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Pennon - acquires SES Water and looks to issue new equity shares

Pennon has acquired Sutton and East Surrey Water (SES Water) for £89mn, representing a 6% premium to its Regulatory Capital Value (RCV).

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Pennon has acquired Sutton and East Surrey Water (SES Water) for £89mn, representing a 6% premium to its Regulatory Capital Value (RCV).

SES Water is a water-only utility business with over 750,000 customers.

The acquisition is expected to increase Pennon's RCV by £351mn, or around 7%. By combining resources, the group expects to deliver £11mn in annual cost savings.

Pennon has also announced its intention to raise up to £180mn of cash by issuing new equity shares. This is to ensure that debt levels remain within its target range.

The shares rose 2.6% following the announcement.

View the latest Pennon share price and how to deal

Our view

Pennon's £89mn acquisition of SES Water further expands its footprint across Southern England, bringing more than 750,000 paying customers into the fold.

The deal's being financed by cash on hand, but because of SES Water's high debt levels, Pennon's set to raise up to £180mn of cash by issuing new equity shares. This will help to keep total debt levels within the group's target range while still providing room for its large infrastructure investment plans over the second half of the decade.

Back to the underlying business. In return for providing reliable water and wastewater services, the regulator allows Pennon to earn an acceptable financial return. First-half revenue was buoyed by an inflation-linked increase from the regulator, as well as some new contract wins from its non-household arm, Pennon Water Services.

But despite rising revenue, profits came under pressure as high power and investment costs took their toll. Operating costs are expected to fall in the second half due to lower prices and usage, which should bring some welcome breathing room.

It's important to remember that a utility company's revenue and earnings power are linked to both inflation and its asset base, measured by Regulatory Capital Value (RCV). That provides Pennon with incentives to invest in its assets (which helps to deliver a good service to customers), as well as operate efficiently (which helps increase company earnings).

With that said, Pennon increased its investment guidance by £100mn, now expecting to pump over £850mn into upgrading its assets by the end of the 2024/25 financial year. And the acquisition of SES Water is supercharging RCV growth, which should provide a further boost to revenue in the years to come.

Another thing to bear in mind is the regulatory pressure that's been mounting against water utility companies. South West Water, which is owned by Pennon, has already been on the receiving end of fines for discharging untreated sewage into rivers and lakes. We expect more fines are on the way due to past offences, with the market forecasting the bill to land around the £50mn mark, due next financial year.

All in, Pennon has a history of sector-leading performance and looks well-placed to benefit if it can execute its long-term strategy. But regulatory challenges and some high-profile slip-ups mean it currently trades at a discount to its peer group. We see that as an opportunity, but nothing is guaranteed.

Pennon key facts

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.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. 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 disclosure for more information.

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Written by
Aarin Chiekrie
Aarin Chiekrie
Equity Analyst

Aarin is a member of the Equity Research team. Alongside our other analysts, he provides regular research and analysis on individual companies and wider sectors. Having a keen interest in global economics, he knows how macro-events can impact individual companies.

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Article history
Published: 10th January 2024