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United Utilities - trading update negative on costs and revenues

Due to moderately lower than forecast consumption, group revenue for the 6 months to 30 September 2022 is expected to be...

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Due to moderately lower than forecast consumption, group revenue for the 6 months to 30 September 2022 is expected to be around 1 per cent lower than the first half of last year. Lower consumption levels are set to continue into the second half with full year revenue now predicted to be below previous guidance of circa 1% growth.

Inflationary increases in input costs, particularly on chemicals and power, prompted the North West's water provider to highlight a further £65m in first half operating costs beyond the previously guided £100m increase. As such underlying operating profits will be below the same period last year.

Over time United Utilities reminds us that the regulatory framework will provide some mitigation against non-cash indexation on the group's index-linked debt and against higher cash operating costs.

The shares were down nearly 2% in early trading.

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 has seen core costs rise because of inflation, leading to downgraded guidance at the half year trading update. Usually some of this increase in costs can be offset by rising prices. However, pressure on suppliers to support consumers during this cost-of-living crisis means the group has pledged not to raise prices this year.

There's an added cost pressure in the form of inflation-linked debt - meaning the cost to service it rises alongside the Retail Price Index, adding another £135m to finance costs in the first half of this financial year. Inflation looks set to remain elevated for longer than anticipated - and a few years of steadily ballooning debt payments isn't ideal.

The hybrid home-working model means household demand has remained above pre-pandemic levels and non-household demand is picking up as more people venture out. However, that's not expected to drive an increase in overall consumption for the full year. Utilities are bound by regulatory limits, so some of these benefits were tempered by expected Ofwat caps.

UU's valuation is currently some way above its long-run average, reflecting the perception that it's one of the more defensive stocks on offer at a time when many stocks are under pressure from higher interest rates and a potential recession. In reality though, average analyst earnings estimates for the current financial year have collapsed over the last 12 months. What's more, they are broadly unchanged for the year ending March 2024 meaning there may be more bad news to come. The group's usual ability to flex its prices alongside inflation means the dividend policy, which calls for growth in line with inflation (CPIH, including occupiers' housing costs), looks likely to remain for now. But that could come under pressure if the group is forced to keep prices down past this year - and no dividend is guaranteed.

United Utilities key facts

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.

Full Year Results (26 May 2022)

Non-household revenue rose £106m, given businesses were able to get back to full operation. The lifting of restrictions meant household consumption fell £58m from the inflated levels seen last year. Higher CPIH inflation gave revenue a 0.6% uptick, but this was offset by a 1.5% drop in the regulatory revenue cap.

Household bad debt relative to regulated revenue dropped from 2.2 to 1.8 times, helped by affordability schemes and good management of cash collection.

The group's hedged over 90% of its power costs for the upcoming financial year, and 67% for the following 2 years.

Net debt rose from £7.3bn to £7.6bn, with underlying net finance expenses up £174m due to the impact of higher inflation on the group's index-linked debt. Gearing, a measure of indebtedness, was 1 percentage point lower at 61%. Free cash flow of £325.4m was up from £249m last year.

This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. It was correct as at the date of publication, and our views may have changed since then. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.

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Written by
Derren Nathan
Derren Nathan
Head of Equity Research

Derren leads our Equity Research team with more than 15 years of experience in his field. Thriving in a passionate environment, Derren finds motivation in intellectual challenges and exploring diverse ideas within his writing.

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Article history
Published: 27th September 2022