Pennon Group(LSE:PNN) a FTSE250 water utility company. This should make it one of the most stable stocks around, but a 44% drop in its share price since 2019 tells a different story.

Despite having no competition and providing an essential service, the company cut its dividend earlier this year. And with pressure coming from multiple quarters, I’m skeptical about the 7.4% yield.

Dividend cuts

Earlier this year, Pennon announced a reduction in its final dividend following a £2.2 million fine imposed on the company for discharging wastewater into rivers.

In itself, this shouldn’t be a big problem. There are several reasons for this. One of them is that it is a one-time event and not a permanent problem.

Secondly, the final dividend of 30.33 pence per share was still an increase from the previous year. The final dividend in 2023 was 29.77 pence per share.

The problem is, however, that’s not the only one – Pennon has been hit with a further £3.5 million fine for a Cryptosporidium outbreak, which is likely to negatively impact its 2025 dividend. And the situation could get even worse.

Regulation

The change of government is a grim omen for water utilities as a whole. I think there is a good chance that the fines the company will pay will be even higher.

A key part of Labour’s manifesto included tougher sanctions for water companies, with a particular focus on sewerage – for which Pennon was fined last year.

This could lead to higher fines and greater power for regulators. Importantly, this is not an isolated incident, but could be a permanent problem for the 7.4% dividend.

Exactly what the consequences will be for Pennon and its shareholders remain to be seen, but I don’t see how this could be a positive for the company and it makes the stock difficult to buy.

Water bills

Pennon’s business is also under pressure from regulators. It is protected from competitors but cannot set its own prices – these must be approved by Ofwat.

The story continues

Earlier this year, South West Water sought permission to increase water bills by 33 percent by 2030. Last month, the regulator announced it would only agree to a 13 percent increase.

This is a potential problem for Pennon. The company needs to invest in its infrastructure and needs to get the necessary capital from somewhere.

Given the high level of debt on the balance sheet, taking out loans appears risky. This means that the money may have to come from dividends, which puts lasting pressure on the company’s profit and loss account.

Sellign short

It’s easy to see why the stock is attracting the attention of short sellers, with Ofwat putting pressure on its revenue and the UK government threatening cost increases.

Neither of these things is good for profitability or dividends, so I’m staying away from the stock, even after a 44% decline over the past five years.

The post “Down 44%, yielding 7.4% – is this FTSE 250 share too cheap to ignore?” appeared first on The Motley Fool UK.

Further reading

Stephen Wright does not own any of the stocks mentioned. The Motley Fool UK has recommended Pennon Group Plc. The views expressed on companies mentioned in this article are those of the author and may therefore differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool, we believe that considering a diverse range of insights makes us better investors.

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