Broker snap: Credit Suisse downgrades Severn Trent after of Ofwat, dividend at risk

23rd Jan 2014 11:14

Credit Suisse has downgraded its rating for Severn Trent from 'neutral' to 'underperform' and cut its target price from 1,580p to 1,540p ahead of the Ofwat regulatory price review that will set prices for 2015-20.The review, which concludes on January 27th, will set a so-called 'vanilla' weighted average cost of capital (WACC) - which does not take taxes into account - of 3.8%, according to Credit Suisse. This will be a historical low and down from the current level of 5.1%.The bank said this estimate reflects: "(a) comments from OFWAT in late December that business plan proposals on risk and reward (circa 4-4.5% overall WACC) were not in alignment with market evidence; and (b) recent evidence from the Competition Commission."Target prices for fellow water providers Pennon ('underperform') and United Utilities ('neutral') have been raised slightly as a valuation 'roll-forward' offsets the anticipated lower WACC. The target for Pennon was lifted from 610p to 630p while United Utilities' target has been lifted from 660p to 680p.Nevertheless, Credit Suisse estimates that the 130 basis-point reduction in baseline allowed returns will have a 20% impact on earnings at the water companies, which means that dividends could be at risk.The bank said: "We see a lower cost of equity allowance reducing company dividend payouts from the year ending March 2016. Political considerations could limit scope for offsetting capital returns, despite a higher notional gearing assumption. We expect Severn Trent and United Utilities to rebase dividends by circa 25% and 20%, respectively, in the year ending March 2016."BC