ii view: Pennon flags decline in water use

First-half trading update to 26 September

ii round-up:

Water company Pennon Group (LSE:PNN) today pointed to lower first-half like-for-like revenue given its own 'Water is Precious' efficiency and save campaigns.

Operating costs had remained broadly flat year-to-date, with reduced customer demand also expected to impact over the full year despite increased tariffs and customer numbers.  

Shares in the FTSE 250 company fell 1% in UK trading having come into this latest news down around a fifth year-to-date. The FTSE 250 index itself is up 7% in 2024. Fellow water companies Severn Trent (LSE:SVT) and United Utilities Group Class A (LSE:UU.) are little changed.   

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Pennon operates across 860 miles of Southwest UK coastline. Exceptional costs during the current financial year are expected to include £16 million in relation to a now resolved water parasite outbreak this summer in the Brixham, Devon area.

Management’s focus on storm overflow systems had helped Pennon battle what was the third wettest October to August period since records began. Capital expenditure for the first half totalled £300 million, with the City expecting a full-year spend of over £600 million. 

In June, the group received clearance from the Competition and Markets Authority for its previous £89 million acquisition of the Sutton and East Surrey (SES) water company, adding to its prior £425 million takeover of Bristol Water.  

A continued restructuring of the business sees savings of £86 million being targeted into the K8 regulatory period 2025 to 2030. 

First-half results are scheduled for 27 November. A regulatory update/final determination for Pennon and the wider water industry is expected on 19 December. 

ii view:

Pennon Group came to the UK stock market in 1989 as South West Water. It later combined with Bournemouth Water becoming Pennon Group. In 2020, it agreed to sell its waste management business Viridor, later returning funds to shareholders. The acquisition of SES adds a further 750,000 customers to the 1.2 million acquired under its previous buy of Bristol Water.  

For investors, previous operational issues have resulted in fines and additional costs, hindering performance. The water industry’s accountability and impact on the environment cannot be forgotten. Periodic negotiations with the industry regulator offer uncertainty, as does a change of government and possible moving of goal posts for the industry. 

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More favourably, the relative defensiveness of a utility operator, given that we all need water no matter what the health of the economy, offers appeal and backing to dividend payments. Group investment in improving its operational efficiency is ongoing. Its acquisition of SES offers further cost saving opportunities, while the last financial year to late March was expected by management to prove a peak in group investment.  

For now, risks raised by operational execution and environmental accountability deserve high consideration. That said, a forecast dividend yield of over 7% is likely to keep income investors happy.

Positives:

• Attractive dividend (not guaranteed)
• Targeting cost savings from SES water acquisition

Negatives:

• The weather can impact performance
• Increased net debt as of late March

The average rating of stock market analysts:

Strong hold