ii view: Pennon shares on a high despite political risk

A full company review will conclude in 2020, but the government in charge will be a big factor.

Half-year results to 30 September 2019

• Revenue down 4.6% to £712.4 million
• Underlying profit up 0.8% to £143.7 million
• Net debt up 3.2% to £3.17 billion
• Dividend payment up 6.4% to 13.66p per share

Chief executive Chris Loughlin said:

"Pennon has maintained its positive momentum through the first half of 2019/20, delivering robust performance across our water and waste businesses. Viridor continues to deliver sustainable growth in UK recycling and residual waste management. South West Water performance is underpinned by strong cost control. 

"In September we announced a full review of Pennon's strategic focus, growth options and capital allocation policy. The review is ongoing and we will announce our conclusions in 2020."

ii round-up:

Former South West water and waste management business Pennon (LSE:PNN) reported profits which exceeded analysts' forecasts in these half-year results. 

Energy Recovery Facilities (ERF) burning non-recyclable waste to generate electricity at its waste management business Viridor helped fuel the outperformance. Adjusted divisional profits (EBITDA) rose by 9.9%.

Its portfolio of 10 operating ERFs remains on track to deliver full-year availability above 90% for the fourth consecutive year, while the recycling business stayed resilient. A new £65 million plastics processing facility is due to add much needed capacity to the UK market.

Generating close to 70% of last year's adjusted profits (EBITDA), reduced customer demand at South West water following the prior year's exceptionally hot, dry summer underwrote a near 3% fall in both revenue and profits.  

However, management underlined strong cost control. South West is on course to deliver £300 million of savings targeted in the current 2015-20 regulatory period and has been awarded fast-track status by industry regulator Ofwat for its plans regarding the next regulatory period – known as K7.

The dividend payment rose in line with the company's policy of 4% year-on-year growth above RPI inflation until 2020. 

The share price gained by more than 2% in early morning post-results trading. 

ii view:

Water companies are generally considered by investors to be defensive in nature. Demand for water changes little no matter what the economic backdrop. Furthermore, reliable customer income also makes for dependable dividends. 

Differentiating it from rivals such as United Utilities (LSE:UU), Pennon also operates an unregulated waste management business Viridor. Previous news of Pennon management's full review raised speculation that the two businesses could be separated. Conclusions of the review are due in 2020. 

For investors, a forward dividend yield of over 4.5% (not guaranteed) still offers attraction, and is a good reason why the shares currently trade around their all-time high. But political risks and uncertainty have clearly increased, and a potential switch to a Labour government that plans to renationalise utility companies at unknown prices now warrant major consideration.

Positives:

• Attractive dividend yield 
• Unlike rivals, Pennon generates additional growth from unregulated waste management business
• Growing public awareness of plastics pollution is good for Viridor recycling business

Negatives:

• Political uncertainty 
• Industry regulation 
• The waste division diversifies risk, but any difficulties will offset profits at the water unit

The average rating of stock market analysts:

Buy