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Severn Trent - Improved delivery for customers

Nicholas Hyett | 23 November 2017 | A A A
Severn Trent - Improved delivery for customers

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Severn Trent plc Ordinary 97 17/19p

Sell: 2,248.00 | Buy: 2,250.00 | Change 33.00 (1.49%)
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Underlying profit before interest and tax payments (PBIT) of £287.8m was up 4.4% on the previous year. This supported a 7.7% increase in underlying earnings per share, to 65.9p, with the interim dividend up 6.2% to 34.63p.

The group has upgraded its expectations on regulatory rewards for the current financial year.

The shares rose 2.3% in early trading.

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 coped well under the system.

Since 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.

The Bank of England's decision to raise interest rates has knocked the shares a bit. But we don't feel investors should be too unduly spooked. 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 4.1%.

Half Year Results

The group's 6.2% dividend rise is in line with its new policy, set out at full year results, of increasing payments by RPI inflation plus at least four percentage points per annum.

Group turnover rose 3.7% in the first half to £850.4m. The improvement was driven by price rises in the Regulated Water and Waste Water business, the acquisition of Dee Valley and growth Business Services.

Despite 22.4% growth in Business Services profits, Regulated Water and Waste continues to account for 97% of group PBIT.

Guidance for 2017/18 outcome delivery incentive (ODI) payments has been upgraded to £50m. This follows a 38% reduction in internal sewer floodings and a 50% reduction in external floodings. The group has earned £71m in ODIs in the first two years of the current regulatory period.

Severn Trent continues to expect make £3bn in capital investments during the 2015-2020 regulatory period with £324m invested during the half. It has now achieved 86% of the £770m in efficiency savings it planned to achieve during this period, including a further £50m this half.

Net debt at the end of the half stood at £5.1bn, compared to £4.7bn at the same point in 2016. PBIT interest cover (the number of times the group can pay its debt interest costs from this half's profits) fell slightly to 2.8 times.

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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.

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.