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Severn Trent - Business as usual

George Salmon | 20 July 2016 | A A A
Severn Trent - Business as usual

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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.

Severn Trent plc Ordinary 97 17/19p

Sell: 2,496.00 | Buy: 2,498.00 | Change 18.00 (0.72%)
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Severn Trent have this morning announced a brief trading update covering the period from 1 April to 19 July 2016. The shares were flat in early trading this morning.

When releasing full-year results in May, Severn Trent said that they expect to significantly outperform in terms of total expenditure (totex) efficiencies, forecasting £670m of benefits over the five year period to 2020. This represents £260m of outperformance versus the regulator's assumptions, £120m of which will be reinvested to benefit customers. Today, the group confirm that plans to deliver these efficiency savings are progressing well.

Other than the joint venture with United Utilities completing on 1 June (following CMA approval on 3 May) there has been no material change in the Group's performance or outlook for the year.

Severn Trent Plc will announce its half-year 2016/17 results for the period ending 30 September 2016 on 24 November 2016.

Our View

Severn Trent is a straight-forward water utility, providing water and sewerage services to customers in the Midlands, along with commercial services across the UK and internationally. We shouldn't get too excited about the latter; the regulated utility division generates the lion's share of group income and this is unlikely to change much.

In the UK, water and sewage prices are regulated, with Ofwat setting price limits every five years, after examining each water company's business plans. The regulator has a track record of setting tough, but achievable limits that allow efficiently run water companies to achieve acceptable financial returns.

Severn Trent has historically coped well under Ofwat's price limits. There seems little reason to expect this to change, given recent trading updates. With revenues that are linked by Ofwat's price formula to RPI, Severn Trent has a relatively predictable level of real income. That visibility of income has previously attracted outside interest from major pension and infrastructure funds, interest that could be renewed in future.

Putting that possibility to one side, the main attraction of Severn Trent, like most utilities, is the dividend. In a world of ultra-low interest rates, Severn Trent and others in the sector have become a more attractive option for income investors and the shares have risen over the last few years, although this is not a guide to future performance.

Severn Trent is committed to a dividend policy of paying dividends linked to the rate of growth of RPI or above, after having reduced the base level by 5% in the 2015/16 financial year. Currently, Severn Trent offer a prospective yield of 3.3%.

With RPI hovering between 1 and 2% at the moment, income growth prospects look muted in the near term. Investors looking for rising utility yields might want to consider Pennon Group, owners of South West Water, where the dividend policy for the current regulatory period is for growth of RPI + 4% per annum.

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.