Investment Column: Not time to wade into Pennon's waters
Paypoint; Young & Co
Friday 26 November 2010
Our view: Avoid
Share price: 633p (+8p)
After the high excitement surrounding Ofwat's five-year price review, concluded last November, some semblance of normality is returning to the water sector.
Notwithstanding the imposition of a £1 real-terms cut for every customer of Pennon subsidiary South West Water's bills by 2015 (compared with the company's request for a £5 rise), Pennon Group's first-half results, published yesterday, still managed to beat analyst expectations.
Revenue was up by more than 10 per cent to £593m and pre-tax profits up by 0.7 per cent to £96.2m. Better still, an interim dividend of 7.5p per share represents an increase of a tasty 7.9 per cent, all part of the policy to raise the dividend by 4 per cent above inflation every year to the end of 2014/15. Within the group totals, South West Water managed a mere 0.6 per cent squeeze on profits from the new price settlement, thanks to a dry summer that boosted earnings by some £7m above analysts' expectations. Meanwhile, Pennon's waste management business, Viridor, recorded a whopping 29 per cent profits rise in the most recent results.
The outlook for the second half is less robust as seasonal factors – such as the boost from the dry summer weather – phase out. But cost-cutting at South West Water, and opportunities from Government targets on landfill, recycling and renewable energy for Viridor, all offer longer-term uplift.
Pennon is not an unattractive stock with the highest dividend growth policy in the sector. It is the water stock most likely to be able to continue this growth beyond 2015. It is also least exposed to inflation, due to the dilutionary effects of Viridor.
But, in the aftermath of the pricing debates, the sector is looking, dare we say it, boring. In January, we recommended Pennon investors take profits. It is not yet time to buy back in. Avoid.
Our view: Hold
Share price: 320.25p (Unchanged)
Investors familiar with Paypoint could not have missed the massive share price spike in July. The stock jumped by more than 30 per cent on the day the National Lottery Commission (NLC) said it was provisionally minded to turn down Camelot's plan to offer activities such as mobile top-ups, bill payments and other services through its lottery terminals.
The nod would have been a headache for Paypoint, which offers similar services. We are still waiting for the final decision, however, and though Paypoint says it is well prepared either way, we think a change in the provisional stance would be negative for the shares.
That said, Paypoint is currently on a firm footing. Yesterday's interim results showed that pre-tax profits were up 5.4 per cent to £14.6m. The interim dividend was raised by a similar amount to 7.8p and the company said that, compared to the first half, it expected bill payment volumes to expand over the second.
The valuation is also supportive. Paypoint trades on multiples of under 10 times UBS's forecasts for next year, under 9 times on the broker's numbers for 2012 and under eight times on its estimates for 2013. This is not an expensive stock. But we worry that it will only tread water over Christmas and in January as the market awaits the NLC's final ruling. Hold for now.
Young & Co
Our view: Hold
Share price: 580p (+35p)
Young & Co's Brewery bought a couple of pubs in the first half of the year, but investors are waiting for news of a more significant acquisition. The management reiterated yesterday that it was looking to buy and the value of the stock will depend on the terms of whatever deal emerges.
Meanwhile, Young's showed an impressive underlying performance in its half-year results with profits up 8 per cent, beating City forecasts. The group trades well in London which helped drive like-for-like managed pub sales up 0.8 per cent. With gearing of 36 per cent it also has one of the sector's stronger balance sheets.
Unusually for an Aim stock, Young's has increased its dividend for each of the past 14 years, with an estimated full-year yield of 2.4 per cent. The stock trades on 18.8 times estimated 2011 earnings, which looks pricey but is in line with peers. The outlook for the pub industry is not particularly rosy, however, with tax rises, job losses and the Government's austerity programme hitting customers' pockets. Young's is a sector star so, while buying now is risky, we'd keep holding.
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