European small and mid caps-Stock picks Q4 2007-Q1 2008 - Fourlis

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Mid cap European small and mid caps 17 October 2007 abc Positioning of Séché Environnement Source: company Overweight; target price of EUR138 Using HSBC DCF model (based on a cost of capital of 8.9% and long-term operating margin of 19.0%), we derive a target price of EUR138. Our target price offers a total potential return of c10.6% to the current share price, and we have an Overweight rating on the stock. In our view, the acquisition of 33% of Saur was motivated by the group’s aim to create a coherent multi-services group, which could become the third-ranking sector player in France. Company profile – at a glance Séché Environnement is the third player in the waste-management market, but it is far behind Suez and Véolia Environnement. Thanks to its smaller size and its more pure business model, the group was able to maintain sustained organic growth over the past 10 years (between 6% and 8% on average). The group should continue to benefit from: 1) an increasingly favourable regulatory environment and 2) its ability to boost treatment capacity steadily and to adapt its plants to deal with the treatment of new waste with higher value added. Séché: sales by division (FY 2006) Séché: sales by region (FY 2006) Upstream activ ities 20% Latin America Asia Europe 4% 3% 0% BIW-HW 24% HIW 56% France 93% Source: company Source: company 60
Mid cap European small and mid caps 17 October 2007 abc When Séché Environnement was floated on the stock market in 1997, it was operating only one landfill (class I and II) near Laval (250 hectares). Its market capitalisation in 2001 was less than EUR400m. The successive acquisitions and consolidations of Alcor in 2001 and Tredi in 2002 lifted this to above the EUR1bn mark. With Saur, the group is, in our view, now about to undergo another change in size. Investment case In our view, the acquisition of 33% of Saur was motivated by the group’s aim to create a coherent multi-services group, which could become the third-ranking sector player in France. We expect significant synergies, not only in waste collection and treatment, but also in water activities, which have several things in common, namely, the same client base, similar ties with local authorities and attractive business models (high entry barriers, recurring cash flow). The recent announcement of Suez Environnement’s future market listing is particularly interesting. Not only does this mean that another pure investment vehicle will exist alongside Séché Environnement, but it will also give the environment market a powerful boost, and reduce dispersion risk for Séché. Catalysts There are several potential catalysts that we think could lead to a medium-term revaluation: Confirmation of growth acceleration in the coming quarters’ releases Positive regulatory changes, resulting from the Grenelle de l’Environnement in France Reassuring announcements regarding Saur’s financial situation Valuation Our valuation is based solely on a DCF approach. The HSBC DCF model is based on the principle that an enterprise cannot create value indefinitely in a competitively efficient market. Return-on-invested capital trends towards the weighted average cost of capital. The HSBC model discounts economic profit over 38 years, during which time the ROIC progressively converges with WACC. We use the cost of equity as the discount rate; the tax shields are valued separately. The cost of equity comes out at 8.9%, assuming a 10-year risk-free rate of 4.4%, a market risk premium of 4.5% and a beta of 1.0 (albeit conservative, given the defensive profile of the stock, this beta level factors in the risks associated to how Séché will go about increasing its stake in Saur). We also assume growth to infinity of 2.5% and a long-term sustainable operating margin of 19.0%. These assumptions give a valuation of EUR1,191m, ie, EUR138 per share. Sensitivity table (EUR) _____________ Discounted over_______________ Years 15 20 25 30 38 Cost of capital 8.0% 102.4 113.6 125.1 138.2 153.8 8.5% 96.8 107.3 118.5 131.6 146.2 8.9% 91.4 101.2 112.1 124.3 138.0 9.5% 89.8 97.4 106.8 119.4 132.4 10.0% 83.4 91.9 101.2 135.8 139.1 Source: HSBC estimates We have not retained the peer comparison approach in our valuation, since major rivals Suez and Veolia are significantly larger and more diversified than Séché. It is, however, interesting to note that on our estimates, Séché is trading at an average discount of around 15% to Véolia, which is excessive, in our view, given that Séché is a purer player than Veolia (also present in transport and energy services). 61
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European small and mid caps-Stock picks Q4 2007-Q1 2008 - Fourlis

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