Interactive Investor

ii view: Pennon’s numbers still meeting expectations

Shares in this water company have underperformed rivals over the last year, although a recent acquisition offers an opportunity. Buy, sell, or hold?

25th March 2024 11:10

Keith Bowman from interactive investor

Full-year trading update to 31 March

ii round-up:

Water company Pennon Group (LSE:PNN) today detailed full-year trading in line with management expectations, said its wastewater operations have been impacted by challenging and much higher than normal rainfall. 

Record investment of £850 million is expected to have been made come the end of the current regulatory five-year period running to 2025, known as K7, with Pennon well positioned to deliver on its ambitious plans for the next K8 period out to 2030. The Environment Agency’s four-star wastewater pollution award is now to be achieved in 2025 as opposed to 2024. 

Shares in the FTSE 250 company fell 2% in UK trading having come into this latest news down around a fifth over the last year. That compares to a near one-tenth fall for fellow water company Severn Trent (LSE:SVT) and contrasts with a 6% increase for the FTSE 250 index itself.  

Pennon operates across 860 miles of Southwest UK coastline and sees its population about treble in the summer months to over 10 million people due to tourism. The £89 million purchase of Sutton and East Surrey (SES) water company adds to previous takeovers of both Bournemouth and Bristol Water companies. 

The acquisition of SES is currently progressing through the Competition and Markets Authority (CMA) review as Pennon management had expected.

Projects completed over the year include construction work at the Blackpool pit quarry to add to its storage resources facilities, winter pump storage work at Gatherley in Devon, while its South Cornwall desalination plant is on track to be operational in the new financial year. 

Broker UBS reiterated its ‘buy’ rating on the shares post the update, flagging a fair value price of 890p per share. Annual results are scheduled for 21 May. 

ii view:

Pennon Group came to the UK stock market in 1989 as South West Water. It later combined with Bournemouth Water to form Pennon Group. In 2020, it agreed to sell its waste management business Viridor, later returning funds to shareholders. Its most recent purchase of SES adds a further 750,000 customers to the 1.2 million acquired through Bristol Water. 

For investors, elevated costs including interest payments on its index-linked debt and those for energy and chemicals are not to be forgotten. The water industry’s accountability and impact on the environment needs to be remembered, while 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. 

More favourably, the defensive nature of a utility operator, given that we all need water no matter what the health of the economy, offers appeal and underpins dividend payments. Investment in improving operational efficiency is ongoing, the acquisition of SES offers further cost saving opportunities, while over £700 million of funding has been secured since March 2023.

In all, the acquisition of SES and a forecast dividend yield of around 6.7% are likely to make Pennon attractive to income investors, although the shares have significantly underperformed sector peers over the past 12 months and in 2024 so far.

Positives:

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

Negatives:

  • The weather can impact performance
  • SES purchase subject to CMA review

The average rating of stock market analysts:

Strong hold

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