HSBC downgrades Severn Trent on asset resilience issues

Analysts at HSBC downgraded their recommendation on shares of Severn Trent in view of the regulator's new push for the sector to increase its 'resilience', which in the case of Coventry-based Severn meant roughly £230.0m of additional capital outlays.

With the advent of the 2014 Water Act, Ofwat's chief duty will be to ensure that the companies under its remit have the ability to recover from "disruptions" and to anticipate trend changes so it can continue to maintain services and protect the natural environment.

Simply put, water companies and the regulator's overriding priority now is to avoid any potential for scarcity of water supplies on a sustainable basis.

That has important implications for Severn, which HSBC judges will not be able to continue to abstract water at the current rate, which will require up to £230.0m of investment in new sources.

On top of that, Severn's 'financial resilience' is less than its peers, HSBC said, "noting" the pension repair contributions announced alongside its first half numbers.

Hence, HSBC downgrades Severn from 'Hold' to 'Reduce' and cuts its target from 2,330p to 2,200p.

Nonetheless, for the UK Water sector as a whole Ofwat's PR19 Price Review may provide an opportunity for accelerated investment by all companies, particularly Severn, which sports the largest regulated asset base to 2020, the analysts said.

As an aside, HSBC indicates that Pennon and United Utilities have "manageable" water resilience issues, with the latter especially having demonstrated both water resilience as well as high high levels of financial resilience.

Pennon and United were kept at a 'Buy', with the broker nudging its target for the latter from 1,060p to 1,070p.