Overview
Pennon Group PLC (PNN) is an Exeter, United Kingdom-headquartered environmental utility infrastructure company which is one of the largest environmental infrastructure groups in the UK. The company owns and operates South West Water Limited and Viridor Limited and has a workforce of around 5,000 people and assets of around GBP 6.5 billion. In 1989, South West Water was one of ten water and sewerage utility companies listed on the London Stock Exchange following the privatisation of the water industry in England and Wales. In 1993, the company acquired its first waste company, which was later renamed as Viridor Waste Management Limited. To better reflect the aim of the strategy of the company to build two different areas of operational focus, the group changed its name to Pennon Group PLC. The group is one of the largest constituent of the FTSE 100 index.

Business and Segments

The operations of the groups are differentiated in three operating divisions: Water and wastewater services, Waste Management, and Non-household retail business. The Water and wastewater services division is focused on providing water and wastewater services through the merged water company of South West Water and Bournemouth Water. The group has significant headroom for investment andis confident of delivering sustainable, long-term returns from waste and water, and continues to seek and identify further growth opportunities within the UK by achieving an appropriate risk/reward balance.Using innovation, new technologies, and a holistic, pioneering approach to water and wastewater management, the company seeks to operate in the most efficient and sustainable way possible to provide water and wastewater services to a population of around 2.3 million in the country. The Waste Management division seeks to recycle, process and transform residual waste into energy, high-quality recyclates and raw materials through Viridor Limited, which is at the forefront of the resource sector in the UK. By helping to recover and regenerate materials at the end of its service life, the company seeks to support the development of a regenerative circular economy that aims to keep resources in use for as long as possible, and provides services to more than 150 local authorities and major corporate clients, along with customers across the country. The non-household retail business comprises the services of providing water retail services for all water management needs of business customers and is a joint venture between Pennon Group PLC and South Staffordshire PLC.

Key Statistics


Management

Sir John Parker is the chairman of the company, he has a wealth of leadership experience across a range of industries and was appointed to the position in August 2015. Christopher Loughlin is the Chief Executive Officer of the group, and he is supported by Susan Davy, who is the Chief Financial Officer of the company.

Top Shareholders


 (Source: Thomson Reuters)

Financial Highlights (FY 2019, in GBP million)


(Source: Company Filings)

Augmented by increased number of connections, an increase of 1.0% in net tariff and a rise of 1.4% in customer demand due to a hot and dry weather over the summer, revenues for South West Water increased by 1.7% (GBP 9.7 million) to GBP 581.0 million. Due to the ERF build out and IFRIC 12 construction revenue, revenues for Viridor increased by 8.5% (GBP 67.0 million) to GBP 852.7 million. This helped the company in posting revenue growth of 6.1% to GBP 1,478.2 million (FY18 GBP 1,393.0 million). Operating profit rose over the year by 8.4% to GBP 351.0 million from GBP 323.9 million, while adjusted EBITDA and group EBITDA were ahead of last year by 5.4% at GBP 592.7 million (FY 2018 GBP 562.3 million) and 7.2% at GBP 546.2 million (FY 2018 GBP 509.6 million) respectively. Focus on cost efficiencies and strong performance across the Water and Waste operations due to increased customer demand over the summer, along with the build out and performance of the Energy Recovery Facilities, which supported the growth of EBITDA of 19.1% at Viridor and helped the company to post strong EBITDA growth in FY2019. Reflecting a non-underlying charge before tax of GBP 19.9 million, on a statutory basis, profit before tax was GBP 260.3 million (FY 2018 GBP 262.9 million) while underlying profit before tax was GBP 280.2 million, an increase of 8.3% (FY 2018 GBP 258.8 million). Statutory profit after tax was GBP 222.6 million, reflecting a growth of 0.3% over GBP 221.9 million reported last year, and corresponding to statutory earnings per share of 51.1p (FY2018 48.0p), an increase of 6.5% due to efficient hybrid financing. Underlying earnings per share rose by 13.6% to 57.8p (FY 2018 50.9p). The company recommended a final dividend of 28.22p, which resulted in a total dividend of 41.06p after paying an interim dividend of 12.84p and reflected an increase of 6.4% over the prior year. The operational cash inflows during the year were GBP 649 million (FY2018 GBP 672 million), and it had GBP 1,170 million worth of cash and committed facilities as at 31 March 2019, indicating a strong liquidity and funding position. The net debt during the year rose by GBP 278 million to GBP 3,080 million.

