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Severn Trent - dividend rises, with more investment planned

George Salmon | 23 May 2018 | A A A
Severn Trent - dividend rises, with more investment planned

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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: 2,337.00 | Buy: 2,339.00 | Change 11.00 (0.47%)
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Severn Trent's final dividend of 51.92p takes the 2017 full year payment to 86.55p, up 6.2% in line with the policy of paying dividend increases four percentage points above the rate of RPI.

With results in-line with expectations, the shares were little moved on the morning of the news.

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Our view

Like others in the utilities sector, Severn Trent has come under pressure recently. However, we feel that for income-seeking investors, many of the core attractions remain in place.

Severn Trent is a straight-forward water utility, providing water and sewerage services to over 4m customers in the Midlands and Wales.

The regulator, Ofwat, sets price limits every five years. These limits will seek to ensure supply is readily available across the network at an affordable price, but also allows for efficiently run water companies to achieve acceptable financial returns.

Severn Trent has historically coped well under the system, and has delivered steady earnings, leading to a gentle flow of dividends. The group's stated aim is to increase the payout by four percentage points above the rate of RPI inflation, and the prospective yield of 4.6% could appeal to income-seeking investors. In the past, these characteristics have attracted interest from major pension and infrastructure funds as well.

However, there are a few black clouds lurking. Ofwat's next set of price reviews look to be more challenging than in the past, possibly as a result of calls for tighter controls from both main political parties.

The tailwind of low interest rates, which has boosted companies where income features prominently in the investment case, looks set to steadily unwind. Higher rates will also have the effect of increasing the group's interest cost on a debt pile that's been steadily growing in recent years.

These factors, together with talk of nationalistation, have seen the shares falter.

It's possible the group could tweak the generous policy of paying increases four percentage points above the rate of RPI in the year ahead, but we think it's unlikely any major changes are afoot. After all, the group has some of the most reliable revenues out there, and can point to a strong operational track record.

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Trading details

Revenue rose 3.4% to £1.7bn, with underlying operating profit up 4% to £541m.

However, higher interest costs and increased investment saw free cash flow drift negative for the year, and net debt increase 5.4% to £5.4bn. Net debt is now a shade over six times earnings before interest, tax, depreciation and amortisation.

Cost efficiency targets have been increased from £770m to £870m for the current regulatory period. The group is planning to reinvest the additional £100m ahead of the start of the next one, AMP7.

The bulk of the spending will be in the Water division, which incurred a £29m regulatory penalty in 2017/18 as a result of weather-induced supply interruptions. Despite this, the group still earned a net £80m reward, with improvements in flooding and pollution metrics behind a £109m reward for the Waste business.

Severn Trent has submitted its plans for AMP7 to Ofwat, while the Dee Valley integration is nearing completion.

Customer service measures were again strong, and Severn Trent continues to have the lowest average combined bills in England and Wales, at £348 for 2018/19.

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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 for more information.