Is Severn Trent Plc A Super Income Stock?

Does Severn Trent Plc (LON: SVT) have the right credentials to be classed as a very attractive income play?

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Strong Performance

The last five years have seen shares in Severn Trent (LSE: SVT) (NASDAQOTH: SVTRF.US) deliver gains of 83%. This is highly encouraging and is ahead of the capital gains posted by the FTSE 100, which is up 73% over the same time period. One reason for this is continued speculation surrounding potential bid rumours, with the board of Severn Trent knocking back a bid last year. Bid rumours aside, does it still hold its own as a super income stock?

Yield

With a yield of 4.3%, Severn Trent appears to tick the ‘income’ box on investors’ checklists. Indeed, it easily beats the FTSE 100’s yield of 3.5% and is well-ahead of both inflation and the best interest rates that high street banks can offer.

water-256349_640However, Severn Trent appears to be extremely generous when it comes to the proportion of earnings that it pays out as a dividend. That’s because dividends for the current year (to the end of March 2014) are set to equate to around 96% of net earnings, which leaves only a sliver of capital with which to reinvest in the business. Furthermore, the dividend payout ratio looks set to remain at equally high levels over the next two years, which could cause a concern for shareholders.

Dividend Growth

Of course, Severn Trent doesn’t have to plough profits back into the business. It can instead borrow to make the necessary capital expenditures, although clearly no company can borrow infinite amounts in perpetuity. Partly due to the payout ratio being so high, Severn Trent is forecast to raise the dividend in 2015 before cutting it to just below its current level in 2016. This means that, while many of its FTSE 100 peers are forecast to raise dividends in both of the next two years, Severn Trent is not.

Looking Ahead

With shares trading on a price to earnings (P/E) ratio over just over 22 (versus around 13.5 for the FTSE 100) they do not seem to offer particularly good value for money. Of course, the current share price may include a premium for bid potential, which would partly explain why its rating is so much higher than that of the market. However, even though its yield is relatively impressive, Severn Trent’s lack of dividend growth prospects over the next two years and high payout ratio mean that while it is a strong income play, it is not quite a super income stock.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter does not own shares in Severn Trent.

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