More on Severn Trent
Severn Trent: 2005/6 results
Severn Trent, a water company, reported that operating profits (before exceptional charges) for the year to March 2006 rose 22.4% (to £488.2m).
Severn Trent Water, which accounted for around 81% of operating profits in 2006, reported a 13.4% increase in turnover (to £1,150.9m) on the back of a regulatory price increase of 15.2%. The disposal of the company’s waste collection and treatment business, Biffa, planned for October 2006 means that future earnings will be dependent entirely on the water business – something that the market has welcomed on the assumption that the company will be more efficient if it focuses on its core business.
The imposition of a couple of fines by the regulator in the recent past however does throw some doubt on the company’s management skills. Ofwat announced, in early June 2006 that it expected to impose a fine on Severn Trent for failure to meet required customer service standards. The exact amount of the fine is yet to be determined and investigations by Ofwat are on-going.
The chairman of Ofwat was quoted in the press as saying “”It is extremely disappointing that we have had to launch this investigation into an area of Severn Trent Water’s customer service activities, following our earlier investigation into other aspects of its business.
“From the evidence we have seen it is clear that Severn Trent Water has failed to meet the GSS performance standards. The failures were within the company’s control and customers’ interests have been damaged”.
Severn Trent responded by saying that it “will continue to work in full and open cooperation with Ofwat and if customers have been disadvantaged then Severn Trent Water shall reimburse them”.
This fine follows one imposed in March 2006 for over billing its customers and submitting incorrect and misleading information to Ofwat. The company agreed to return £42m to customers and sacked a number of staff. Steps are also being taken to tighten internal procedures.
Our concern is not so much the financial penalties imposed but the weakness in its processes that Ofwat has uncovered.
Most utilities have reported decent results on the back of regulatory price increases. Given the fairly captive nature of their markets, most utilities would experience little difficulty in reporting good earnings provided they succeeded in winning favourable price reviews and maintaining operational efficiency. Given that most water companies have succeeded in winning favourable price reviews, investors in the sector need to weed out the less efficient players.
The company claims to have launched programmes that have reduced employee numbers; removed management layers; consolidated office accommodation and is streamlining procurement processes. As a result, operating expenditure is now,
Said to be “less than £4m” from the Ofwat determination.
Leakage, a measure of efficiency, increased by 3% from last year and was blamed on the colder weather and a greater number of burst pipes.
The share trades at 1190p, on a prospective PE (2007 earnings) of 14.5x, in line with the sector with a yield of 4.6%.
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