Key Performance Indicators

The average ERF availability during the year was 91%, which was in excess of 90% and above the initial base case expectations of the company. Also, customer satisfaction with overall service, which reflects theSouth West Water score for 2018/19,was 96% and the score for Bournemouth Water was 96%. The underlying profit before tax, which indicates theprofitability and efficiency of the business,was GBP 280 million. Group assets as at 31 March was GBP 6.5 billion, up by 4.8% over the year.

Financial Ratios


(Source: Thomson Reuters)

Ratios Commentary

The profitability ratio of the company has improved marginally over the last couple of years and is better than the industry margin for some measures. The liquidity position improved considerably in the financial year 2019, indicating good management of short-term assets. Though the company became more leveraged during the year, it was still less geared than its competitors. The group has a better asset turnover ratio than its peers, indicating that the company is optimally utilising its assets.

Valuation Methodology
Method 1:Price/Earnings Multiple Approach (NTM)

To compare PNN with its peers, P/E multiple has been used. The peers are Centrica PLC(NTM P/E was 8.19), Drax Group PLC(NTM P/E was 9.38),SSE PLC(NTM P/E was 11.56), National Grid PLC(NTM P/E was 14.44), United Utilities Group PLC(NTM P/E was 14.92) and Severn Trent PLC(NTM P/E was 16.15). The median of P/E (NTM) of the company’s peers was 13.00x (approx.).

Method 2:Price/Cash Flow Multiple Approach (NTM)

To compare PNN with its peers, P/CF multiple has been used. The peers are Centrica PLC(NTM P/CF was 2.91), Drax Group PLC(NTM P/CF was 3.81),SSE PLC(NTM P/CF was 6.58), National Grid PLC(NTM P/CF was 7.42), United Utilities Group PLC(NTM P/CF was 6.50), Severn Trent PLC(NTM P/CF was 7.10) and Orsted A/S(NTM P/CF was 15.83). The mean of P/CF (NTM) of the company’s peers was 7.16x (approx.).

Share Price Commentary


Daily Chart as at 05-August-19, before the market close (Source: Thomson Reuters)

On 05 August 2019, at the time of writing (before the market close, at 12:56 pm GMT), PNN shares were trading at GBX 716.7, down by 1.55 per cent against the previous day closing price. Stock's 52 weeks High and Low is GBX 800.00/GBX 679.48. Stock’s average traded volume for 5 days was 5918,482.80; 30 days – 1,022,084.80 and 90 days – 980,836.96. The average traded volume for 5 days was down by 10.14 per cent as compared to 30 days average traded volume. The company’s stock beta was 0.67, reflecting less volatility as compared to the benchmark index. The outstanding market capitalisation was around £3.06 billion, with a dividend yield of 5.64 per cent.

Risks Assessment and Growth Prospects
One of the principal risks faced by the company which might result in its failure to deliver on its strategic priorities and add value is the threat of change in government policies, especially renationalisation of the water industry that is being envisioned by the Labour Party in the United Kingdom. While the company continues to engage with all political parties, customers and other stakeholders, nationalisation of utility companies remains a possibility in the event of a change in government. Although the group has taken measures which have helped to improve collection rates and decrease bad debt exposure during the past three years, reduced customer debt collection has the potential to impact the revenue of the group. Moreover, revenues generated by recycling and energy businesses can be affected by a decrease in the power prices, reduced global demand for recycled commodities and continued austerity measures undertaken by local authority. However, as a domestically-focused utility company, it is well positioned to deliver sustained growth despite domestic uncertainties, like Brexit.

Conclusion
The group has significant headroom for investment andis confident of delivering sustainable, long-term returns from waste and water, and continues to seek and identify further growth opportunities within the UK by achieving an appropriate risk/reward balance.

The company aims to become a leader in the UK water and waste infrastructure and seeks to attain leadership in cost base efficiency through ongoing initiatives to reduce the cost base. The company was ranked 2nd out of all water and wastewater companies for the quality of service, reflecting the focus of the company on delivering sector-leading customer experience. The 2020-25 business plan by the company received fast-track status from Ofwat for the second consecutive review, and this will allow the company to plan and provide early certainty of service to its customers.

Based on the prospects as a result of perusal of innovative products supported by advanced technologies, we have given a “BUY” recommendation at the current price of GBX 716.7 (as on 05 August 2019) with single-digit upside potential based on 7.16x NTM Price/Cash Flow (approx.) on FY20E Cash Flow per share and 13.00x NTM Price/Earnings (approx.) on FY20E Earnings per share.
 
*All forecasted figures and Peers information has been taken from Thomson Reuters.

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