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Pennon benefits from a dry summer

BROKERS' TIPS: Pennon still has the most attractive dividend policy in the sector
November 29, 2010

What's new?

■ Half-year profits broadly flat

■ South West Water revenues increase after the dry summer

■ Viridor confident on the outlook for recycled waste

IC TIP: Buy at 627p

Pennon's mix of a stable water utility and growing waste management business produced a steady set of half-year results, with pre-tax profits broadly flat at £96.2m and the dividend raised 7.9 per cent to 7.5p.

South West Water's revenues rose 1.9 per cent to £231m on the back of higher customer demand due to the dry summer. Regulatory tariff increases contributed £4.2m to the increase and 2,800 new customers added £0.9m, but this was partly offset by customers switching to meter charging, which reduced turnover by £3.3m. Overall, operating profits fell by £0.3m to £100m as depreciation, restructuring and investment costs offset a number of cost savings.

Revenues at Viridor, the waste management business, also increased, up 17 per cent to £363m, with the existing business contributing £35.5m and acquisitions £17.8m. The division bought London Recycling and Intercontinental Recycling back in 2009, Reconomy in 2010 and completed a £16m deal with Anglia-based Pearsons in November. Including joint ventures, the division's pre-tax profits increased 29 per cent to £28.6m. Enhancing the recycling waste proposition, George Osborne's budget announced a £8 a year increase in landfill tax to 2015.

Evolution Securities says...

Neutral. Pennon has the highest dividend growth policy in the sector at 4 per cent above inflation to 2015. We think it's the water stock most likely to be able to continue this growth beyond 2015 and is also the least exposed to inflation (up or down), due to the dilutionary effects of Viridor. We estimate 60p a share unrisked upside potential just from Viridor, which is not in our price target. Although we retain a neutral recommendation, Pennon is the cheapest water stock in the sector. We forecast adjusted pre-tax profits of £177m, EPS of 36.2p and a dividend of 24.1p in the 12 months to March 2011 (£187m, 40.7p and 22.6p, respectively, in 2010).

Investec Securities says...

Buy. The group has a knack of beating expectations even though observers know that this has been the case in the past. A flat performance in water was a good result in our view, while Viridor continues on its strong growth path. Pennon remains well placed in both businesses and the potential demerger of Viridor adds spice. The waste management division now has the critical mass to be a standalone entity, as it is already run as a separate entity with a separate board and management team. We believe that Pennon could be split into two - for instance, by a scrip issue of Viridor shares. Such a move would, we suspect, be very well received by Pennon's shareholders. We expect full-year profits of £180m, EPS of 35p and a dividend of 24.4p.