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Severn Trent - Results in line, but Dee Valley bid forced up

George Salmon | 24 November 2016 | A A A
Severn Trent - Results in line, but Dee Valley bid forced up

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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: 2,606.00 | Buy: 2,608.00 | Change -45.00 (-1.69%)
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Severn Trent's half year results were in line with expectations. Having had to raise its bid for the Dee Valley Group, the shares fell by 0.7 % this morning.

Our view

Severn Trent is a straight-forward water utility, providing water and sewerage services to customers in the Midlands. While it does also provide commercial services across the UK and internationally, it is the regulated utility division generates the lion's share of group income. This side of the business could get more important still, should the group win the bidding war over Dee Valley Group. Severn Trent's most recent offer is £84m.

In the UK, water and sewage prices are regulated, with Ofwat setting price limits every five years. 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.

With revenues that are linked by Ofwat's price formula to inflation, 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.

For now, however, the main attraction of Severn Trent, like most utilities, is the dividend. In a world of ultra-low interest rates, and depressed bond yields, these stocks have become a more attractive option for income investors. This has seen the shares rise in recent years, and they currently trade well above their historic average price to earnings ratio.

The prospect of what a Donald Trump presidency may do to the bond market has rocked the boat, however. In recent weeks, bond yields have ticked up, an d investors should be mindful that if this trend continues, there may be some volatility ahead for Severn Trent.

For long-term income investors, however, the group's regulated revenues mean that earnings are unlikely to fluctuate much, which should underpin confidence in the dividend. The shares currently offer a prospective yield of 3.6% and the group is set to increase the dividend at or above the rate of RPI inflation.

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, although as ever this is not guaranteed.

First half trading in detail

Group revenue increased 3.2% to £907m, assisted by regulatory price increases.

Underlying profit before interest and tax rose 3.1% to £278m, of which £269m comes from the Regulated Water and Waste Water division. The group continues to expect rewards of around £15m in 2016/17 for exceeding the regulators target standards.

The interim dividend has increased to 32.6p per share, with the full year dividend set to be 81.5p (2015/16: 80.66p). The group's policy is to grow the dividend by at least RPI annually out to 2020.

The group plans to strip out £670m of costs by 2020 and locked in a further £50m of efficiencies on top of the £490m already identified. For the year, total expenditure is forecast to be around £1.05bn, around £70m lower than had previously been expected.

Net debt of £4.7bn is £104m up on last year, but the effective interest rate of 4.2% is 0.4 percentage points lower.

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.