Shares in utilities such as water and electricity companies are often associated with steady dividend streams. That makes them attractive to a lot of investors with a long-term horizon. Over the past year, Pennon (LSE: PNN) shares have become 19% cheaper. Does the reduced Pennon share price mean this utility is now a bargain I should add to my portfolio?
The defensiveness of utilities
One thing that is true of Pennon as well as utilities more generally is that they are not always as defensive as many investors seem to think. At the moment, the Pennon dividend yield is 3.8%. I find that reasonably attractive. But if I overpay for a share, what I earn from a 3.8% dividend yield could be wiped out by the capital loss if I sell the shares in future.
Utilities have large capital expenditure costs, such as laying and replacing pipe networks. That can eat into profits and, like any share, a utility’s dividends are never guaranteed. Indeed, Pennon’s dividend last year was lower than it had been in 2020.
Pennon does have attractive characteristics common to many utilities, such as robust customer demand and limited competition. I think those things are financially appealing – I just do not want to overstate their attractiveness.
Falling Pennon share price
Why has the Pennon share price been losing ground?
The dividend cut could explain part of it, as that reduces the attractiveness of the investment case. But the profit picture has also been getting less attractive than before. Last year’s profit was 99% lower but that shocking figure obscures the reality, as it includes some exceptional accounting items. I think a more useful figure is pre-tax profits. They also fell last year, but by a more modest 3.3% to £128m.
Still, a fall is a fall. Profits were down and the dividend is also lower than it used to be. So, what is the investment case for Pennon at this point?
Pennon bull case
Water utilities benefit from fairly stable and predictable long-term demand. Pennon has a well-established customer base and stable business. It is also trying to grow, for example, through its acquisition of Bristol Water. Bristol Water’s most recent business results came in ahead of expectations at the time of the deal.
Pennon will likely never be an exciting or fast-growing business. But it benefits from ongoing demand in a market with little or no real competition. Sprinkle in the chance of growth by acquisition and there is clearly long-term profit potential.
Not a bargain
However, I do not see the Pennon share price as a bargain. The market capitalisation of £2.6bn does not look cheap for a water share, based on last year’s earnings. The dividend is decent but there are many other companies offering similar or higher dividends in today’s market.
So I do not see the shares as a good deal and have no plans to buy any.
The post Does the falling Pennon share price make it a bargain utility? appeared first on The Motley Fool UK.
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Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Pennon Group. 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.