Utility Week

UTILITY WEEK | 8TH - 14TH JUNE 2018 | 13 Finance & Investment Analysis I n successive days, the three remaining quoted water companies – Severn Trent, United Utilities and Pennon – reported their full-year results for 2017/18. There were few surprises, with the mar- ket reacting most positively to the Pennon results and the 7.3 per cent dividend rise that was confirmed. Severn Trent's and United Utilities' dividend increases were 6.2 per cent and 2.2 per cent respectively. Of course, there is an elephant in the room – and a very large one at that. The forthcoming regulatory review, PR19, will affect the water companies' returns from April 2020 onwards. Given Ofwat's recent weighted average cost of capital (Wacc) pro- jections – 2.4 per cent rather than 3.7 per cent at present – a sharp fall in earnings and, possibly, dividends is on the cards. Severn Trent First up was Severn Trent's announcement, described by chief executive Liv Garfield as "a strong set of financial results". Underlying profit before interest rose by some 4 per cent to £541 million, and underly- ing earnings per share rose slightly faster to reach 121p. Significant progress was made at the operating level, with a major outcome deliv- ery incentive (ODI) outperformance. Further- more, the full integration of Dee Valley is expected later this summer, which should lead to further savings. Severn Trent was able to announce a 6.2 per cent increase in its dividend – which, for the full year, will be 86.55p per share. At the analysts' meeting, emphasis was placed on its management of net debt, which now amounts to £5.36 billion – a substantial figure but only about half that of the private equity-owned Thames. During 2017/18, Severn Trent says it has outperformed Ofwat's allowed cost of debt projections by £79 million – an astonishing figure that hardly reflects well on Ofwat's forecasting abilities. Looking forward, there must be some doubt about whether Severn Trent's dividend is sustainable from 2020/21 onwards. For the current year, though, it is being underpinned by a property sale – of Teal Close in Nottingham – to housebuilder Per- simmon. An £18.2 million profit is to be booked by Severn Trent from this single deal. United Utilities Elsewhere, United Utilities' operating per- formance was sound. Underlying operat- ing profit rose from £622.9 million to £645.1 million; there was a £7 million ODI penalty imposed by Ofwat. More importantly, though, it was higher interest rate charges that meant underlying earnings per share fell from 46.0p in 2016/17 to 44.7p for 2017/18. United Utilities confirmed that its com- paratively high proportion of index-linked debt gave rise to a £40 million increase in underlying net financial expenses: the con- trast with Severn Trent's 2017/18 interest bill is quite marked. United Utilities' net debt rose over the period to almost £6.9 billion, a near £300 million increase over the year. Compared with Severn Trent and Pennon, its 2.2 per cent dividend increase was decid- edly modest, although not unexpected. On the pensions' front, United Utilities revealed a pension surplus of £344 million. Another privatised utility, British Telecom, will be casting envious eyes at this figure as it continues to be challenged by an £11.3 bil- lion pension deficit. In addressing concerns that its pension surplus could encourage Ofwat to cut its PR19 allowance for pension costs, United Utilities firmly repudiated the suggestion. It does, though, raise questions about how this surplus will be treated in the future, with lower ongoing pension contributions being the most likely scenario. Pennon Pennon's numbers met expectations, with pre-tax profits at £258.8 million – up slightly on 2016/17. However, the more relevant underlying earnings before tax, deprecia- tion and amortisation (Ebitda) figure rose by 4.9 per cent. The increase in adjusted earnings per share – up from 47.0p in 2016/17 to 50.9p in 2017/18 – was more pronounced at 8.3 per cent. Consequently, the 7.3 per cent divi- dend increase enabled dividend cover to rise slightly. Not surprisingly, Pennon is proud of its dividend record – it leads the sector over the decade between 2010/11 to 2019/20. Its balance sheet, too, is comparatively strong – net debt at March 2018 stood at just over £2.8 billion. Although Pennon's returns from its core utility businesses were solid – with signifi- cant outperformance of Ofwat's numbers – the Viridor waste business also reported discernible progress. Previously, Viridor has disappointed but its 2017/18 Ebitda exceeded £150 million, compared with £138.3 million in 2016/17. The energy recovery facilities (ERF) port- folio, which represents more than 75 per cent of Viridor's Ebitda, is developing nicely – and making a meaningful contribution to Pennon's overall returns. Pennon will be hoping this continues, especially in 2020/21, because its impressive progress may enable it to avoid a divided cut aer PR19. PR19 is pivotal for all water companies, but there was little discussion of political issues – not even in Severn Trent's presentation – despite their potential to hammer share price ratings. For the moment, though, the three quoted water companies are fully focused on PR19. Solid results, but PR19 looms The three listed water companies have shown a solid performance in their financial results for the year ended March 2018, but their focus will remain on PR19, Nigel Hawkins says. SEVERN TRENT SHARE PRICE 2,600 2,400 2,200 2,000 1,800 1,600 Aug 2017 Dece 2017 Apr 2018

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