Analyst comment: tie ups hedge against "full-blown" competition as Severn Trent prelims sh


Incumbent water companies may hedge against the possibility of "full-blown wholesale competition" by forming "mutual non-encroachment pacts" in a bid to prevent competitors gaining a hold on their patches according to analysts with Agency Partners, Lakis Athanasiou.

In a comment on Severn Trent' Water's 2015-16 preliminary results, Athanasiou included the company's recently unveiled joint venture with United Utilities as an example of such a protective pact. "Industry re-structuring of this kind will not add value or provide investment opportunity. It merely seeks to preserve the status quo and prevent value destruction," he said.

He said a bid for the company was "unlikely" with the risk of slower returns across the sector were there to be a shift in the inflation measure form retail price index to consumer price index (CPI). But the company's current stock value, at 128% regulated asset value (RAV), included bid speculation according to Athanasiou.

"Value above 100% of RAV comes solely from assuming Ofwat continues to give excess returns in future price reviews. The market is willing to make this assumption given regulatory precedent, and current low real market rates," he added.

Value additions from operational outperformance was "trivial" compared to the impacts of efficiency gains on allowed returns and the potential dampening of returns by CPI said Athanasiou. Severn Trent predicted a £260m totex efficiency gain from the price review period. A forecast £120m in reinvestment would give it a net gain of £140m. Severn Trent reported Output Delivery Incentive gains at £20m post tax, with £15m predicted for 2016/17.

Severn Trent preliminary annual results to 31 March 2016

· Group turnover £1,787m – down 0.8% year-on-year "due to regulated price decrease."

· Group underlying profit before interest and tax (PBIT) of £523m, down 3.2% year-on-year.

· Group reported PBIT £524m up 0.4%

· Return on Regulatory Equity (RoRE) of 8.4%

· Underlying basic earnings per share of 108.7p

· Final dividend of 48.40p, in line with dividend policy, taking the 2015/16 dividend to 80.66p

· ODIs: net reward of £23.2 million

· Efficiencies: now forecasting £670 million of totex efficiencies across AMP6 (£260 million outperformance).

· Totex: 2015/16 wholesale totex of £1,017 million, £38 million lower than Ofwat's Final Determination

· Energy: now generating equivalent of 33% of energy needs through our renewables programme; on track for 50% by 2020

· Financing: effective interest rate reduced by 90 basis points to 4.5%