Interactive Investor

ii view: Pennon yet to decide on spending Viridor sale proceeds

30th March 2021 16:11

Keith Bowman from interactive investor

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Value accretive growth opportunities or a substantial return of capital to shareholders?

Full-year trading update to 31 March 

ii round-up:

Water company Pennon Group (LSE:PNN) today confirmed that it remained on track to meet its own full-year forecasts. 

Increased household water demand at its South West Water business had more than offset a retreat in business demand under pandemic restrictions during the second half. 

Pennon shares fell by more than 3% in UK trading, adding to a 10%-plus fall over the last year. Shares for fellow water companies United Utilities (LSE:UU.) and Severn Trent (LSE:SVT) are little changed over the same period. 

In July, Pennon completed a £4.2 billion sale of its waste management business Viridor, raising net proceeds of £3.7 billion. Around £1 billion of the proceeds has been used to reduced debt, with an assessment as to how best to utilise the balance ongoing. An update is likely at its 3 June annual results. Potential value accretive growth opportunities continue to be assessed. The alternative is a substantial return of capital to shareholders.   

A strong operational performance at South West Water was outlined. A committed target for supply interruptions is two years ahead of plan, with targets for sewer flooding and pollution incident reduction also either ahead of plan or gaining momentum. Outcome Delivery Incentives (ODIs) are paid to water companies by the regulator for meeting or exceeding performance targets. Although a net ODI penalty is expected this financial year. 

Cash collections have stayed robust and management’s expected credit loss assumptions, made at the outset of virus crisis, given some customers inability to pay, remain largely intact.

ii view:

Founded in 1989, the merged water company of South West and Bournemouth today provides water and wastewater services to a population of around 1.7 million in Cornwall, Devon and parts of Dorset and Somerset. It also delivers water only services to around half a million people in parts of Dorset, Hampshire and Wiltshire.

For investors, the sale of Viridor removes a company specific growth driver. Waste management business Viridor gave Pennon opportunity for growth outside of its regulated water business. That said, a decision on a large part of the sale proceeds is still pending. An estimated forward dividend yield in the region of 2%, although below rivals, is still not derisory in an era of ultra-low interest rates, while the broad dependability of a utility company is not to be overlooked in a world of many uncertainties. 

Positives:

  • Reliable dividend income
  • Cash and committed facilities well in excess of £3 billion

Negatives:

  • Growth opportunities via waste management business now removed
  • A Covid-19 business hit to revenue

The average rating of stock market analysts:

Buy

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