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Severn Trent - All in order

George Salmon | 19 July 2017 | A A A
Severn Trent - All in order

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Severn Trent plc Ordinary 97 17/19p

Sell: 2,036.00 | Buy: 2,038.00 | Change 0.00 (0.00%)
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Severn Trent has announced a trading update covering the period 1 April to 19 July 2017. The announcement contains little in the way of surprises, and there is no change to previous full-year guidance. The shares were broadly flat on the news.

Our View

Severn Trent is a straight-forward water utility, providing water and sewerage services to over 4m customers in the Midlands and Wales. While it also provides services to commercial customers across the UK and internationally, it is the regulated utility division that generates the lion's share of group profits.

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 the system.

With revenues that are linked to inflation by Ofwat's price formula, 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 is the dividend. In a world of ultra-low interest rates and depressed bond yields, utility stocks have become a more attractive option for income-seeking investors. This has seen Severn Trent's shares rise in recent years.

Recently, there has been talk of the Bank of England raising interest rates earlier than had previously been expected, with a return to the 2009-16 level of 0.5% being mooted. However, we don't feel investors should be too spooked by this. The economic uncertainty around the UK looks like it's here to stay, so we don't see the Bank raising interest rates to anything like pre-crisis levels in the near term.

Whatever the future holds for the UK's economy, the group's regulated revenues mean that its earnings are unlikely to fluctuate much, which should underpin confidence in the dividend. The shares currently offer a prospective yield of 3.8% and the group plans to increase the dividend by 4% above the rate of RPI inflation.

Details of current trading

Severn Trent says it has made a good start towards its target of achieving £23m in net Outcome Delivery Incentives (ODIs) from the regulator in 2017/18.

The group continues to work towards delivering total expenditure efficiencies of £770m over the 2015-2020 regulatory period. As expected, Ofwat's most recent price review looks more challenging, however the group is encouraged that it offers ambitious and innovative companies the opportunity to earn higher returns.

The business-to-business Water Plus joint venture won a number of large multi-site customers such as Kwik-Fit and David Lloyd Leisure.

In July, the group announced the sale of its US business for $62m. Elsewhere, the integration of the Dee Valley business, finalised in February, in progressing well.

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 disclosure for more information.