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United Utilities - Rising costs to weigh on profits

Full year revenue is expected to grow by around 3%, as expected.

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Full year revenue is expected to grow by around 3%, as expected. An increase in operating costs and inflationary pressure is expected to mostly offset this rise and underlying operating profits are expected to be broadly flat.

United Utilities' index linked debt, which tracks inflation, has become more expensive and as a result underlying net finance expense for the year is expected to rise by around £175m. Together with increased expenditure on infrastructure, this is expected to increase net debt.

Trading in the current period is in line with expectations.

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. Some of that can be mitigated, 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. Finance costs are expected to nearly double this year. The ''transitory'' nature of inflation is starting to look longer than anticipated, and a few years of steadily ballooning debt payments isn't ideal.

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.

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.

Half Year Results (24 November 2021)

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.

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.

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
Laura Hoy
Laura Hoy
ESG Analyst

Laura is part of HL's ESG analysis team, working to offer research and analysis to help with sustainable decision making. She also works with other parts of the business to help integrate ESG.

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Article history
Published: 25th March 2022