and back to about 20% from 2020 onward).
A negative rating action could result from greater disruptions due to current market conditions than we expect, such that the company's remedy measures might not be enough to offset them. Larger debt-financed acquisitions, without FFO to debt reverting to 20%; less supportive financial policies; or expansion into more volatile markets beyond currently announced plans could also negatively affect the rating.
We could upgrade Veolia if the group continues to generate strong free operating cash flow (FOCF) before dividends, with adjusted FFO to debt sustainably above 25% and debt to EBITDA below 3x. We could also raise the rating if we consider its business risk profile to have strengthened on the back of improved profitability, business flexibility, and market conditions. Veolia's business performance during the lockdown period in Europe will be fundamental for us to consider an upgrade.

Ultimately, any upgrade potential would also hinge on management's financial policy, especially since we believe that the group may use its financial headroom to further accelerate growth rather than materially strengthen its balance sheet.
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