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Severn Trent - guidance unchanged, bolt-on deal for Green Power

Severn Trent reiterated that its full-year guidance remains unchanged.

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Severn Trent reiterated that its full-year guidance remains unchanged. The Regulated Water and Waste Water businesses expected to deliver between £1.97 - £2.02bn in turnover, and total dividends for the year are expected to be 106.82p per share.

Severn Trent Green Power has announced its acquisition of Andigestion Ltd, which operates two food waste digestion plants. This is expected to bring an additional 45GWh per annum of energy generation, increasing the Green Power's output by 16%. Although the acquisition is still subject to regulatory clearance.

The Group self-generated over 50% of it's energy consumption which it notes has acted as a natural hedge for the group, ''significantly reducing the impact of higher power prices on shareholder returns.''

The shares were broadly flat following the announcement.

Our view

Severn Trent is primarily a straight-forward water utility, providing water and sewerage services to over 4 million 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 considering the current, uncertain, economic conditions where reliable cash flows attract a premium.

However, there are challenges ahead.

Inflation in costs from power to chemicals means costs are expected to rise. The group has a natural hedge against rising energy costs, with Bioresources and Severn Trent Green Power generating over half of the group's energy consumption. Pending regulatory approval, the acquisition of food-waste company, Andigestion, is set to increase Green Power's output by 16% too, further mitigating energy price volatility risks.

The group's currently aiming to grow dividends to grow at least in line with inflation. This isn't to say above-inflation dividend growth is out of the question. Things like operational outperformance and cost efficiencies can still provide a boost to earnings, which will increase the pool of cash available for dividends. But Severn Trent does have other demands on its cash resources.

The balance sheet remains stable for now, but given the groups ambitious plans for investing in its infrastructure, net debt is expected to grow over the next few years. Higher inflation and interest rates mean the cost of servicing this debt could creep up. Severn Trent's in a better position that most, though, with only 25% of debt linked to inflation compared to an industry average of 60%. For now, the cash interest rate payable on debt shouldn't be an issue, but it's something we'll be keeping an eye on as time ticks on.

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 and the group trades at a steep premium to peers as a result. Remember though, nothing is guaranteed and share prices can fall as well as rise.

The Share Research team is ceasing covering of Severn Trent. This is the last update and house view HL will produce on this stock. You can still find out more about our thoughts on the Financials industry by signing up to our Share Insight email.

Severn Trent 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: 8th February 2023