Pennon Group PLC (LON: PNN) – Capitalizing Resources Towards UK Water Services to Become an Industry Leader

Founded in 1989, Pennon Group PLC is a FTSE 100-listed Environmental Infrastructure Company, which provides services related to waste management, water & wastewater, and water retail services. It operates through three businesses – Pennon Water Services Limited, South West Water Limited, and Viridor Limited. The Company’s waste management service is involved in the transformation of waste into energy, recycles, and raw materials. The water & wastewater services manage wastewater improvement and water services for drinking. The water retail service is engaged in providing water retail and consultancy services to the non-household customer in Great Britain. The Group’s water and wastewater catered to 2.2 million customers in FY20 through the 18,370 km of drinking water mains network and 17,515 km of wastewater mains network. In 2019, the Company received a ‘Green Economy Mark’ accreditation from the London Stock Exchange.


(Source: Presentation, Company Website)

On 25 September 2020, the Company is expected to release the next trading statement, while it is planning to announce the H1 FY21 results on 24 November 2020.

Key Fundamental Statistics



Segment Analysis

Following the completion of Viridor’s sale, the Company will remove the waste management business from the segments. The Company will continue the business with two businesses - water and wastewater services (undertaken by South West Water) and non-household retail business (managed by Pennon Water Services).


 (Source: Annual Report,  Company Website)

Synopsis of Recent Developments

10 July 2020: The Company announced the additional listing of 1,079,275 equity shares, which will be effective from 14 July 2020. The application for additional listing is pertinent to the exercise of options under All-Employee Sharesave Scheme.

8 July 2020: The Company completed the disposal of Viridor business for the cash proceeds of £3.7 billion (after considering debt and customary transaction costs). Going forward, the Company plans to focus the resources in water and wastewater businesses. Besides the deal completion, the Company also affirmed that Gill Rider would take over Sir John Parker, as Chairman of the Board from 31 July 2020.

Achievement in Operational KPIs

During the FY20, the Company shown decent performance across all the non-financial parameters, which is underpinned by improvement in environmental programmes, engaging workforce, social capital programmes, customer satisfaction. The Company also reduced the lost time injury frequency significantly in FY20 as compared to FY19.


(Source: Presentation, Company Website)

Top Shareholders Statistics
 

Completion of Sale of Viridor (8^th July 2020)

Pennon Group announced the completion of Viridor sale to KKR (Kohlberg Kravis Roberts & Co. L.P.) for an EV (enterprise value) of £4.2 billion and received cash proceeds of £3.7 billion, including debt and customary transaction costs.  The disposal of Viridor will bring significant strategic value, and the Company will focus on water and wastewater businesses.

Financial Highlights – Decent Financial Performance for FY2020 (31^st March 2020)


(Source: Annual Report, Company Website)

For the financial year ending 31^st March 2020, due to decline in revenue from water business and Non-household retail business, the revenue from continuing operations and Viridor declined by 6% to £1,390 million (FY2019: £1,478 million). The revenue from continuing business stood at £637 million in FY2020 (FY2019: £633 million), reflecting an increase of 0.6% for the period. The underlying EBITDA from continuing operations and Viridor surged by 3.1% to £563 million in the financial year 2020 (FY2019: £546 million), and underlying EBITDA from continuing operations declined by 0.5% to £365 million in FY2020 (FY2019: £367 million). The underlying PBT (profit before tax) from continuing operations and Viridorstood at £288 million in FY2020 (FY2019: £280 million), reflecting an increase of 2.6% and underlying PBT (profit before tax) from continuing operations declined by 4.5% to £183 million in FY2020 (FY2019: £192 million). The Group’s PBT (profit before tax) including non-underlying items from continuing operations and Viridor increased by 15.8% to £302 million in FY2020 (FY2019: £260 million), and PBT (profit before tax) from continuing operations declined by 4.1% to £193 million in FY2020 (FY2019: £201 million). The underlying earnings per share from continuing operations and Viridorsurged by 6.7% to 61.7 pence in FY2020 (FY2019: 57.8 pence). The capital investment stood at £339 million in the financial year 2020 (FY2019: £396 million).

Financial Ratios – Strong Profitability and Liquidity for FY2020 versus Industry Median

Reported profitability metrics in the financial year 2020 were higher against the industry median, reflecting higher revenue generated and better control over expenses as compared to peers. On the liquidity front, Pennon Group Plc’s current ratio was significantly higher than the industry median of 2.68, reflecting sufficient current assets to pay short-term obligations, which shows a robust liquidity profile to tackle the uncertainty due to covid-19 outbreak. On leverage front, the debt-equity ratio of the Pennon Group Plc’s was 2.17x, which was lower as compared to the industry median of 2.34x, reflecting that the company is less leveraged as compared to the industry.  

