Pennon dilutes profits to fix pipes

It has been 30 years since there was a significant round of spending on water infrastructure, and it was clear from its interim results that Pennon (PNN) is having to increase capital expenditure hugely to keep on top of the depreciation of its physical infrastructure.

Doing so at a time of heightened inflation only adds to the burden, and it was no surprise that reported profits almost disappeared during the half. In this context, attempting to cite adjusted cash profit figures, which exclude both depreciation and amortisation, for a business with £4.2bn of physical assets is a largely pointless exercise.  

The need to create cash headroom was evident, with management time taken up with refinancing a substantial part of the company’s balance sheet – since the 31 March year-end Pennon has refinanced or taken on debt facilities of £710mn. And its capital expenditure programme, which is running at approximately 1.5 times ahead of depreciation, is generating a significant cash requirement; wages rose by 21 per cent to £60.3mn, while consumables and materials were 17 per cent higher at £18.6mn. Total capital investment soared by 87 per cent to £266mn as Pennon ramped up its renovation programme.    

It is fair to say that the market is applying a “political discount” to water company shares, given their unpopularity with voters, along with regulatory inquiries that could yet impose stiff penalties for pollution offences.

Along with other companies, Pennon’s profitability, indeed its future structure and ownership, is in the gift of whoever forms the next government. Until there is clarity on these points, we keep our recommendation steady despite the inflation-linked income appeal of the shares. Hold.

Last IC view: Hold, 781p, 1 Jun 2023