Why I'd shun Severn Trent plc in favour of this 8%-yielding dividend hero

Severn Trent(LSE: SVT) clicked up almost 2.5% in early trading following publication of today's results, although it has since slipped a little. The water utility delivered a strong set of interims for the six months to 30 September which are headlined: "Strong customer delivery and investment across the network drive continued progress."

Sewerage success

The figures include 4.4% growth in group underlying profits before interest and tax payments to £287.8m, with group turnover up 3.7% to £850.4m, and underlying basic earnings per share (EPS) climbing 7.7% to 65.9p. CEO Liv Garfield hailed the group's "customer-first approach" and "strong operational performance", which has seen it reduce total sewer flooding by 48% while keeping bills down to less than £1 a day, the lowest average combined water and sewerage bills in Britain. Garfield also hiked full-year guidance for customer outcome delivery incentives from £23m to "at least £50m", as a mark of her confidence.

Investors will be celebrating a 6.2% increase in the interim dividend to 34.63p, while Severn Trent plans to raise further cash by selling sell land made available through operational efficiency. These are a sturdy set of results and the share price might be flying even higher except that Severn Trent trades at a forecast valuation of 17.5 times earnings, so much of its strength is already reflected in the share price.

Lucky number Severn

Growth might slow, with City analysts pencilling in a watery 3% drop in EPS in 2018, albeit followed by a 10% rise in 2019. Water companies have performed badly lately (Severn Trent is down 17% over the past six months), partly on fears of what a resurgent Labour Party might do to them if Jeremy Corbyn ever becomes Prime Minister.

There are also fears that Ofwat will be less generous in its next regulatory price review, PR 19, with water companies enjoying bumper profits over the last decade. Severn Trent's dividends have been flowing for years and today it offers a forecast yield of 4.1% and cover of 1.4.

Hotline

Direct Line Insurance Group(LSE: DLG) is set to pay double that, currently trading on a forecast dividend yield of 8%, courtesy of a forecast 52% rise in EPS in 2017, which should lift its dividend to 29p a share (up from 14.60p in 2016). Even though the dividend is forecast to dip slightly in 2018 to 27.55p, that still offers a 7.7% yield.

If these forecasts are correct, you are looking at a total return from dividends alone of more than 15% over the next couple of years, regardless of what happens to the share price. Here are some other dividend bargains you might like.

Share performance has been patchy, with the motor and home insurer's stock trading 11% lower than two years ago. It dipped 6% in the last month following a patchy set of results on 7 November, with Direct Line warning its 2017 impairment charge could exceed that incurred in 2016. However, the group also reported a 2.8% rise in gross written premium in Q3 amid strong trading and good customer retention.

Direct action

These uncertainties are reflected in a discounted forward valuation of 10.9 times earnings and revenues could increase nicely with both motor and home insurance premiums rising strongly across the industry. It will help that Chancellor Philip Hammond did not increase insurance tax again in this week's Budget.

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Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may 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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