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United Utilities - business as usual

Nicholas Hyett | 25 September 2019 | A A A
United Utilities - business as usual

No recommendation

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: 1,010.50 | Buy: 1,011.00 | Change 31.00 (3.16%)
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A brief trading update showed first half trading in line with management expectations, half year results will be announced on 20 November.

The shares were little moved on the news.

View the latest share price and how to deal

Our view

While the various Brexit permutations have buffeted other sectors, utilities' revenue and profits have been shielded from the wider economic uncertainty. After all, come rain or shine, we all need water.

Life in this bubble has been reasonably straightforward in recent years, and the group has been able to focus on making incremental improvements to its service, while delivering its target of RPI-linked dividend growth.

However, a few risks are creeping in. And together they've conspired to move the shares from 20+ times expected earnings to just 15.8, with the prospective yield rising to 5.3%.

A recent headwind has been the beginning of an upward trend in interest rates. That's not really an operating issue, but higher rates have the effect of eroding the relative appeal of shares, particularly those where income is central to the investment case, over the likes of bonds and gilts. Rate rises seem to have stalled for now, and even gone into reverse, but it's a lingering threat.

Believe it or not, there's also an existential risk. A general election is now a distinct possibility, and Labour has confirmed that, if Jeremy Corbyn gets the keys to Number 10, he'll be looking to nationalise the utilities. Whether that's the right thing for the country is another question altogether, but nationalisation could mean are stripped of their shares for less than market value.

A tougher pricing structure from the regulator presents obvious challenges too. The group's confident it can find significant cost savings, and its plans have got a glowing review from Ofwat. However, it's increased investment to improve efficiency and analysts expect profits to fall as a result.

We'll need to wait and see if the lower profits could have knock-on effects for the dividend. For now, we feel it's likely any change to the policy would be in the pace of future increases, rather than a material rebasing, but there's always a risk the group decides to cut. UU will confirm its plans at the end of the year.

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Half Year Trading Update

First half revenue is expected to be ahead of last year driving increased underlying operating profit boosted by lower infrastructure spending. The contribution from joint ventures is expected to be slightly negative during the half.

Higher RPI inflation, while increasing the company's regulatory capital value, will increase the cost of the group's debt resulting in a £10m increase in financing costs.

Net debt is expected to increase by around £250m compared to the beginning of the financial year. That includes a £100m prepayment to the group's pension scheme and a £55m increase from the adoption of new accounting standards. Gearing is set to remain comfortably within the group's target range.

Find out more about United Utilities shares including how to invest

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.