Severn Trent Plc (SVT) Ordinary 97 17/19p
HL comment (15 July 2020)
Severn Trent's (SVT) first quarter has been in line with expectations and full year guidance remains unchanged.
The group still expects coronavirus to have a negative impact of £50 - 85m on revenue this financial year. However, the regulatory mechanism will allow SVT to recoup this in 2022/2023.
Cash collection from customers has been broadly in line with last year but the group expects bad debts to rise as UK furlough schemes start coming to an end.
The shares were broadly flat in early trading.
Under the bonnet of Severn Trent you'll find renewable energy and food waste recycling. But in the main it's a straight-forward water utility, providing water and sewerage services to over 4m customers in the Midlands and Wales.
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 acceptable financial returns.
Severn Trent has historically coped well under the system, delivering steady earnings growth and a gentle flow of dividends - characteristics which make it a popular choice for income seeking investors. 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 acceptable 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). The shares offer a prospective yield of 4.3%. Above inflation growth isn't out of the question, but coronavirus could make operational outperformance and cost efficiencies (both of which can boost earnings) harder to achieve.
The global fight against coronavirus also means interest rates are likely to stay low for a while - boosting 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 cost on a growing debt pile.
Despite headwinds Severn Trent has some of the more reliable revenues out there, and a strong operational record. In a time of wider economic turmoil, such qualities have not gone unnoticed. The shares currently trade at 21.3 times future earnings - above their long run average.
Severn Trent key facts
- Forward Price/Earnings Ratio: 21.3
- 10 year average Forward Price/Earnings ratio: 18.8
- Prospective yield: 4.3%
We've introduced this section in response to recent survey feedback.
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.
The group is confident it will be able to outperform Customer delivery targets in the new regulatory period (2020-2025) - with potential to earn outperformance payments as a result.
Renewable energy generation from the group's Solar and Bioresource assets increased by4% versus the same period last year to 127Gwh.
SVT's capital investment for the year is expected to be £430 - 510m and the group has seen minimal disruption to plans so far. Severn Trent has £1.1bn in undrawn facilities and issued its first sustainable bond in June, raising £300m at a fixed rate of 2% over 20 years.
The group has not made any redundancies or put any staff on furlough.
Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. 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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