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Severn Trent - on course with full year guidance

Emilie Stevens, Equity Analyst | 31 March 2020 | A A A
Severn Trent - on course with full year guidance

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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: 2,484.00 | Buy: 2,486.00 | Change -19.00 (-0.76%)
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In light of COVID-19, Severn Trent said it hasn't seen a material change to business performance. The group remains on track to deliver full year results as previously guided.

However, Severn Trent does expect UK government restrictions to have a material impact on its business water joint venture - WaterPlus.

The shares remained 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 and food waste recycling, 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 - characteristics which make it a popular choice for income seeking investors. This is particularly true in light of the current pandemic. While many sectors are seeing significant hits to revenue, life as a water utility is more predictable.

However, there are challenges ahead.

A 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.

The dividend is now intended 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 4.4%. 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 global fight against coronavirus means interest rates are likely to stay low for a while - providing a boost to companies where income features prominently in the investment case. However, higher rates in the future will likely reduce the relative appeal of Severn Trent's income and will 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 turmoil, go some way to explaining why the shares currently trade just above their long run average at 19.4 times earnings.

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Trading Update

Severn Trent has committed £1m to support groups and charities working locally with those impacted by COVID-19. The group has enacted homeworking where possible and has ramped up communication with customers in regards to bill support.

The group expects UK government restrictions will impact the pace and recovery of WaterPlus' recovery plan. Prior to the outbreak the business was making good progress in its underlying operating performance.

Severn Trent remains on track to earn at least £25m of Outcome Delivery Incentives (ODI) this year, bringing the total earned this regulatory period to at least £163m.

Despite higher net debt levels, Severn Trent now expects net financing costs to be in line with last year as opposed to previous guidance of higher year-on-year. That reflects lower inflation levels and increased levels of capitalised interest.

At the start of March the group raised £200m through a debt issue on the US Private Placement market.

Severn Trent has access to over £1.1bn in cash and committed facilities. It also said less than 2.5% of its debt requires refinancing in 2020.

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.