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United Utilities - delivering on the dividend

George Salmon | 21 November 2018 | A A A
United Utilities - delivering on the dividend

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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: 1,087.50 | Buy: 1,088.50 | Change 2.50 (0.23%)
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Shares in United Utilities' were little moved on the release of half year results, which were bang in line with expectations.

The interim dividend is set to rise 3.9%, consistent with the target of increasing the payment by at least RPI inflation through to 2020.

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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, in recent years UU has obliged accordingly.

Shareholders can expect the company to focus on making incremental improvements to its service, while delivering its target of RPI-linked dividend growth.

However, conditions in the sector have started to look more dynamic for some time.

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. While it's also confident it can find significant cost savings, analysts expect profits to drop. That could have knock-on effects for the dividend.

The shares have de-rated to 14 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 in play, especially for income-seeking investors.

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Half year results details

Half year revenue rose 4.6% to £916m, with underlying operating profit, which excludes the impact of extreme weather and restructuring, rose 6.9% to £368m.

Total net regulatory capital investment was £393m. For the full year, UU expects to spend £830m, including £70m of additional investment around shoring up the network after the extreme hot and dry weather earlier in the year.

Net debt rose from £6.7bn to £6.9bn, as factors including capital expenditure, dividends and interest costs more than offset operating cash flow and gains on derivative positions.

However, the increase in regulatory capital value saw gearing, a measure of indebtedness that compares net debt to asset values, drop from 61% to 60%.

The group has delivered continued improvements in customer service, and remains on track to achieve £11m in service incentive mechanism rewards, and up to £30m in outcome deliver incentive rewards from the regulator in the 2015-2020 regulatory period.

UU has submitted its plans for the next regulatory period, and expects to be able to save £1bn over 2020-2025 compared to the 2010-15 period, while still lowering prices in real terms.

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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.