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Have you considered these ‘hidden’ risks with Severn Trent’s 5% dividend?

I last wrote about water and wastewater company Severn Trent (LSE: SVT) back in November 2018 and since then the share price has wiggled a bit but essentially made no upward progress.

So what? Dividend investments are all about income for shareholders, right? Well, on that score, today’s full-year results announcement delivers positive news. The directors increased the total dividend for the year by almost 8% on the back of revenue coming in 4.2% higher than the year before, and underlying earnings per share shooting up 21%.

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Big borrowings

To put that in context, though, the dividend has only risen by around 16% over the past five years. One of the big challenges, as I see it, is the way the firm has to manage its gargantuan debt load.

Severn Trent isn’t unusual among utility outfits in having high borrowings. Indeed, the sector sucks up money in vast quantities to keep infrastructure well maintained and to invest in an almost constant flow of improvements. But whichever way you look at things, there’s always a limited inflow of cash from operations, and interest on debt competes with shareholder dividends for that cash.

Today’s report reveals net debt stood at just over £5,834m on 31 March, up almost 9% compared to one year earlier. Meanwhile, the company brought in net cash from operations of £805m during the year. That sounds like a hefty amount of cash, but the cash flow statement reveals that investments cost the firm almost £826m, mainly in property, plant and equipment. That’s right, Severn Trent ploughed more money back into the business than it generated during the year.

After that, it still had to pay out £158m to service interest on its borrowings and almost £212m to pay dividends to shareholders, among other things, which I think explains why borrowings went up during the year. Should a company be paying dividends at all if it has to borrow money to do it? I’m not comfortable with that.

Principal risks and uncertainties

Admittedly, the company did finance at least one acquisition during the period, a company called Agrivert Holdings, which cost £120m. The enterprise generates renewable energy from food waste and Severn Trent added it to its non-regulated green power business segment.

I’m not convinced it’s a good idea to divert cash flow to expansion and diversification when the company’s existing mountain of debt makes the enterprise so precarious in its financial standing, at least in my view.

Today’s report is remarkable in its detail, but one of the most interesting aspects to me is the company’s list of principal risks and uncertainties. For example, the directors highlight the risk of non-compliance because of being unable to keep pace with complex and ever-changing regulation.

There’s also the risk that a Labour government could nationalise the industry. And the firm also named one of my main fears – that it may find itself unable to fund the business sufficiently in order to meet its liabilities as they fall due. 

Any one of these risks could knock on the door in the future and I think Severn Trent is far from being a ‘no brainer’ dividend investment.

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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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