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Questor: United Utilities worth holding amid flood of change
Don’t be fooled on April 1 this year: a rare dose of excitement really is flooding into the water industry. It is the day when competition finally arrives in a sector where regional monopolies have been largely preserved since privatisation in 1989. Some 1.2m businesses, charities and public bodies in England can start shopping around for their water supplier. The exercise means a business customer in London needs no longer deal with Thames Water and Yorkshire Water won’t hold sway in Leeds as long as new entrants set up shop.
Better still, if they operate from several sites around the country, firms can buy the wet stuff from a single supplier, cutting paperwork.
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The changes foreshadow a bigger shake-up to come, which could impact investors as much as water customers. By 2020, households should be able to shop around just as they already can do for the best energy or broadband deal.
The reservoir-to-tap, vertically-integrated model could become a thing of the past as companies decide what part of the market they want to operate in.
United Utilities, the largest listed water provider, has already pooled its business customer base with Severn Trent, the second-largest, to create a venture called Water Plus.
In itself, this new division is unlikely to influence the investment case. Analysts at RBC Capital Markets value United Utilities’s share of Water Plus at 0.9pc of its £13.1bn group enterprise value.
A more granular approach to regulation will impact valuations, though.
The next five-year cycle in which prices are fixed, from 2020 onwards, threatens to impose separate price controls for every stage of supply.
Cathryn Ross, head of regulator Ofwat, has already pushed down prices but is determined to drive a harder bargain on behalf of consumers. Affordability is an issue for United Utilities, whose 7m-strong customer base in the North West contains deprived areas.
United Utilities chief executive Steve Mogford has managed to reassure that he is striking a balance so far, even though half-year figures in November showed signs of inflation hitting interest charges before feeding through into better revenues.
The company is committed to increasing the dividend by more than the rate of RPI inflation – up 1.7pc to 39.12p for the full year just ending, forecasts UBS, a yield of 4pc – while it is forced to cap price rises below inflation.
The trick has been to improve customer service and invest carefully. United Utilities has flagged £800m of capital expenditure this financial year.
Water shares gushed higher following the Brexit vote, but trickled lower as risk abated, only to rally in February and March.
For such a predictable sector, there is a degree of unpredictability about where they will flow to next.
Bond yields should rise this year, hitting utilities, unless European election results surprise. At the same time, higher inflation means earnings per share growth will be held back.
There is no denying the steady dividend makes United Utilities an attractive investment but the current price – at highs not seen since last October – is not an ideal entry point. Hold.
Questor says: Hold
Share price: £9.99
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