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Severn Trent - on track and new dividend policy announced

Emilie Stevens | 28 January 2020 | A A A
Severn Trent - on track and new dividend policy announced

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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: 2,349.00 | Buy: 2,351.00 | Change 0.00 (0.00%)
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Severn Trent has announced a new dividend policy for the next regulatory period (2020-2025). Going forwards the dividend will grow by at least CPIH (a measure of inflation which includes housing costs). That starts from a base of 100.8p this year (2019/20), with next year's dividend expected to be 101.58p.

The outlook for the current financial year remains unchanged.

The shares remained broadly flat following the announcement.

View the latest Severn Trent share price and how to deal

Our view

Under the hood of Severn Trent you'll find renewable energy, food waste recycling, and property projects within the Business Services division, but in the main, it's 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.

However, the new regulatory regime which starts in April and lasts until 2025, has moved the goal posts. Ofwat has reduced the acceptable financial returns water utilities can make. As with most businesses, lower earnings tend to mean less generous returns for shareholders. Cue Severn Trent's new dividend policy.

They now aim for dividends to grow at least in line with inflation - compared to 4% above the rate of inflation under the old regime - and based on full year dividend expectations for 2020, the shares offer a prospective yield of 3.9%. This isn't to say above inflation growth is out of the question, things like operational outperformance and cost efficiencies can still provide a boost to earnings. But the regulated and more predictable earnings will be lower.

The other thing to bear in mind is that 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.

However, despite the headwinds it's important not to lose sight of the fact Severn Trent has some of the most predictable 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 21.6 times earnings.

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Third Quarter Trading Update

Severn Trent remains on track to earn at least £25m of Outcome Delivery Incentives (ODI) this year. This reflects continued operational improvements, expected to be offset partially by penalties in relation to flooding targets.

For the next regulatory period, 2020 - 2025. Severn Trent's totex (total expenditure including - operating, infrastructure renewal and capital expenditure) will be £6.8bn. Reflecting this investment Severn Trent expects its regulated capital value (the value of its regulated business) to grow 3.8% a year, after accounting for inflation.

Severn Trent recognised new customer ODI targets for the 2020 - 2025 period, as "stretching but achievable". They include reducing leaks by 15%, blockages by 5% and helping 200,000 customers a year to pay their bill.

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.