TheChek News Flow

News:

Gapping up
In reaction to earnings/guidance:

Other news:

Analyst comments:

UK water company Severn Trent to raise £1bn to tackle pollution

Customers’ bills to rise almost 37% by end of decade under new five-year spending plan

UK water company Severn Trent will raise £1bn through a new share issue to support plans for infrastructure investment to reduce water leakage and cut sewage outflows.

The FTSE 100-listed utility, which provides water and sewage services to 8mn people in areas including the Midlands and Wales, said the share issue would raise £500mn from the Qatar Investment Authority, which already has a 4.59 per cent stake in the company.

A further £500mn will be raised from institutional investors, and up to £7mn from retail investors. An unspecified number of company directors will buy shares worth £275,000 each.

The share issue comes as the industry seeks to combat a reputational and financial crisis that has led to calls for renationalisation of the UK’s privatised water industry.

Severn Trent’s stock rose more than 4 per cent to £23.57 a share on Friday morning. Shares were down 13 per cent this year before the update.

Severn plans to raise the average customer’s bill by almost 37 per cent in the region by the end of the decade to £518, as part of a new five-year spending plan. Water companies are allowed to adjust bills for inflation every year so in real terms the sums would be higher.

Severn will submit its draft business plan to the water industry regulator by Monday, which will decide whether to sign off on water companies’ steep bill increases to pay for investment in infrastructure including reservoirs, water transfer pipes and sewage treatment plants. 

Severn plans to invest £12.9bn over five years from April 2025, almost double the £6.9bn agreed for the regulatory period between 2020 and 2025, with £5bn earmarked for cutting leakage and sewage spills.

The company is targeting a 30 per cent reduction in both spills and storm overflows by 2030. It received a £1.5mn fine for sewage discharges in 2021.

Ofwat is not expected to approve companies’ plans until the end of next year, and will have to balance the need for investment with the impact on customers struggling with a cost of living crisis.

The UK’s privatised water companies have been criticised for amassing £60bn of debt since they were sold in 1989, while paying out more than £72bn in dividends. They have also attracted scrutiny for awarding senior executives generous pay packages, while failing to invest sufficiently in infrastructure, generating calls for renationalisation from campaign groups.

Earlier this year Liv Garfield, chief executive of Severn Trent, emailed other industry chiefs to call for a new task force that would work with the Labour party and head off any future threat of nationalisation.

Garfield is the water sector’s highest-paid executive, receiving a total pay package of £3.2mn in the year to 31 March 2023, down from £3.9mn in the prior period, but still 73 times average employee earnings at the company.

Like other water companies Severn Trent has suffered the impact of rising inflation on energy, construction, labour and financing costs. Its net debt rose from £6.5bn to £7.1bn this year. The company paid a £261.3mn dividend in the year to March 2023.

Severn’s share issuance will help to keep gearing — a measure of indebtedness — at around 65 per cent over the next regulatory period, satisfying Ofwat’s guidance to keep it below 70 per cent.

Equity injections have been rare in the 34 years since the regional water monopolies in England and Wales were privatised. But in the past three years Anglian Water, Southern Water, Thames Water and Yorkshire Water have all received cash from their shareholders as their finances came under pressure. Severn Trent also raised £250mn in equity in 2021.

The company’s share issue will be led by Bank of America Securities and Morgan Stanley, with Citigroup as joint bookrunner and Rothschild as financial adviser.

Takeover offers for auto dealership are hard to compare

There is widespread consensus that UK stocks are, for the most part, extraordinarily cheap. Yet, despite the collective hand-wringing, public markets have not moved to correct this anomaly. That leaves many a company idling by the roadside. 

One strategy for stalled British stocks is to cast around for a takeover offer. This process gives shareholders the option to either sell out (preferably above current prices) or decide there is value in the old banger after all. 

Better still, once a company does attract a bidder, other would-be acquirers are forced to step on the gas. For an example of a veritable bid pile-up, look no further than Pendragon. The UK car retailer has in the past week received offers from three US peers, one of which has teamed up with its own major shareholder, Sweden’s Hedin.  

Receiving a clutch of bids can put shareholders in a tricky position — especially when it is not immediately clear which one offers superior value or will actually materialise. Company boards are on hand to proffer recommendations. But the canny private investor will also want to make up their own mind about which offer — if any — merits snapping up. 

The first thing investors should consider is which bid is higher. In the case of Pendragon, they are not directly comparable.

