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Pennon maintains profit and dividend targets

Charlie Huggins | 11 February 2016 | A A A
Pennon maintains profit and dividend targets

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

Pennon Group Ord 40.7p

Sell: 1,149.50 | Buy: 1,150.50 | Change 4.00 (0.35%)
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Pennon is on track to meet expectations for FY16 and has reiterated its aim of growing dividends at +4% above RPI inflation through to 2020. The shares fell by 2.5% in early morning trading, broadly in line with the wider market.

South West Water and Bournemouth Water are said to be performing well. Return on Regulated Equity for the combined water business is on track to remain at c.11.5% for the full year. The group is outperforming its total expenditure commitments, as a result of efficiency initiatives, suggesting a smooth transition to the new 2015-20 regulatory regime.

At Viridor, the waste management business, the five Energy Recovery Facilities (ERFs) brought on-stream in FY15 are ramping-up as planned. Despite pressure on power prices the group remains confident of delivering c.£100m of EBITDA in FY17, when nine out of the eleven committed ERFs are expected to be operational. The group remains cautious about future recyclate price growth, but is targeting margin enhancements through cost and efficiency savings to offset these pressures.

Our view:

So far, Pennon is coping well with pressures in its waste management business, Viridor. This business collects household waste and sorts it, then recycles as much as possible. The residual waste is burned in Energy Recovery Facilities (ERFs) and converted into energy. The problem is that lower oil prices are making recycled plastics and metals less competitive versus virgin materials, resulting in lower recyclate prices.

Pennon remains cautious about future recyclate prices, but is conducting a cost-cutting and efficiency drive to support margins. In addition, as more of these ERFs come on stream, the profitability of this business should improve. BY 2016/17 the ERF business should be contributing c. £100m to Viridor's earnings before interest, taxes, depreciation and amortisation (EBITDA), c.20% of the group total, on current analyst estimates.

If Viridor's profitability improves this will provide a nice fillip for the group, but it's the regulated water business that really matters, since this is what dividend expectations are based on. Encouragingly, this business has made a good start to the new regulatory period.

Pennon has the most attractive dividend policy out of the three UK-listed water companies. United Utilities and Severn Trent yield 4.3% and 4.0%, respectively and aim to grow the dividend at least in line with RPI inflation until 2020. Pennon offers a similar yield (4.2%) but aims to grow the pay-out by RPI plus 4% over the same period.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.