Pennon’s full-year revenue rose 15% to £1.0bn. Growth was driven by a whole year’s contribution from the acquisition of SES Water, while tariff increases were offset by lower customer usage in other parts of the business.
Underlying cash profit (EBITDA) fell marginally to £336mn as the increased revenue was offset by higher costs.
Free cash outflows worsened from £405mn to £568mn, largely due to increased infrastructure investment. Net debt rose from £3.8bn to £4.1bn.
Full-year revenue is expected to increase by nearly 18% to £1.2bn, according to market forecasts. Alongside “broadly stable” costs, underlying cash profit is expected to increase by around two-thirds. Capital expenditure is expected to increase to a range of £710-740mn.
The full-year dividend was rebased lower from 36.67p per share to 31.57p due to the rights issue.
The shares fell 1.1% in early trading.
Our view
Pennon’s full-year revenue was buoyed by the acquisition of SES Water, but profitability came under pressure as its infrastructure investment ramps up. This year’s price increases are expected to flow down to the bottom line and help improve profitability, but the market reaction was muted on the day.
In return for providing reliable water and wastewater services, the regulator allows Pennon to earn an acceptable financial return. Inflation-linked tariff increases were offset by customers' more conservative water usage last year. But as long as Pennon keeps delivering its contracted level of service, it should be able to recover this shortfall in future periods.
It's important to remember that Pennon'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).
The new regulatory period will see Pennon’s customers’ bills rise by 23% in the five years to March 2030. That’s set to be front-loaded, so the top line will shoot higher in the near term. In return for the increased allowed revenue, Pennon will have to spend £3.2bn upgrading its water network over the same period.
The forward prospective dividend yield of 5.6% is at the top end of the peer group, and the current dividend policy calls for them to grow in line with inflation. Despite the ongoing investment projects, relatively reliable revenues mean we think the dividend looks sustainable, whilst also keeping debt levels in check. As always though, nothing is guaranteed.
While they’re putting demand on cash resources now, in the long run, these infrastructure projects are expected to be a net benefit. The acquisition of SES Water also helped boost RCV growth, which should further lift revenue in the years to come.
Water companies improving their environmental performance remains high on the public agenda. Pennon’s making good progress on this front, reducing its use of storm overflows year-on-year. While that’s a positive start, there’s still much further to go. And until water companies as a whole clean up their act, sentiment around the sector is likely to be muted, putting downward pressure on valuations.
We think Pennon looks well-placed to benefit if it can execute its long-term strategy. Regulatory pressure and some high-profile slip-ups mean it currently trades at a steep discount to its peer group, which we see as an opportunity. But it can take time for investor attitudes to change, and nothing is guaranteed.
Environmental, social and governance (ESG) risk
The utilities industry is high-risk in terms of ESG. Management of these risks tends to be strong, with European firms outperforming their overseas counterparts. Environmental risks like carbon emissions, resource use and non-carbon emissions and spills tend to be the most significant risks for this industry. Employee health and safety and community relations are also key risks to monitor.
According to Sustainalytics, Pennon’s management of ESG risk is strong.
It has a very strong health and safety programme, with zero fatalities among its employees and contractors over the last three years. However, Pennon has been fined for numerous unpermitted wastewater releases in recent years and has been heavily criticised by the regulator.
Pennon key facts
All ratios are sourced from LSEG Datastream, based on previous day’s closing values. 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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