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Severn Trent - COVID hits revenues as expected

Nicholas Hyett, Equity Analyst | 26 November 2020 | A A A
Severn Trent - COVID hits revenues as expected

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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: 2,769.00 | Buy: 2,772.00 | Change 78.00 (2.88%)
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Severn Trent's (SVT) first half revenue fell 2.5% to £887.6m. That primarily reflects lower commercial consumption due to the pandemic, partially offset by higher household consumption.

Underlying profit before interest and tax fell 21.2% to £225.6m. This reflects lower revenue, and an increase in money set aside to cover bad debts.

The board has declared an interim dividend of 40.63p per share, up 1.5% on last year.

The shares were broadly flat in early trading.

View the Severn Trent share price and how to deal

Our view

Under the bonnet of Severn Trent you'll find renewable energy and food waste recycling. But in the main it's a straight-forward water utility, providing 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 water is readily available at an affordable price. In return well run water companies can achieve reasonable 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 lasts until 2025 has moved the goal posts. Ofwat has reduced the financial returns water utilities can make and set challenging performance targets. As with most businesses, lower earnings tend to mean less generous returns for shareholders. Cue Severn Trent's new dividend policy.

The goal is to grow the dividend at least in line with inflation (compared to 4% above inflation under the old regime). The shares offer a prospective yield of 4.2%. Above inflation growth isn't out of the question, but coronavirus has made operational outperformance and cost efficiencies (both of which can boost earnings) harder to achieve.

The global fight against coronavirus also means interest rates are likely to stay low for a while - boosting companies where income features prominently in the investment case. However, higher rates in the future would reduce the relative appeal of Severn Trent's income and increase the group's interest costs on a growing debt pile.

Despite headwinds Severn Trent has some of the more reliable revenues out there, and a strong operational record. In a time of wider economic turmoil, such qualities have not gone unnoticed.

Severn Trent key facts

  • Forward Price/Earnings Ratio: 20.6
  • Ten year average 12m forward Price/Earnings ratio: 19.0
  • Prospective yield: 4.2%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Half Year Results

Regulated Water and Waste Water revenue fell 2.4% to £829.9m. This primarily reflects the shift from business to household consumption, but also reflects regulatory changes. Operating costs increased across the board, especially for bad debts, with total costs up 9.6%. Infrastructure spending fell by £10m or 13.2%, reflecting the completion of projects from the previous regulatory period. However the combination of lower revenues and a net increase in costs meant underlying profit before interest and taxes for the division fell 19.4% to £219.6m.

Business Services revenue fell 4.1% to £59.1m, due to declines in both Green Power and Operating Services. Underlying profit before interest and taxes fell 53.4% to £8.2m.

Net debt was flat over the half at £2.4bn, which is 66.1% of regulatory capital, up from 64.9% in March. Free cash flow rose from £26.9m last year to £129.3m, reflecting lower capital spending this year.

Find out more about Severn Trent shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.