Pennon Group : Company visit – Growth targets well on track

Last week, we met Colin Drummond, CEO of Viridor, and Jo Finely, Director of IR, as well as several site managers at Viridor. This private visit reinforced our investment thesis: we estimate Pennon will grow its underlying EPS by 9% pa between FY12 and FY16, driven by Viridor’s large capex programme. We find this very attractive given the low risk profile of the company, with the regulated water activity representing ~75% of the group’s profits.

• The most exposed to the UK waste market: In our coverage, Pennon is (by far) the most exposed company to the UK waste market. Viridor, the number 2-3 player, represents 27% of the group’s EBITDA and 100% of Viridor’s EBITDA.

• Well positioned to take advantage of the structural shift in the UK waste market: Viridor’s strategy has long been focused on the structural shift in the UK market, offering the company the possibility to bid for the most attractive energy-from-waste projects. We believe the group is firmly on track to meet its target of doubling Viridor’s EBITDA in the next 5 years. While this will require the additional contribution of 4 large EfW plants, 3 are already under construction and the construction of the fourth is imminent. We estimate Viridor has ~45% of market share of EfW treatment capacity under construction. 

• Strong balance sheet is a key competitive advantage: We view Pennon’s flexible balance sheet as a key competitive advantage, allowing Pennon to raise corporate debt to fund EfW projects, eliminating the reliance on more expensive project finance. While its main competitors are capex-constrained, Pennon benefits from: (i) significant room for increasing Viridor’s leverage; and (ii) the strong balance-sheet of South West Water, with net debt in the low-end of Ofwat’s requirements.

• Tweaking estimates: Following the release of the IMS in mid-august, we model in a weaker start to the year by tweaking down our FY13-15 estimates; on average, our EBITDA is reduced by 0.9%. However, we increased by 5% our FY16 EBITDA to GBP586m to better reflect the delivery of EfW plants according to the schedule. 

• Tweaking up our FV to 840p/sh: As a result of adjusting our estimates and fine-tuning our valuation assumptions, our fair value moves to 840p/sh vs. 791p.