The moral of Severn Trent’s tale is that a ‘tough’ regulatory outcome in year one often looks very gentle by year three
Severn Trent today produced a pleasant surprise for its shareholders — a 63p per share special dividend costing £150m. Hold on, you might say, wasn’t the water industry clobbered in Ofwat’s last five-year price review? Didn’t Tony Wray, Severn Trent’s chief executive, himself describe the settlement for 2010-15 as “a tough outcome” — indeed, so tough that the regular dividend had to be sliced by a tenth?
Yes, the moral of this tale is that a “tough” outcome in year one often looks very gentle by year three. The principle of “buy the rumour, sell the fact” has long applied in the water sector. Share prices develop a wobble in the fourth and fifth year of the five-year regulatory period as investors contemplate the terrible things Ofwat might be about to do; the regulator, anxious not to appear a soft touch, encourages the thinking; the companies, obliged to present themselves as models of efficiency, squeal in terror.
By the time the drama has reached a conclusion, and share prices have been knocked, it’s usually time to turn bullish. In Severn Trent’s case, if you bought at the moment of the “tough” outcome at the end of 2009, you’ve enjoyed a two-thirds capital gain. Indeed, the shares have performed so well over the past three years that the yield implied by the regular dividend (up 7.7% to 70.1p) is 4.1%. That’s less than, say, Tesco’s safe-looking 4.9%, which is not the natural order of things.
To be fair to Severn Trent, it has also helped itself. Wray makes a strong case that he has delivered on the other half of his 2009 assessment that Ofwat’s price determination would prove “manageable.” He was able to point today to fewer leaks (below Ofwat’s target), a 15th consecutive year without a hosepipe ban and additional (ie, beyond the agreed business plan) investment of £150m in the network.
For all that, the special dividend may prove “somewhat inflammatory”, as Investec puts it, given customers have just had a 5.2% increase in the bills. So the stage is set for a repeat of the familiar regulatory drama as the show gets going again next year. In other words, shareholders will get nervous in about 18 months’ time; 12 months after that, there’ll be a buying opportunity.