Today’s quarterly update from water services company Severn Trent (LSE: SVT) contains a pleasant surprise for its investors. It now expects to receive a payout of over £23m, thanks to over-delivering on its performance targets. Furthermore, the rest of its business has operated in line with expectations, which provides more evidence that it is a stable business. Alongside a relatively high yield and dividend growth potential, does this make it the best dividend stock in the world?
The company now expects the net customer Outcome Delivery Incentive (ODI) reward for the full year to be at least as much as for the prior year. This means they should be at least £23.2m, which is significantly higher than previous guidance of £15m. Although there are a couple of unpredictable winter months ahead for the business, the chances of a greater amount being received than previous guidance seem high.
Severn Trent remains committed to delivering its £670m total expenditure efficiency target in the current regulatory period. It will also seek to keep financing costs lower as it embarks on a major efficiency programme. This could help to boost the company’s financial performance and lead to greater capital available for distribution to shareholders.
Clearly, utility stocks such as Severn Trent and water services peer United Utilities (LSE: UU) offer their investors relatively consistent business models. Due to the nature of the services they provide, demand is relatively consistent and their financial outlooks are fairly straightforward to forecast, since they must adhere to long term regulatory plans. Coupled with yields which are generally above average, this makes them ideal income stocks.
United Utilities currently yields 4.4%, which is 0.7% higher than Severn Trent’s yield. Certainly, the latter has a higher dividend coverage ratio of 1.3 versus 1.2 for United Utilities. However, in both cases dividend growth is expected to average 3% per annum during the next two financial years. This rate of growth should mean that the two stocks offer above-inflation increases in their payouts, which is likely to mean they remain in-demand among investors.
As well as having a higher yield than Severn Trent, United Utilities has a lower valuation. It trades on a price-to-earnings (P/E) ratio of 19.8, versus 20.8 for its sector peer. While there is not a large difference between the two, there is likely to be more capital gain potential in the cheaper stock – especially since it has a higher yield and may therefore be more enticing to income-hungry investors.
As such, Severn Trent does not appear to be the best income stock in the world. Its yield is too low and its dividend growth rate too sluggish when compared to a sector peer. However, it continues to offer an above-average yield, dividend growth which should at least match inflation, and above all else a business model which is very consistent, predictable and robust. For these reasons, it remains a sound income stock for the long term.