Pennon Group (PNN) ORD GBP0.6105

Pennon confirmed that its full-year financial performance was in line with group expectations. Full-year results are set to be released on 21 May 2024.

Pennon’s recent acquisition of Sutton and East Surrey Water (SES Water) is moving through the Competition & Markets Authority (CMA) review process as expected. There’s potential for it to receive clearance at phase 1 of the process in summer 2024.

Investment into water and wastewater infrastructure for the 2020-2025 period is expected to reach record levels of around £850mn.

The shares were broadly flat following the announcement.

Our view

Everything appears to be flowing smoothly at Pennon, with the group’s financial performance tracking in line with management’s expectations.

The recent acquisition of Sutton and East Surrey Water (SES Water) is also moving through the Competition & Markets Authority (CMA) review process as expected and could be completed this summer. The £89mn price tag looks attractive and helps Pennon expand its footprint across Southern England, bringing more than 750,000 paying customers into the fold.

Back to the underlying business. In return for providing reliable water and wastewater services, the regulator allows Pennon to earn an acceptable financial return. At the half-year mark, 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 have fallen 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’s set to deliver record levels of investment into its infrastructure, with a total of around £850mn expected in the five years to 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, which will likely weigh on investor sentiment in the near term.

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.

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