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United Utilities - profits fall, with investment levels rising

George Salmon | 24 May 2018 | A A A
United Utilities - profits fall, with investment levels rising

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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: 1,042.50 | Buy: 1,043.50 | Change -22.50 (-2.12%)
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Headline numbers in United Utilities' full year results were broadly in line with expectations, but a £7m net penalty from the regulator limited return on regulated equity to 7.7%.

The final dividend rises 2.2% to 26.49p per share, in-line with the target of growing the dividend by at least RPI inflation through to 2020. This takes the total for the year to 39.73p.

The group also detailed plans to increase investment levels ahead of the next regulatory period.

The shares fell 2% 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 £3.8bn 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 have started to look more dynamic.

Interest rates have finally started to rise. 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 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, and the group has responded by increasing investment. United Utilities is confident its plans for the next review will deliver against Ofwat's priorities, but lower returns and higher spending could have knock-on effects for the dividend.

The shares have de-rated to 15.3 times expected earnings, with the prospective yield rising past 5%. This shows doubts have started to bubble to the surface. We're yet to hear whether the goal of inflation linked increases will be renewed past 2020.

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 income-seeking investors.

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Full year results

Revenue rose 1.8% to £.7bn in the year to 31 March, which helped deliver a slightly higher operating profit of £636m. However, after accounting for higher interest costs and stripping out factors like gains on the group's derivatives positions, post-tax profits fell 2.7% to £305m.

Total regulatory capital investment in the year was £816m. The group has increased its budget for service improvements over the remainder of the 2015-20 regulatory period to from £100m to £250m, and has earmarked a further £100m to non-regulated projects such as solar power.

UU incurred a net £7m penalty from the regulator in the year, despite a better performance on wastewater measures. The group has narrowed expectations around regulatory rewards payments. UU says it's confident of achieving a net reward over the 5 years to 2020, above the mid-range of previous guidance of a result somewhere between a £30m reward and £50m penalty.

Net debt including derivatives at 31 March 2018 was £6.9bn, up from £6.6bn a year prior.

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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.