Share Price Performance Analysis


Daily Chart as on 13^th July 2020, before the market close (Source: Refinitiv, Thomson Reuters)

On July 13, 2020, at the time of writing (before the market close, at 10:54 AM GMT+1), Pennon Group Plc shares were trading at GBX 1,086.00, up by 0.46% against the previous day closing price. Stock's 52 weeks High and Low are GBX 1,210.50 and GBX 695.20, respectively.

Bullish Technical Indicators

From the technical standpoint, shares were trading above the support level of 200-day simple moving average prices, which reflects an uptrend in the stock and carrying the potential to move up further.

14-day RSI is currently in an oversold zone, which means there is a good potential for a short term rebound in the stock price.

Valuation Methodology

Price/Earnings Approach (NTM)



To compare Pennon Group Plc with peers, Price/Earnings multiple has been used. The peers are Audax Renovables SA (Price/NTM Earnings was 53.97), Biffa Plc (Price/NTM Earnings was 27.81), Telecom Plus Plc (Price/NTM Earnings was 23.32), Severn Trent Plc (Price/NTM Earnings was 21.12) and National Grid Plc (Price/NTM Earnings was 15.18). The Average of Price/NTM Earnings of the company’s peers was 28.28x (approx.).

Pennon Group Plc Vs FTSE-100 Index (1 Year)


(Source: Refinitiv, Thomson Reuters)

In the last year, Pennon Groupshare price has delivered 47.70% returns as compared to negative 18.29% returns of FTSE-100 index, which shows that the stock has outperformed the index during the last one year.

Industry Outlook Dynamics

As per the publication from the ReportLinker, the market size for global water and wastewater treatment equipment industry is projected to reach around USD 38.65 billion by 2025, representing a compounded annual growth rate (CAGR) of 3.68% between 2019 to 2025. The growing demand for clean water is primarily driven by rapid urbanisation, increasing population, and infrastructure development. The water industry in the UK serves nearly 50 million household and business customers across Wales and England. The UK water industry caters through a network which is more than 340,000 km long. It manages 6,000 wastewater treatment plants and 567,000 km of sewers. Among the 16 regional Companies in the UK water industry, 10 Company provides both water and wastewater services.

Growth Prospects and Risk Assessment

The Company has a unique combination of environmental infrastructure assets, which has created significant shareholder value over the years. The Company aims to be the industry leader in the UK water industry, after the disposal of Viridor division. It has a vast network of water and wastewater services to serve around 2.2 million customers annually. Moreover, the business has been resilient during the Covid-19 disruption, while maintaining a strong funding and liquidity position. Furthermore, the Group has created a substantial headroom with net cash proceeds of around £3.7 billion (from the sale of Viridor business) for pursuing growth opportunities. The Group is focused on innovations and new techniques to deliver improved services and long-term value. The Company is capitalising on synergies, best practice, capabilities and strengths to achieve a leading position in UK infrastructure. PNN is seeking growth opportunities through increased investment in asset portfolio, expansion of customer base and partnerships with other Companies. 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. However, as a domestically-focused utility company, it is well-positioned to deliver sustained growth despite domestic uncertainties.


 (Source: Presentation, Company Website)

However, the Company also operates in a strict regulatory framework, which can affect the pricing and performance. Moreover, the unfavourable economic conditions can lead to a non-recovery of customer debt and change in the commodity prices. The Group is also exposed to operational risk arising from a loss of customers with increased competition and poor operating performance due to the climate change. One of the principal risks faced by the company, which might result in failure to deliver on strategic priorities and add value is the threat of change in government policies, especially renationalisation of the water industry. 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 the local authority. To meet the new regulations, the group needs to implement new processes, failing to do so would increase the compliance risk.

Business Outlook Scenario

The Company has declared a higher dividend growth of 6.6 per cent for FY2020 (43.77 pence) against last year comparative, but it expects revenue for FY21 will be on the lower side, due to the COVID-19 pandemic. The Group witnessed a solid operational and financial performance in FY2020. It is also on-track with robust liquidity and funding capabilities to weather the existing uncertainty due to Coronavirus. The defensive business nature of the company is allowing shares to uphold despite free fall in the broader market space. Further, the Company has consistently delivered ROE of above 10% over the past five years. PNN has successfully completed the sale of its Viridor business with an objective to focus on industry-leading water and wastewater businesses.

Over the course of 4 years (FY16 – FY20), the company’s revenue surged from GBP 168.3 million in FY16 to GBP 207.4 million in FY20. Compounded annual growth rate (CAGR) stood at 5.36 per cent.

Based on the decent prospects and support from the valuation as done using the above method, we have given a “BUY” recommendation at the current price of GBX 1,086.00 (as on 13^th July 2020, before the market close at 10:54 AM GMT+1), with lower double-digit upside potential based on 28.28x Price/Earnings (approx.) on FY21E earnings per share (approx.).
 
*All forecasted figures and Peer information have been taken from Refinitiv, Thomson Reuters.
*Dividend Yield may vary as per the stock price movement. 

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