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Severn Trent - trading returning to normal

Nicholas Hyett, Equity Analyst | 23 November 2021 | A A A
Severn Trent - trading returning to normal

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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 reported an 8.0% rise in turnover in the first half, reaching £958m, as non-household demand recovered following the end of lockdown restrictions. The group is on track to hit 90% of outcome delivery incentives (ODIs) across Water, Waste, Customer and Environment.

Profits before interest and tax rose 13.8% to £256m, as the group reported a fall in bad debts and slower growth in contractor costs.

The group announced an interim dividend of 40.86p per share, in line with the policy confirmed in May 2021.

Severn Trent shares were broadly flat following the announcement.

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. There are renewable energy and food waste recycling businesses tucked in there too - but their contribution to profits is minimal at present.

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 have made it a popular choice with pension funds and other income seeking institutions.. 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 has pushed interest rates down to record lows - potentially boosting the appeal of 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. We've seen some signs of that already - and it's one to watch going forwards.

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 (next 12 months): 20.0
  • 10 year average Price/Earnings ratio: 19.5
  • Prospective dividend yield (next 12 months): 3.7%

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

The Regulated Water and Waste Water business reported turnover of £893.9m, up 7.7% year-on-year. That reflects a £38.9m increase from higher non-household consumption, with £12.9m additional benefits from changing accounting treatments. Other reasons for increased revenue include: bringing new properties into charge, increased revenue from the group's Bioresources business and gains from inflation adjustments.

Reduced bad debts, together with a 1.5% increase in contractor expenses was partially offset by a big increase in infrastructure renewals spending. As a result, profit before interest and tax rose 10.4% to £242.4m.

Business Services reported turnover of £66.1m, up 11.8% year-on-year. Profits before interest and tax more than doubled to £17.4m, with strong growth in Green Power and Property Development activities.

Average net debt over the half was broadly unchanged at £6.3bn. However, net finance costs rose 32.6% to £120.8m, reflecting the inflation linked debt the group issues, with the effective interest costs rising to 4.2% from 3.3%. The effective cash cost of debt remained unchanged at 3.1%. Gearing, a measure of overall indebtedness, fell from 84.9% at the start of the financial year to 84.4%.

Management believe the group is on course to deliver 10% growth in regulatory capital value in the current regulatory period, aided by a £292m reduction in the pension deficit in the half.

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.