ii view: Severn Trent raises dividend despite expensive debt

A robust operational performance with the shares sat on an attractive forecast dividend yield. Buy, sell, or hold?

First-half results to 30 September

• Revenue up 11% to £1.062 billion 
• Adjusted profit up 2.4% to £262 million
• Pre-tax profit down 29% to £105 million
• Interim dividend up 4.6% to 42.73p per share
• Net debt up 6% to £6.63 billion 

Chief executive Liv Garfield said:

"The first half of this year has shown the benefits of the sustained investment we've made over many years in our people, region and environment. We have delivered a robust financial performance leaving us well positioned to support our customers, invest for the long term, and support future growth.”

ii round-up:

Water company Severn Trent (LSE:SVT) today increased its interim dividend by an inflation-linked 4.6% to 42.73p per share. it also maintained its expectation for the total full-year payment to come in at 106.82p per share, up from 102.1p in 2021. 

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A strong operational performance over the hot dry summer was countered by rising costs for its predominantly inflation-linked debt, pushing its effective interest cost to 6.4% from last year’s 4.2%. 

Severn Trent shares fell by more than 1% in UK trading having come into this latest announcement down around 6% year-to-date, but up over 20% in the past five weeks. Annual performance is similar to fellow water company United Utilities Group (LSE:UU.) and compares to a 4% retreat year-to-date for the FTSE All Share index. 

Severn Trent’s interim dividend of 42.73p per share, linked to the Consumer Price Index including housing costs (CPIH), is payable to eligible shareholders on 11 January. 

An 11% increase in revenues year-over-year to £1.06 billion helped drive profits before interest and taxes up 2.6% to £262 million.  Pre-tax profit, taking into account the increase in debt financing costs, fell 29% to £105 million. 

Management’s expectations for full-year Outcome Delivery Incentives (ODI), paid to water companies by the regulator for meeting or exceeding targets like reducing environmental pollution and customer blockages, remained unchanged for at least £50 million.

Severn’s significant investment programme in operational improvements and the environment continues, while overall group net debt rose 6% year-over-year to £6.63 billion.

Broker Morgan Stanley reiterated its ‘overweight’ stance on the shares following the results, with Severn’s investment programme in future growth outweighing pressure on current full-year earnings given rising finance costs.  

ii view:

Severn Trent supplies over eight million people with around two billion litres of clean drinking water every day. Its name comes from the two predecessor River Authorities which managed the catchment of the Severn and the Trent. The company, a constituent of the FTSE 100 index, employs over 6,000 people. 

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For investors, index-linked group debt is seeing financing costs rise, pressuring earnings. Periodic negotiations with the industry regulator continue to warrant consideration, as does the expense of tackling the cost-of-living crisis and the water industry’s general accountability for the environment. 

On the upside, operational improvements are being made and measures to address financially squeezed customers taken. The current regulatory period AMP7 runs through to 2025, while management remains happy with what it still considers to be a strong balance sheet. 

On balance, and with the shares sat on an estimated future dividend yield of close to 4%, income investors are likely to stick with this defensive business.   

Positives: 

• Attractive dividend payment (not guaranteed)
• Defensive recession qualities 

Negatives:

• Uncontrollable factors such as the weather can hinder performance
• Regulatory constraints

The average rating of stock market analysts:

Strong hold