The first, initially recommended by the board, was from $8bn market value Lithia Motors. It has offered to buy Pendragon’s UK cars business for £250mn It would also inject £30mn of capital into a division that sells software for car dealerships, securing a 16.7 per cent stake. This software unit would continue trading under Pendragon’s listing.

Shareholders can also choose from another two non-binding bids, by Sweden’s Hedin and the US’s AutoNation, which value the whole of Pendragon at £447mn. 

A quick look under the bonnet suggests Lithia’s is the less attractive offer. Pendragon’s investors would get £250mn for the motor business and be left with 83 per cent of the software business, valued at £150mn. That is a total of £400mn, some £47mn less than alternative bids.

But investors should also ask whether any of the bidders can deliver on their promises. Hedin, which owns 28 per cent of Pendragon, disappointed shareholders last year when its bid for the company failed. This time around, its interest is subject to a number of preconditions. And Hedin’s own bid may cause AutoNation’s deal to misfire. After all, even if AutoNation wins, it risks getting stuck with a large, recalcitrant shareholder.

The two companies only have a week or so to finalise their offers and seek a board recommendation. Lithia, which does not want its own bid shopped around the market, has made it conditional on securing shareholder approval by October 6.

Private investors will hope Pendragon gets an auction under way. Lithia’s bid has been useful to get the ball rolling. But, by valuing the motor business at only 3.5 times this year’s ebitda, it has a whiff of the lemon about it.

Car dealerships such as Pendragon hope to navigate the disruption caused by electric vehicles — though the likes of Tesla tend to skip the middlemen and take their sleek offerings directly to consumers. Other areas of the economy — including car manufacturers — are going to have to adapt faster than they thought. There are signs that electric vehicles have already reached a tipping point.

Europe’s demand for EVs is such that politicians worry about a flood of imports from China. An EU trade probe on production subsidies has begun. About 20 per cent of all EVs sold in Europe are produced in China.

About 26mn EVs have been sold worldwide to date, according to the International Energy Agency. These include plug-in hybrids, which have an internal combustion engine alongside a battery. That is a fraction of the total car stock of 1.3bn. But sales are revving up. They are set to increase from about 10mn in 2022 to about 14mn in 2023 — 18 per cent of all cars sold.

Drivers making the switch can expect to save money, though the exact figures depend on local electricity prices. Greater efficiency makes EVs cheaper to run. Assume, for example, that UK drivers charge their EVs at home for 32p per kWh and that cars travel 5km on each kWh. That equates to 6.4p per km. Diesel cars, meanwhile, might be able to do 15km on one litre, which at present costs 152p. This means they are paying 10p per km.

In terms of initial outlay, EVs are becoming more affordable. The cheapest Tesla Model Y ($46,900) now costs less than the average amount paid for a new car in the US. Chinese carmakers known for their cheaper models are setting their sights on increased exports to the US and Europe.

Slow charging times and the need for comprehensive charging infrastructure remain barriers. But forecasts for EV sales suggest rapid growth over the next few years. Bernstein analyst Oswald Clint superimposed EV growth trajectory on that achieved by the internal combustion engine at the start of the century and found that the curves matched.

The implication is clear: within the next decade, there could be 800mn battery, plug-in and hybrid electric vehicles on the roads.

Americans spent more in August on expensive gasoline, but the Fed could be pleased with cooler underlying inflation

Higher gasoline prices likely boosted August consumer spending and kept inflation elevated, while underlying price pressures cooled, analysts say.

• Economists surveyed by The Wall Street Journal estimate consumer spending rose 0.4% last month, down from a 0.8% rise a month earlier. That still-strong August increase was fueled by solid growth in jobs and wages, but also rising pump prices. Keeping up that pace this fall could be a challenge as Americans face the resumption of student-loan repayments, the depletion of pandemic savings and high interest rates.
• Other broad measures of inflation rose in August, largely because of energy costs, but underlying prices appear more tame. When excluding volatile food and energy costs, economists estimate that the core personal-consumption expenditures price index rose 3.9% in August from a year earlier, slowing from a 4.2% annual increase in July.
• Underlying inflation has cooled as the Federal Reserve aggressively raised interest rates over the past 18 months. Central bank officials say they need to see this trend continue before determining whether to raise rates again.
• The Commerce Department will release the August personal income and outlays report at 8:30 a.m. Eastern time Friday.

The Fed held its benchmark interest rate steady at a 22-year high last week, and most officials penciled in one more rate increase for this year. Fed Chair Jerome Powell said officials want to see “convincing evidence” that they have raised rates enough to sustainably lower inflation to their 2% goal.

