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United Utilities- Inflation weighs on profits

Nicholas Hyett, Equity Analyst | 24 November 2021 | A A A
United Utilities- Inflation weighs on profits

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United Utilities Group Plc Ordinary 5p

Sell: 1,104.50 | Buy: 1,105.50 | Change 9.00 (0.82%)
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Revenue for the period rose 4.2% to £932.3m, as increased consumption from businesses offset a slight decline in household consumption and the negative impact of regulatory caps. This fed into a 4.5% uplift in operating profits, partially offset by rising costs.

However, a 62.1% increase in underlying net finance expenses due to the rising cost of inflation-linked debt meant underlying earnings per share fell from 29.2p to 28.4p. Including a one-off tax charge of £382m, the group reported a loss of 31.7p compared to EPS of 23.8p last year.

Continued elevated consumption is expected to create a 2% increase in full-year revenue, but inflationary pressure is seen upping underlying operating costs and finance expenses.

The board proposed a 14.5p interim dividend, reflecting a 0.6% increase from last year.

The shares were broadly flat following the announcement.

View the latest United Utilities share price and how to deal

Our View

United Utilities is a utility as pure as the water that flows through its pipes. In return for providing a reliable and affordable water supply to North West England, Ofwat (the regulator) allows UU to earn an acceptable financial return.

With prices set by the regulator and reviewed every five years, utilities' earnings have tended to be stable and predictable, which has supported a reliable dividend. However, UU could find itself in a sticky situation if inflation remains elevated.

The group's seen core costs rise because of inflation. That should be a transitory problem, since over the medium term the group's able to increase prices alongside inflation. Instead, our concern comes from its inflation-linked debt--meaning the cost to service it rises alongside the Retail Price Index. The first half of the year saw finance costs rise by £51m as a result. If inflationary pressures prove fleeting as some have forecast, this shouldn't be more than a blip on the radar. But if the new elevated finance costs stick around, it could start to chip away at UU's balance sheet.

On the bright side, non-household demand is picking up as more people venture out and the hybrid home-working model means household demand has remained above pre-pandemic levels. Utilities are bound by regulatory limits, so some of these benefits were tempered by expected Ofwat caps, but ultimately the new normal looks like a good thing for UU.

UU's valuation is currently slightly above its long run average, which is understandable considering it's one of the more defensive stocks on offer. The group's ability to flex its prices alongside inflation means the dividend policy, which calls for growth in line with CPIH inflation, looks likely to remain for now, but no dividend is guaranteed.

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Half Year Results

Easing lockdown restrictions meant non-household revenue rose £68m.This offset a £20m decrease in household consumption, though it remained elevated compared to pre-pandemic levels. Household bad debt improved to 1.8% of revenue, in line with pre-pandemic levels.

Inflation was responsible for a £9.2m uptick in core costs and depreciation and amortisation charges increased by almost £5m but are expected to be in line with 2020 at the full year.

Rising costs meant net debt rose to £7.4bn from £7.3bn, or 62% of Regulatory Capital Value, within the group's target range of 55% to 65%. Free cash was £191.9m, up from £83.3m last year due to higher operating profits and lower capital expenditure.

United Utilities key facts

  • Price/Earnings ratio: 21.0
  • 10 year Average Price/Earnings Ratio: 18.2
  • Prospective dividend yield (next 12 months): 4.2%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

Find out more about United Utilities shares including how to invest

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. 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.