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Severn Trent - another dividend increase

George Salmon | 21 May 2019 | A A A
Severn Trent - another dividend increase

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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: 2,294.00 | Buy: 2,296.00 | Change 47.00 (2.09%)
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Severn Trent has seen revenues and profits rise by mid-single digit percentages, helping the group deliver its target of inflation-beating dividend growth. The full year payout is set to rise 7.9% to 93.37p per share.

The shares were unmoved on the news.

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Our view

Like others in the utilities sector, Severn Trent has come under pressure recently. We think that many of the core attractions remain in place, although there are extra risks around. Not least the fact a change in the government could bring about nationalisation at well below market value.

There are renewables and property projects within the Business Services division, but in the main, Severn Trent is a straight-forward water utility. It provides 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 growth, 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 5.3% could be appealing. 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 the talk of nationalisation, have seen the shares falter.

Severn Trent has some of the most reliable revenues out there, and a strong operational track record. But debts have increased as the group splashed out on the asset base and completed bolt on deals. Spending is likely to wind down now, but tighter controls mean there are no guarantees the generous inflation-beating dividend policy will be sustained into the next regulatory period. The group will likely confirm its plans in early 2020.

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Full year results

In the core regulated Water and Waste Water division, revenue in the 12 months to 31 March rose 4% to £1.6bn, as inflation-linked growth more than offset the impact of a £4.5m ODI penalty from the regulator. Despite that, the group has delivered cumulative regulatory rewards payments of £138m over the current AMP6 period (from 2015).

Underlying pre-tax profits rose 5.7% to £527m, despite an additional £22m of operating costs from the hot, dry summer.

In the Business Services unit, a £19.9m boost from property development and extra bioresources profits helped underlying profits rise from £34.8m to £64.1m. Underlying profits rose 2%. Severn Trent continues to target generating £100m of cumulative property PBIT by 2027.

Capital expenditure was £769.3m, the group's largest spend in a decade. 28 projects were completed to improve the waste network, with further progress on the Birmingham Resilience Programme.

The rise in capital investment and increased dividend last year saw net debt rise to £5.8bn, but low interest rates on refinanced debt helped net finance costs fall £25.3m to £194.2m.

Guidance for 2019/20 is for regulated water and wastewater revenue of around £1.6bn, with a £25m ODI boost. Underlying profits in the Business Services division are set to rise, but property profits will likely be lower.

Severn Trent's capital expenditure will be around £700-£800m.

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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.