In a brief trading update ahead of full year results, Pennon said it was on track to deliver a strong performance in South West Water, with a the ramp up of its new Energy Recovery Facilities (ERFs) going well.
The shares rose 1.2% in early trading.
As with most utilities, the potential for a reliable income is the main attraction for investors.
However, Pennon's waste management division, Viridor, means there's a bit more under the bonnet than your average water utility.
Viridor collects household waste, sorts it, then recycles as much as possible. The residual waste is burned in energy recovery facilities (ERFs) to generate electricity. Pennon has proven adept at controlling cost, and the addition of new facilities means there's potential for this side of the business to grow its profits.
However, recent history shows there are potential trip wires. Management have found pricing doesn't have the same regulation-induced predictability, but are hopeful conditions will improve as recycling becomes ever-more important.
While Viridor tends to get the headlines, the majority of profit is still generated in the regulated water business. And it's this that underpins the dividend policy - namely to increase the payout by RPI inflation plus 4 percentage points each year.
The group's built a good record in its core business. Rigid cost control has helped generate some of the best regulated returns in the sector, while service levels have been good enough to earn rewards from Ofwat.
However, regulatory conditions are expected to be tougher from 2020, and with a debate about nationalisation resurfacing for the first time in decades, the political climate is far from welcoming.
Pennon deserves credit for its achievements, but in an increasingly political environment there are some headwinds that are out of its control. That's pushed the prospective yield up to 5.6% for 2020.
Pre-Close Trading Update
South West Water is on course to deliver a Return on Regulated Equity of 11.8% this year. The group's on course to achieve further net Outcome Delivery Incentive rewards in the year, and expects its overall customer experience result to improve.
South West Water's business plan for 2020-2025 has been approved for a 'fast-track' process by regulator Ofwat.
The ramp up of activity continues at the Glasgow, Dunbar and Beddington ERFs with construction progressing well at Avonmouth. The recycling business is on course to meet management's expectations for the full year - with recyclate prices broadly stable.
Pennon was due to receive £72m of compensation from Interserve, relating to construction issues at its Glasgow ERF. However, since Interserve entered administration earlier this year, the group has taken a £16m non-cash provision against that amount to reflect the chances of this being received.
Full year results are due on 30 May 2019.
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.
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