UPDATE 2-Pennon buys Bristol Water for 425 mln pounds, to pay special dividend

* Bristol acquisition to be earnings accretive

* Annual profit falls 14.2%

* Expects dividend base in 2021/22 to increase by about 9% (Adds CEO, analyst comments, details on results)

June 3 (Reuters) - British water company Pennon has bought smaller rival Bristol Water for 425 million pounds ($601 million) to help to expand its South West Water business.

Pennon’s purchase of Bristol will mean the group will be serving a total population of about 3.5 million, the company said on Thursday.

“We think that there is an attractive growth opportunity in the UK water,” Chief Executive Officer Susan Davy said in an interview, but she did not elaborate about any possible future acquisition targets.

Pennon in March had said it would consider making a “substantial” return of capital to shareholders using proceeds from the 4.2-billion-pound sale of its waste management business.

On Thursday, the company proposed a special dividend of 1.5 billion pounds and announced a share buyback programme worth up to 400 million pounds.

Pennon shares were up 4.2% at 1,113.5 pence in early trading.

“The acquisition (of Bristol) is a sensible one. It’s positive to see so much cash getting returned to shareholders,” Hargreaves Lansdown analyst William Ryder said in a client note.

“There’s always a temptation for management to keep cash in the business where possible, so a commitment to shareholder returns is always good to see.”

Pennon on Thursday also reported a 14.2% fall in underlying profit before tax to 157 million pounds for the year ended March 31, in line with expectations. This was largely due to price reductions arising from a transition to a new regulatory period and as business demand fell during COVID-19 lockdowns.

The company however had a net increase in household demand.

It also said its dividend base in 2021/22 should grow by 9% thanks to earnings from Bristol Water. ($1 = 0.7066 pounds) (Reporting by Shanima A in Bengaluru; Editing by Ramakrishnan M. and Jane Merriman)