Pennon Group : Company visit – Growth targets well on track

 
Fair Value 840p vs. 791p (price 736.00p)           BUY
News published on September Tuesday 4, 2012
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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.


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