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Severn Trent - new cash to be raised for green recovery

William Ryder, Equity Analyst | 19 May 2021 | A A A
Severn Trent - new cash to be raised for green recovery

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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 has reported a 17.1% fall in underlying operating profit to £472.8m. This reflects lower revenue and higher labour, power, chemical and depreciation costs. The group received £79m in Outcome Delivery Incentive awards - the highest ever seen in the water industry.

The regulator has approved plans to invest £624m as part of the Green Recovery Award scheme. Severn Trent plans to raise £250m by issuing new shares to help fund this.

The group has proposed a final dividend of 60.95p per share, bringing the full year payment to 101.58p, up 1.5% year-on-year.

The shares fell 0.9% in early trading.

View the Severn Trent share price and how to deal

Our view

Severn Trent is primarily a straight-forward water utility, providing water and sewerage services to over 4m customers in the Midlands and Wales. Although, under the bonnet you'll also find renewable energy and food waste recycling.

Water utility 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 portfolios. 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). 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 could stay low for a while - potentially 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. Such qualities are especially valuable when the world is so uncertain. Remember though, nothing is guaranteed and share prices can fall as well as rise.

Severn Trent key facts

  • 12m forward Price/Earnings ratio: 19.7
  • Ten year average 12m forward Price/Earnings ratio: 19.2
  • Prospective yield: 4.1%

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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Full year results

Severn Trent's full year revenue fell 0.9% to £1.8bn due to the price review and the pandemic. Management said they expect to recover much of the lost revenue in the coming years.

Regulated Water and Waste Water revenue fell 0.8% to £1.7bn. This primarily reflects the shift from business to household consumption, but also regulatory changes. Operating costs increased across the board, except for bad debt provisions, which fell 4.7% to £40.5m. The combination of lower revenues and a net increase in costs meant underlying operating profit for the division fell 16.3% to £452.1m.

Business Services revenue fell 2.3% to £134.7m, due to declines in both Green Power and Operating Services. Underlying operating profit fell 28.3% to £25.8m.

Net debt rose from £6.2bn to £6.4bn over the year and is 64.5% of regulatory capital, up from 64.4% last year. Free cash generation after interest and taxes was £58.2m compared with £129.4m last year. Cash capital spending was £593.2m, down from £799.5m.

Next year Severn Trent expects Regulated Water and Waste Water revenue to be between £1.78bn and £1.81bn, with at least £40m of Outcome Delivery Incentives. Capital spending is expected to be between £550m and £650m.

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.