In a brief trading statement, Chris Loughlin, Pennon CEO confirmed that the group is on course to deliver a good set of results for the full year 2016/17. South West Water is on course to remain at a sector-leading 11.7% return on regulated equity and Viridor is on track to contribute the targeted c.£100 million of EBITDA from its portfolio of Energy Recovery Facilities. The shares rose by 2.5% on the news.
Pennon has been doing a very good job with the core water business over recent years. A rigid control on costs has allowed it to generate some of the best returns on regulated business in the sector, while also earning rewards from Ofwat for exceeding the regulator's targets.
The group is also coping well with the pressures of lower recyclate prices in its waste management business. Viridor collects household waste, sorts it, then recycles as much as possible. The residual waste is burned in energy recovery facilities (ERFs) generating useable power.
The group is successfully expanding its ERF estate such that higher profits can be expected from the division despite the lower recyclate prices. At the full year stage, the ERF business should be contributing c. £100m to Viridor's EBITDA, c.20% of the group total, on current analyst estimates.
If Viridor's profitability continues to improve, it 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. Pennon's double digit returns on regulated equity is impressive and supports the group's targets of above sector average dividend growth.
Pennon has the most attractive dividend policy out of the three UK-listed water companies. United Utilities and Severn Trent's prospective yields are 4.3% and 3.6% respectively, and both aim to grow the dividend at least in line with RPI inflation until 2020. Pennon offers a higher prospective yield (4.7%) and aims to grow the pay-out by RPI plus 4 percentage points over the same period.
In a time of economic uncertainty and low interest rates, the group's regulated revenues and generous dividend policy mean the shares are now trading almost 10% above their historic average price to earnings ratio.
Trading update details
As previously confirmed, the group has seen delays in the progress of the Glasgow Energy Recovery Facility. Viridor is assembling a new team to finish the work, with a new Engineering, Procurement and Construction contractor appointed. Glasgow City Council is supportive of this move, and Viridor will receive contractual remedies after terminating the contract with its previous partner, Interserve.
In Greater Manchester, while diversion of waste from landfill remains ahead of contractual commitments, the group recognises that prolonged austerity is creating challenges for it client, Greater Manchester Waste Disposal Authority. The group working with its partners on a response.
Unless otherwise stated, all estimated figures, including prospective dividend yields, are taken from a consensus of analyst forecasts compiled by Thomson Reuters. These estimates should not be taken as a reliable indicator of future performance.
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