ii view: Pennon details expected Bristol Water savings

Working to improve its leakage and pollution performance and offering a respectable dividend yield. Buy, sell, or hold?

Full-year trading update to 31 March

ii round-up:

Water company Pennon Group (LSE:PNN) today outlined full-year trading to the end of March which had remained in line with management’s own expectations. 

The Exeter headquartered company pointed to a resilient financial and operational performance ahead of its full-year results scheduled for 31 May. 

Shares in Pennon, which received regulatory clearance in March  for its £425 million acquisition of Bristol Water, were little changed in UK trading having fallen by around 10% year-to-date. Shares for fellow water companies United Utilities (LSE:UU.) and Severn Trent (LSE:SVT) are both up around 3% in 2022. 

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Pennon expects the merger of Bristol Water with its own South West Water to generate cost savings of £20 million per year come financial year 2024/2025. It plans to keep the Bristol Water brand, with targeted efficiencies expected to total £50 million over the current regulatory K7 period from 2020 to 2025. 

As summer approaches, water resources remain robust with reservoir storage at 93%. Outcome Delivery Incentives (ODIs), paid to water companies by the regulator for meeting or exceeding performance targets, are expected to improve from the prior year due to its improved leakage and pollutions performance. 

Half the previously announced £400 million share buyback programme had now been completed, with the balance of £200 million subject to growth opportunities such as possible attractive water company acquisitions. 

Broker Morgan Stanley retained its overweight stance on Pennon following the update, leaving its estimated fair value price target unchanged at 1,220p per share.  

ii view:

Pennon Group came to the UK stock market in 1989 as Southwest Water and later combined with Bournemouth Water to become Pennon. The purchase of Bristol Water adds around 1.2 million new customers. Pennon now serves parts of the country such as Cornwall, Devon, parts of Dorset, Hampshire, Wiltshire and Somerset. 

Earlier in 2021, Pennon returned £1.5 billion to shareholders via a special dividend following its sale of waste management group Viridor. Money from the sale is now helping to fund its current ongoing share buy-back programme. 

For investors, the sale of Viridor removed a growth driver that gave Pennon an opportunity for growth outside of its regulated water business. Rising energy costs also warrant consideration, as does elevated inflation and its impact on servicing its index-linked debt. 

More favourably, proceeds from Viridor are being used for multiple purposes, including reducing debt and expanding its core water business through an earnings accretive purchase of Bristol Water. Other possible acquisitions have also not been ruled out. Its energy costs are also 60% hedged, while inflation is something of a double-edged sword, with revenues and its capital base also inflation linked. For now, and with the shares sat on an estimated future dividend yield of 3.5%, income seekers at least are likely to stay patient. 

Positives:

• Reliable dividend income
• Targeting cost savings from Bristol Water acquisition

Negatives:

• Growth opportunities via waste management business now removed
• The weather can impact performance

The average rating of stock market analysts:

Hold