United Utilities Group Plc (UU.) Ordinary 5p

Full-year Outcome Delivery Incentives (ODIs) are expected to be around £25mn lower than prior group expectations at around £40mn, due to exceptionally wet weather.

Despite this, there have been "no material changes" to full-year guidance. Revenue is expected to rise by around £150mn from a base of £1.8bn, more than offsetting an expected £60mn increase in underlying operating costs.

The shares rose 1.2% following the announcement.

Half Year Results (16 November 2023)

United Utilities reported half-year revenue of £982.0mn, up 6.8% from last year. This increase was largely driven by inflation-linked increases allowed as part of the group's revenue cap, while higher levels of consumer consumption also provided a smaller contribution.

Underlying operating profit grew at a slower rate than revenue, rising 4.9% to £271.1mn. This was due to inflationary pressures having an even larger impact on costs, particularly power, labour and chemical costs.

Net debt increased by 9.1% to £8.5bn. Free cash flow fell from £77.2mn to £24.1mn as a result of slightly lower operational cash generation and higher levels of investment.

An interim dividend of 16.59p per share has been announced, up 9.4% on last year.

Our view

In a short trading update, United Utilities confirmed that the big-picture performance remains on track, despite exceptionally wet weather causing some challenges.

In return for providing a reliable and affordable water supply to Northwest England, Ofwat allows United Utilities to earn an acceptable financial return.

At the half-year mark, an inflation-linked increase in the group's revenue cap, as well as an uplift in consumer consumption levels, meant that revenue was on the rise. This is expected to continue in the second half, helping push the full-year total around £150mn higher than last year's £1.8bn. But inflation's also pushing up costs, meaning not all of the bumper revenue will flow through to the bottom line.

The group looks set to earn around £40mn worth of customer outcome delivery incentives this year, which are effectively bonuses for delivering above and beyond their committed levels of service. These bonuses should help to offset some of the higher costs the group's currently facing.

Over the medium term, the group's allowed to increase prices alongside inflation, providing a natural hedge to rising costs. The caveat here is that the funds are only received two years later, so in the meantime, we're seeing cash flows and earnings get squeezed.

Last we heard, the balance sheet was stable despite the increased infrastructure spending. Given the group's ambitious £13.7bn plans to expand and upgrade its assets between 2025-2030, United Utilities needs to raise around £5.2bn of cash. That'll require issuing new debt and will likely push debt levels towards the top end of its target range.

Customers' ability to pay their bills as the cost-of-living crisis persists is also something to be wary of. So far this looks under control and there's government support in place. But United Utilities is calling for this to be more fairly distributed, with some of the country's most deprived communities being within the areas it services.

While high levels of inflation could put a strain on some areas of the business in the short term, it's likely to be a net benefit over the long term. That's because inflation increases the amount of revenue the group's allowed to earn on its asset base, which is measured by Regulatory Capital Value (RCV). The mammoth investment plan should help on that front, raising RCV by 50% by the end of the decade.

All in, the group runs a tight ship, with some of the best margins relative to peers. Its regular cash flows and inflation-linked revenue are enviable assets to have in an uncertain environment. But the group's not immune to missteps, and adverse weather could continue to present challenges.

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