MIDAS SHARE TIPS: Severn Trent inflation proof bond offers safe income

MIDAS SHARE TIPS: Severn Trent inflation proof bond offers safe income

By Joanne Hart

PUBLISHED: 15:42 EST, 23 June 2012 | UPDATED: 09:59 EST, 24 June 2012

Income hungry investors keen to beat inflation are being tempted by Severn Trent. Midas takes a look at the water firm's offer.

One of Britain’s biggest water companies, Severn Trent, is wading into the bond market with a new issue aimed particularly at investors looking for safety in today’s uncertain times.

The company, which has more than seven million customers in Wales and the Midlands, is launching a ten-year inflation-linked bond to raise money for its investment programme. The coupon, or interest payment, will be 1.3 per cent, paid every six months.

The amount may sound low, but the key point about these bonds is that the coupon and the amount investors receive when they are repaid depends on the retail prices index measure of inflation.

Water move: Severn Trent is wading into the bond market with a new issue aimed particularly at investors looking for safety in uncertain times

If, for example, an individual invests the minimum £2,000 in this bond issue and inflation averages just one per cent a year over the next ten years, the amount repaid will be £2,209.

If it averages three per cent, the sum paid will be £2,687 and if it averages five per cent, it will be £3,257. But if there is no inflation, and even if there is deflation, Severn Trent will simply repay investors the full £2,000.

The coupon, paid out twice a year much like a dividend, will also  vary according to inflation. At an inflation rate of one per cent, the coupon on a £2,000 investment will be £13.20 each half-year, rising to £13.60 if RPI is five per cent and falling to £12.60 if RPI is minus five per cent.

Inflation has been a stubborn worry for the past two years, but figures last week revealed that RPI fell to 3.1 per cent in May from 3.5 per cent in April. Many economists predict further falls this year and some are worried that Britain may enter a period of negative inflation, or deflation.

If they are right, Severn Trent’s bonds would make an unattractive investment. But if they are wrong,  investing in inflation-linked bonds makes sense. For investors, perhaps the most important point to bear in mind is that economists have never been terribly good at predicting the future and today it is particularly difficult.

Suggesting that inflation might fall over the next six months is one thing â€" knowing how prices will move over the life of Severn Trent’s bonds is quite another.

However, the bonds are tradeable as they will be listed on the London Stock Exchange’s Order Book for Retail Bonds (ORB), designed specifically to enable individual investors to buy and sell bonds easily.

Three other firms have launched index-linked bonds on the ORB over the past year â€" National Grid, Tesco Personal Finance and Places for People, the social housing group. National Grid paid a coupon of 1.25 per cent and the other two paid just one per cent, so Severn Trent is putting a bit more on the table for investors.

In the year to March 31, underlying profits before tax fell three per cent to £504 million as the company incurred new costs on drains, sewers and a levy to reduce carbon emissions. But the dividend rose 7.7 per cent to 70.1p and there was a special, one-off dividend of 63p.

Severn Trent is well-respected in the water industry, it has some of the lowest charges in the country and has also managed to avoid drought restrictions for the past  15 years. But in common with other water businesses, it has a huge investment programme, averaging £2.5 billion every five years and largely financed by debt.

The group frequently issues bonds to large institutional investors, but this is its first foray into the retail market. Boss Tony Wray hopes to raise between £50 million and £100 million with this bond and expects to return to the market with more issues if all goes well.

Midas verdict: Inflation-linked bonds are intended to offer investors peace of mind and Severn Trent’s issue should do just that. Safe and reliable, these bonds provide a solid balance against other, riskier investments. In the current volatile climate, investors will almost certainly benefit from tucking away some of these bonds for the next few years. Buy.

Midas update: Vitec

Investors have done well with Vitec, Midas takes a look at what to do now and whether new investors should get in.

As millions of people settle down this evening to watch England play Italy, they will see the game from angles that would have been unimaginable only a few years ago.

The equipment broadcasting these dramatic images is made by Vitec, a fast-growing firm whose shares at 660p have risen 78 per cent since Midas Extra recommended them in August 2008 and 36 per cent since an update 18 months ago. 

Vitec’s business is split into three parts. On the broadcast side, it makes products such as teleprompters and the supports that enable cameras to glide around studios.

Following the recent acquisition of Camera Corps, Vitec also produces the Q-Ball camera, which is used extensively at sporting fixtures.

The group also makes accessories for professional cameras, such as tripods. And  it has an arm providing  high-definition transmission equipment used in defence. In 2011, Vitec delivered profits up 16.8 per cent at £33 million and a dividend 7.9 per cent higher at 20.5p. Analysts expect profits of almost £38 million this year and a dividend of 22.5p.

The broadcast arm should benefit from the Olympics and it is gaining ground as emerging markets improve their TV output. Surveillance and defence, mainly a US business, has been hit by spending cuts but it is set to pick up this year.

Midas verdict: Investors have done well with Vitec and should sell half their stock. But keep the rest as boss Stephen Bird is doing a good job. New investors may buy on weakness.

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