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Pennon - Profits continue to flow, with dividend up 7.2%

Nicholas Hyett | 24 May 2017 | A A A
Pennon - Profits continue to flow, with dividend up 7.2%

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Pennon Group Ord 40.7p

Sell: 1,138.00 | Buy: 1,139.00 | Change -9.00 (-0.79%)
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Pennon shares rose 1.1% following the announcement of full year results. Profits before tax of £250m are up 18.3% on the year before, with revenue broadly flat at £1.4bn.

The group continues to target an increase in the dividend of 4% per annum above RPI inflation out to 2020. The final dividend of 24.87p per share takes the full year payment to 35.96p (up 7.1% on the previous year).

Our View

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.

Viridor collects household waste, sorts it, then recycles as much as possible. The residual waste is burned in energy recovery facilities (ERFs) to generate energy. Pennon is coping well with the pressures of lower recyclate prices, with margins improving substantially following various cost saving initiatives.

The group is successfully expanding its ERF estate such that higher profits can be expected from the division despite the lower recyclate prices. Full year EBITDA from the ERF business of £107m is a significant outperformance against the c.£100m target, and represents 22% of the group total.

However, it's the regulated water business that really matters, since this is what dividend expectations are based on. Pennon's double digit return on regulated equity is impressive and supports the group's inflation beating dividend growth target.

Pennon has one of the most attractive dividends of the three UK-listed water companies, with a prospective yield of 4.3%, which is expected to grow by RPI inflation plus 4% out to 2020. By comparison United Utilities offers a prospective yield of 3.8% and aims to grow the dividend at least in line with RPI, while Severn Trent now matches Pennon's RPI +4% commitment, but from a lower base of 3.4%. Of course these are targets, so are not guaranteed to be met.

In a time of economic uncertainty and low interest rates, the group's regulated revenues and generous dividend policy have seen the shares rise in value. They are now trading over 16% above their historic average price to earnings ratio, a valuation that could come under pressure if interest rates were to rise.

Full Year Results

South West Water continued to deliver a market leading return on regulated equity in the year, at 12.6% (2015/16: 11.7%). Profits before tax of £173.9m are up 4.9% on the previous year, with EBITDA (earnings before interest, tax, depreciation and amortisation) up 4.1% at £349.1m.

The division has delivered cumulative savings of £129m since the start of the current regulatory period (2015-2020) and will continue to focus on cost efficiencies going forward. The integration of Bournemouth Water has been effectively completed, and is on track to deliver £27m of synergies by 2020.

The group received net Outcome Delivery Incentive (ODI) payments of £3.6m in the year, taking the regulatory period total to £5.5m, with bathing water quality, interruptions to supply and leakage showing significant improvements on 2015/16. The group received penalties for pollution events and external flooding.

The Viridor recycling and waste management business saw profits before tax increase 96.7% to £60.4m, with EBITDA rising 18.7% to £138.3. The robust performance was driven by a strong showing from recycling and energy recovery facilities (ERFs), offsetting weakness in Landfill Gas.

The group remains in negotiations with the Greater Management Waste Disposal Authority regarding the exit from the Viridor Laing Recycling & Waste Management Private Finance Initiative.

Net debt of £2.7bn was 7.3% ahead of the previous year.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.