Pennon - in OFWAT's good books

Pennon: After the dividend disappointments at Severn Trent and United Utilities, it is a pleasant relief to see Pennon extending their existing dividend policy of RPI+4% into the full 2015-20 K6 period. They are upbeat on the prospects for South West Water to exceed their assumed return on equity over this period, having beaten the targets for K% (2005-10). They even seem to have managed to claw back in K6 the lost revenue from the 2014/15 price freeze. These all seem to be benefits from having got into OFWAT’s good books for good behaviour. Over at the Viridor waste business, the recession post the banking crisis was a very tough period for a business focussed on landfill. The parallel trend for less landfill (encouraged by higher landfill taxes) and more recycling also hurt. The company is saying now that the strategic re-positioning of Viridor into an ERF (Energy, Recycling & Resources) business is at an inflection point and that EBITDA is set to move ahead this year. This is despite poor recycled material prices caused by low commodity prices. The pipeline of new contracts and business mean that further progress is envisaged too, with ERF forecast to contribute £100m to EBITDA by 2016/17.

This is all positive news, but the rub is that the valuation looks fairly rich to me. Consensus eps for the year to 31^st March 2015 looks like 37.5p, being a chunky PE of 22.5x at 845p, with high single digit growth thereafter. The dividend could just break 32p, which is a yield of 3.8%, (with that RPI+4% growth trajectory beyond). This all looks enough for now. The wild card is corporate activity. The group has been eyed up in the past, most notably in the recent past by the Abu Dhabi Investment Authority. Only this month Jonson Cox (the OFWAT Chairman) signalled that he was now more open to the idea of corporate activity of various kinds in the sector. The last official Asset Value of Pennon was £5.0bn against a current Enterprise Value of some £6.2bn, whilst the Regulatory Capital Value of South West Water is probably just over £3bn and not far short of the £3.4bn market capitalisation of Pennon as a whole (an apples and pears comparison but interesting all the same). It is all a bit ‘finger in the air’ but a corporate buyer probably could still justify paying a decent premium to the current share price. Whether it is worth hanging on for that I am not sure, the choice is yours. (Neil Cumming^, 23^rd March 2015)

These comments are not a personal recommendation to deal. Any investments can fall as well as rise in value, so you could get back less than you invest. I may have a financial interest in some of the stocks written about. www.dividendpower.co.uk or e-mail at info@dividendpower.co.uk  Twitter:  @DividendPower