Water services company Pennon(LSE: PNN) has reported a solid set of first-half results. They show that it's on target to deliver on guidance, while also investing for growth and reducing its cost base. Crucially, Pennon's dividend growth prospects remain sound. Could this make it the best income stock around?
Pennon's dividend yield of 4.3% is only around 0.6% higher than that of the FTSE 100. Therefore, on paper at least, investors may feel that it falls short of that lofty title. However, Pennon's dividend growth prospects are what mark it out as a top-notch income play. For example, in the first half of the current year Pennon has increased dividends per share by 6%, which is well ahead of inflation forecasts over the next few years.
In fact, Pennon aims to increase dividends by 4% plus inflation in the next four years. This means that even if inflation spikes, as the Bank of England expects over the next couple of years, Pennon's investors should see their incomes rise by 4% in real terms. Few companies in the FTSE 100 offer such a generous dividend growth forecast over such a long time period. And with Pennon's business model being robust and resilient even during the worst of economic downturns, the reliability of its dividend remains high.
Pennon's performance during the first half of the year was in line with expectations. Both its water services and waste services divisions have growth potential over the medium term, with Pennon's operating profit growth of 13.7% showing that cost reductions and investment are starting to pay off.
Looking ahead, Pennon expects to make £17m in savings per annum from 2019 after a major review of its services, while its water division has recorded £80m of cost savings since the start of the current regulatory period in 2015. More improvements in this area could allow Pennon to raise dividends even further.
Higher yields now
Of course, for many investors a higher yield matters more than dividend growth potential. In this regard, a stock such as HSBC(LSE: HSBA) may be of greater interest in the short run. HSBC currently yields 6.2%, which is among the highest in the FTSE 100. However, HSBC lacks dividend growth potential and has a highly uncertain future.
Next year, HSBC's dividend is due to fall by 3.8% as the bank focuses on improving its operational performance. Its cost base has swelled in recent years and has caused the bank to become inefficient compared to its peers. And with the outlook for the global economy being uncertain due to Brexit and a Trump presidency, HSBC's financial performance could come under pressure and cause dividends to be cut yet further.
As such, Pennon's resilience and dividend growth outlook make it a superior income play. Few FTSE 100 companies offer its level of defensive characteristics, which means that it's one of the very best income stocks around at the present time.
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Peter Stephens owns shares of HSBC Holdings. The Motley Fool UK has recommended HSBC Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.