Severn Trent PLC (LON: SVT) – Sound business model and robust financial position

Severn Trent PLC (LON: SVT) is an FTSE-100 listed Utility Company, which deals in providing water & waste services and developing renewable energy solutions. SVT provides regulated waste and water services through two companies. Severn Trent provides water-related services throughout England, and Hafren Dyfrdwy encapsulates the Wales region. Furthermore, Severn Trent Business Services offers diverse services to municipal and industrial clients. It also generates renewable energy from wind turbines, hydro schemes, and solar panels. SVT has also expanded its footprints in the food waste market from Derbyshire to South Wales. SVT is also engaged in the property development business and developer services.

On 26 May 2021, SVT will release the full-year FY21 results.

(Source: Company website) 

Recent Trend of Dividend Payments

(Source: LSE, chart created by Kalkine Group)

Severn Trent has adopted a progressive dividend policy and recognised the importance of dividends for pensioners and other investors. Moreover, the interim dividends for FY21 grew by 1.5% to 40.63 per share. It was paid on 06 January 2021, with an ex-dividend date of 03 December 2020. Furthermore, SVT had affirmed that the final FY21 dividend would remain in line with AMP7 (seventh cycle of Asset Management Plan) policy.

Growth Prospects and Risk Assessment

SVT has a proven track record of generating regular dividend payments for the investors and maintained remarkable Return on Equity from the last five years. Meanwhile, in terms of credit ratings, Moody’s and Standard & Poor had maintained a stable outlook with long term credit ratings of Baa2 and BBB, respectively. SVT had begun a discussion with Ofwat regarding the funding being made available to invest in Green Recovery in the next five years. Moreover, it would deliver sustainable improvements, including reduced carbon water treatment, water abstraction, flooding resilience and river quality for the region.

(Source: Company presentation)

The Biodiversity program remained on track to deliver genuine environmental improvement in the region of 3,000 hectares. Moreover, SVT has a long-term objective to deliver a significant environmental improvement of 5,000 hectares by 2027.

However, there are certain potential risks that can impact the business, such as financial risk, sustainable risk, legal & regulatory environment, failure of the water reservoir, interest rates fluctuations, higher inflation, climate change, etc. Moreover, SVT may be unable to maintain the desired level of customer services. There might be a danger to the health & safety of people considering the nature of operations.

Industry Outlook Dynamics

According to Grand View Research’s latest report, the market size of the global water and wastewater treatment equipment industry was USD 61.60 billion during 2020. Furthermore, the industry is expected to grow at a CAGR of 4.0% from 2021 to 2028. The increasing demand for water due to rapid industrialization and urbanization would fuel up the product demand for the forecasted period. Moreover, growing investments in wastewater treatment facilities would drive market growth.

After understanding the industry dynamics, we will analyse some key fundamental and shareholders statistics of Severn Trent Plc.

A Glimpse of Business Segments (H1 FY21)

(Source: Company Website, created by Kalkine Group)

Trading Update (for the period 1 October 2020 to 4 February 2021)

• The Company has carried positive momentum through the winter, while delivering resilient financial results and strong operational performance.
• It remains on track in the water business, with a number of measures, including the water quality complaints and compliance risk index.
• In the Waste business, SVT has started the AMP (Asset Management Plan) strongly with a 15% reduction in pollutions and 25% fewer blockages in the calendar year.
• Further, the Company is ahead of target for around 80% of the customer performance measures and expects 2021 Customer ODIs to be in the range of £25- £50 million.
• In FY21, the Company expects a stable outlook and remain confident of delivering the results in line with expectations.
• It also confirmed that the 2021 final dividend would be in line with the AMP7 policy.
• The Company supports the Net Zero campaign through the Triple Carbon Pledge and makes good progress, with the recently launched Terra Carta.
• In the Government's Green Recovery initiative, the Company made potential investment opportunities and submitted a number of proposals on 31 January 2021.

