Water and waste services specialist Pennon (LSE: PNN) has released an upbeat trading statement today. It provides clues as to whether now is a good time to buy it, or if sector peer Centrica (LSE: CNA) is a better buy for the long term.
Pennon’s update shows that it’s on track to meet expectations for the 2017 financial year. Encouragingly, its performance across water and waste has been strong and its portfolio of energy recovery facilities is performing in line with expectations. In fact, Pennon’s energy recovery facilities are on track to contribute the targeted £100m of EBITDA (earnings before interest, tax, depreciation and amortisation) for the current year.
Furthermore, Pennon’s South West Water division continues to significantly outperform its regulatory contract and is set to record a sector-leading return on regulated equity again in the current year. Pennon’s cost savings programme is progressing well alongside a shared services review that’s now nearing completion. This positions it well for the long term as the liberalisation of the water services market is due to take place in the near term.
Clearly, a major appeal of Pennon is its stability. The waste and water services sector is a very stable space in which to operate and Pennon has proven to be a very defensive stock in recent years. In fact, it’s often the subject of a flight to safety among investors and with the outlook for the UK and world economies being uncertain, Pennon’s shares could outperform the wider index in the short run.
Volatility
Certainly, Pennon has more defensive appeal than fellow utility stock Centrica. The latter has been severely hurt by a falling oil price, which has caused its profitability to come under severe pressure. As a result, Centrica has initiated a major reorganisation and restructure that will see it sell off most of its oil and gas interests as it refocuses on becoming a more stable and consistent utility business.
As part of its restructuring, Centrica has slashed dividends. Despite this, it still yields 5.4% versus 4% for Pennon. However, in terms of the robustness of their dividends, Pennon has greater appeal. That’s despite Centrica having a superior dividend coverage ratio of 1.2 versus 1.1 for Pennon. In Centrica’s case, its earnings are far more volatile and less certain than for Pennon. Therefore, there’s a higher chance that Centrica’s dividend will come under pressure as it seeks to turn its fortunes around, while Pennon’s high degree of stability means that its income return should be relatively secure.
In the long run, Centrica has major turnaround potential. Its current strategy is sound and over the coming years it would be unsurprising for it to record strong returns. However, Pennon’s stability and the fact that it’s operating in line with expectations make it the better buy at the moment. That’s especially the case since the outlook for the global economy is highly uncertain, which could increase demand for safer stocks such as Pennon.
