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United Utilities - still strong, but tighter regulations loom

George Salmon | 27 March 2018 | A A A
United Utilities - still strong, but tighter regulations loom

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No news or research item is a personal recommendation to deal. All investments can fall as well as rise in value so you could get back less than you invest.

United Utilities Group Plc Ordinary 5p

Sell: 1,095.00 | Buy: 1,096.00 | Change -16.50 (-1.48%)
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In a brief trading update ahead of full year results on 24 May, United Utilities (UU) has confirmed trading remains in line with expectations.

The shares nudged slightly higher on the news.

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Our View

Utility stocks are not meant to be racy investments. Despite being in the middle of what, at £3.6bn by 2020, is one of the largest capital investment programmes in the industry, UU obliges accordingly.

In the short-term at least, shareholders can expect the company to focus on making incremental improvements to its service, while delivering its target of RPI-linked dividend growth.

However, in recent months conditions in the sector look more dynamic.

Interest rates have finally started to rise, and the Bank of England has said the pace of future increases will likely be higher than previously expected. Higher rates have the effect of eroding the relative appeal of shares over other income-focused assets like bonds and gilts.

Water utilities are under the pump from political pressure too, with the debate over nationalisation resurfacing for the first time in decades. Perhaps in light of Westminster's sharper focus on utilities, Ofwat confirmed the introduction of a tougher pricing structure from 2020.

Stricter regulations make delivering higher returns more difficult, which could have knock-on effects for the dividend. United Utilities is confident its plans for the next review will deliver against Ofwat's priorities, which should ease investor worries, but we're yet to hear whether the goal of inflation linked increases will be renewed past 2020.

The fact the shares have de-rated to 12.7 times expected earnings, with the prospective yield rising to 6%, shows doubts have started to bubble to the surface.

Nonetheless, at this stage, we feel it's likely any change to the policy would be on the pace of future increases, rather than a material rebasing. With that in mind, barring any significant political surprises in the near future, many of the fundamental attractions of companies like UU should remain, especially for long-term income-seeking investors.

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Trading details

United Utilities expects revenue in the year to 31 March 2018 to come in slightly ahead of the £1.7bn reported in 2016/17, with operating profits rising too.

Spending on infrastructure upkeep and renewals is set to come in level with last year, at around £148m, after a slight increase in expenditure in the second half.

Higher inflation has increased the group's regulatory capital value by around £400m. However, this will also see interest expense on the group's RPI-linked debt tick up around £40m. Following continued investment in its asset base, UU is expecting a small increase from the £6.7bn net debt reported at the half year.

Customer service levels continue to improve, in line with the group's innovative Systems Thinking approach. Previous guidance on regulatory rewards is maintained, meaning the group continues to expect an overall outcome between a £30m reward and £50m penalty over the 5 years to 2020.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

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.

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