When searching for lucrative dividend stocks, I often compare the yield and price histories. Since the yield’s a percentage of the price, the two metrics are usually inversely correlated to a degree. Variations in this correlation can give me deeper insights into how the company manages its dividends.
If the company maintains a steady dividend, the yield falls as the price rises. Ideally, I look for a yield that remains stable, indicating a steady increase in dividend payments in line with price growth. These types of stocks can make reliable additions to a passive income portfolio.
Searching the FTSE 250 index, one stock caught my eye that could be promising. So I decided to peek under the hood.
A lesser-known utility group
Pennon Group‘s (LSE: PNN) a £1.6bn water and waste management company better known by its subsidiaries, including South West Water and Bristol Water. Founded in 1989, it’s relatively young compared to most UK utility companies.
I like utility companies because their regulated business models and essential services provide a degree of stability and resilience. Lately, many have been struggling, and even leading providers like National Grid and Severn Trent have suffered losses. Pennon’s share price has been in decline since mid-2021, now down by almost 60% in five years.
On the face of things, that doesn’t look great. But things may start improving soon. Earnings are forecast to grow 37.9% a year going forward, leading analysts to predict an average 12-month price target up 23% from current levels. That could translate to some decent returns when adding in the 7.7% dividend yield.
It’s a promising forecast, particularly considering the majority of analysts are in agreement. But that doesn’t mean it’ll happen.
What could derail the performance?
Pennon says it’s been actively investing in infrastructure to improve its services and enhance its long-term growth prospects. But despite efforts to reduce costs and improve operational efficiency, I’m yet to see any notable improvement in its financial performance.
This was made evident earlier this year when the company released its full-year 2023 results. Although revenue grew 14% and operating income increased 8.6%, it reported a £9.5m loss and dividends took a hit. In previous years, it increased dividends by 6% on average but this year, growth was reduced to only 3.8%.
Fortunately, the reduction may just be a once-off. The redirection of funds is to cover a £2.4m fine from the Environmental Agency for a sewage leak that caused a parasitic outbreak in Brixham.
That’s reportedly been resolved but a repeat of such an issue could cost the company dearly — both reputationally and financially. What’s more, its total debt has risen from £3.1m in 2023 to almost £4bn this year after acquiring Sutton and East Surrey (SES) water company for £89m.
My verdict
Pennon’s attractive from a dividends point of view, with a good payment history and high yield. However, it seems to be making costly operational errors and taking on a level of debt that could soon become unmanageable. Its interest coverage has dropped to 1.1 times and its debt-to-equity (D/E) ratio’s up to 246%.
For me, that makes it too risky an investment to consider for a long-term income portfolio.
This post was originally published on Motley Fool
