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Severn Trent - On track for guidance so far

Nicholas Hyett | 17 July 2019 | A A A
Severn Trent - On track for guidance so far

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Severn Trent plc Ordinary 97 17/19p

Sell: 1,996.00 | Buy: 1,998.00 | Change -39.00 (-1.91%)
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Severn Trent says it has made a good start to the year, with no material changes to the guidance issued at full year results.

Regulator Ofwat is expected to announce the details of the next price review on 18 July.

The shares were down 1.3% in early trading.

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Our view

Like others in the utilities sector, Severn Trent has come under political and financial 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 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% 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 increase 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. Spending is likely to wind down now, but tighter regulation mean there's no guarantee the generous inflation-beating dividend policy will continue into the next regulatory period.

The group will likely confirm its plans in early 2020.

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First Quarter Trading Update

Severn Trent remains on track to earn £25m of Outcome Delivery Incentives this year, with the focus on delivering improvements to 1,600km of river by the end of the regulatory period. Work has already begun on the design of capital investment projects for the next regulatory period.

The group is now generating 52% of its energy needs from its own renewable sources, ahead of its 50% target.

Raw water resources are 10% ahead of the same period last year, meaning the group is well placed going into the summer period.

Find out more about Severn Trent shares including how to invest

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.