Pennon’s liquid assets keep the dividends pouring in
SOME professional investors take pleasure in unpredictable markets. They enjoy the adventure and the potential to make a fast buck. For most investors, however, current conditions are rather frightening. Share prices are gyrating, sentiment is fragile and the outlook remains uncertain.
In such circumstances, dividend payments are more welcome than ever, particularly when they are foreseeable for the next five years. This is the position at Pennon Group, which owns South West Water, Bournemouth Water and a substantial waste management firm.
Pennon has pledged to pay a dividend that is 4 per cent above the Retail Prices Index rate of inflation until 2020, a promise that offers real comfort to investors in search of income in a low interest rate environment.
Yet Pennon shares have fallen 20 per cent to 737p since the beginning of the year, hit by concerns over future profits at its waste division, Viridor. Many followers believe these worries are overdone and that Pennon is well positioned to offer good returns over the next five years and beyond.
South West Water is unusual among the ten regional companies that provide both water and sewerage in England and Wales.
Covering Devon and Cornwall, the area has 1.7 million customers. But numbers swell to about eight million in the summer when tourists flock to the West Country.
This can be difficult for the region, especially as it is home to 127 of England’s 418 bathing beaches.
Pennon is determined to rise to the challenge however, improving the quality of the region’s beaches and its drinking water. Water watchdog Ofwat thinks the group is doing a pretty good job.
The company has promised to invest £1 billion in the region between now and 2020, while reducing water bills and delivering dividends to shareholders.
Pennon also bought Bournemouth Water in April this year, which adds almost 500,000 customers to the group’s roster and should boost profits.
Then there is Viridor, viewed by some as an engine for growth and others as Pennon’s burden. Viridor offers three types of waste management – landfill, recycling and so-called energy recovery facilities, which produce electricity and in some cases heat from waste.
Sceptics point out that landfill is in decline, the money received for recycled goods has fallen as commodity prices have tumbled, and the energy recovery facilities have been years in the making.
However, Pennon is still making money from landfill and even though the number of its sites will fall from 20 to three by 2020, the group expects to find profitable new uses for these assets.
On the recycling front, Pennon has robust, long-term contracts with local authorities and industrial firms, and this business is set to grow as the Government and European Union strive to recycle more waste.
There are also high hopes for the energy recovery facilities, which are expected to make a substantial contribution to profits from 2017.
Seven facilities spread across the UK are now up and running and four more will come on stream by 2019, turning the contents of black bin bags into enough electricity to power a city the size of Birmingham. They already provide enough electricity to supply a city such as Leeds, according to Viridor.
Most analysts predict solid 4 per cent growth in Pennon’s underlying profits to £257million in the year to March 2016 and £281million the following year. A steady increase in the dividend is also forecast from 31.8p this year to 33.75p next year and 36p in 2017.
Midas verdict: Pennon offers a decent income and the shares should rebound after their excessive decline this year. A rewarding long-term buy.