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United Utilities - high inflation eats into profits

United Utilities' full-year underlying revenue fell 2.1% to £1.8bn, as lower customer consumption more than offset the group's allowed regulatory...

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United Utilities' full-year underlying revenue fell 2.1% to £1.8bn, as lower customer consumption more than offset the group's allowed regulatory revenue increase.

Underlying operating profit fell 27.7% to £440.8m. This was driven by lower revenue and the inflationary impact on costs, especially electricity and chemicals.

Free cash flow fell from £325.4m to £111.6m, due to lower operating profits. Net debt rose from £7.6bn to £8.2bn.

For the new year, revenue and operating costs are expected to rise by around £150m and £60m, respectively.

A final dividend of 30.34p per share takes the full-year dividend to 45.51p, a 4.6% increase on the prior year.

The shares were broadly flat following the announcement.

View the latest United Utilities share price and how to deal

Our view

In return for providing a reliable and affordable water supply to North West England, Ofwat (the regulator) allows United Utilities to earn an acceptable financial return.

But lower water usage by customers more than offset the group's higher allowed revenues, causing total revenues to decline last year. Combined with extreme weather and high inflation levels which pushed up operating costs, it wasn't surprising to see profits fall.

Falling revenues should only be a temporary problem, though, since over the medium term, the group can increase prices alongside inflation. And if the amount of water it bills its customers for falls below a certain threshold, the regulator will pay United Utilities the difference. The caveat here is that the funds are only received two years later, so in the meantime, we're seeing cash flows and earnings taking a hit.

The balance sheet remains stable for now, but given the group's ambitious plans for expanding and upgrading its assets, we wouldn't be surprised to see net debt creep upwards. High levels of inflation make the cost of servicing this debt more expensive, although the majority of this is a non-cash charge. But inflation also increases the amount of revenue the group's allowed to earn on its assets. Longer term, inflation is likely to be a net benefit.

Inflation could also impact customers' ability to pay as the cost-of-living crisis persists. So far this looks under control and there's government support in place. But United Utilities is calling for this to be more fairly distributed, with some of the country's most deprived communities being within the areas it services.

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 a prolonged period of inflation would cause some challenges, and no dividend is guaranteed.

It's also worth remembering that water utility companies have recently been in the news for the wrong reasons. Consistently pumping untreated sewage into rivers has stoked anger among the public and that's not gone unnoticed by regulators, who have the power to impose unlimited fines on water companies. With United Utilities being a serious offender, the group's made an early start on its £900m infrastructure upgrade, but whether this will be enough to evade the wrath of the regulators remains to be seen.

The valuation's currently above its long run average, which is understandable given its defensive characteristics. Should inflation come under control, there's likely to be some tailwinds too. But if high inflation turns out to be here for the longer term, United Utilities' customers, cost base and interest charges will all come under further pressure.

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.

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
Aarin Chiekrie
Aarin Chiekrie
Equity Analyst

Aarin is a member of the Equity Research team. Alongside our other analysts, he provides regular research and analysis on individual companies and wider sectors. Having a keen interest in global economics, he knows how macro-events can impact individual companies.

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Article history
Published: 25th May 2023