One of the lessons that experience will teach an investor is that almost nothing good comes cheap. In the case of income stocks, a high dividend yield may sound great, but it is often the case that an eye-popping dividend comes with a stressed company that may well struggle to maintain that dividend.
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Veolia (NYSE:VE) is a good case in point. Management has realized that the Veolia that was, just wasn't a sustainable enterprise, and has launched a fairly extensive program of restructuring. While the dividend here is arguably sustainable, worries about growth and balance sheet restructuring may limit the capital gains potential.
A Turbulent Year Comes to an End
Although Veolia did report EBIT results for 2011 that surpassed expectations, performance was definitely mixed.
Revenue rose 3% for the year on a reported basis and 2% on an organic basis. The large water business posted slightly better than 1% growth, while waste climbed nearly 5% and energy dropped about 0.5%. Adjusted operating income dropped 10% for the year. (For related reading, see Zooming In On Net Operating Income.)
The final results don't really reflect the turbulence investors saw this year. Veolia had to contend with various contract failures, accounting changes and business disposals. On top of that, there was a fair bit of uncertainty about management's new direction, though recent meetings and comments from management seem to have everyone on more or less the same page.
Shuffling the Deck
Veolia is looking to sell about 5 billion euros' worth of assets over the next two years, centered on the U.K. water, U.S. waste and transport segments. Veolia will still remain a major operator of water utility and waste management systems, but it will be a leaner, hopefully more profitable, enterprise. With the new structure, France and Germany will be more than half of the revenue base, while both the U.S. and China will be about 6%.
Beware of Leverage
Veolia drives home once again one of the most important lessons about utility service businesses - when companies gorge on debt in the pursuit of growth by acquisition, it rarely ends well. These are not growth industries and there is only so much leverage to be gained from scale and efficiency enhancements.
That said, well-run utility business can generate respectable returns. Veolia's issues with the U.S. waste business are not an indictment of Waste Management (NYSE:WM) or Republic Services (NYSE:RSG), they are a recognition that the company lacked scale. Likewise, water utilities like American Water Works (NYSE:AWK) and Aqua America (NYSE:WTR) can be solid long-term stories, so long as they balance ambition with prudence in regards to the balance sheet.
The Bottom Line
Veolia is a so-so stock at this point. Management seems to have a cogent plan to improve the business and dividend preservation does appear to be a priority. That said, investors should be very wary if management changes course and starts talking about its desire to acquire more utility operations in emerging markets on the basis of the potential growth.
Although it doesn't look like there should be much capital appreciation potential in the stock today, odds are that investors will return to the name as they see consistent execution of the restructuring plan. In the meantime, investors can collect a solid dividend. All in all, then, Veolia is an iffy stock - not the greatest potential, but not a bad source of dividend income relative to the risks.
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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.