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Severn Trent - dividend intact despite lower profits

Nicholas Hyett | 21 November 2019 | A A A
Severn Trent - dividend intact despite lower profits

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Severn Trent plc Ordinary 97 17/19p

Sell: 2,790.00 | Buy: 2,792.00 | Change 0.00 (0.00%)
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Severn Trent's half year revenues rose 3.2% to £910m. However, underlying profits fell 4.3% to £286m, with lower profits in both the Water and Business Services divisions.

An interim dividend of 40.03p was announced, in line with the current policy to increase the dividend by RPI plus 4%.

The shares fell 1.1% on the news.

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Our view

Like others in the utilities sector, Severn Trent has come under political and financial pressure recently - not least the fact a change in the government could bring about nationalisation at below market value. Despite the extra risks though we think many of the core attractions remain in place.

There are renewables, food waste recycling, 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.

Prices are set by the regulator, Ofwat. They're reviewed every five years and aim to make sure supply is readily available, at an affordable price, and in return efficiently run water companies can achieve acceptable financial returns.

Severn Trent has historically coped well under the system, delivering steady earnings growth and 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 4.3% 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. This means the dividend policy may not be as generous going forwards, although the group will likely confirm its plans in early 2020.

Meanwhile the tailwind of low interest rates, which has boosted companies where income features prominently in the investment case, will have to unwind at some point. Higher rates will also increase the group's interest cost on a debt pile that's been steadily growing in recent years.

Despite the headwinds it's important not to lose sight of the fact Severn Trent has some of the most reliable revenues out there, and a strong operational track record. We think these factors, in a time of wider economic uncertainty, go some way to explaining why the shares currently trade just above their long run average at 19.5 times earnings.

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Half year results

Revenue in the core Water and Waste Water business rose 1.6% to £807.5m, as higher prices offset lower outperformance payments from the regulator. Underlying pre-tax profits fell 3.1% to £260.1m, as below inflation revenue growth failed to offset an increase in bad debts and maintenance expenditure.

In Business Services revenues rose 15.8% to £112.3m, reflecting the integration of the food waste management business acquired last year. The rest of the businesses reported small declines in revenues. Underlying pre-tax profits fell 19.8% to £29.9m, mainly driven by lower property sales, but Bioresources' profits also fell 1.4%.

Net debt increased to £6.0bn, up from £5.4bn last year. The increase reflects higher capital expenditure and an increase in tax paid, due to a change in the timing of payments. Severn Trent's level of indebtedness, measured by net debt as a percentage of Regulatory Capital Value, was 63.1%, up from 59.6% last year.

Severn Trent's pension deficit now stands at £390.6m, a reduction of £62.3m, thanks to strong investment performance.

Looking ahead full year revenues in the Water Business are expected to be £1.61bn - 1.64bn, up from £1.58bn last year and Business Services expect to generate a profit above last year's £44m. Capital expenditure is expected to remain level between £700m - 800m. The full year dividend is set at 100.08p an increase of 7.2%.

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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.