Financial and Operational Highlights (for the six months to 30 September 2020 (H1 FY21), as on 26 November 2020)

(Source: Company Website)

• The Company delivered a strong operational performance, with 4 EPA accreditation from the Environment Agency, a full-year ODI reward of at least £25 million, and improved UK customer satisfaction index scores.
• Group turnover was in line with expectations, while the revenue declined by 2.5% YoY in H1 FY21.
• The decline in revenue was caused by the lower consumption from non-household customers due to the Covid-19 pandemic; however, it was partly offset by higher household consumption during the lockdown.
• Group’s underlying PBIT (profit before interest and tax) was down by 21.2% YoY, driven by lower revenue and an increase in bad loan provision.
• Underlying basic EPS declined by 25.4% YoY, and basic EPS decreased by 30.8% YoY, both impacted by lower PBIT.
• The Company did not record any loss in H1 FY21 as it completed the write-down of its investment in the joint venture Water Plus.
• It witnessed strong liquidity, with a sustainable bond issue of £300 million and a one-year extension of the RCF (£890 million of undrawn facilities).
• SVT has made a fast start to the capital programme for AMP7, recording a cash capex of £283.5 million.
• It announced an interim dividend per share of 40.63 pence, an increase of 1.5% as compared with the previous year. This dividend was in line with the AMP7 policy. Moreover, SVT has a proven track record of paying consistent dividends.
• Operationally, it has delivered a strong start and remained confident of a net positive outcome on Customer ODIs (Outcome Delivery Incentives).
• The business remained financially strong, and it has made significant improvement against leakage, supply interruptions and water quality complaints.

Financial Ratios (H1 FY21)

Share Price Performance Analysis

On 12 March 2021, at the time of writing (before the market close, at 9:05 AM GMT), Severn Trent PLC shares were trading at GBX 2,222.00, down by 1.06% against the previous day closing price. Stock 52-week High was GBX 2,593.00, and Low was GBX 1,994.50, respectively.

From a technical standpoint, 14-day RSI (46.52) supports an upside potential.

In the last ten years, Severn Trent PLC’s stock price has delivered a return of ~64.95% as compared to ~70.78% return of FTSE 100 index and a ~5.45% return of FTSE All-Share Gas Water & Multiutilities index, which shows that the stock has outperformed the benchmark sector but underperformed the benchmark index.

Valuation Methodology: Price/Cash Flow Approach (NTM) (Illustrative)

Business Outlook Scenario

The Company had provided proper financial guidance for FY21 and anticipated full-year results to fall in line with the expectations. SVT remained ahead of target for approximately 80% of its customer performance measures. Severn Trent expects to generate a turnover in the range of £1.63 billion to £1.67 billion for the Regulated Water & Wastewater division, which is expected to decline by around £50 million to £85 million adversely impacted by the Covid-19 pandemic. The operating costs for FY21 are expected to be higher year-on-year due to an increase in chemical usage to meet tighter effluent consents. Moreover, SVT had raised its guidance for Customer ODI (Outcome Delivery Incentive) from at least £25 million to at least £50 million during FY21.

For the Business Services division, SVT anticipated lower underlying PBIT (profit before interest & tax) for FY21 due to the impact of lower energy prices on renewable energy revenue. The underlying property PBIT is estimated to remain between £2 million and £5 million during FY21. At the Group level, the capital expenditure is expected to be in the range of £500 million and £580 million during FY21. Moreover, SVT had estimated growth in annual FY21 dividend to 101.58 pence per share.

(Source: Company Presentation)

Considering the decent track record of dividend payments, strong operational performance, robust cash collections, robust liquidity and financing flexibility, the transition to a net-zero economy, good progress on both the disposals programme and the significant low-carbon investment opportunities, robust balance sheet, high level of cash generation capabilities, and support from the valuation as done using the above method, we have given a “BUY” recommendation on Severn Trent at the current price of GBX 2,222.00 (as on 12 March 2021, before the market close at 9:05 AM GMT), with lower-double digit upside potential based on 9.85x Price/NTM Cash Flow (approx.) on FY21E cash flow 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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