United Utilities has announced a new dividend policy for the next regulatory period (2020-2025).
Going forwards the group will target dividend growth in line with CPIH (a measure of inflation which includes housing costs) rather than RPI. Dividend growth is expected to be lower under CPIH. The policy starts from a base of 42.6p this year (2019/20), up from 41.3p the prior year.
The shares were broadly unmoved following the announcement.
United Utilities (UU) is a utility as pure as the water that flows through its pipes. In return for providing a reliable and affordable water supply to the North West, and for being an efficiently run business, Ofwat (the regulator) allows UU to earn an acceptable financial return.
With prices set by the regulator and reviewed every five years, earnings tend to be stable, predictable and appeal to investors looking for income, away from the noise of Brexit or trade wars.
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, the new regulatory period, which starts in April and lasts until 2025, is set to make life tougher.
Ofwat's reduced the level of financial returns UU and its water peers can earn and increased performance targets. As with other businesses, lower earnings tend to mean less generous returns for shareholders. It's still early days, but UU's new dividend policy fits that bill.
Fortunately UU is good at what it does. Beating performance targets (ODIs for the technically minded) provides an extra source of earnings and so does finding cost savings. Both of which the group is confident it can continue to do going forwards and Ofwat seems to agree - giving UU's plans a glowing review. However, the challenge of balancing investment to improve efficiency with a tougher pricing regime shouldn't be underestimated.
A low interest rate world has boosted the relative appeal of utilities, with income being central to the investment case. And whilst interest rate rises seem to have stalled for now, it's something to keep an eye on. Should rates start to rise, UU's share price would likely fall.
The shares currently trade above their long run average at 20.3 times expected earnings. That's perhaps thanks to lingering economic headwinds facing wider markets and potential for further interest rates cuts, making the 4.2% prospective yield more attractive.
Half year results (20 November 2019)
United Utilities saw half year revenues rise 2.1% to £936m, which together with lower infrastructure renewal spending, meant operating profits rose 6.5% £392m.
The interim dividend is set to rise 3.2%, to 14.2p, consistent with the target of increasing the payment by at least RPI inflation through to 2020.
Revenue growth reflects allowed regulatory changes following increased investment.
Total net regulatory capital investment in the first half of the year was £323m, down from £393m the year before. For the full year, United Utilities expects to spend £700m.
Net debt rose from £6.9bn to £7.2bn. Lower operating cash flows, reflecting a £103m contribution to the pension deficit, a change in the way the company accounts for leases, and losses on derivative positions were key contributors to the increase.
Despite an increase in United Utilities' regulatory capital value the rise in net debt saw gearing, a measure of indebtedness that compares net debt to asset values, rise from 61% to 62%.
Continued improvements in customer service means the group expects to receive a service incentive payment of at least £6m this year. The group now expects to achieve £50m, up from £30m, in outcome deliver incentive rewards from the regulator in the 2015-2020 regulatory period. The increase reflects a £22.5m outperformance payment in relation to the West Cumbria project - where the group is switching the areas water supply from the Ennerdale Valley to the wider regional water network.
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.
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