Equity prospects

SEVERN TRENT

John Royden, Head of Research

Price£22.43

52 week high-low£23.79—£17.58

Net yield4.3%

Hist / pros per17.8—16.5

Equity market cap£5,292

Ofwat regulates the water companies. On 16th December 2019 Ofwat publishes its determinations for how water companies will get rewarded in the next regulatory period called AMP7 (2020 to 2025).

There has been political pressure on our utilities. The Tories capped electricity bills and the pressure on the water industry has manifested itself in an expectation for bill reductions. This in turn has driven Ofwat into pressing for a lower allowed return on equity and moving from RPI to CPI as the basis for growing revenues. Ofwat will also squeeze total expenditure, which is the amount that Ofwat expects companies to spend over the AMP (Asset Management Period).

Whilst lower bills and moving to CPI make for good tabloid headlines and smiling politicians, there is an element of Ofwat taking with one hand and giving with another. By changing “below the tabloid radar” rules to accelerate water companies’ cashflows over the medium term, Ofwat can compensate for some of their taking. The result is that if Severn Trent and others in the industry (such as Pennon and United Utilities) cut their dividend, we would expect compensation to come in the form of higher expected dividend growth rates.

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