ii view: Pennon sinks as dividends hit by fine and compensation

Full-year results to 31 March

• Revenue up 14% to £908 million
• Adjusted operating profit up 8.6% to £166 million
• Final dividend of 30.33p per share
• Total dividend for the year up 3.8% to 44.37p per share
• Net debt of £3.8 billion, up from £2.96 billion a year ago

ii round-up:

Water company Pennon Group (LSE:PNN) today increased its dividend payment by less than expected as it redirected funds towards the payment of a £2.4 million fine from the Environment Agency.

A final dividend of 30.44p was lower than the City had expected, leaving the total payment for the year up 3.8% to 44.37p per share. Full-year adjusted profit of £166 million was also shy of analyst forecasts of £174 million, with the owner of South West Water also revealing a £3.5 million compensation payment to customers in the Brixham area following a recent water parasite outbreak. 

Shares in the FTSE 250 company fell 6% in UK trading having come into these latest results down around 5% year-to-date. That’s below a near 7% improvement for the FTSE 250 index during 2024 and in contrast to a 3% gain for fellow water company United Utilities Group Class A (LSE:UU.). 

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Pennon operates across 860 miles of Southwest UK coastline. An earlier year £89 million move to buy Sutton and East Surrey (SES) water company potentially adds to its previous takeover of Bristol Water, although with the purchase still under review by the Competition and Markets Authority.

Heavy rainfall and subsequent operational issues resulted in a net Outcome Delivery Incentive (ODI) deduction of £12.1 million for South West Water and £1.7 million for Bristol Water. ODI’s are paid to or taken from water companies by the regulator depending on the performance of criteria such as reducing leakage or environmental pollution.

Group net debt rose to £3.8 billion from £2.96 billion in late March 2023 given factors including its proposed acquisition of SES. 

Management outlook forecasts for the year ahead pointed to expected organic revenue growth, driven by inflationary tariff increases, as well as broadly flat operating costs for South West Water. 

Broker UBS reiterated its ‘buy’ rating on the shares post the results, flagging a fair value price estimate of 890p per share.

ii view:

Pennon Group came to the UK stock market 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. Its most recent move to buy SES adds a potential further 750,000 customers to the 1.2 million acquired under its previous buy of Bristol Water. 

For investors, a move to redirect dividend monies to pay fines could set a precedent for both Pennon and the industry. Elevated costs including interest payments on debt are not to be forgotten. The water industry’s accountability and impact on the environment needs remembering. 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 ongoing. Its pending acquisition of SES offers further cost saving opportunities, while this latest fiscal year gone is expected by management to prove a peak in group investment. 

In all, risks raised by operational execution and environmental accountability are clearly an issue. However, investors happy to overlook this can still lock in a forecast dividend yield of over 5%.

Positives:

• Attractive dividend (not guaranteed)
• Targeting cost savings from SES water acquisition

Negatives:

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

The average rating of stock market analysts:

Strong hold