Despite enjoying a bit of a rally since October 2023, the Severn Trent (LSE:SVT) share price hasn’t exactly been a stellar performer of late. The UK water infrastructure enterprise has seen its market capitalisation slide by over 10% over the last 12 months. And it seems investors are getting concerned about falling profit margins and its growing pile of debt.
However, has this downward trajectory secretly created a buying opportunity for long-term investors? Let’s take a closer look.
Cleaning up sewage spills
Given the high levels of oversight Severn Trent has to operate with, management has a tough time turning a real profit. It also doesn’t help that the sector as a whole has received a lot of criticism in Parliament relating to sewage dumps.
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To be fair, the company is hardly the worst offender. And a proven investing strategy is to buy when stocks are temporarily battered. After all, unpopular stocks have a habit of emerging as bargains.
In November last year, management unveiled its new spending plan, which seems to have been well received. The group is shifting £400m from the next regulatory period (that spans from 2025 to 2030) into the current one. This capital is being invested across the board with the sole purpose of cutting down the number of cracks and leaks in infrastructure to prevent sewage spills.
If everything goes according to plan, Severn Trent will have to spend less money in the long run on its clean-up, resulting in higher margins. That certainly sounds like a sensible plan. The only caveat is that it required another round of raising capital.
Severn Trent managed to get its hands on another £1bn through issuing new equity. While that has created dilution, the multi-billion-pound pile of debt on its balance sheet doesn’t exactly give it much choice. The good news is the firm has fully funded its new higher spending plans until 2026. And in the long run, as margins increase, Severn Trent’s leverage should start moving back in the right direction.
What’s new in 2024?
Today (14 February), the company released a brief trading update to give investors fresh insight into the progress being made. But it was pretty light on details.
The company intends to increase the number of customers for whom it provides financial support to 315,000 by the end of 2025. While it’s encouraging to see the firm take care of more vulnerable households, this move may be motivated by the appeasement of regulators. However, it’s also translating into higher Outcome Delivery Incentives (ODIs).
As a quick reminder, an ODI is a form of financial reward from regulators that feeds into revenue, providing companies like Severn Trent hit specific targets. Management is expecting to receive £50m by the end of its current fiscal year (ending in March).
Pairing this with as-expected performance, management has reiterated its full-year guidance issued last November. In other words, everything seems to be chugging along nicely.
So, is this a buying opportunity? Personally, I remain unconvinced. Today’s trading update provided very little insight into the state of the balance sheet and the progress made to reduce debt – a critical weak spot in this enterprise. Pairing that with a price-to-earnings ratio of 60 despite the downward trajectory of Severn Trent’s share price makes this business still look too expensive in my eyes.
