Pennon Group PLC (LON: PNN) – Having a strong liquidity position to pursue investment opportunities and return lucrative value to the shareholders.

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 customers 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.

On 24 November 2020, Pennon expects to release the half-yearly results for FY21.

(Source: Company Presentation)

Dividend Track Record

In FY20, the Company declared a higher dividend growth of 6.6% (with a total dividend of 43.77 pence per share) against the FY19. At the annual general meeting on 31 July 2020, a final dividend of 30.11 pence per share was approved, which was paid on 2 September 2020. The next ex-dividend date is 21 January 2021.

The last dividend declared was in line with their dividend policy for FY2010-20 with retail price index (RPI) +4% growth per annum, which has been achieved while investing over £3.6 billion into the business over the past 10 years.

Going forward, the Company’s dividend policy for FY2020-25 would be the growth of CPIH (consumer price index) +2% per annum. The shift from RPI to CPIH reflects the change in the regulatory model for South West Water. The rebased dividend demonstrates the sector-leading position of the Company.

(Source: Kalkine Research, Refinitiv)

Growth Prospects and Risk Assessment

The Company has 23 raw water reservoirs, with a network of 17,515 km (kilometre) wastewater mains and 18,370 km of drinking water mains to serve around 2.2 million customers annually. Going forward, with the disposal of Viridor business, the Company has created a substantial headroom for pursuing growth opportunities and reorganising the capital structure to generate significant shareholders’ value. Moreover, the business has been resilient during the Covid-19 disruption while maintaining a strong funding and liquidity position. It 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.

(Source: Kalkine Research, Refinitiv)

However, there are certain risk and uncertainties to business growth. It is exposed to operational risk arising from a loss of customers with increased competition and poor operating performance due to climate change. Moreover, the unfavourable economic conditions can lead to a non-recovery of customer debt and change in the commodity prices. It also operates in a strict regulatory framework, which can affect the pricing and performance. Furthermore, 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.

Industry Outlook Dynamics

As per the publication from the Grand View Research, the market size for water and wastewater treatment equipment sector was valued around US$59.97 billion in 2019 and it is projected to reach around US$80.28 billion by 2027, representing a compounded annual growth rate (CAGR) of ~3.7% between 2019 to 2027. 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.

Key Fundamental Statistics

Key Shareholders Statistics

 

Key Recent Developments

On 8 July 2020, Pennon 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.

Business Segments

(Source: Company Website)

Trading Statement (as on 25 September 2020)

The Company unveiled the trading update ahead of the results for the half-year ended 30 September 2020. Trading performance was in line with the management expectations and is well-positioned to deliver resilient financial results. The impact of Covid-19 was broadly in line with the initial assumptions for a net revenue impact of £10 million in FY21. The cash collections across the Group remained robust. Led by efficient financing and totex, South West Water stays on track to deliver continued RORE (Return on Regulated Equity) outperformance. The Company will see approximately £20 million of outperformance from K6 shared, which comes under South West Water's WaterShare+ scheme (earlier launched in September). Further, Pennon remains in a strong financial position with anticipated cash and committed facilities well over £3 billion at 30 September 2020.

Financial and Operational Highlights (for the year ended 31 March 2020 (FY20), as on 4 June 2020)

(Source: Company Website)

• In FY20, the Company delivered strong financial performance and operational progress, with an increase in underlying EBITDA from continuing operations and Viridor of 3.1% and minimal changes to their business plan to 2025.
• The revenue from the continuing operations and Viridor for FY20 decreased by 6% year-on-year, driven by a decline in revenue from water business and Non-household retail business. However, the revenue from continuing business stood at £637 million in FY20, reflecting an increase of 0.6% for the period.
• The Company witnessed better control over expenses and strong performance across Viridor activities.
• The Board has declared a dividend per share of 43.77 pence for the financial year 2020, reflecting 6.6% higher on a year-on-year basis. Pennon has a consistent dividend payment track record from the last 10 years, with a lucrative dividend yield of ~4.18%.
• It has a vast network of water and wastewater services to serve around 2.2 million customers annually.

Financial Ratios – Strong Profitability and Liquidity Position versus Industry Median (31-March, FY2020).

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 the peers. On the liquidity front, Pennon Group Plc’s current ratio was significantly higher than the industry median of 2.68x, reflecting sufficient current assets to pay the 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 stood at 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

 (Source: Kalkine Research, Refinitiv)

On 25 September 2020, at the time of writing (before the market close, at 8:01 AM GMT+1), Pennon Group Plc shares were trading at GBX 1,027.00, down by 1.25% against the previous day closing price. Stock 52-week High was GBX 1,210.50 and Low of GBX 770.60, respectively.

From the technical standpoint, shares were trading well above the support level of 20-day (GBX 1,029.50) simple moving average prices, which reflects an uptrend in the stock and carrying the potential to move up further. Also, 90-day RSI is currently supporting an upside move (around 48.55 level), which means the stock price could increase in the short term.

(Source: Kalkine Research, Refinitiv)

In the last one year, Pennon Group Plc share price has delivered ~34.91% return as compared to negative ~20.20% return of FTSE 100 index, which shows that the stock has outperformed the index during the last one year.

Valuation Methodology: EV/Sales Approach (NTM) (Illustrative)

(Source: Kalkine Research, Refinitiv)

Business Outlook Scenario

Pennon is on track to deliver resilient financial results in H1 FY21. Moreover, the impact of Covid-19 is in accord with the initial assumption of £10 million impact over net revenue. The Company has received £3.7 billion as net cash proceeds pertinent to the sale of Viridor business. 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. As of 30 September 2020, it expects to have cash and committed facilities over £3 billion, while the debt restructuring plan is going well. 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. Going forward, the Company shall continue to pursue growth opportunities within the UK water industry, while returning attractive value to the shareholders.

Considering the solid financial position, high level of cash generation capabilities, strong relationship with customers and support from the valuation as done using the above method, we have given a “Buy” recommendation on Pennon Group at the current price of GBX 1,027.00 (as on 25 September 2020, before the market close at 8:01 AM GMT+1), with lower-double digit upside potential based on 7.18x EV/NTM Sales (approx.) on FY21E Sales (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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