ii view: Pennon boosts dividend despite rising costs

First-half results to 30 September

• Revenue up 5.4% to £448.6 million
• Adjusted pre-tax profit down 60% to £9.1 million
• Interim dividend up 8.3% to 14.04p per share
• Net debt up 16% to £3.32 billion

Chief executive Susan Davy said:

“Pennon has continued to make progress in the last six months on delivering for customers and shareholders, improving operational resilience across the group through an 87% step up in investment, supported by a healthy balance sheet. 

“We are executing on our twin track strategy of organic and acquisitive growth in UK water, creating long term value and making progress on what matters most to those across our regions.”

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ii round-up:

Water company Pennon Group (LSE:PNN) today detailed first-half results broadly in line with City estimates as it raised its dividend by an inflation-linked 8.3% to 14.04p per share. 

Higher inflation driven costs dragged adjusted pre-tax profit down 60% to £9.1 million year-over-year despite a 5.4% increase in inflation-linked revenues to £448.6 million. 

Shares in the FTSE 250 company fell around 1% in UK trading having come into this latest news down by around 16% year-to-date. That compares to a near 4% retreat for the FTSE 250 index itself and gains of 3% and 13% for fellow water companies Severn Trent (LSE:SVT) and United Utilities Group Class A (LSE:UU.) respectively in 2023. 

Cost increases for Pennon included a 13% hike in power related charges to £55 million and a near 4% increase in interest related costs to £77 million given an in increase in group net debt to £3.32 billion from £2.87 billion a year ago. 

Investment by Pennon increased 87% compared to the first half of last year to £266 million, as management looks to improve water supply resilience via new desalination facilities, reduce pollution, and improve its environmental impact via additional renewable energy generation.  

Pennon operates across 860 miles of coastline and sees its population about treble in the summer months to over 10 million people due to tourism. 

It remains on track to achieve around 75% of its Outcome Delivery Incentives (ODI) for South West Water and around 70% for Bristol Water following its acquisition. ODI’s are paid to water companies by the regulator for meeting or exceeding targets in relation to operational items such as reducing leakage or environmental pollution.

Around £16 million of annualised cost savings have been achieved to date following the £425 million Bristol Water deal. 

The interim dividend of 14.04p per share is expected to be paid to eligible shareholders on 5 April. Full-year results are scheduled for 21 May. 

ii view:

Pennon Group came to the UK stock market back in 1989 as South West Water. It later combined with Bournemouth Water becoming Pennon Group. In 2020, it agreed to sell its waste management business Viridor, later returning funds to shareholders. Most recently, it bought Bristol Water, adding around 1.2 million new customers. 

For investors, elevated costs including interest payments on its index-linked debt and those for energy and chemicals are not to be overlooked. The water industry’s accountability and impact on the environment needs to be remembered, and periodic negotiations with the industry regulator offer uncertainty, as do potential changes of government and a possible moving of the goal posts for the industry as a whole. 

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On the upside, the relative defensiveness of a utility operator, given that we all need water no matter what the health of the economy, offers appeal and backing to dividend payments. Group investment in improving its operational efficiency is being made. Its acquisition of Bristol Water has provided cost saving opportunities, while management continues to point towards a responsible and sustainable balance sheet. 

For now, and with Bristol Water generating cost savings and the shares offering a forecast dividend yield of around 6%, income investors will likely find the shares attractive. 

Positives:

• Attractive dividend (not guaranteed)
• Targeting cost savings from Bristol Water acquisition

Negatives:

• The weather can impact performance
• Pending possible change of government

The average rating of stock market analysts:

Strong hold