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United Utilities - higher costs eat into profit gains

Full year revenue rose 3% to £1.9bn, driven by higher non-household consumption as business activity returned to pre-pandemic levels.

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Full year revenue rose 3% to £1.9bn, driven by higher non-household consumption as business activity returned to pre-pandemic levels. Higher material and labour costs offset almost all the extra revenue and operating profit was £8m higher at £610m.

2022/23 revenue is expected to rise around 1%, but inflation's expected to push operating and finance costs a combined £250m higher.

The board has proposed a final dividend of 29p, resulting in a total of 43.5p for the year.

The shares fell 6.0% 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. Usually some of that can be mitigated with rising prices, but pressure on suppliers to support consumers in light of a cost-of-living crisis means the group's 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. Having nearly doubled last year, finance costs are expected to jump another 50% higher 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 and broader risk on assets are under pressure from higher interest rates and a potential recession. The group's usual 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 that could come under pressure if the group's 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

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
Matt Britzman
Equity Analyst

Matt is an Equity Analyst on the share research team, providing up-to-date research and analysis on individual companies and wider sectors.

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Article history
Published: 26th May 2022