“We’re seeing progress, and we welcome that, but we need to see more progress,” he said. “We want to see that it’s more than just three months.”

Friday’s Commerce report will include the Fed’s preferred inflation gauge, the PCE price index. While the separate consumer-price index showed firmer core prices in August, analysts expect a milder increase in the core PCE index. Several areas of strength in the CPI, such as airfares, are calculated differently in the PCE price index and were lower last month.

Fed officials’ projections indicate they expect core inflation to cool further next year. But even if that occurs, the Fed risks holding interest rates too high for too long, said Simona Mocuta, chief economist at State Street Global Advisors. She worried that would lower the Fed’s chances of achieving a so-called soft landing—beating inflation without causing a recession.

“I do wonder whether the soft landing can truly survive the Fed,” she said.

Consumers remained resilient this summer

Consumer spending, the economy’s main engine, has been strong much of this year. A solid labor market and slower price increases have boosted Americans’ inflation-adjusted incomes, propelling purchases.

Shoppers snapped up vehicles earlier this year as they flowed back onto dealership lots amid easing supply-chain disruptions. They also spent more on experiences, flocking to “Barbie” and “Oppenheimer” this summer and splurging on tickets to Taylor Swift and Beyoncé concerts.

The spending spree bolstered economic growth. Many forecasters think the economy is expanding faster this quarter than earlier this year.

Some of the factors that helped consumer spending in the past two years are fading and signs of stress are emerging: Many Americans are dipping into savings. The personal saving rate, a measure of how much money people have left each month after outlays and taxes, has trended down.

“The excess savings is drying up and the credit has gotten a lot more expensive, so I think that diminishes the resilience angle,” said Tim Quinlan, senior economist at Wells Fargo. “Our staying power is going to be tested.”

New challenges could further dent spending, including the resumption of student-loan repayments and higher gas prices, which cut into Americans’ budgets for dining out and travel. Strikes and a potential government shutdown could at least temporarily curtail the spending power of some workers.

The consumer’s resilience will depend in large part on whether the labor market falters. While unemployment is still historically low, it has edged higher recently. If companies begin to widely lay off workers, incomes will take a hit.

“That’s where I get antsy about the capacity for consumers to keep going,” Quinlan said.

Hedge fund Third Point, after years of strong returns, has registered big losses after misreading the market. Now it faces a flood of customer withdrawals.

Dan Loeb, one of the most successful hedge-fund managers of his generation, is having a rough year.

Funds at his Third Point fell by about 1.6% this year through August after tumbling 21.8% or more in 2022, according to investors. Both figures are worse than those of peers and the broader market.

Loeb, who oversees roughly $11.7 billion, said he expected higher interest rates to take a bite out of the U.S. economy this year, so he turned cautious. As a result, he didn’t own enough technology shares to fully benefit from the summer’s AI-powered rally that drove stocks such as Nvidia skyward.

Compounding the error, Loeb recently boosted stakes in tech and other riskier companies, just in time for those stocks to stumble in recent weeks.

Strategies that once produced big gains for him—shareholder activism, short selling and startup bets—also haven’t helped.

The missteps highlight the perils of wagering on a market in which interest rates are surging but the economy continues to grow, a phenomenon that has surprised some pros. For much of the year, high-price tech and other risk stocks kept moving higher, ignoring the rate rise, though they’ve faltered lately.

Loeb has turned things around after past stumbles, often by shifting gears. Third Point posted a double-digit loss in the first quarter of 2020 when the arrival of the coronavirus pandemic sank stocks, but it ended the year up about 19% thanks in part to bets that consumer and commercial debt would be more resilient than many expected.

In early 2009, on the heels of the 2008 financial crisis, Third Point’s assets dropped to $1.4 billion from $7 billion. A decade later, they were up to $15 billion. Loeb has scored some of his best returns during periods of turbulence for debt markets, for example betting on distressed Greek bonds in 2012.

Now, Loeb is betting on an eventual credit crunch as companies are forced to refinance their debt amid high interest rates, something he expects to create investment opportunities for his funds.

Some investors aren’t waiting around to see if he can stage another comeback. They’ve requested withdrawals at the end of September amounting to $850 million, or more than 7% of the firm’s assets, according to people close to the matter. More than $1 billion of Third Point’s total capital is held under terms that prevent it from being easily withdrawn.

The expected withdrawals add to the $1 billion or so that was redeemed from Third Point funds during the first eight months of the year, according to the people.

