Interactive Investor

Severn Trent results keep everyone happy

26th November 2015 14:10

Lee Wild from interactive investor

It may be cutting water prices, but Severn Trent has still made more money than last year, while reducing the number of complaints by over a third, in what boss Liv Garfield called a "good start" to the new five-year regulatory period.

In the six months ended 30 September, Severn Trent increased underlying profit before interest and tax by 2.6% to £281 million on turnover flat at £896 million. Underlying earnings per share (EPS) rose 11.4% to 58.6p

And Severn has put a lot of hard work into speeding up decision-making and approval processes. It's also heavily incentivised to keep improving. Industry regulator Ofwat recently increased the value of so-called Outcome Delivery Incentives (ODIs) by grossing them up for tax. That means Severn can make up an extra £70 million before tax each year by delivering a better service - flooding and supply disruptions are down by a third and sewer flooding by a 24%.

And since the final results in May, the utility has found another £72 million of savings - competition among suppliers is clearly working - which means it's now locked in all £372 million of its target efficiencies for the AMP6 regulatory period 2015 to 2020. And it expects to have found an extra £50 million by next May.

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Full-year revenue at the water business is still tipped to come in at £1.49-£1.51 billion, as predicted in July, while total expenditure will be just over £1 billion.

Crucially, the average cost of debt is down - from 5.5% to 4.6% - and will keep falling as maturing fixed-rate debt is replaced with lower floating-rate financing.

There's an interim dividend of 32.26p per share, too, 5% lower than last year, as expected. That means a full-year dividend of 80.66p will be paid next year, part of Severn's promise to grow the payout by at least retail price index (RPI) annually over AMP6.

Severn Trent, which announces its third-quarter trading update on 3 February, currently offers a prospective dividend yield of a not-too-shabby 3.7%.

It's been the target of bid speculation, too, and on more than one occasion. Only this summer, there was talk that Canada's Borealis Infrastructure - part of a consortium whose £5 billion offer for Severn failed in 2013 - was about to have another go.

The bid price then of £22 a share would have to be way north of £24 this time, say those in the know.

And it's easy to see why. According to analysts at Macquarie, Severn's growth in its regulatory asset base (RAB) out to 2020 is amongst the highest of the UK regulated utilities. "It's also well-place placed with changes in the Water Act, with a water surplus and a central location," says the broker. But that does mean strong results are factored into the share price already, and Severn trades at a 24% premium to RAB versus United Utilities at 16% and National Grid at 43%.

Still, Deutsch bank likes what it sees. "We continue to see the UK water stocks offering attractive low risk returns, with M&A potential," writes analyst James Brand. "Severn Trent offers prospective investor returns of c.6.5% p.a., which is attractive in our view, and slightly above our estimates for fully regulated peers." Buy up to 2,300p, he says.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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