ii view: Severn Trent details new dividend policy

Investor uncertainties have reduced at Severn, but should investors now buy for the dividend income?

Third-quarter trading update

• Full-year guidance unchanged
• New five-year dividend policy 

ii round-up:

Water and business services company Severn Trent (LSE:SVT) outlined its new dividend policy in this third-quarter trading update. 

Having agreed terms with the water regulator OFWAT for the new regulatory period 2020 to 2025 known as AMP7, dividend growth in the period should at least equal the inflation measure of CPIH - Consumer Prices Index including owner occupiers' Housing costs. 

As such, based on the full year 2019/2020 dividend of 100.08p, the dividend for the full year 2020/2021 is therefore expected to be 101.58p, using CPIH of 1.50% - the government’s November 2019 measure. 

The half-year dividend announced in November 2019 under the regulatory terms of AMP6 was increased by 7.2%. 

The AMP7 period will also include a totex or expenditure allowance of £6.8 billion, a target to reduce leakages and blockages by 15% and 5% respectively and a goal to help 200,000 customers a year to pay their bill. 

Trading for the third quarter had remained in line with management’s expectations. Severn is on track to deliver at least £25 million in customer Outcome Delivery Incentives (ODI) for the full year. 

ODIs are paid to water companies by the regulator for meeting or exceeding targets like project completions and standards of customer service.

The share price proved little changed in late morning trading. 

ii view:

Severn Trent, like utility companies in general, is viewed as highly defensive. After all, no matter what the state of the economy, people will always need water and power. As such, and given their dependable cashflows from bill paying customers, their dividend paying abilities have become highly prized, particularly in this era of ultra-low interest rates. 

For investors, a forecast dividend yield of just under 4% (not guaranteed), is not unattractive in the current low-interest rate environment. Regulatory agreement for the period 2020 to 2025, and the removal of possible nationalisation under a Corbyn government, have reduced uncertainty for investors. The share price is up by nearly 16% since the December election day. However, group debt remains elevated and earnings dividend cover at 1.3 times is below the three-year average of 1.5 times. 

Positives: 

• Trading in line with management expectations
• Attractive dividend payment
• Targeting £100 million of property profit over the 10 years to 2027 - £33 million delivered to date

Negatives:

• Dividend cover below three-year average
• Borrowing or gearing is higher than rivals
• Uncontrollable factors, such as the weather can hinder performance

The average rating of stock market analysts:

Hold