ii view: Pennon sees record water demand as population rises

Buying Bristol Water and offering a forecast dividend yield of over 3.5%. Buy, sell, or hold?

First-half trading update to 30 September 2021

Chief executive Susan Davy said:

“Pennon Group is on track to deliver resilient financial performance in line with management expectations. At the same time we are delivering a step change in environmental performance, as we focus on our Green Recovery and Net Zero ambitions.”

ii round-up:

Water company Pennon (LSE:PNN) detailed trading in line with its own expectations, although flagged ongoing operational pressure given both a rebound in business use following last year’s Covid lockdowns and increased regional population numbers. 

Record water demand underpins an expected rise in revenue for the first half to 30 September. Expected adjusted profit (EBITDA) remains in line with management estimates as rising costs have been countered by the increase in revenue.

Pennon shares fell by more than 2% in UK trading. Shares for United Utilities (LSE:UU.) closed just over 1% lower following its recent first-half trading update. Covid rates across Pennon’s regions stayed low in the early pandemic.  

In June, Pennon announced both the acquisition of Bristol Water and a return of funds to shareholders as it moved to use the monies it received from its previous sale of waste management business Viridor.

Its purchase of Bristol Water is progressing through a Competition and Markets Authority (CMA) review. Funds of £1.5 billion have now been returned to shareholders via a special dividend and an accompanying share consolidation completed, with up to £400 million now funding a share buy-back programme.

Management continues to build on a position of 80% of its business plan commitments being on track or ahead of target. Further significant progress in delivering its Pollutions Incident Reduction Plan was flagged, with Pennon on track to deliver a step change in its environmental performance.  

The completion of the share buy-back programme is linked to management's continued review of value creating opportunities in the UK water sector, where it believes there remains significant scope for consolidation.

First-half results are due on 30 November.

ii view:

Founded in 1989, the previously merged water companies of Southwest and Bournemouth Water are now being expanded, with the pending addition of Bristol Water. Along with serving customers across Cornwall, Devon and parts of Dorset, Hampshire, Wiltshire and Somerset, the City of Bristol will now expand its footprint – subject to a competition review. 

For investors, the previous sale of Viridor removed a company-specific growth driver. Waste management business Viridor gave Pennon opportunity for growth outside of its regulated water business. 

But proceeds from the sale have and are being used for multiple purposes. These include reducing debt and expanding its core water business through an earnings accretive purchase of Bristol Water. Other possible acquisitions are not being ruled out, while a forecast future dividend yield of over 3.5% is not derisory in the current era of ultra-low interest rates. In all, with increased financial flexibility and an expanded but focused business offering, Pennon will likely attract further long-term shareholder support. 

Positives:

• Reliable dividend income
• Likely 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