An Ofwat fast-tracker

Severn Trent (SVT) is one of 10 water companies privatised in 1989, of which just three remain publicly quoted. SVT supplies 4.3m homes and businesses with clean water and sewerage services. Its base is in the Midlands; following the acquisition of Dee Valley, it now has a Welsh business, Hafren Dyfrdwy. The water sector is now in the throes of a key price review – the new pricing formula will apply as from April 2020. Ofwat has awarded ‘fast-tracker’ status to SVT, enabling it to secure a better deal than its peers – a dividend cut in 2020/21 is possible. Re-nationalisation by an incoming Labour Government is also a risk.

• Strategy: SVT seeks to deliver its £700m+ annual water investment programme, including the Birmingham Resilience Project, as efficiently as possible, whilst improving customer service. SVT is also at the centre of a major new Midlandsbased house-building programme, requiring large water infrastructure expenditure.
• Water/sewerage: The core business ‒ delivering clean water and sewerage services to its defined customer base ‒ is key. The ongoing price review is undoubtedly far tougher than its predecessor. SVT’s well-received 2018/19 fullyear results showed inherent core business strength, contributing £527m of PBIT.
• Valuation: SVT’s quoted valuation is £4.9bn. The prime valuation parameter is its Regulated Asset Value (RAV), which was £9.3bn at March 2019. It is this figure that is used – as the denominator – by Ofwat to calculate its price determination: indirectly, it sets the scope for dividend growth.
• Risks: Currently, water companies face two major risks: i) the price review – as a ‘fast-tracker’, SVT is better placed than many of its peers: focus will be on its dividend growth potential after 2019/20; and ii) possible re-nationalisation by an incoming Labour Government – any shareholder compensation could be meagre.
• Investment summary: SVT’s finances, despite net debt of £5.8bn, remain strong. Importantly, to boost its dividend growth potential, it has built up £177m of ODIs (Outcome Delivery Incentives) to use in the 2020/21-2024/25 regulatory period. Political concerns are also weighing heavily on utility sector share prices. 2020/21 figures below are primarily illustrative, given uncertainties on the AMP 7 outcome.