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Are Pennon Group Shares a Way to Trade Inflation Worries?

Tim Worstall
Tim Worstall trader
Updated 29 Nov 2021

One worry that the markets have – or, to be accurate, participants in the markets have – is that the establishment is wrong about inflation. We are having a burst of it, that we can all see. The view of the authorities – government, the Bank of England, people in offices in general – is that this is all transitory. Just an effect of the strains of opening up the economy again after lockdown. Not everyone is wholly convinced about this, some at least see a return of the horrors of the 1970s.

This means a return to those investing habits that pulled the lucky few through those terrible years for the markets. This means looking for those with pricing power, or at least the ability to keep raising prices in line with inflation. The last time around this was the FMCG sector (fast-moving consumer goods) and utilities. Serious thought is now returning to how attractive those rather stodgy companies might be.

A good example is Pennon Group (LON: PNN) whose results are out tomorrow. Those half-year figures will concentrate attention on the group and could well lead to serious thought about the attractions of what seems like a fairly boring business. We don’t particularly expect any upsurge in demand for their product, water, after all, nor do we see any new and radical technologies on the horizon.

However, it is possible that we get a new financial world around us. Making safe and stable income streams relatively more attractive. If inflation returns as an ongoing, rather than a temporary feature of the economy this will indeed happen.

For the water company pricing is governed by CPIH, that’s the version of inflation (CPI) which includes housing costs. Inflation goes up and water companies can raise their prices by exactly that amount. Which they will do of course. We have near-complete inflation protection on the revenue stream.

The company has also paid down significant debt as a result of disposals, they’re talking of continuing increases in the dividend – that is, before any inflation effects upon revenues – and their debt burden looks protective. Some 26% or so is at market rates which will change with whatever the BoE does and inflation. The other 74% is at fixed rates and so will diminish in burden if and when inflation rises.

This is not to say that the Pennon Group is some exciting and go ahead prospect. Rather, the share price depends upon what the rest of the market thinks are its attractions. If inflation worries increase then that near-total revenue protection against it, a diminishing debt burden, and an aggressive dividend policy will attract investors. The half-year results tomorrow could well be the trigger for such a rerating. It shouldn’t be true but it is that the general market attention only falls upon such prospects when they have something to announce. So results announcements are often enough the trigger for thoughts and re-thoughts about such apparently already well-known companies.

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Tim Worstall
Tim Worstall is a freelance writer specialising in economics and the financial markets.