Pennon: A FTSE 100 Dividend-Raising Star

LONDON -- In an outcome that's tough on investors, the FTSE 100 has failed to deliver a rising dividend payout over the last few years.

Just look at the iShares FTSE 100 ETF, for example. This is an exchange-traded fund that tracks the benchmark index, and we can see the aggregate payment from Britain's top 100 companies has yet to regain its pre-recession peak:

Year 2007 2008 2009 2010 2011
Dividend per share (in pence) 19.1 20.2 17.1 16.2 18.1

But some companies within London's premier index have performed well on dividends, despite these austere times, and this series aims to seek them out. One such name is Pennon Group (LSE: PNN.L  ) .

The big question is: Can the company's dividend continue to outperform its index? Let's take a closer look.

Pennon runs South West Water, which provides water and sewerage services to Devon, Cornwall, and parts of Dorset and Somerset; and Viridor Waste, a waste treatment and disposal business.With the shares at 725 pence, the market cap is 2,647 million pounds. This table summarizes the firm's recent financial record:

Year to March 2008 2009 2010 2011 2012
Revenue (in millions of pounds) 875 958 1,069 1,159 1,233
Net cash from operations (in millions of pounds) 219 166 277 255 209
Adjusted earnings per share (in pence) 36.9 38.1 40.8 42.3 47.3
Dividend per share (in pence) 19.81 21 22.55 24.65 26.52

So, the dividend has increased by 34% during the last five years -- equivalent to a 7.6% compound annual growth rate.

Through its two divisions, Pennon employs around 4,500 people and manages assets it reckons are worth around 4.3 billion pounds. At 76%, the company derives most of its profits from its water and sewage business, with the remaining 24% coming primarily from waste management.

Although its customer base is largely captive, the company operates in a tough regularity environment and must invest in its infrastructure constantly. That situation appears to lead to three outcomes: a generally consistent and predictable incoming cash flow, a consistent cash outflow, and generally rising levels of debt.

In fact, one of the key metrics that the company monitors is its debt-management performance. That generally means making sure that it is borrowing at the lowest rates possible. It likes to compare its borrowing costs to that of its utility company peers and, by that measure, reckons it is borrowing efficiently, placing itself at the bottom of a borrowing-cost league table.

The firm's steady cash flow looks promising for the prospects of the dividend, but I get the twitches when capital-intensive businesses load up on debt as Pennon has, even if they are utility providers. Maybe that's just me.

Pennon's dividend growth score
I analyze four different features of a company to judge whether its dividend can continue to rise:

  1. Dividend cover: adjusted earnings covered the last payout around 1.78 times. 3/5
  2. Net cash or debt: net gearing around 250%, interest cover of about 3.8. 2/5
  3. Cash flow: although supporting earnings, cash flow has been trending down. 2/5
  4. Outlook and recent trading: recent trading is mixed and the outlook is cautious. 3/5

Overall, I score Pennon 10 out of 20, which leads me to believe the firm's dividend growth might struggle to outpace that of the FTSE 100 going forward.

Foolish summary
There's a fair chunk of debt, which the firm relies on its consistent cash flow to service. That brings the cautious outlook and declining cash flow into focus.

Right now, the forecast full-year dividend is 30.31 pence per share, which supports a possible income of 4.2%. That's quite good, but not tempting enough for me.

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Further investment opportunities:

Kevin Godbold does not own shares of any company mentioned in this article. The Motley Fool has a disclosure policy.
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