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Severn Trent - still churning off the dividend increases

George Salmon | 22 November 2018 | A A A
Severn Trent - still churning off the dividend increases

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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: 2,008.00 | Buy: 2,009.00 | Change 16.00 (0.80%)
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Severn Trent has released half year results, with underlying revenues and profits broadly in line with expectations.

The interim dividend rises 7.9% to 37.35p per share, consistent with the target of paying dividend increases of at least 4 percentage points above the rate of RPI.

The shares fell 3% 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. While there are a few more uncertainties than in the recent past, we feel, 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 aims to increase the payout by four percentage points above the rate of RPI inflation, and the prospective yield of 5.2% could appeal to income-seeking investors. In the past, these characteristics have attracted interest from major pension and infrastructure funds as well.

However, recent developments have muddied the waters. 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.

Longer term, investors shouldn't forget the group has some of the most reliable revenues out there, and a strong operational track record.

That said, the tighter controls around the next regulatory period mean there's no guarantee the generous inflation-beating dividend will be sustained into the next regulatory period. The group will likely confirm its plans in early 2020.

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Half year trading details

Revenue rose 3.6% to £881.5m, boosted by higher tariffs from increased inflation. Despite higher costs, including an additional £10.1m from the hot, dry summer, underlying operating profit increased 4.3% to £299.1m.

Capital expenditure was £340.1m, up £69.7m on last year, and is on track to total £650m this year. A second service reservoir at Ambergate has completed ahead of expectations, with the Birmingham Resilience Programme also progressing.

The increased spending has seen net debt rise £61.9m, to £5.4bn. However, at 59.6% that represents a slightly lower percentage of regulatory capital value.

95% of the £870m in total expenditure efficiencies targeted over the 2015-2020 period have now been locked in, and Severn Trent is due to reinvest £100m in advance of the new regulatory period in 2020. The group is confident of hitting its financial targets for AMP7 while maintaining the lowest bills in England and Wales.

Severn Trent has earned a cumulative £150m in incentive payments over the current 5 year period, 2015-2020, but looking ahead it expects operating costs to rise as a result of Environment Agency license fee increases.

The £120m acquisition of Agrivert Holdings Limited, a leading energy from food waste business, was announced in May, while the property disposal programme, set to deliver £100m in profits by 2027, continues.

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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.