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United Utilities - on track for the full year

Emilie Stevens, Equity Analyst | 25 March 2020 | A A A
United Utilities - on track for the full year

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United Utilities Group Plc Ordinary 5p

Sell: 900.20 | Buy: 900.80 | Change -15.00 (-1.64%)
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United Utilities (UU) says full year group revenue and underlying operating profit to increase this year. Current trading is in line with the group's expectations for the full year ending 31 March 2020.

The shares were broadly unmoved following the announcement.

View the latest United Utilities share price and how to deal

Our view

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.

The coronavirus pandemic acts a strong reminder of these qualities. While many companies face significant earnings uncertainty, thanks to the regulatory model, any shortfall UU sees can be recovered in future years.

While life in this bubble has been relatively straightforward, 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 while interest rate rises are unlikely at present, it's something to keep in mind. Future rate rises would likely see UU's share price fall.

The shares currently trade at 15.9 times expected earnings below their longer run average of 17.5. While that's notably below where they were just before the coronavirus outbreak, relatively speaking, the shares have held their value. The prospective yield is 5.3%, which against a backdrop of wider economic uncertainty, widespread dividend and interest rate cuts, is attractive.

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Trading update

Disruption caused by storms in February is expected to reduce the Outcome Delivery Incentive (ODI) reward UU receives from the regulator this pricing period (2015-2020) to £40m down from £50m.

In response to COVID-19, UU have put in place measures to protect employees and maintain service levels. UU reiterated that its revenues for the next five years are fixed by the regulatory control model and any shortfalls from one year can be recovered in later years. The group recognises the current economic climate may make paying bills harder for both retail and business clients. Given this UU said Water Plus (the group's business water joint venture) recovery plan, will be delayed. The group will continue to help retail customers with bills through its affordability schemes.

UU has funding available to cover the next 24 months of projected cash outflows, which is at the upper end of its liquidity policy to have 15 - 24 months covered.

While full year revenue and underlying operating profits are expected to be higher this year, reported operating profits will be lower. That's due to an £80m accelerated depreciation charge in relation to the Bioresources business.

Full year group net debt is expected to be broadly the same as at 30 September 2019 of £7.2bn - an increase from last year's full year result of just over £7bn. Gearing, a measure of indebtedness that compares net debt to asset values, is within UU's target range of 55% - 65%.

Ahead of the next pricing period which starts in April 2020, UU have invested £100 million over the last twelve months to accelerate planned improvements.

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 disclosure for more information.