Sewage and wastewater treatment remain a cloud over the water sector that UBS does not expect to dissipate soon.
Yesterday’s Environment Agency annual review again highlighted storm overflows, notes the broker, and while there was an improvement for some companies, the headline data was still poor and attracted criticism from the EA chair.
Ofwat’s draft for the coming price control covering 2025-30, meanwhile, has wastewater enhancement capex growing 500% for the listed companies (£8.8bn in 2025-30 vs £1.5bn in 2020-25).
To maintain their social licence to operate, companies need to make the expenditure and get quick results, but UBS sees it as a negative risk for the sector, even for the highest or 4* rated companies such as Severn Trent and United Utilities.
Of the listed companies, Severn Trent is a 'sell' with a price target of 2,340p with the bank seeing dividend sustainability in the price.
“The stock yields c5% in the full year to March 2026 (the same as National Grid).
“There is an 800bps higher RAB [regulatory asset base] premium over UU and 1,500bps higher over Pennon, which are high levels. In the case of Pennon, the shares price in a 30% dividend cut.”
UBS notes that while Severn Trent boasts it is sector-leading on environmental spills, it is not immune to criticism as evidenced by the OFWAT enforcement case opened against the company.
Pennon (PT 870p, Buy) remains UBS's top pick on a 1% premium to March 2025 RAB, followed by United Utilities (PT 1,180p, Neutral) on an 8% premium and Severn Trent (PT 2,340p, Sell) on a 16% premium.
“We see a dividend cut priced in for Pennon, but Severn Trent already looks to price in very high ODI [performance incentives].”