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United Utilities - network investment continues as profits fall

Half year revenues were down by 1.4% to £919.3m.

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Half year revenues were down by 1.4% to £919.3m. A £30m boost related to inflation-linked increases allowed by the regulator, was not enough to offset lower water consumption.

Underlying operating profit was down by 22.3% to £258.5m, with inflation being the largest contributor to the fall.

Free cash flow fell by around 60% to £77.2m reflecting both lower operating cash flows, and a higher capital expenditure, which was mainly spent in the regulated water and wastewater programmes.

Compared to the same period last year, net debt increased by over £400m to £7.8bn.

United Utilities intends to pay an interim dividend of 15.17p per share.

For the full year United Utilities expects a 1% fall in revenue. It anticipates the £34m impact expected from lower consumption will be recovered in the year ending March 2025.

Guidance on underlying operating costs is for a £130m increase. Meanwhile underlying finance costs are likely to rise £165m, with every percentage point rise in inflation adding about £43m in additional interest charges to its index-linked debt.

The shares fell 1.9% 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 and incurred some expenses related to the exceptionally dry weather we had this summer. Revenue has also taken a hit as customers were actively encouraged to save water. The pandemic saw water usage jump dramatically with working from home being a key driver but those tailwinds are unwinding and consumption's headed back down towards pre-pandemic levels faster than expected.

These should be transitory problems, since over the medium term the group's able to increase prices alongside inflation. If the amount of water it bills its customers for falls below a certain threshold, the regulator will pay United Utilities the difference. But the funds are only received two years later. In the short term, cash flows and earnings still feel the impact of rising costs and declines in water usage.

Our bigger concern comes from its inflation-linked debt--meaning the cost to service it rises alongside the Retail Price Index. As a result, United Utilities has seen its average interest rate on debt double to 9%. Fortunately, a large chunk of this relates to non-cash charges. 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 the Group's s balance sheet.

Inflation could also impact customers' ability to pay as the cost of living crisis intensifies. 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.

The valuation's currently above its long run average on several metrics. This understandable, considering it's seen as one of the more defensive stocks on offer. And should inflation come under control the negative accounting impact to earnings is unlikely to repeat. 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
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: 23rd November 2022