Should I Buy Severn Trent?
Dec 10th 2012 12:01PM
Updated Dec 10th 2012 12:06PM
It's time to go shopping for shares again, but where to start? There are loads of great stocks to choose from, and I've got my wallet out. So here's the question I'm asking right now. Should I buy Severn Trent ?
Weak as water
It's been a soggy six months for water company Severn Trent, whose share price has plunged nearly 14% since June to £15.50. It is supposed to be a solid high-yielding utility, an ideal safe haven in these troubled times. So what went wrong, and is now the time to fill your glass?
Lucky number Severn
You might think a water company would welcome a wet summer (unlike the rest of us), but business customers such as farmers don't need to pay for stuff that is freely falling from the sky, and consumption fell 2.8%. This was more than offset by regulated price increases, which rose 5.2%, leaving overall group revenue up 3.5% to £917 million, according to the company's recent half-year results. Underlying profit before tax rose 1.6% to £157.5 million, and management raised its half-year dividend 8.2%, from 28.04 pence to 30.34 pence per share. Group debt rose slightly, as did customer bad debts, but Severn Trent said it was on course to meet its full-year earnings. Nothing too stormy, but the results still dampened market spirits. As did fading speculation of a takeover.
The Trent is your friend
Anybody who invests in U.K. utility companies has to worry about heavy-handed regulation. That's what persuaded dividend maestro Neil Woodford to sell his entire stake in both Severn Trent and United Utilities in 2010, warning that if pressed too hard, water companies will have to turn off the dividend taps. Investors are waiting to hear what Ofwat has in store for the next regulatory period (the current one ends in 2015), and that could cast further shadows over the sector. Efficiency targets are likely to remain tough, although Severn Trent's board says its £150 million investment program is paying off, cutting leakages and pollution, and improving the service it offers to customers. But that's £150 million it won't be able to dish out to shareholders.
Sixes and Severns
The prime reason to invest in Severn Trent is its 4.5% yield, covered 1.3 times, which management aims to increase by 3% above inflation between now and 2015. But it is hampered by high levels of net debt at £4.05 billion, and will always be at the mercy of the regulator, who has to keep a restive public and meddling politicians happy. It also has only limited scope to expand its customer base. Long-term income seekers will be tempted, but with Severn Trent trading on a price-to-earnings ratio of 17 times earnings, they could end up overpaying for that yield. I'm not buying now. It would take a share price shock to change my mind. There's always the chance that an ill wind from the regulator could blow an opportunity our way.
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