Sacramento County Employees’ Retirement System, SCERS, which first invested in Third Point in 2012, requested its roughly $60 million investment back earlier this year. The decision was based on Third Point’s performance and a decision to transition away from “growth-oriented” hedge funds, said Steve Davis, chief investment officer at SCERS, in an email. Investors asking for their money back get it over the course of several quarters.

“I’m not thrilled with the results, but each time we’ve had 20% drawdowns, we’ve more than made up for them,” Loeb said in an interview with The Wall Street Journal.

Loeb, who began his career as a junk-bond salesman catering to investors including hedge-fund titan and current-Carolina Panthers owner David Tepper, launched Third Point in 1995. Since then, the 61-year-old billionaire has wagered on and against stocks and debt instruments while agitating for changes at companies including Nestlé, Sony, and Yahoo—sometimes with acid-tipped letters to boards of directors.

More recently, he has used Twitter, the social-media platform now known as X, as a forum to share and debate ideas. Since joining in 2020, he has amassed over 100,000 followers and weighed in on investments and economic policy, offered life advice and extolled the quality of Loro Piana sweaters. Loeb has also spoken publicly about his renewed interest in his Jewish religion and how it has given him an improved perspective on life.

Third Point racked up average annualized returns of 16% after fees over the past 28 years. As recently as 2021, the firm’s hedge funds rose as much as 27%.

But Third Point’s results this year are a far cry from the S&P 500’s total return of 18.7% through August, and also below the 4.7% gain for the average hedge fund, according to HFRI.

Last year’s losses at Third Point exceeded the 18.1% decline for the S&P 500, including dividends, and the 4.1% average loss for hedge funds.

In the past few years, Loeb has made high-profile pushes for significant changes at companies including Intel, Disney and Shell. The results have been mixed.

While Intel quickly hired a new CEO Loeb praised, its stock has done little since. A campaign to split Shell into two companies was unsuccessful, though the oil giant did simplify its structure and Third Point has made money on its investment. A more than $1 billion bet on Disney has made the firm roughly $200 million so far.

This year, the firm launched a campaign against Bath & Body Works in February, and though it gained a board seat in a settlement, the retailer’s stock is still down about 20% for 2023.

Third Point’s recent bearish bets have been ill-timed. The firm shorted companies including Carvana and Evergrande, but Loeb, worried about a rising market, closed many of those positions in 2020 and 2021 before they could pay off.

In the second half of 2022, Third Point added to its short positions, only to be caught off-guard when the market started racing upward in 2023.

In 2021, venture-capital investments in cybersecurity firm SentinelOne and fintech lender Upstart Network produced big gains for Third Point after the companies went public. That year, Loeb raised a venture fund and hired former Goldman Sachs analyst Heath Terry to seek out additional investments. Another Third Point executive, Bob Boroujerdi, started focusing on crypto investing.

The firm sold most of its stake in Upstart before it tumbled, but SentinelOne was a losing position last year, as was electric-vehicle maker Rivian Automotive.

Third Point made a sizable investment in FTX that became worthless when the crypto exchange imploded last year. Terry and Boroujerdi left the firm in late 2022.

Loeb attributes the continued strength in the economy to government actions and earlier stimulus that have left consumers and companies flush with cash. That has delayed “the kind of credit cycle we had hoped for from the investment side,” he said.

Loeb maintains that debt troubles are on the way. He said so much corporate debt will mature and need to be refinanced over the next few years at higher rates that it will pressure various bonds, loans and other so-called credit investments.

Other investors are also cautious. Bridgewater Associates has told clients that rising bond yields will crimp economic growth and stock and bond prices. Victor Haghani, a former senior executive at Long-Term Capital Management who now runs investment manager Elm Wealth, says U.S. stocks offer the lowest expected return relative to safe investments since early 2007, despite their recent losses.

For Loeb and others, betting on a credit crunch carries risk. Corporate earnings have been robust and unemployment remains low, suggesting that distressed opportunities may not emerge as he expects.

Third Point has been hiring staffers with credit and lending experience so it can deploy capital when the next cycle arrives. It recently tapped a senior investment specialist from New York Life, Chris Taylor, to run its private credit business. Taylor will help raise money for a new private-lending fund, Loeb said, and some of those loans will be added to his main hedge fund.

“I don’t know if it will happen in 2024 or 2025, but we’re pretty confident we will see an avalanche” of private and other companies that need to refinance their debt, Loeb said. “We want to be good and ready to deploy capital when the next cycle comes.”