Pennon Group‘s (LSE:PNN) a FTSE 250 water utilities business. This should make it one of the most stable stocks around, but a 44% decline in the share price since 2019 tells a different story.
Despite having no competition and providing a service people can’t do without, the firm cut its dividend earlier this year. And with pressure coming from multiple sides, I’m wary of the 7.4% yield.
Dividend cuts
Earlier this year, Pennon announced a reduction in the amount it would be paying out for its final dividend. This was because the company was fined £2.2m for disposing of sewage into rivers.
By itself, this shouldn’t a big problem. There are a couple of reasons for this, one of which is if it’s a one-off event that won’t be an ongoing issue.
The other is the fact the 30.33p per share paid out as a final dividend was still an increase on the year before. The final dividend in 2023 was 29.77p per share.
The trouble is, this isn’t the only problem – Pennon’s been fined another £3.5m for an outbreak of cryptosporidium that’s likely to weigh on the dividend for 2025. And this could be about to get worse.
Regulation
The change of government looks ominous for water utilities across the board. I think there’s a decent chance the fines the company’s been paying could increase.
A key part of Labour’s manifesto involved tougher sanctions for water companies. And there’s a particular focus on sewage disposal – which is what Pennon was fined for last year.
This could result in greater fines, as well as increased power for regulators. Importantly, this isn’t a one-off thing, it has the potential to be an enduring issue for that 7.4% dividend.
Exactly what the consequences will be for Pennon and its shareholders remain to be seen. But I don’t see how it can be a positive for the company and it makes it difficult to buy the stock.
Water bills
Pennon’s business is also under pressure from regulators. It’s protected from competitors, but that means it doesn’t have the ability to set its own prices – these have to be approved by Ofwat.
Earlier this year, South West Water requested permission to increase water bills by 33% between now and 2030. Last month, the regulator announced that it would approve an increase of just 13%.
That’s a potential problem for Pennon. The company has to invest in its infrastructure and it will need to find the capital from somewhere.
Borrowing seems risky with a lot of debt already on its balance sheet. That means the cash may well have to come from dividends, creating a lasting pressure on the company’s income statement.
Sellign short
It’s easy to see why the stock’s attracting the attention of short sellers. Ofwat’s putting pressure on its revenues and the UK government’s threatening to increase costs.
Neither’s good for profitability or the dividend. That’s why I’m staying away from the stock even after a 44% decline over the last five years.
The post Down 44% and yielding 7.4%, is this FTSE 250 stock too cheap to ignore? appeared first on The Motley Fool UK.
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Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Pennon Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
