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Should I Buy Severn Trent plc?

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I’m out shopping for shares again. Should I add Severn Trent (LSE: SVT) to my wish list?

Cry me a river

When I last looked at water company Severn Trent in December, its share price had plummeted 15% to £15.50 after a wet summer had hit agricultural demand and regulator Ofwat had made ominous rumbles over water company profits. That was a big concern, with the current regulatory agreement set to expire in 2015. Invesco Perpetual’s Neil Woodford sold his entire stake in Severn Trent in 2010, fearing that water company dividends would be diluted if Ofwat got too tough. At 17 times earnings, I concluded the risk wasn’t worth the price. But is it better value today?

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Severn Trent’s share price has had a flat 12 months, aside from a bout of takeover excitement in May, which pushed the stock to a 12-month high of £20.90. But management rejected the bid, claiming it failed to recognise the value in the business, and the excitement trickled away. Now it trades at £17.20. That still represents of rise of 23% over three years and 29% over five years, against 18% and 26% for the FTSE 100 respectively. So there is growth to be had, although being a utility, most investors will focus on the income. Right now, Severn Trent yields 4.41%. That is less than fellow water company United Utilities Group, which yields 5.05%, but still comfortably above the FTSE 100 average of 3.54%.

Lucky number Severn

It is also far more than you will get through a savings account, and better still, management increased the dividend by 8.2% over the last full year, in line with group policy of targeting dividend growth of RPI plus 3% until March 2015. In line with this policy, the 2013/14 dividend was lifted 6% to 80.40p. Maybe dividend stocks like this won’t look so tempting when interest rates finally start rising, but right now, they give succour for savers.

Severn Trent’s Q1 trading update broadly in line with expectations, with a 2% rise in customer prices, and a small, anticipated drop in consumption. Management welcomed the framework for the next price review, and is preparing to submit its plan to Ofwat in December. It recently claimed that its customers “continue to benefit from the lowest average combined water and sewerage bills in England and Wales”, which it no doubt hopes will keep the regulator off its back. Goldman Sachs has just reiterated its ‘buy’ recommendation with a target price of £22.11 almost 30% higher than today’s price. If you’re looking for a regular, rising income, and maybe a splash of growth, this stock could be for you. At 17.3 times earnings, however, it still isn’t cheap.

We know of one FTSE 100 utility that is paying a far higher income. That is why we have called it Motley Fool’s favourite stock pick. Our analysts have singled out this FTSE 100 favourite because it offers a sky high yield and great growth prospects. To find out what it is, download our free guide Power up Your Portfolio. It won’t be available much longer, so click here now.

> Harvey doesn’t own shares in any company mentioned in this article

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