Should I Invest in Severn Trent?

LONDON -- To me, capital growth and dividend income are equally important. Together they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value
If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.

So this series aims to identify appealing FTSE 100 investment opportunities and today I'm looking at Severn Trent  (LSE: SVT  ) , the water utility company.

With the shares at 1732 pence, Severn Trent's market cap. is £4,130 million.

This table summarizes the firm's recent financial record:

Year to March

2008

2009

2010

2011

2012

Revenue (£m)

1,552

1,642

1,704

1,711

1771

Net cash from operations (£m)

570

645

654

721

654

Adjusted earnings per share

97.8p

92.7p

122.8p

105.6p

88.9p

Dividend per share

65.63p

67.34p

72.32p

65.09p

70.1p

In recent news Severn Trent's CEO, Tony Wray, intends to retire in early 2014, after seven years in post. Such forward planning should help achieve a smooth succession process.

The new boss will control a water utility company established in 1974 when the then regional state-owned water authority was created, based in Birmingham, and snappily named after two of Britain's largest rivers within its catchment area (no prizes for correct identification!).

The firm provides water and sewerage services to domestic and commercial customers, and these regulated operations deliver around 97% of revenue. The remaining 3% is derived from non-regulated services and products associated with water, wastewater and contaminated land in the U.S., U.K. and Europe.

You only have to look at the debt-pile to realize the capital-intensive nature of the business. Interest payments take around 50% of operating profits, but then the firm's water infrastructure assets are reliable revenue producers with locked-in consumers. That's why investors are traditionally attracted to utility companies for the steady dividends they pay. Right now, the firm is yielding a thinly covered 4.7% based on forecasts. That's not bad, but the firm's high debt, low dividend cover and high-looking P/E multiple inclines me to be cautious about total-return prospects from here.

Severn Trent's total return potential
Let's examine five indicators to help judge the quality of the company's total-return potential:

  1. Dividend cover: adjusted earnings covered last year's dividend around 1.25 times. 2/5
  2. Borrowings: net gearing around 480% with net debt almost nine times operating profit. 1/5
  3. Growth: growing revenue, and declining earnings well supported by flat cash flow. 3/5
  4. Price to earnings: a forward 18 or so looks ahead of growth and yield forecasts. 1/5
  5. Outlook: satisfactory recent trading and a neutral outlook. 3/5

Overall, I score Severn Trent 10 out of 25, and I'm not expecting the firm to outperform on total-returns, going forward.

Foolish summary
By these criteria, Severn Trent is a low-scorer and that makes me cautious, so I won't be investing. But when it comes to dividend yield I'm excited about an idea from the Motley Fool's top value investor who has discovered what he believes is the best income generating share-play for 2013. He sets out his three-point investing thesis in a report called "The Motley Fool's Top Income Share for 2013", which I recommend you download now. For a limited time, the report is free so, to download it immediately, and discover the identity of this dividend-generating star, click here.

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