Severn Trent: past, present and future

As the market anticipates further M&A in water, Nigel Hawkins looks back at the history of prime target Severn Trent

In world affairs, 1989 was a big year, memorable for the fall of the Berlin Wall and the collapse of communism in much of Eastern Europe. The changes there since those halcyon days have been massive.

In the UK, 1989 saw the controversial privatisation of the water sector. Ten companies were floated, led by Thames, which reputedly viewed itself as water’s British Airways, whilst the other nine were sometimes relegated to the status of country cousins, including Severn Trent.

Remarkably, in the intervening 26 years, whilst other major companies have undergone deep-seated change, Severn Trent remains essentially the same, namely the monopoly supplier of water and sewerage services to c3.7 million households centred on the Midlands.

Aside from its acquisition in 1991 of Biffa, the waste company that it subsequently demerged, and the acquisitions of a few minor businesses in the UK and in the US, its structure has remained intact.

Boring maybe – and hardly in line with the ‘conquering the world’ philosophy that some ambitious water executives held at flotation.

Instead, Severn Trent has effectively ‘stuck to the knitting’ and avoided the high-profile non-core mishaps that befell many of its competitors, including Thames and Anglian inter alia.

At flotation, there had been concerns about Severn Trent’s formidable investment programme, although the water and sewerage facilities in Birmingham during the latter part of the 19th century were well ahead of their time.

But other urban centres, including depressed Wolverhampton, the Potteries centre of Stoke and war-torn Coventry, all had pressing sewerage infrastructure back-logs.

In recent years, investment levels have remained high, with £547 million being spent in 2014/15: over the current five-year regulatory period, Severn Trent will continue to invest heavily.  

Significantly, Severn Trent’s supply base remains broadly unchanged, although it did absorb many former statutory water companies prior to privatisation.

Subsequently, only East Worcester, with just 100,000 customers, was acquired in 1993.

Rather oddly, perhaps, Severn Trent – despite being the only land-locked water and sewerage company – did make a pitch to acquire South West – and its beach challenges – in 1996.

But, like the similar Wessex initiative, this failed, leaving South West as the core element within the publicly-quoted Pennon Group. 

Given its large supply base at the heart of England, and its comparatively low water charges, Severn Trent was better placed than most to develop a multi-utility supply business.

However, unlike ScottishPower, United Utilities and the ill-fated Hyder (Welsh Water), it did not pursue this route. And looking at the problems that Hyder in particular faced, Severn Trent’s investors will not regret this unadventurous – but prudent – decision.

Severn Trent has, though, developed various small non-core businesses, including scientific services, although none has provided the break-through returns – which have stalled recently – of Pennon’s Viridor.

It is, though, becoming increasingly involved with renewable energy and plans to invest £190 million in such projects over the next five years

Investors have benefitted substantially from Severn Trent’s cautious approach. Not only have they received a decent dividend flow, but there has also been impressive capital appreciation.

In 1989, the original flotation price had been 240p, with Severn Trent being sold – on partly-paid basis – on a yield exceeding 7%.

The share price is now c£21. Whilst various adjustments need to be made to calculate an exact out-performance, Severn Trent’s returns have more than trebled against the FTSE 100 Index.  

Of course, there have been occasional glitches, some of which were due to political nervousness before election day – 1992 being an example – and others being exclusive to Severn Trent, mostly either Ofwat or Biffa-related.    

With its strong core business focus, Ofwat and its periodic reviews are critical to Severn Trent’s financial health – and its ability to meet investors‘ dividend growth expectations.

In fact, Severn Trent has enjoyed good periodic reviews, with only the 1999/2000 review, undertaken by Sir Ian Byatt, being seen as tough.  

Subsequently, the periodic reviews have been more benign, although Ofwat’s latest determination under chief executive Cathryn Ross, was far more searching and rigorous – as Bristol has discovered to its cost.

Indeed, whilst water prices have increased substantially in real terms since flotation, Severn Trent’s customers currently pay the lowest annual charges nation-wide – an average £329.

More immediately for Severn Trent, the market remains on the look-out for a renewed bid.   

Back in 2013, Severn Trent’s board bravely rejected a private equity bid of £22 per share, in the expectation that, once the periodic review was ‘done and dusted’, its share price would top this figure.

Last October, it did so, but it has fallen back subsequently, as the market frets about economic uncertainty: there has been a dire trading start to 2016.

Deflation and asset sell-downs are two recurring themes that have become more prominent recently. If they do persist, then Severn Trent investors may have to wait rather longer for a renewed bid.

But, for Severn Trent’s chief executive Liv Garfield and her team, the priority has to remain managing the core business and achieving significant out-performance of Ofwat’s 2014/15 determination, whilst simultaneously delivering real dividend growth, albeit from a slightly lower base than previously.    

Nigel Hawkins (nigelhawkins1010@aol.com) is a Director of Nigel Hawkins Associates which undertakes investment and policy research