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Pennon's announced plans to sell its recycling and waste business, Viridor, to investment firm KKR in a deal which values the business at £4.2bn. The deal is contingent on shareholder and regulatory approval.
Pennon expects to receive cash proceeds of around £3.7bn. It plans to use the cash to reduce debt, make a return to shareholders and and keep some for future investment.
Pennon confirmed it will stick to its current dividend policy, of growing the dividend by 4% above inflation, this financial year. The dividend policy for the next regulatory period (2020-2025) will be announced alongside final results on June 4.
The shares rose 10.5% following the announcement.
With Viridor, the waste management business, on the way out, Pennon's focus in future will be on one thing and one thing only - water.
If the deal's given the go ahead Pennon could receive cash proceeds of around £3.7bn. It plans to return some to shareholders, reduce debt, and keep some for future investment. All eminently sensible in our opinion.
As with most utilities, the potential for a reliable income is Pennon's main attraction. The current dividend policy, of increasing the payout by RPI inflation plus 4 percentage points each year, is very generous. But with a new regulatory period beginning this April and lasting until 2025, this policy is likely to change.
Life as a utility means that in return for providing an affordable water supply, Pennon's allowed to make an acceptable return on capital invested. Ofwat's reduced what it considers to be 'acceptable' for the coming period and increased performance targets. Lower earnings tend to mean less generous returns for shareholders and that's been the case for Pennon's rivals. We suspect Pennon will follow suit.
To date Pennon's built a good record as a water 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.
While the next regulatory cycle is set to be tougher, we see no reason why this shouldn't continue. Pennon's plans have received approval from the regulator and the group's confident it can continue to outperform. Investment using sale proceeds could help Pennon's quest for outperformance.
Against a backdrop of wider uncertainty, Pennon currently trades on 19.8 times future earnings, some way above the long run average. Given the reliable nature of Pennon's business, that doesn't come as too much of a surprise. The prospective yield is 4.2%, but be aware the dividend policy will likely change in June.
Half Year Results (26 November 2019)
Pennon's underlying half year revenue fell 4.6% to £712.4m, with lower revenues in both water and waste management businesses. However, underlying profits before tax rose 0.8% to £143.7m buoyed by higher profits in waste management.
The interim dividend rose 6.4% to 13.66p per share.
South West Water saw revenues fall 2.9% to £292.9m and profit before tax come in 3.7% lower at £96.2m. The decline was driven by a fall in customer demand compared to last year's hot and dry summer. Operating costs fell 3.4%, reflecting continued efficiencies and no extreme weather.
Operational performance for the half-year resulted in a net Outcome Delivery Incentive reward of £1.7m, bringing the cumulative reward for the 2015-20 period to £13m. Customer service levels were maintained, with lower instances of pollution, flooding and leakage.
Viridor revenues fell 8.1% to £388.1m, driven by the end of a recycling contract in Greater Manchester and lower landfill volumes from the net closure of two sites. However, pre-tax profits were 15.7% higher at £41.5m, as the Energy Recovery Facility (ERF) Business continues to perform strongly and Pennon increased its stake in the Runcorn ERF to 75%.
Revenue from Pennon Water Services rose 3% to £86.6m with lower pre-tax losses at £0.3m, thanks to reduced costs.
Despite an increase in operating cash flows, net debt rose 8.4% to £3.3bn versus the prior year, reflecting cotinued investment and a change to the way the company now has to account for leases. Excluding the accouting change net debt rose 3.2%.
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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