United Utilities has issued a pre-close trading update ahead of its half year results, scheduled for 25 November 2015. Group revenue is expected to be similar to the first half of last year, as the impact of lower regulated revenue is offset by slightly higher non-regulated sales.
Underlying operating profit is in line with management expectations, albeit lower than the first half of 2014/15. This reflects the new regulated price controls, increased depreciation and other costs, partly offset by a reduction in bad debts and regulatory fees.
Reported operating profit will be impacted by customer compensation and one-off costs, totalling around £25 million. This relates to a "significant water quality incident" in Lancashire which affected over 300,000 properties, representing around 10% of United Utilities' customer base. The group commented: "Customer satisfaction is a key area of focus and so we were very disappointed.... We recognise the inconvenience this placed on many of our customers and are very grateful for their patience and understanding." The cause of the incident is still being investigated. Restructuring costs of around £5 million have also been incurred in the first half and will be excluded from underlying profit measures.
The underlying net finance expense is expected to be around £20 million below the first half of last year, reflecting lower RPI inflation and interest costs. Net debt is expected to be slightly higher than the position at 31 March 2015, although gearing remains comfortably within the group's target range, supporting a solid A3 credit rating for United Utilities Water.
The shares were 0.5-1% higher in early morning trading.
The water regulator, Ofwat, recently announced a new five year regulatory framework, which determines how much water companies can charge and the level of dividends they can afford to pay. In response, United Utilities has said it aims to grow the dividend at least in line with RPI inflation until 2020.
The previous policy (for 2010 to 2015) was to grow the dividend at RPI plus 2%, so the new policy is not quite as generous. Nevertheless, a prospective yield of 4.3%, growing at least in line with inflation is still attractive in the current environment, although remember, neither the level nor the growth of the income is guaranteed. By comparison, ten year UK government bonds yield just 1.8%, and offer no prospect of income growth.
The main risk for investors is that interest rates and bond yields rise, making United Utilities' dividend yield seem less attractive. But with RPI Inflation running at 1.1% (CPI inflation is 0%) and concerns over Chinese growth intensifying, it seems unlikely that either bond yields or interest rates will rise significantly in the short term. We can't help but point out however that Pennon Group, owner of South West Water, recently announced a dividend policy of RPI+4% p.a and offers a prospective yield of 4.7% (variable and not guaranteed), which looks altogether more interesting.
This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.